Alaska Permanent Fund

Over the years I've written a few times about the Alaska Permanent Fund (APF) which is akin to a sovereign wealth fund that pays the annual dividend to Alaska residents. Generally I've not been too flattering to the fund for performance issues and benchmark switching. Slightly bigger picture I think they overreact to the short term but do so without a solid strategy for the long term.

The latest bit of news comes via IndexUniverse that the Alaska Permanent Fund is going to put $1 billion (out of $36 billion total) into the FTSE RAFI US 1000 index. This index has of course been available in an ETF from PowerShares with symbol PRF for almost five years. The idea is that companies are weighted by four fundamental factors not market cap which tends to reward momentum as opposed to value. Before the fund debuted the back test was solid and since PRF started trading it has been up 2.4% versus a decline 8.7% for the S&P 500.

The outperformance is meaningful but I would also note the correlation to the S&P 500 is very high; per ETFreplay it has been between 0.94 and 1.00 for the last two years. The value bias did not help much during the worst of the panic as the fund was very heavy in financials (I believe more so than the SPX) and today has 20.78 in financials. From the October 2007 peak to March 2009 low PRF actually dropped more than the S&P 500.

The APF has an unusual target asset allocation;

Company Exposure 53%
Special Opportunities 21%
Real Assets 18%
Interest Rates 6%
Cash 2%

Company exposure can include equity and fixed income and within equity is a mix of passive and active. Within the active management the APF has stuck with some serial underperformers. The results overall have been very mediocre and I think the reason for this is that if you look down the performance report the categories seem to be mostly taken from the Morningstar Style Boxes and the managers benchmark to things like the MSCI EAFE Index and other broad domestic indexes. It is the rare manager who, when benchmarked to the EAFE, is going to seriously underweight all trouble spots I have been talking about (with absolutely no claim of uniqueness) for many years now.

The special opportunities includes a mish mash of managed pools, some names that will be familiar to many people and some not and the returns are a mish mash as well compared to objectives that have consultant fingerprints all over them. The real assets segment appears to have a lot of real estate, both traded and direct.

We often here more about the success stories in this space like Harvard and Yale. You can search for the couple of things I've written about the APF or do some exploring on the APF site, maybe you will disagree but the APF has not been a success story but it is something to learn from.

The fund changed strategies from a sort of normal target allocation to what you see above right in the middle of the crisis which strikes me as one of the worst things that can be done by professionals. Tweaking is one thing, that is merely dicey, but a complete overhaul during the last couple of years leads me to believe the APF will have problems for years to come.

One concept laid out here over the years has been long term planning. This includes developing some thoughts about the future of the world, thinking about how things might evolve and then laying some sort of framework that is consistent with conclusions drawn and the circumstance/purpose of the pool of money in question.

This endeavor represents the building blocks of forward looking analysis perhaps in a similar fashion to a business plan. You may think this is difficult for the typical do-it-yourselfer to do and that might be true (although I think this is more of a function of time spent for most people than anything else) but is should not be the case for the people running the APF or the consultants they use. PRF is intended to add value versus SPX. If SPX goes nowhere for another seven years then PRF will, if all goes well, do a little better than go nowhere--not much in the way of innovative thinking.

There are constraints that are along the lines of peer pressure that have turned out to have bad consequences for many professional pools. For example as financials kept growing relative to the S&P 500 it would have been very difficult to have a substantial underweight to the sector for fear of being wrong. Long before any problems for the sector manifested themselves I talked about what to look for; a weight in the SPX greater than 20% and an inverted yield curve. Either or both would be bad news for the sector but there are certain pools of capital that cannot take the risk of going severely underweight because being wrong about such a thing creates career risk. This is just one example, there are others like zero in Japan or France for international managers but of course you do not have such constraints and can learn from the experiences of others.

I think the APF needs to simplify the target allocation and allow more flexibility of its active managers to deviate away from their benchmarks in terms of things like countries and themes. I am making assumptions on a lot of this but that is based on the published returns which go back five years and don't provide any evidence that I can see of meaningful value having been added. Although the market has been rough for a while, five years is enough time for any value-add to emerge if there was going to be any value-add.

The picture is looking down on downtown Juneau.