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TABLE OF CONTENTS

• Background

  • Introduction

  • Fiscal Context

  • Purpose

• 2002-05 Business Plan

• Fund Structure

• Goals, Strategies and Outputs, Outcomes and Performance Measures 

  • Goal 1:  Earn Income to Support the Government's Consolidated Fiscal Plan

  • Goal 2:  Make Investments in the Endowment Portfolio to Maximize Long Term Financial Returns

  • To Improve Albertans' Understanding and the Transparency of the Alberta Heritage Savings Trust Fund

• Management and Accountability

• Income and Expenses

• Attachment A:  Heritage Fund Allocation of Responsibilities

• Attachment B:  Description of Benchmark Indices for the Endowment Fund

• Attachment C:  Business Plan Performance

• Attachment D:  Glossary

The Business Plan was reviewed and approved by Treasury Board on January 28, 2002 and by the Legislature's Standing Committee on the Alberta Heritage Savings Trust Fund on February 13, 2002.

BACKGROUND 

INTRODUCTION 

• The Alberta Heritage Savings Trust Fund (the Heritage Fund) was created in 1976 as a means to provide savings of non-renewable resource revenue. The Heritage Fund grew from a portion of Alberta's oil and gas revenue being deposited into the Fund since inception in 1976 and until 1987. As well, prior to 1982, the Heritage Fund kept its investment income. 

• On January 1, 1997 the Heritage Fund was restructured in response to a public review of the Fund. The restructuring included a new governance structure as well as the establishment of new investment objectives and performance measures. The Heritage Fund's first business plan was implemented in January 1997. 

• Assets and income of the Heritage Fund are fully consolidated with the assets and revenue of the Province. For fiscal planning purposes, and under the Balanced Budget and Debt Retirement Act of 1995: (i) consolidated Heritage Fund income is included in the determination of the Province's budget surplus, and (ii) Heritage Fund assets are netted off gross liabilities in determining the net asset position of the Province.

• The Fiscal Responsibility Act (FRA) sets out a legislative schedule to eliminate the Province's accumulated debt in no more than 25 years. The FRA amended the Alberta Heritage Savings Trust Fund Act to grant the Minister of Revenue the discretion to protect the real value of the Heritage Fund when revenue is sufficient to do so. 

PURPOSE

• This is the sixth business plan for the Heritage Fund, which amends the previous business plans and incorporates updated financial information and income forecasts. This plan sets out the broad objectives of the Heritage Fund as expressed in the legislation, specific investment objectives, goals and strategies to achieve the Heritage Fund's objectives, and performance measures.

2002-05 BUSINESS PLAN

The business plan incorporates the following changes:

1. Heritage Fund exposure to real estate and private equity has been increased. Absolute return strategies have been introduced to continue the focus on the long term. Research has demonstrated that increasing exposure to real estate, private equity and absolute return strategies can create a portfolio with improved risk/return possibilities even after the additional investment costs associated with these assets are taken into account. Furthermore, a 15% exposure phased in over a 2-year period, and composed of 2% in private equity, 3% in absolute return strategies, and 10% real estate, can be justified towards improving portfolio risk and return. A 15% exposure is also in line with other North American endowment funds.

2. Consistent with the changes in the weightings for non-traditional asset classes new benchmarks and new benchmark allocations have been selected. In choosing a benchmark to measure investment performance, it is appropriate to distinguish between the policy benchmark for each asset class (i.e., the benchmark used in calculating the total fund benchmark); and the manager benchmark (i.e., the benchmark used to assess the performance of the manager(s) within each asset class). This approach is being used with small cap investments. For Canadian Small Cap, the policy benchmark is the TSE 300, while the manager benchmark is the Nesbitt Burns Small Cap Index. The policy benchmarks for the real estate, private equity, and absolute return strategy asset classes are inflation, as measured by the CPI index, plus 5%, 8%, and 6%, respectively. Benchmarking these investments at the policy level to a spread over inflation is consistent with the objective of endowment funds to generate a return that will protect the real value of the fund and facilitate spending over this amount. The basis for the manager benchmarks for each asset class is as follows:
   

   • Real Estate - Russell Canada Property Index (RCPI) is a total return index based on holdings across 14 Canadian institutional real estate investment advisors. RCPI is the current Canadian manager benchmark and in the absence of compelling reasons to do otherwise, it will be retained until it is replaced by a more viable alternative. For U.S. real estate the National Council of Real Estate Investment Fiduciaries (NCREIF) has been chosen for physical, or traditional real estate investing. This index is similar in construction to the RCPI. The National Association of Real Estate Investment Trusts (NAREIT) is used for investments in publicly traded real estate investment trusts and measures the total return of all 198 REITs currently trading on the NYSE. Both indices are widely accepted benchmarks for institutional real estate investing. 
     
   • Private Equities - With no private equity benchmarks in Canada, the TSE 300 + 2.5% will be retained as the manager benchmark for this asset class. This is the current benchmark used in the Private Equity Pools (PEP and PEP98) product description. In the U.S., the widely recognized Venture Economics index is used as the manager benchmark. 
     
   • Absolute Return Strategies - The three major absolute return strategy indices are Hedge Fund Research (HFR), Managed Account Reports (MAR) / Zurich and Credit Suisse First Boston (CSFB) / Tremont. These benchmarks are median manager surveys based on a pool of firms. The decision as to which index to use should be made in consultation with the selected fund-of-funds manager(s). An informal survey of fund-of-funds managers has indicated that CSFB/Tremont is the preferred choice.

    

3. The Transition Portfolio transfer is maintained at $3.6 billion annually or $300 million per month. As the Endowment Portfolio now exceeds the Transition Portfolio the Transition Portfolio's focus has moved to providing greater liquidity to facilitate the transfers to the Endowment Portfolio. This requires the Portfolio maintain short-term assets that act as a drag on the total fund performance. To maintain the Heritage Fund performance and reduce the "cash drag" the transfers will continue as indicated so as to liquidate the Transition Portfolio by August 2002. This allows flexibility to take advantage of market conditions or opportunities without compromising the discipline of "dollar-averaging"(the systematic investing of funds over time) used in the transition. 

FUND STRUCTURE

The mission of the Heritage Fund is as follows:

"To provide prudent stewardship of the savings from Alberta's non-renewable resources by providing the greatest financial returns for current and future generations of Albertans".

• The government keeps it books on a consolidated basis and therefore the Heritage Fund income is included in consolidated income for the Province. Consequently, the level and variability of Heritage Fund income is important to the government's fiscal plan. 

• Income will vary significantly from year to year for the following reasons:
  1. An investment policy to maximize long-term returns implies a significantly higher weighting towards investments in equities in comparison to the equity holdings at the time the Heritage Fund was restructured. Equities have historically provided investors with higher total returns (dividends and capital gains) than fixed income investments, however, dividend rates in general are lower than interest rates thereby providing lower current income. The timing of realizing capital gains is also uncertain. 
  2. The well-established capital market principle that increased returns, as provided by equity investments, are accompanied with increased risk or return volatility means that the Heritage Fund's income would be more variable.

• In order to provide for an orderly transition between the need for current income and long-term investment goals, the Heritage Fund was divided into two separate portfolios: a Transition Portfolio and an Endowment Portfolio.

• The Transition Portfolio is invested primarily in interest bearing securities to generate current income to support the Province's fiscal plan and to provide liquidity to facilitate transfers to the Endowment Portfolio. The Transition Portfolio has supported the Province's current income but now sees its role diminish as it is reduced in size and the Endowment Portfolio grows over the transition period.

• The Endowment Portfolio is invested in a diversified portfolio including interest bearing securities, Canadian equities, international equities, and real estate. The Portfolio is invested to generate long-term returns to support the Province's income and spending needs. 

• The 1996-1997 re-structuring of the Heritage Fund allowed for a ten year transition where all assets would be transferred from the Transition Portfolio to the Endowment Portfolio by December 31, 2005 based on minimum annual transfers of $1.2 billion. With the $2.4 billion transfer for fiscal 2000-01, $3.6 billion for 2001-02 and continuing into 2002-03 the Transition Portfolio should be eliminated by August 2002.

Goals, Strategies and Outputs, Outcomes and Performance Measures

The legislated investment objective of the Endowment Portfolio is:

Investments shall be made with the objective of maximizing long-term financial returns.

• Given a long-term investment horizon, investment practice suggests that a mix of equities (including real estate) and interest-bearing securities best achieves the objective of optimizing financial returns as it provides enhanced returns and diversifies risk. A long-term investment horizon generally means 10 years, however, for investment performance comparisons a minimum period of 4 years will be examined. Emphasis on "long-term" in the investment objective is designed to help the investment manager continue to plan and execute strategies in a long-term context at times when short-term pressures exist.

The legislated investment objective of the Transition Portfolio is:

Investments shall be made with the objective of supporting the government's short-term to medium-term income needs as reflected in the government's consolidated fiscal plan.

• To support the Province's revenue needs the Transition Portfolio was required to generate a stable source of income. Consequently, it was important the assets be revenue generating, and not exposed to significant credit risk. Additionally, due to the transfer program, assets were required to be liquid (easily traded) so as to facilitate the monthly transfers to the Endowment Portfolio. This was accomplished by having a high quality portfolio of bonds and money market securities.

• The transition is nearly complete such that the current rate of transfer of $300 million per month will eliminate the Portfolio, save policy loans, in less than a year. As such, the need for liquidity to match the monthly income and Endowment transfers continues to grow. The Transition Portfolio's size also means it is no longer able to generate a level of income consistent with the investment objective. However, the Endowment Portfolio contains a substantial holding in fixed income securities including bonds and mortgages. These assets provide a stable source of revenue to the Province, as does the income from real estate investments. 

• In the past, the Transition Portfolio has been compared to the cost of the Province's debt. As the Transition Portfolio declines in size and the liquidity needs increase, due to the transfer program, this comparison has become less meaningful.

GOAL 1:  EARN INCOME TO SUPPORT THE GOVERNMENT'S CONSOLIDATED FISCAL PLAN

¹ Would be swapped into Canadian dollars to eliminate currency risk.

GOAL 2:  MAKE INVESTMENTS IN THE ENDOWMENT PORTFOLIO TO MAXIMIZE LONG TERM FINANCIAL RETURNS

² Includes money market instruments, bonds and mortgages.

³ Includes Canadian public and private equities, foreign equities and Canadian real estate. Foreign investments will be limited to 40% of market value.

GOAL 3:  TO IMPROVE ALBERTANS' UNDERSTANDING AND THE TRANSPARENCY OF THE ALBERTA HERITAGE SAVINGS TRUST FUND

MANAGEMENT AND ACCOUNTABILITY

• A clear mission statement and investment objectives for the Heritage Fund have been established in legislation.

• A Standing Committee of the Legislature has been established to provide overall direction and evaluate the performance of the Heritage Fund and report regularly to Albertans.

• The Investment Operations Committee reviews and approves the Business Plan, quarterly and annual reports, and the investment policies for the Heritage Fund. The Committee includes a majority of private sector members with relevant financial and business expertise.

• Ongoing investment decisions will be made within Alberta Revenue consistent with the allocation of responsibilities set out in Attachment A.

• For each component of the Heritage Fund that is externally managed, an investment management mandate describing its purpose, goals and constraints will be established.

• The investment management mandates of external managers will be consistent with this Business Plan.

• The Auditor General is the auditor of the Heritage Fund.

• There are restrictions on the kind of investments that can be made. Heritage Fund assets are to be invested prudently and cannot be used directly for economic development or social investment purposes.

INCOME AND EXPENSES 

• The rates of return on, and the income from, the Heritage Fund have become more volatile as the Endowment Portfolio grows and as equity investments increase. While equity investments have historically, over long periods of time, provided higher rates of return than fixed income investments they are also significantly more volatile. Capital gains on traditional equity investments are not recognized as income until the investment is sold, so strong performance reflected in rates of return may not be reflected in income for some time. Unlike traditional equity instruments, income and expenses on equity index swaps are accrued as earned. As a result, market value gains and losses are realized as they occur.

• Following are current projections of the Heritage Fund income based on the assumptions noted. Actual results will vary from projected income depending on the extent to which actual interest rates and equity market returns vary from the assumptions used. Forecast gross investment income decreases over the fiscal plan period due to the lower interest rate environment and the increasing investment in equities in the Endowment Portfolio, which contribute lower "current income".

• The income projections include:

  • interest income

  • dividend income

  • capital gains or losses only when they are realized, such as when an investment is sold

  • income and expense on index swaps and interest rate swaps accrued as earned

• The income projections do not include:

  • unrealized capital gains
    

• Investment income is in part dependent on prevailing market conditions that are subject to occasional volatile movements. A significant portion of the current portfolio is invested in bonds, and has a predictable income stream. As these holdings mature, the future income will be increasingly dependent on the prevailing market conditions at the time of re-investment.

• The above income projections for the Heritage Fund are net of estimated investment expenses as outlined below:

ATTACHMENT A:  Heritage Fund Allocation of Responsibilities

• The Alberta Heritage Savings Fund Act sets out the governance structure for the Heritage Fund. The general division of responsibilities is described below.

Standing Committee on the Alberta Heritage Savings Trust Fund

(A Committee of the Legislative Assembly)

1. Review and approve annually the Business Plan for the Heritage Fund.

2. Receive and review quarterly reports from the Minister of Revenue on the operation and results of the operation and results of the Heritage Fund.

3. Approve and release the Heritage Fund Annual Report on, or before, June 30 following the conclusion of the fiscal year for which the annual report was made.

4. Review after each fiscal year end the investment activities and the performance of the Heritage Fund and report to the Legislative Assembly as to whether the mission of the Heritage Fund is being fulfilled.

5. Hold public meetings with Albertans on the Heritage Fund's investment activities and results.

Treasury Board

1. Annually review and approve the Business Plan of the Heritage Fund.

Minister of Revenue

1. Approve the Statements of Investment Policy for each portfolio, including any proposed changes thereto.

2. Approve and present the annual Business Plan of the Heritage Fund to Treasury Board and to the Standing Committee.

Investment Operations Committee

1. Review and recommend the Business Plan to the Minister of Revenue for transmittal to Treasury Board and the Standing Committee.

2. Review and recommend the investment policy statements for the Endowment Portfolio and the Transition Portfolio to the Minister of Revenue.

3. Review and approve the financial statements and recommend the Annual Report.

4. Approve the quarterly reports for transmittal to the Minister of Revenue.

5. Advise on the extent of use of external managers and the criteria for selection.

1. Serve as investment manager of the assets of the Heritage Fund.

2. Prepare and recommend a Business Plan to the Investment Operations Committee and the Minister of Revenue.

3. Prepare, and recommend to the Investment Operations Committee and the Minister of Revenue, Statements of Investment Policy for each portfolio and any proposed changes to the investment policies.

4. Prepare a quarterly report on the investment activities and results of the Heritage Fund including income forecasts.

5. Prepare financial statements for the Heritage Fund.

6. Prepare the Annual Report of the Heritage Fund.

ATTACHMENT B:  Description of Benchmark Indices for the Endowment Fund

Scotia Capital 91-day T-Bills Index (SC T-Bills Index)
Reflects the performance of the Canadian money market as measured by investments in 91 day Treasury Bills.

Scotia Capital Universe Bond Index (SC Universe Index)
Covers all marketable Canadian bonds with terms to maturity of more than one year. The purpose of this index is to reflect performance of the broad Canadian bond market in a manner similar to the way the TSE 300 represents the Canadian equity market.

Toronto Stock Exchange 300 Total Return Index (TSE 300 Index)
An index of 300 stocks, in fourteen subgroups, listed on the Toronto Stock Exchange designed to represent the Canadian equity market. It is a capitalization-weighted index calculated on a total return basis.

Morgan Stanley Capital International World (excluding Canada) (MSCI World)
An index of over 1,470 stocks on 23 stock exchanges around the world designed to represent an international equity market (excluding Canada). The index is calculated on a total return basis, which includes investment of gross dividends before deduction of withholding taxes. The index covers about 60% of the issues listed on the exchanges of the countries included.

Russell Canadian Property Index (RCPI)
An index comprised of institutionally held real estate investments consisting of over 1,100 properties distributed across Canada.

Standard & Poor’s 500 Index (S & P 500 Index)
Covers 500 industrial, utility, transportation and financial companies of the US markets, mostly New York Stock Exchange issues. It is a capitalization-weighted index calculated on a total return basis with dividends reinvested.

Morgan Stanley Capital International Europe, Australia, Far East Index (MSCI EAFE Index)
An index of over 900 securities listed on the stock exchanges of countries in Europe, Australia and the Far East. The index is calculated on a total return basis, which includes re-investment of gross dividends before deduction of withholding taxes.

Consumer Price Index, Canada (CPI)
A measure of the average change in Canadian prices over time in a fixed market basket of goods and services.

ATTACHMENT C:  Business Plan Performance

ATTACHMENT D:  Glossary

active management
Attempts to achieve portfolio returns greater than a specific index while controlling risk, either by forecasting broad market trends or by identifying particular mispriced sectors of a market or securities in a market.

asset allocation
The investment process by which the investment manager chooses or allocates funds among broad Asset Classes such as stocks and bonds.

asset-backed securities
These are debt instruments collateralized by a pool of assets such as automobile loans or equipment leases. 

asset (or investment) class
Refers to a broad category of investments with similar characteristics (the typical asset classes are cash, stocks, bonds and real estate).

benchmark index
A statistical yardstick tracking the ups and downs of a particular market by monitoring a representative group of securities over time. For example, the Scotia Capital Universe Bond Index is a Benchmark Index that is designed to reflect the changes in the Canadian bond market.

bond
A financial instrument representing a debt where the issuer (corporation or government) promises to pay to the holder a specific rate of interest over the life of the bond. On the bond's maturity date, the principal is repaid in full to the holder.

capital gain (or capital loss)
The market value received on the sale of an asset, which is higher (lower) than its purchase price (also called cost). If an asset is bought for $50 and sold for $75, the realized capital gain or profit is $25.

diversification
The allocation of investment assets within an Asset Class and among asset classes. In general, the greater the number of holdings within an asset class and among asset classes, the greater the diversification, which reduces risk.

dividends
Earnings distributed to shareholders of a company proportionate to their ownership interest.

duration (or modified duration)
Modified duration is a measure of price volatility and is the weighted average term to maturity of the security's cash flows (i.e., interest and principal), with weights proportional to the present value of the cash flows. Bonds with a longer duration are more price sensitive to interest rate changes than bonds with short durations.

equities
Equities are synonymously called stocks or shares and represent an ownership interest in a company (could be either a public or private firm). The shareholder normally has voting rights and may receive dividends based on their proportionate ownership. 

inflation
Increases in the general price level of goods and services. Inflation is one of the major risks to investors over the long-term as savings may actually buy less in the future. 

interest-bearing securities
An investment which is required to pay a fixed interest rate at periodic intervals such as bonds, mortgages and debentures.

investment grade
An investment grade bond is rated a minimum of BBB (or equivalent) by a rating agency, with AAA being the highest grade. Bonds rated below BBB are generally classified as being speculative grade and carry higher levels of credit risk than investment grade bonds (i.e., they have a higher probability of default on interest or principal payments).

long-term
A long-term investment horizon in the context of the Endowment Portfolio means a period of time that would include two business cycles, which would generally mean about 10 years.

market value rate of return
An annual percentage, which measures the total proceeds, returned to the investor per dollar invested. Total proceeds for market value rates of return = "money in the bank" plus paper profits or losses (paper profits or losses are also called unrealized capital gains or losses). "Money in the bank" means cash interest and dividends and realized capital gains or losses from selling the investment.

median return
The median return of a group of investment managers reflects the return associated with the manager ranked at the 50th percentile (the 50th percentile is that point where half the managers had a higher return, and half the managers had a lower return).

money market instruments
Debt instruments such as Treasury Bills or corporate paper with a maturity of less than one year.

mortgage-backed securities (MBS)
A debt instrument that has an ownership claim in a pool of mortgages or an obligation that is secured by such a pool.

mortgage investment
A debt instrument collateralized by real assets (e.g., a building) and requiring periodic payments consisting of interest and principal.

nominal rate of return
A measure of the earnings performance of a fund measured in current dollars.

passive management
Buying or investing in a portfolio that represents a market index without attempting to search out mispriced sectors or securities. The opposite of Active Management.

portfolio
A collection of investments owned by an investor.

real rate of return
The nominal rate of return minus the rate of inflation.

realized/unrealized
Terms generally used to describe capital gains or losses. A gain or loss is generally realized when an asset is sold; prior to sale the gain or loss is unrealized and it is only a potential or "paper" gain or loss.

 

Copyright © 2002 Government of Alberta. WebMaster@treas.gov.ab.ca.