Most people who read this blog are already aware of the recent decision by the Alaska Permanent Fund Corporation (APFC) to dedicate 5% of the fund’s balance toward investing in Alaska. The resolution, passed last week, initiated the process with $200 million of seed money out of the existing “special opportunities” pool of assets.
The ADN recently published some thoughts that are floating around my circle of peers. The article mostly focuses on the positive aspects, including a quote from me. However, I don’t think we should gloss over the risks and caveats here.
So, here are some of my thoughts on the issue.
Is this a way to use the Permanent Fund for the gas line?
There is a lot of suspicion about the gas line. The biggest question has been “where will the money come from?”
With 75% debt financing, the State would still need to come up with about $11 billion to fund the project. That is a bigger capital project that the State can handle through the capital budget.
So, many people have suspected that the Permanent Fund would be the ultimate investment vehicle. And this latest move plays right into that fear. Especially given the board members’ relationship with Governor Walker.
While I don’t believe that is the intent with the resolution, it is a possibility. There will be around $3 billion available to invest from the fund under this resolution and it’s voiced targets. Who knows how those targets will change over the next few years.
But, I think this is actually just a misinterpretation of what is going on. The APFC already has over $7 billion invested in private equities. These are small businesses with high growth potential. Right now, those investment are in businesses located in Silicon Valley and other large economic regions of the country. None of them are in Alaska.
We are geographically challenged in the global investment pool, making it very difficult for entrepreneurs and inventors to get their ideas to market. Alaska needs someone who can locate good projects and invest in them.
While we do have some good efforts going on by Economic Development Corporations, Community Development Financing Institutions, and private equity firms, I think having a global powerhouse like the APFC in our corner can shine a light on good projects that other investment firms aren’t seeing.
For that reason, I think the idea of diverting some of the existing pool of money into Alaska can be beneficial. But only with the appropriate safeguards in place.
Isn’t this risky?
Private equity is always risky. There are much higher chances of losing your whole investment, but there is also a lot more upside.
If you invest in the next Amazon when it’s still in its infancy, you reap huge rewards when it grows up. That’s why you want a portion of your portfolio making these kinds of gambles, but only a small portion.
The real risk in the resolution is that the APFC takes on additional risk, without the corresponding potential reward, just for the sake of investing in Alaska. That is where this idea can get bad in a hurry.
There are two ways to combat this problem. First, demand that outside money co-invest in any projects. That way, it requires an independent vetting by an outside party before money is put at risk.
Second, do not set a mandate for how much to invest in Alaska. Rather, set a limit for how much can be invested. Otherwise, the manager will be required to invest in poor quality projects to fill the mandate.
Won’t this process crowd out private investment?
This is the tricky part. The APFC is a profit seeking organization, making money for all Alaskans. They currently compete in the investment world for projects, implying that they are crowding out other investment firms that wanted to buy the assets we own.
When they start investing is Alaska, they will have to compete with other investors. Some of those investors are Alaskan banks and investment firms.
If the APFC were to set a policy of non-competing, they would only be taking on projects not worth investing in (the projects the banks turn down). That would be a bad move.
So, the only way this idea makes sense is if there are more projects than funding in the current market. That may be the case. The APFC just needs to be careful not to invest so much money in Alaska that they take over the market.
They also need to compete on fair terms. If they use their governmental status to offer lower rates than the banks, the result will be an unfair advantage to the APFC at the expense of the private markets.
Doesn’t this effort infringe on AIDEA’s mission?
AIDEA was created for the purpose of investing in infrastructure that promotes economic development. That means that they don’t look exclusively at the rate of return on their financing decisions. They also consider the economic impacts of their investments.
For that reason, we would expect them to have a lower (or maybe even negative) long-term return on investments. That’s because maximizing their return isn’t how they measure success. In the world of finance, we would say they live in the “concessionary” layer of the capital stack.
What the APFC is talking about doing is investing in the “mezzanine” layer. Those are high risk investments with high rewards when the investment pans out. This is generally done by taking an equity position in a business, but can also occur through high rate loans or bonds.
The APFC should stay in the mezzanine layer, with a small portion of their portfolio, and avoid the concessionary layer altogether. We already have AIDEA to for that.
If the APFC board thinks they want to promote economic growth, the State would be better served by moving the money to AIDEA’s balance sheet rather than blurring the line of what the APFC is trying to do (maximize returns).
If we ever see the APFC justify an investment on the basis of economic impacts, it should immediately raise red flags.
The recent board resolution is probably innocent and could be beneficial. But, it does have the potential to turn into something really bad. We need to be very cautious as we proceed, and we need to ensure safeguards are in place.
Additionally, we all need to watch closely as this unfolds. If it becomes a vessel for pet projects, the whole fund could sink.
I think removing the restriction from investing in Alaska is the right thing to do. But, there should not be an investment mandate, there should be required third-party co-investment, and we should not accept higher risk or lower returns from an investment, solely because they have an Alaskan address.