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The ups and downs

Permanent fund, other large Alaska investments, weather the stock storms

Posted: Sunday, February 06, 2000

Jan. 4, 2000, was one of the worst days in the history of the Alaska Permanent Fund.

As the stock market dipped sharply, the fund lost $513 million in value in just eight hours, said fund spokesman Jim Kelly.

But don't worry. Your dividend next fall is guaranteed to increase from 1999's record payout of $1,769.84 per Alaskan, Kelly said.

The truth is that the short-term volatility of the stock market can mask its strong performance over time, especially because news accounts give disproportionate attention to the downturns, according to local observers.

For smart investors who aren't trying to score a quick fortune, the market remains reliable, they say.

``I think the volatility is perhaps less important than what people perceive as the longer-term average,'' said economist Gregg Erickson, who edits the Alaska Budget Report. ``Sometimes it's up; sometimes it's down.''

``For most investors, it really makes no difference at all,'' said Mike Dalessi, branch manager for Salomon Smith Barney in Juneau. ``For the day traders, it makes a tremendous difference. . . . In the short term, it's a very emotional market that goes up and down with every quote from Dan Rather.''

But investors are advised against letting themselves be influenced in that way.

``You should have at least a five-year investment time horizon,'' said Robert Storer, chief investment officer for the Treasury Division of the Alaska Department of Revenue, and soon to be executive director of the permanent fund.

In other words, don't put money in if you need it before five years are up.

Major investors, who take a long-term view, are bemused by scare stories in the national media.

``The carnage was widespread,'' the Washington Post declared Jan. 4, describing how the Dow Jones industrial average ``toppled below 11,000,'' as investors were worried about an upcoming interest rate increase by the Federal Reserve.

``Carnage?'' Kelly said. ``That's just a short-term perspective, to call it carnage. . . . Stocks have been the place to be any time in the last 15 years.''

``This is essentially (background) noise within our long-term goals,'' said Storer, who invests $12.9 billion of retirement funds for public employees. ``You cannot react to short-term volatility. . . . Nobody likes the downside, but it is part of investing.''

In fact, the market was merely undergoing a 10 percent ``correction'' that resulted from it being overvalued during fourth-quarter gains in 1999, said economist William S. Brown, a member of the faculty at the University of Alaska Southeast.

But overheated media rhetoric is typical, Dalessi said. ``The volatility of the stock market always seems to gather more news on the down side than it does on the up side.''

While a 150-point market downturn is a ``plummet,'' a 150-point surge is never described as ``skyrocketing,'' he said. ``But good news doesn't sell.''

But two reporters who cover Wall Street contend that it is the news media that convinced Americans that the stock market is the safest long-term investment, an idea that couldn't have been sold 25 years ago, they said.

At the permanent fund, Kelly isn't sweating Jan. 4. That's because the fund gained $366 million of value on Jan. 7, $235 million more on Jan. 10 and $293 million more on Jan. 13 - more than wiping out the previous ``losses,'' he said. It's been up and down since then, too.

From Jan. 1, 1999, through Jan. 31, 2000, there were 15 days in which the permanent fund has lost $200 million or more, and 17 days in which $200 million or more was gained, Kelly said.

Despite the peaks and valleys, domestic stocks have done very well over time, he said, returning 23.48 percent to the fund over the last three years, 21.87 percent over the last five years, and 16.26 percent in the 15-plus years the fund has been in the market.

In fact, the Alaska Permanent Fund is more firmly established in the stock market than ever.

Legislation last year authorized the corporation board that manages the fund to increase holdings in equities from 50 percent to at least 55 percent, with an increase to 60 percent if the board chooses not to pursue certain alternative investments (such as venture capital for an initial public offering by a new Internet company).

In November, the board chose 53 percent as a target, with a margin for error of plus or minus 3 percentage points. That target could be revisited in April.

The legislation was intended to correct a counterproductive situation in which the fund had to sell off high-performance stocks because earnings were pushing the percentage of stock market investments beyond 50 percent.

``We kept selling our winners, really,'' Kelly said.

The fund was valued at $26.8 billion on Jan. 31, down from $27.4 billion on Dec. 31, but up from $25.8 in November.

At the close of the 1999 fiscal year, last June 30, the fund had record earnings of $2.544 billion, which was a return of 9.49 percent in cash income, not including unrealized gains in equities.

``In any given year, there's a chance for losses,'' Kelly said. ``What's reliable is that diversification works.''

In society generally, there is more understanding of and involvement with the stock market, said Brown, the university economist. ``It's much easier to own stocks now than ever before.''

The deregulation of brokerage houses 20 years ago ended up lowering commissions, and now an individual investor sometimes can put $1,000 in a mutual fund without paying any fee, Brown said. Earnings go as high as 30 percent, eclipsing a 4 percent return on a savings account, he said.

Now, more college students nationally take an introductory economics course than any other single course, resulting in a more market-savvy population, Brown said.

With the advent of the Internet, stock becomes easy to buy and sell, which contributes to volatility, Brown said. A few years ago it might have taken two days to liquidate a portfolio, and now it can be done in five minutes, he said.

At the same time, investment strategy has become globalized, Brown said. ``Trillions of dollars cross international boundaries every day.''

At the Alaska Permanent Fund, there has been a big change in attitude since the early days, in the late 1970s, when 100 percent of investments were in bonds, Clark Gruening, chairman of the fund's board of trustees, told the Juneau Chamber of Commerce recently.

The state was reluctant to invest in equities then because it had recently lost millions in other investments on the market, Gruening said.

Today, the permanent fund has ``a middle-of-the-road volatility posture,'' diversifying its portfolio enough to hedge against crippling downturns, said Michael O'Leary of San Francisco-based Callan Associates, a consultant to the fund. Gruening noted that most endowments and corporate pension funds have 60 percent of their investment portfolios in stocks.

In all, the Alaska Permanent Fund has invested in 4,000 companies in 42 countries, Kelly said. The largest domestic holding is Microsoft, in which the fund had 2.4 million shares for a value of $222 million, as of Sept. 30.

Gruening broke down the fund this way: Domestic equities, about 35 percent; international equities, about 19 percent; domestic bonds, bills and other fixed-income, 35 percent; real estate, 9 percent; and non-U.S. fixed income, 2 percent. International equities have been performing well recently, cushioning the ups and downs domestically.

Despite diversification, there are some bumps in the road.

Domestic stocks held by the fund went down 7.31 percent in the third quarter of 1999, with all fund managers reporting negative returns. The fourth quarter was a big improvement, but the fund released one of its 11 outside managers on Jan. 19 for failing to meet his benchmark for earnings, Gruening said.

But even if the market was performing poorly now, causing losses in the permanent fund, that wouldn't immediately affect dividends, which are calculated on a five-year rolling average.

``That feedback is so, so damped,'' said economist Erickson.

In some cases, fear of the stock market can still be attributed to the infamous ``Black Friday'' crash of 1929 that ushered in the Great Depression.

Brown said his late mother, who invested only in certificates of deposit, ``was always terrified of that.''

``Well, I never lived through that,'' he said.

Today, in the words of President Franklin D. Roosevelt, who came into office during the depression, there might be nothing to fear but fear itself.

Erickson points to the October 1987 crash, which, as a percentage decline in the Dow Jones index, was worse than 1929.

It was assumed the economy would stagnate, but it didn't happen, he said.

``The economy didn't even blink,'' Brown said. Given the strength of U.S. companies, ``Why should it? ... The link between the stock market and the current economy is not very strong.''

Federal Reserve Chairman Alan Greenspan was on television immediately promising to supply enough money to keep banks liquid, and by the spring of 1988 the stock market had risen above its pre-crash level, Brown said.

The permanent fund sold off a third of its domestic stock portfolio in the spring before the crash, Kelly said. ``We thought the market was overvalued at the time.''

But the permanent fund would have earned more if the portfolio had been left intact, he said.

And after the 1987 crash, additional safety measures were put in place, including such ``circuit-breakers'' as a mandatory cutoff of computerized trading after a precipitous decline.

The stock market has been safe enough to lure investments from Alaska Native corporations, which safeguard money conveyed under a 1971 federal act that settled longstanding land claims. In some cases, the performance of an investment portfolio is a significant factor in the payment of dividends to shareholders.

At Sealaska, the regional Native corporation for Southeast, the investment strategy is similar to the permanent fund's, said spokesman Ross Soboleff. ``For the most part, we have a long-term investment strategy, and even though we keep an eye on the daily ups and downs of the market, we keep a focus on the long view.''

As of September 1998, Sealaska had 20 percent of its portfolio, $78 million, invested in the stock market, according to then-Vice President for Corporate Communications Vikki Matta. Soboleff declined to provide comparable contemporary figures.

Meanwhile, Goldbelt, the urban corporation for Juneau, has been out of the stock market.

A shareholder vote in 1994 forced liquidation of the investment portfolio, said outgoing President and CEO Joe Beedle.

There was a $50 million ``shrinkage'' overnight, as Goldbelt paid $45 million in shareholder dividends and took a hit of $5 million for ending its investments prematurely, eating up all of the money the corporation had earned from the sale of net operating losses, Beedle said. About $20 million remained from the investment of timber profits, but that was transferred to investments in Goldbelt's transition to tourism, he said.

Even so, the bull market has benefited Goldbelt, Beedle said. ``More people can ride cruise ships because they feel like they have wealth. . . . From our perspective, some tourists came in part because of a strong market.''

There is some disagreement about whether the unprecedented bull market - with equity earnings above 20 percent for five years running - can be sustained much longer.

``I think it gives rise to both fear and overconfidence,'' Erickson said. ``Some people believe five years means a new paradigm - it's a new universe - onward and upwards forever. Other people, me included, aren't ready to accept that.''

O'Leary, the permanent fund consultant, said a generation of investors has now been schooled in the philosophy of ``on any weakness (in the market), buy.''

``And they've been right,'' O'Leary said. ``(But) life isn't this way, unfortunately.''

As interest rates have risen more than 1 percentage point over the past year, stocks are now ``a little less attractive'' than they were, he said.

At the permanent fund, the goal is ``intergenerational equity,'' Kelly said. That is, if there is an advantage to selling in the short term and increasing dividends, the fund will do that rather than hoard for future generations, he said. In September, the fund liquidated $310 million of stock to help finance the 1999 dividend.

But for the average individual investor, Brown said the best strategy is probably to buy and hold.

``I say if you've got money with a three-year - and preferably a five-year - time horizon, put it in some stock and ignore it,'' he said.

That's because the American economic engine is chugging along just fine, he and others said.

``Corporate America is strong and healthy,'' said Dalessi of Salomon Smith Barney.

``The evidence is that the stock market is going to beat the inflation rate at 6 to 10 percent over the long term,'' Brown said. ``Ultimately, it reflects the viability of American business, and I believe in American business. . . .

``The economy now is in the best shape it's been in since I've been alive. And I don't see anything interrupting that. We're the envy of the world.''



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