In the December 2007 Shareholder there was a story on the Sealaska Permanent Fund, highlighting its history, strong investment performance, and distribution policy, all in terms of the goal of the Fund to provide long-term reliable distributions to tribal member shareholders. This time we look more in-depth at the management of the Fund and the creation of the strong performance witnessed over the last few years.
It was mentioned in the last article that the Permanent Fund maintains a diversified portfolio, diversification being a cornerstone principle that the Board of Directors uses when setting the asset allocation of the Fund. A diversified asset allocation can be likened to the saying “don’t keep all your eggs in one basket.” The Permanent Fund, under its investment policy is able to invest in six distinct asset classes; domestic US stocks, international stocks, fixed income / bonds, private equity, real estate, and hedge funds. The asset allocation is the mix of percentages, or allocation, each of the six asset classes has of the total Fund value.
When the Board puts together the Fund’s portfolio of diverse asset classes, to control the risk and return of the Fund, it is following the direction of modern portfolio theory. Modern portfolio theory tells us not to base our asset allocation decisions on the amount of risk that an individual investment carries with it. Instead, consider how that investment or asset class contributes to the overall risk of the portfolio.
The inclusion of alternative investments in the Permanent Fund highlights the use of modern portfolio theory. Alternative investments such as private equity, hedge funds or real estate, can be more risky than investing in the stock market, but because of the less than perfect and often times low relationship with gains or losses from the stock and bond markets their inclusion in a portfolio can accomplish one of two goals. The use of alternative investments can either raise the expected return of the Fund with little increase in risk, or it can decrease the risk of the Fund with little change in the expected return.
Given the goal of the Permanent Fund to provide a consistent source of dividends, the Board has focused on using alternative investments to decrease the overall risk of the Fund while maintaining the same return expectations as a traditional stock and bond only portfolio.
From the inception of the current asset allocation in December of 2002 through 2006 the Permanent Fund created annual returns of 20 percent. This compares very favorable to our investment benchmark, or market based returns of around 14 percent. An example of the benefit of this level of outperformance is that with a Permanent Fund balance of $100 million, 6 percent of outperformance provides an additional $6 million in earnings above what is expected from our benchmark market returns. This additional $6 million raises the size of current distributions, but also increases the balance of the Fund increasing distributions in the future.
This level of performance is in large part provided by the asset allocation approved by the Board, but also includes strong success from the investment managers chosen within each asset class. With the Board authorized asset allocation as the investment road map, Sealaska’s executive management searches for active investment managers that offer the best risk and reward for the portfolio. The strong outperformance witnessed over the last four years came from finding strong managers in specific asset classes, and while the portfolio return was greater than the overall market we maintained the same level of risk as the market over this period. This is an important statistic that verifies that the success did not come solely by investing in high risk / high reward managers.
The search for appropriate investment managers for the Fund will be the topic of future editions of the Shareholder.