Lessons From A Sovereign Wealth Fund in the United States (Correct)

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Hello and welcome to another episode of the Odd Locks Podcast.

I'm Joe Wisenthal and I'm Tracy Alloway.

Tracy, we're back here in New York City, where it's warm and the sun sets at a normal hour of the day and I don't need to have blackout curtains. But I had a really good time on our recent voyage to Alaska.

Alaska was great. I don't know why the overall state population has been declining.

Yeah, it's great you moved there.

There's nice weather, at least in the summer. In the summer, beautiful scenery, as much salmon as you can fishes out of the rivers. And every year you get paid some money by the state.

Yeah, yeah, that's exactly right. No, there's a lot to like about it. I think it's first type of person. It certainly has a lot going for it. But it was really nice. You know, I didn't really know much about Alaska. I didn't have much fuel for its layout, it didn't might have much feel for its geography. I truly did feel like I was sort of at the far western edge of the Empire out there, very very distant.

It has a very frontier feel. I mean, that's why they call it the last frontier.

Extremely frontier field. And of course we talk to people in all kinds of industry there, et cetera. But as you mentioned, one thing that people know about Alaska, I mean, people know there's oil, and also people know that there is something that kind of resembles perhaps a sovereign wealth fund, and also that every citizen over I think the age of like eighteen months or whatever, ten months or something gets a check from the state, which sounds pretty nice.

It sounds nice. It also sounds like a loaded political and financial hot potato, right, and I can imagine every year there is probably lots and lots of debate about

That's right, that's right. Whether anything at the federal level that resembles a sovereign Well's fund or any sort of fund. What actually happened, who knows, But we have certain models of all this stuff, and it's worth learning a little bit more how they work. And I do think to sort of conclude our intellectual journey and our literal journey to Alaska, we sort of have to touch.

On this element.

Absolutely, let's do it.

Okay, Well, I'm really excited to say we literally have the two perfect guests to talk about the Alaska Permanent Fund and what it is. We're going to be speaking with Marcus Frampton, he is the CIO of the Alaska Permanent Fund, and Devin Mitchell, CEO of the Alaska Permanent Fund. So Marcus and Devin, thank you so much both for coming on the Odd Lass Podcast.

Yeah, thank you. We're happy to be here.

Why don't we start with maybe one of you could just give us the very clicked like what is the size of the fund and how, when and why was it started?

So this is Devin Mitchell and I'll take that question. When you think about Alaska, and you guys have a just a small sample of Alaska, of course, when you think about it. You went to the largest city in Alaska, but if you superimposed Alaska over the continental US, you would have each of the coasts touched by Alaska, as well as the southern and northern borders.

So it's a huge state.

Let's say you went to Nebraska, so you didn't really experience all that Alaska has to offer, but certainly it sounds like you got a good sample. The state's a young state. We became a state in nineteen fifty nine, and when Alaska became a state, there was a lot of concern about the ability of Alaska to support itself economically because of a relatively small population, remote location, lack

For the state.

And this is at a time when the state's budget was one hundred and fifty million dollars and so an incredible amount of money for the day for this state.

Yeah, that's a that's a hefty chunk. Marcus, Why don't you give us from the sort of portfolios downpoint talk to us about how the fund has evolved over time. So nineteen seventy six, you know, it gets set up. What do the initial investments look like, and what do they look like today?

Yeah?

Sure, So this is Marcus Frampton. I'm the chief investment officer. Initially when the fund was set up, we were in a very high interest rate environment. At the end of the seventies, equities had kind of fallen out of favor, and so it was very much a fixed income fund up until the mid nineteen eighties. Real estate was introduced at that point as the second asset class. In the early nineties, first domestic stocks and then later in the

Is why we target that inflation plus five.

I'm curious. You know, markets are markets, and sometimes as valuations go down any year, what happens then for either the fund or Alaska when there's a bad year. Maybe it's like twenty twenty two and stocks have a pretty rough year, or two thousand and eight and two thousand and nine and stocks have a rough year. What happens when you can't satisfy the demand for state revenue or

Yeah, well, at a high level, we've got a very complicated system with the constantually protected principle and then an earnings reserve that accumulates realized earnings. And so at the investment level, we're rebalancing, we're buying stocks and doing all the things all investors do. But I'll hand it to Devin on how we think about the pressure on the earnings reserve in those situations.

Sure, So, as I said earlier, the Constitution was pretty broad in how it established the fund, and then there's a statutory overlay on top of that, and the statutory overlay defines earnings or revenue that's available to appropriate as realized income. And so when we have unrealized income, we hold it in either principle or what we call the earnings reserve account. That's where we hold the realized earnings of the fund and a pro rata allocation of unrealized earnings.

Is around nine billion dollars.

And then we have the current years POMB and our POMV structure has only been in place since twenty nineteen. It's a historical five year average five percent draw structure and has, like I said, been providing the majority of state revenue since. But prior to that, the only thing funded out of the permanent fund were Permanent Fund dividends. So that was a big shift timeframe that we've gone

If it were to.

Erode beyond that level, then you would be in a situation at some point where the earnings Reserve Account would be deficient and there wouldn't be an ability to provide for a transfer to the state of Alaska, and that in part is why we've been advocating at the fund, based on our trustees direction, to evolve the fund from this historical model created fifty years ago to something that's a little more modern and a little more in line with a true endowment or sovereign wealth fund and recognize

So in a year like twenty twenty five, if Joe and I were flies in the room when you were maybe actually mosquitos in the room, given that it's Alaska, if we were in the room when you were making the decision about what this year's dividend payout is actually going to be, what would the conversations actually sound like. What are the considerations that you were thinking about as you announce this number.

So, first of all, we're not those flies.

We don't decide how big the permanent fund dividend is going to be. We just earn and provide the annual transfer to the state. The policymakers that decide how much the dividend is going to be, or the legislature and the governor. So in twenty nineteen, when they created the percent of market value statutory structure.

They left in.

Place the historic, the historical or legacy Permanent Fund Dividend statute, which was in earnings model. It was twenty one percent of the last five completed fiscal years earnings. You take that, you split it in half. Half goes to the Permanent Fund dividend. Half goes theoretically of the state, although the state always just put their half back into the fund, and so our governor has proposed each year of his administration that that formula be followed for purposes of establishing

Yeah, Aly, can you talk about that a little bit more from your perspective of thinking about the long term health of the State of Alaska, the long term health of the fund and so forth, How can either political elected leaders or people such as yourself whose job is to safeguard the fund for the long term, for the benefit of the state of Alaska, you know, avoid essentially people eating the seed corn, right, because that's what we're

I think the discipline that's required in any financial system is something that we circle around to continually that in the event that you exceed what we've determined to the best degree possible as a reasonable draw. The five percent historical draw is a reasonable draw if you want to ensure that you have an inflation proof fund into the future that to the extent you deviate from that, because there's available money in the stats, in the earnings reserve account.

That's just the first time that.

You're going to overspend, and next year there's going to be another reason that you overspend, and you're almost ensuring that the system's going to fail. And I circle around to why does this money even exist. It exists because there were fifty generations of Alaskans before this generation that didn't spend all of the current year revenue that came in.

Marcus, How does declining oil revenue or just the cyclicality of the oil business feed into your actual investment decisions? You know, if the price of crude goes down, is that a year where maybe you invest in risky, er, higher yielding things. Do you calibrate it in that way?

Yeah? Sure.

So today the royalty income for the fund is less than a billion a year, and we're dispersing over three billion a year to the state through the five percent draw So movements in oil do impact our inflows, but

Given the size of the royalties.

I'm actually really intrigued by that. Can you talk more about that, because I remember sometimes you hear about these questions should people in finance have exposure to fund banks right in their portfolio? There's a good reason to say no, because their career is going to be levered to the cycle of the financial cycle, and if they get laid off, it's probably going to be at a time when bank stocks low and so forth. So that's actually a very

Yeah, I mean, we feel like energy is an attractive area, so many investors don't want to be in fossil fuels that even today, I mean in twenty twenty one, there was a clear scarcity of capital and there were comments being made that people weren't me using fossil fuels in ten years, which like clearly in our opinion, contradicted the data.

So we just liked it from an opportunistic standpoint.

I mean, I think that it's a small enough portion of the S and P five hundred and our private equity benchmark that you know, if the index is at four percent and we're at five.

It's it's not like an outsized impact.

I mean, you see tech people that work at Google and their whole portfolios and tech and I would advise against that, but I think our sizing is reasonable.

And we like the outlook for Weill and gas, so we're active there.

Just to give you an idea of the magnitude of the royalties that are coming to the fund at this point, the high and the low over the last ten years are only two hundred million dollars apart, three hundred fifteen ish for the low and five forty ish for the high, and so in comparison to revenues and investments of the fund, fairly inconsequential.

Other than generating a return and being able to fund the state and pay out a nice bonus to citizens,

We invest entirely with a financial lens, and that was with the exception of one. There's one state law that says if we're in our rags that say that if there's an investment of equivalent risk and return, we should prefer the Alaskan investment. And it's very difficult to measure that. Like, if you look at the stock market, I think there's one stock Northern Bank that's an Alaskan based stock on

And I like Northern.

Bank, and like we own stock at Northern Bank, but there's a limit to how much you can have in a three hundred million market cap community bank.

And so pretty well, I just pulled up the church. It's a pretty success. Just a small little bank, but it looks like this. It's a nice yeah, and I have.

An account there. I like Northern Bank. But so none of this is meant to denigrate Northern Bank. We love Northern Bank.

But so when there are opportunities in Alaska, we will take a look, probably more frequently than we would if it's a random opportunity in another state. But our mandate is very much highest and best return financially, and some of our private equity managers have done deals in the state, and we have some minor investment activity in the state, but that's the overall look that we take.

And again it goes back to the development fund model versus a public trust model, and that was the debate that happened in the nineteen seventies, from seventy six to nineteen eighty, and the public trust model one, rather than we're going to try to invest this money in Alaska and develop Alaska. Alberta Heritage Fund is actually a good proxy for how you might expect a fund to have

Marcus, while we have you here, can you tell us a little bit about your sense of the state of private assets because two things. A, you always hear it's the golden age of private credit. I don't really know what that means. Are you just hear about private all the time, But also with private assets in general, you hear it particularly on the private equity side, and maybe you hear it on the VC side too. The sort of paucity of distributions and so forth, and this idea

Yeah, sure, I would say generally, I'm quite cautious on privates. I mean, I started my career at Lehman Brothers in one and I remember going through LBO training and you know, you sketch out your typical LBOs maybe five six times EBITDA with three four times leverage, and the debt pays down and by the end of the two thousands, buyouts or eight nine times EBITDAH. Now on average US mid market buyouts or mid teens EBITDAH multiples, and a lot

Private equity about in half in end of twenty twenty.

One, and we've kept it around there and ticked it up a little bit, but we're still like well below where we.

Were deploying five years ago. We have an allocation to private credit.

I think that's something we debate regularly, and it's maybe four percent of our fund. I think if you look at the unlevered yield on middle market direct lending versus high yield or levered loans versus where it was five years ago, I think maybe you're getting one hundred basis points spread today versus several hundred and a few years ago.

I mean, it's just not.

Even debatable that it's less attractive than it was. And then if you go through a recession cycle default cycle, I think it'll really get tested.

So we're kind of ben tapping the.

Brakes on private it's the last few years, and are pretty cautious on the outlook.

Right now, what have you been doing this year in terms of allocation, Because the word uncertainty seems to come up a lot in conversations nowadays. There's uncertainty over policy and of course uncertainty over the direction of the economy. Are you more cautious or are you I guess changing any of your traditional allocations.

I think right now is a really tough time to make that macro calls. I mean, you've got big budget deficits that aren't going to come down anytime soon any probably have FED funds coming down rapidly in the next year with a new FED share so to want to

But it's just an expensive market.

So if you didn't have that dynamic of rates coming down, I think you'd want to be really cautious right now. But then given that backdrop, you kind of just have to take the long view allocate in line with benchmarks. And like I said, on privates, we're definitely tapping the brakes we deploy every year because we cut our pacing. We're still deploying, but just much less. And we're getting more in distributions than contributions on our private equity portfolio,

Devin, can you talk more about the sort of the legal status of the fund? There was an amendment to the Alaska State Constitution that establish it. I have to imagine that an amendment is like a very difficult it is a very legally secure backing for you. I don't know the Alaska constitutional process, but constitutions are hard to change. But when you think about past your tenure, past all of our tenures, like how legally durable is the fund

It's very difficult to change the structure of the fund in a durable way. Statutorily, it's not that difficult. That's a simple majority and concurrence of the governor, and you can change statutes. The reason it took a constitutional amendment to create the Permanent Fund is our constitution as a prohibition on dedication of revenues, and so in order to have a dedicated revenue pledge there had to be an amendment. It was an overwhelming majority. It was just about two

It's doing these.

Other things at this point, and that's where that educational process has been the challenge. We have had decent traction, and we have a bi annual legislative session, so a two year session where they meet one year and then they carry forward those bills to the next. This is the second year of that session. We had a number of hearings last session on the concept of a constitutional amendment,

I don't know.

I could see school services versus down payment on a new snowmobil y being a tough choice for some Alaskans. But on this note, I realized this isn't necessarily your wheelhouse. But do you've noticed any like macro economic impacts from the dividend or maybe a broader question would be how does it fit into Alaska's overall culture? You know, around dividend time, do you start to see advertisements for how to spend that extra money? How does it actually impact Alaskan's behavior?

Oh?

Absolutely, you see, there will be sales the airlines that sort of alask all have permanent fund dividends, sales you have if you go buy a costco on the day that dividends are distributed, you will be waiting in line a long time. There is absolutely an economic impact on the state, and similarly from the the transfer that's used for state services that cycles within the state as well.

He made that month, which wages aren't the same.

And of course logging isn't happening on that industrial scale and Alaska anymore either, But even a slope worker is not making fifty thousand dollars a month, and so when you look at some of the other sectors in the economy that there are bright spots, but certainly there's some struggles as well.

Is it another question? I guess it's sort of looking for and again not necessarily the wheelhouse of the fund per se, but just thinking about the economy of Alaska. When we were there, we heard a couple different things like, Okay, so you're talking about the oil royalties in general, like sort of long term decline. We heard someone talk about, well, maybe like Alaska could one day be a hydrogen hub.

From the funds perspective, we tend to just focus on institutional investing. From the policy Alaska perspective, those are obvious, the all very.

Interesting things to consider.

And when you're thinking about Alaska, and again it's a huge state, five hundred and eighty six thousand square miles, and so you can cut Alaska in half and make Texas the third largest state, it's huge.

It's people measures Alaska in number of Texas tech funny, yeah.

And Texas do that to the other states too, So it's this Russian nesting doll of states lording over loading their square miles over other states.

Anyway, keep going, but it's maybe we're a little defensive because Alaska is on a different scale. On most maps, we're out in the Pacific Ocean and it looks like we're about half the size of Texas, and so oh yeah, perhaps that's.

What drives that that emphasis.

But certainly from a resource development perspective and the open skies or if somebody needed space, there's incredible spaces in Alaska. Obviously, we have a lot of beautiful spaces that are protected for both at the national and state level for future generations. But there's a lot of land that's available for other uses, and so as those ideas come along and they make

Marcus, I want to go back to private credit for one second, because I found what you were saying really interesting that you've dialed down your exposure since twenty twenty.

I don't think of it as like an illiquidity premium that you get. I think it's an illiquity premium that you have to demand.

I mean, like in.

Private credit or allocation has stayed roughly the same, We've just committed less and so across in private equity too, and across the industry you see investors that are over their target allocation now and they may in the future have to reduce down their pacing. And so I feel like if you look at private credit, the illiquidity premium that you're getting without adjusting.

For defaults has declined in the last five years.

And so we've been less enthusiastic about it, and if you adjust for default you may not even be getting a premium. In private equity, in private credit today, it's like a debate like.

Are you getting an appropriate illoquity premium?

And so I think of it as kind of like keeping our powder dry for a different environment where there is real opportunistic situations that you can demand a very high return premium for locking up your money for ten years.

I don't think it's like.

I think it's a market thing that in different markets you may not even get an ill liquidity premium, and we may be close to that now, and in those situations, liquidity should be value. And I think liquidity should be valued now, whereas ten years ago it was a real compelling environment for harvesting and aliquidity premium.

Yeah, you kind of touched on this earlier, the idea that you're hoping for some sort of dislocation to take advantage of, which we're journalists. We like it when stuff happens and we have a lot to talk and write about. But what dislocation are you sort of envisioning here, Well.

It depends on the asset class.

I mean, in fixed income, for example, we've had like very tight spreads for a very long time, and our fixed income team is kind of just trying to stay out of trouble. If you look at a month like April, the first two days the market was down over ten percent. Most pension funds and endowments rebounced monthly. Because our benchmarks rebounced monthly, we've decided that we just are going to ignore that, and so we like bought the dip graduations. Yeah, and then it was so it was so brief that

You know, and a cycle will come.

It may not be, it probably will not be next year with rates coming down, or maybe it will be because no one thinks it will.

I have a real short question, then a real question. The short question is if there's some manager, all manager of any sort, do they have to fly to Juno and be you or do you go to the lower forty eight or how do those introductions work?

Yeah.

When I started here about ten years ago, we were really building out private markets, and we had this idea that we should kind of haze managers and not only should they come out, that should come out in January and.

Do a glacier cruise with high high waves.

Anyway, when we started trying to get into the real premiere venture funds and stuff, we realized that was not a good model. So we've been using our Alaska air minds.

Okay, real question. This is the last thing for me. So it occurred to me and I bring this up because of the mention of logging and your mention of oil. Earlier famously, David Swinton at Yale made timber allocation a core part of his portfolio, and there's all this thinking that like natural resource environment investments like that could play a good diversifying role that they were sort of acyclical in certain ways, and they're very natural indie endowment setting.

Oh, I think so.

I think commodities and resources have always been an interesting area to look but like one of my favorite investment quotes is Barton Biggs quote that there's no investment idea that's so good that too much capital can destroy it, ruin it for everyone.

And that was definitely the case.

Like once David Swinson, yeah, publicly that anything. Usually a lot of people followed him, and so Timber kind of got uninteresting. But I mean, I think resource development, mining are areas that have been like underinvested in the United States at least the last decade. So, I mean that's a that's a real interesting area for some of our private market managers.

I have one more question, which is I am looking at the White House website right now. I'm looking at a page that says up plan for establishing a United States Sovereign Wealth Fund, And as we discussed in the beginning, who knows if that's actually going to happen, but certainly there are some discussions around it. If the US at a federal level were to establish a sovereign Wealth fund and SWF, what advice would you have for something at that level.

Well, I mean, I think setting up something with like clear rules based investment policy makes a lot of sense. I mean, anytime you're investing public funds, like one of the most important things to do is to get the trust of the citizenry, your stakeholders, and how you're making investment decisions, how you do due diligence, how you build

I don't know if you have anything.

To haven those were my thoughts as well.

I'm later on it's when the idea initially came out just from a personal perspective. I had a little bit of a hard time understanding why we would be doing

Yeah, it definitely seems though. All around the world, if you look at sovereign wealth funds, they frequently associated with oil oil and frequently associated with economy that are too small for the money to be deployed in a short period of time without creating a lot of waste inflation. Anyway,

Yeah, thank you.

Thanks.

I forgot to mention I saw a bear on the way to work this morning.

Black bear, Just a black bear.

We have those in Connecticut exactly.

I didn't see when yesterday where on my mom's roof, which is that's unusual.

Yeah, Tracy, I love that conversation. First of all, I'm glad we did that after after we had returned from Alaska, because I just felt like understanding just what a distinct economy is Alaska is, and the specific needs of the Alaskan economy, et cetera, and the sort of weirdness and the exposure to booms and busts, and whether an economy that farflung can even like support itself, it gives me a deeper understanding of like why a state would have

Yeah.

Well, on that note, I did think it was interesting when we asked about what would their advice be for a federal sovereign wealth fund, and they said something rules based, Yes, where you you know, you stick to a certain payout formula in order to insulate the fund from political whims

Yeah.

I thought that was interesting. I also thought, I mean, it sounds like being a portfolio manager at the Alaska Fund would be like a nice job.

I thought, yeah, but would you but the Alaska part? Would you take it?

I haven't done an Alaskan winter, so I highly suspect my opinions of living in the state would change drastically if I was there in January versus August.

Can I say something that is not meant to be insulting to anyone who lives there or any of the wonderful guests that we've had, is certainly not meant to be insulting to anyone. Yeah, who anyone who lives in Alaska. There are a lot of bars and anchorage. There are a lot of dive bars. I feel like there's a reason I do not Yes that too. I suspect that there is a link between all those bars in like eight months where the sun comes up at like eleven am and goes down at four peu.

It's a long winter.

You got to go somewhere.

You gotta do something that seems like pretty tough on the human condition. Two other things that I thought were interesting, So on that point about whether or nation sovereign wealth fund makes sense, I do agree with, like this basic idea, like we're it's most logical is if you have this big windfall of money and you can't put it all into the economy right now because you act the capacity right, you create inflation or whatever. I think that we don't

Age right now?

All right, shall we leave it there, Let's leave it there. This has been another episode of the Authots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

And I'm Joe Wisenthal. You can follow me at the Stalwart. You can follow our producers Kerman Rodriguez at Kerman armand Dash, Ob Bennett at Dashbod and Kelbrooks and Kilbrooks. For more Odd Lots content, go to Bloomberg dot com slash odd Lots, where we have a daily newsletter and all of our episodes, and you could chat about all of these topics twenty four to seven in our discord discord dot gg slash odlines.

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