Balance Sheet
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Statement
of Operations
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Statement
of Cash Flow
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Notes
to the Financial Statements
December
31 , 2004 (unaudited)
NOTE
1 AUTHORITY AND MISSION
The Alberta
Heritage Savings Trust Fund operates under the authority of the
Alberta Heritage Savings Trust Fund Act (the Act), Chapter A-23,
Revised Statutes of Alberta 2000, as amended.
The preamble
to the Act describes the mission of the Fund as follows:
"To
provide prudent stewardship of the savings from Alberta's non-renewable
resources by providing the greatest financial returns on those
savings for current and future generations of Albertans."
NOTE
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND REPORTING PRACTICES
These financial
statements are prepared in accordance with generally accepted
accounting principles.
The accounting
policies of significance to the Fund are as follows:
(a) Portfolio
Investments
Fixed-income
securities, mortgages, equities, real estate investments and absolute
return strategy investments held directly by the Fund or by pooled
investment funds are recorded at cost. Cost includes the amount
of applicable amortization of discount or premium using the straight-line
method over the life of the investments.
Investments
in loans are recorded at cost less any allowance for credit loss.
Where there is no longer reasonable assurance of timely collection
of the full amount of principal and interest of a loan, a specific
provision for credit loss is made and the carrying amount of the
loan is reduced to its estimated realizable amount.
Investments
are recorded as of the trade date.
The
cost of disposals is determined on the average cost basis.
Where
there has been a loss in value of an investment in fixed-income
securities, mortgages, equities, real estate and absolute return
strategies that is other than a temporary decline, the investment
is written down to recognize the loss. The written down value
is deemed to be the new cost.
(b) Investment
Income
Investment income is
recorded on the accrual basis where there is reasonable assurance
as to its measurement and collectability. When a loan becomes
impaired, recognition of interest income in accordance with the
terms of the original loan agreement ceases.
Any
subsequent payments received on an impaired loan are applied to
reduce the loan's book value.
Gains
and losses arising as a result of disposals of investments are
included in the determination of investment income.
Income and expense from derivative contracts are included in investment
income. Certain derivative contracts, which are primarily interest
rate swaps and cross-currency interest rate swaps, are designated
as hedges of market risks for purposes of hedge accounting. Hedge
accounting recognizes gains and losses from derivatives in the
statement of income in the same period as the gains and losses
of the security being hedged. As a result, income and expense
from derivative contracts designated as hedges are recognized
in income on an accrual basis with gains and losses recognized
in income to the extent realized.
Derivative
contracts not designated as hedges for purposes of hedge accounting,
which are primarily bond index swaps, equity index swaps, equity
index futures, forward foreign exchange contracts and credit default
swap contracts are recorded at fair value.
(c) Foreign
Currency
Foreign currency transactions
are translated into Canadian dollars using average rates of exchange;
except for hedged foreign currency transactions, which are translated
at rates of exchange, established by the terms of the forward
exchange contracts. Exchange differences on unhedged transactions
are included in the determination of investment income.
(d) Investment
Valuation
Fair
value is the amount of consideration agreed upon in an arm's length
transaction between knowledgeable, willing parties who are under
no compulsion to act. Fair values of investments held either directly
by the Fund or by pooled investment funds are determined as follows:
(i) Public fixed-income
securities and equities are valued at the period-end closing
sale price, or the average of the latest bid and ask prices
quoted by an independent securities valuation company.
(ii) Mortgages, provincial corporation debentures and private
fixed-income securities are valued based on the net present
value of future cash flows. These cash flows are discounted
using appropriate interest rate premiums over similar Government
of Canada benchmark bonds trading in the market.
(iii) The fair value of private equities is estimated by managers
or general partners of private equity funds, pools and limited
partnerships. Valuation methods may encompass a broad range
of approaches. The cost approach is used to value companies
without either profits or cash flows. Established private companies
are valued using the fair market value approach reflecting conventional
valuation methods including discounted cash flows and multiple
analysis.
(iv) The fair value of real estate investments is reported at
the most recent appraised value, net of any liabilities against
the real property. Real estate properties are appraised annually
by qualified external real estate appraisers. Appraisers use
a combination of methods to determine fair value including the
replacement cost approach, direct comparison approach, direct
capitalization of earnings approach and the discounted cash
flows approach.
(v) The fair value of Absolute Return Strategy Pool investments
are estimated by external managers.
(vi) The fair value of loans is estimated by management based
on the present value of discounted cash flows.
(vii) The fair value of deposits, receivables, accrued interest
and payables are estimated to approximate their book values.
(viii) The fair value of investments and any other assets and
liabilities denominated in a foreign currency are translated
at the year-end exchange rate.
(e)
Valuation of Derivative Contracts
Derivative contracts include
equity and bond index swaps, interest rate swaps, cross-currency
interest rate swaps, credit default swaps, forward foreign exchange
contracts and equity index futures contracts. As disclosed in
Note 4, the value of derivative contracts is included in the fair
value of pooled investment funds. The estimated fair value of
derivative contracts at the reporting date is determined by the
following methods:
(i) Equity and bond
index swaps are valued based on changes in the appropriate market
based index net of accrued floating rate interest.
(ii) Interest rate swaps and cross-currency interest rate swaps
are valued based on discounted cash flows using current market
yields and exchange rates.
(iii) Credit default swaps are valued based on discounted cash
flows using current market yields and calculated default probabilities.
(iv) Forward foreign exchange contracts and equity index futures
contracts are valued based on quoted market prices.
NOTE
3 PORTFOLIO INVESTMENTS
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The majority of the
Fund's investments are held in pooled investment funds established
and administered by Alberta Finance. Pooled investment funds have
a market based unit value that is used to allocate income to participants
and to value purchases and sales of pool units. As at December
31, 2004, the Fund's percentage ownership, at market, in pooled
investment funds is as follows:
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(a)The Consolidated Cash Investment
Trust Fund is managed with the objective of providing competitive
interest income to depositors while maintaining appropriate security
and liquidity of depositors' capital. The portfolio is comprised
of high-quality short-term and mid-term fixed-income securities
with a maximum term-to-maturity of three years. As at December
31, 2004, securities held by the Fund have an average effective
market yield of 2.64% per annum (March 31, 2004: 2.11% per annum).
(b) The Canadian Dollar Public Bond Pool is managed with the
objective of providing above average returns compared to the total
return of the Scotia Capital Universe Bond Index over a four-year
period while maintaining adequate security and liquidity of participants'
capital. The excess return is achieved through management of portfolio
duration and sector rotation. The portfolio is comprised of high
quality Canadian fixed-income instruments and debt related derivatives.
As at December 31, 2004, securities held by the Pool have an average
effective market yield of 4.31% per annum (March 31, 2004: 4.20%
per annum) and the following term structure based on principal
amount: under 1 year: 2% (March 31, 2004: 2%); 1 to 5 years: 39%
(March 31, 2004: 40%); 5 to 10 years: 31% (March 31, 2004: 30%);
10 to 20 years: 13% (March 31, 2004: 10%); over 20 years: 15%
(March 31, 2004: 18%).
(c) As at December 31, 2004, fixed-income securities held directly
by the Fund have an average effective market yield of 3.04% per
annum (March 31, 2004: 2.69% per annum). As at December 31, 2004,
fixed-income securities have the following term structure based
on principal amount: under one year: 100%.
(d) The Private Mortgage Pool is managed with the objective of
providing investment returns higher than attainable from the Scotia
Capital Universe Bond Index over a four-year period or longer.
The portfolio is comprised primarily of high quality commercial
mortgage loans (93.9%) and provincial bond residuals (6.1%). To
limit investment risk, mortgage loans are restricted to first
mortgage loans, diversified by property usage and geographic location,
and include a small portion of NHA insured loans. As at December
31, 2004, securities held by the Pool have an average effective
market yield of 5.18% per annum (March 31, 2004: 5.50% per annum)
and the following term structure based on principal amount: under
1 year: 4% (March 31, 2004: 7%); 1 to 5 years: 21% (March 31,
2004: 23%); 5 to 10 years: 41% (March 31, 2004: 26%); 10 to 20
years: 14% (March 31, 2004: 20%); and over 20 years: 20% (March
31, 2004: 24%).
(e) As at December 31, 2004, Provincial corporation debentures
have an average effective market yield of 7.44% per annum (March
31, 2004: 7.10% per annum) and the following term structure based
on principal amounts: 5 to 10 years: 100%.
(f) Investments in loans are recorded at cost. The fair value
of loans is estimated by management based on the present value
of discounted cash flows.
As at December 31, 2004, investment in loans, at cost, include
the Ridley Grain loan amounting to $91,245, 000 (March 31, 2004:
$91,245,000) and the Vencap loan amounting to $2,014,000 (March
31, 2004: $1,899,000). The increase in the carrying value of the
Vencap loan resulted from amortization of the loan on a constant
yield basis.
- Under the
terms of the loan to Ridley Grain, 11% Participating First Mortgage
Bonds due July 31, 2015, interest is compounded semi-annually
and payable annually to the extent of available cash flow and
any shortfall is to be deferred and capitalized. The principal
of $91,245,000 and deferred interest is repayable on or before
July 31, 2015. Deferred interest at December 31, 2004 amounted
to $92,516,697 (March 31, 2004: $88,414,959). Grain throughput
volumes are the main determinant of profitability of the grain
terminal and the value of the loan to the Fund. Due to the uncertainty
of forecasting the grain throughput volumes, income from the
participating bonds is recognized when it is measurable and
collectable.
- The principal
amount of the Vencap loan, amounting to $52,588,000, is due
July 2046 and bears no interest.
(g) The Domestic Passive Equity
Pooled Fund is managed on a passive approach with the objective
of providing investment returns comparable to the Toronto Stock
Exchange S&P/TSX Composite Index. The portfolio is comprised
of publicly traded Canadian equities and structured investments
replicating the S&P/TSX 60 Index. The Pool's investment in
units of the Floating Rate Note Pool (FRNP) are used as the underlying
securities to support the index swaps of the pool. FRNP is managed
with the objective of generating floating rate income needed for
the swap obligations in respect of structured investments in foreign
equities, domestic equities and domestic bonds. Through the use
of interest rate swaps, FRNP provides investment opportunities
in high quality floating-rate instruments with remaining term-to-maturity
of five years or less.
(h) The Canadian Pooled Equity Fund is managed with the objective
of providing competitive returns comparable to the total return
of the S&P/TSX Composite Index while maintaining
maximum preservation of participants' capital. The portfolio
is comprised of publicly traded equities in Canadian corporations.
Risk is reduced by prudent security selection and sector rotation.
(i) The externally managed Canadian Equity Enhanced Index Pool
allows participants the opportunity to gain investment exposure
to the Canadian large cap equity market. The performance objective
is to provide returns higher than the total return of the S&P/TSX
Composite Index over a four-year moving average period. The portfolio
is comprised of publicly traded equities in Canadian corporations.
The enhanced index generates a consistent level of return above
the Index with relatively low risk.
(j) The Canadian Large Cap Equity Pool consists of multiple portfolios
of publicly traded Canadian equities. The portfolios are actively
managed by external managers with expertise in the Canadian large
cap equity market. The performance objective is to provide returns
higher than the total return of the S&P/TSX Composite Index
over a four-year period. Return volatility is reduced through
multiple manager investment style and market capitalization focus.
(k) The Growing Equity Income Pool is managed with the objective
of providing a steady and growing stream of dividend income by
investing in mature companies with strong financial characteristics
and growing distributions. Risk is reduced by holding established
well capitalized companies. The performance of the pool is measured
against the total return of the S&P/TSX Composite Index.
(l) The Canadian Multi-Cap Pool allows participants to gain investment
exposure to the Canadian equity market through internally managed
structured investments replicating the S&P/TSX 60 Index and
external actively managed Canadian small and mid cap investments.
The performance of the pool is measured against the total return
of the S&P/TSX Composite Index over a four-year moving average
period.
(m)Publicly traded US equities held in the S & P 500 Index
Fund replicate the Standard & Poor's (S&P) 500 Index.
The performance objective is to provide returns comparable to
the total return of the S&P 500 Index over a four-year period.
The Pool's investment in units of the Floating Rate Note Pool
(FRNP) are used as the underlying securities to support the index
swaps of the pool (see Note 3g).
(n) The US Large Cap Equity Pool consists of multiple portfolios
of publicly traded United States equities. Each portfolio is actively
managed by an external manager with expertise in the US large
cap equity market. The performance objective is to provide returns
higher than the total return of the Standard & Poor's (S&P)
500 Index over a four-year period. Return volatility is reduced
through multiple manager investment style and large capitalization
focus.
(o) The US Small/Mid Cap Equity Pool consists of one portfolio
of publicly traded United States equities. The portfolio is actively
managed by an external manager with expertise in the small cap
and mid cap US equity market. The performance objective is to
provide returns higher than the total return of the Russell 2500
Index over a four-year period.
(p) The Portable Alpha United States Equity Pool consists of
futures and swap contracts which provide exposure to the U.S.
equity market by replicating the S&P 500 Index and investments
in value added absolute return strategies. The performance objective
is to provide returns higher than the total return of the Standard
& Poor's S&P 500 Index over a four-year period.
(q) The Europe, Australasia and Far East (EAFE) Core and Plus
Equity Pools consist of multiple portfolios of publicly traded
non-North American equities. EAFE Core portfolios are actively
managed by external managers with European and Pacific Basin mandates.
EAFE core managers have constraints on foreign currency management
and deviations from the MSCI EAFE Index asset mix by country.
The EAFE Plus portfolios are actively managed by external managers
with less constraints on country allocation, stock selection,
currency management and investments in emerging markets. The performance
objective is to provide returns higher than the total return of
the Morgan Stanley Capital International (MSCI) EAFE Index over
a four-year period.
(r) The externally managed EAFE Passive Equity Pool consists of
one portfolio of non-North American publicly traded equities that
replicates the MSCI EAFE Index. The performance objective is to
provide returns comparable to the total return of the MSCI EAFE
Index over a four-year period.
(s) The External Managers Emerging Markets Equity Pool consists
of publicly traded equities in emerging markets around the world.
The portfolio is actively managed by external managers with expertise
in emerging markets. The performance objective is to provide returns
higher than the total return of the Morgan Stanley Capital Index
Emerging Markets Free (MSCI EMF) Index over a four-year period.
(t) The Private Real Estate Pool is managed with the objective
of providing investment returns higher than the Consumer Price
Index plus 5%. Real estate is held through intermediary companies
which have issued to the Pool, common shares and participating
debentures secured by a charge on real estate. Risk is reduced
by investing in properties that provide diversification by geographic
location, by property type and by tenancy. As real estate returns
are positively correlated to inflation and negatively correlated
to returns from fixed income securities and equities, the Pool
provides diversification from the securities market with opportunities
for high return.
(u) The Foreign Private Real Estate Pool is managed with the objective
of providing investment returns higher than the Consumer Price
Index plus 5%. The Pool provides diverse exposure to non-domestic
real estate by investing in foreign real estate backed securities
and assets.
(v) The Absolute Return Strategy Pool is managed with the objective
of providing investment returns higher than the Consumer Price
Index (CPI) plus 6%. The Pool uses external managers who employ
various investment strategies. These strategies are expected to
produce absolute positive investment returns with lower volatility.
(w) Private Equity Pools are managed with the objective of providing
investment returns higher than the Consumer Price Index (CPI)
plus 8.0%. The Private Equity Portfolio consists of the Private
Equity Pool, PEP98, PEP02, PEP04 and the Foreign Private Equity
Pool 2002. Private equity investments are held in institutionally
sponsored private equity pools. Risk is reduced by avoiding direct
investments in private companies and by limiting holdings in any
single pool. The Private Income Pool invests in infrastructure
related projects that are structured to yield high current income
with the objective of providing investment returns higher than
the CPI plus 6.0%.
(x) Where there has been a loss in value of an investment that
is other than a temporary decline, the cost of the investment
is written down to recognize the loss (see Note 2 (a)). Where
the fair value remains less than cost, after recording a writedown,
it is management's best judgement that the decline in value is
caused by short-term market trends and is temporary in nature.
NOTE
4 DERIVATIVE CONTRACTS
Derivative contracts are financial contracts, the
value of which is derived from the value of underlying assets,
indices, interest rates or currency rates. The Fund uses derivative
contracts held indirectly through pooled investment funds to enhance
return, manage exposure to interest rate risk and foreign currency
risk and for asset mix management purposes. The notional value
of a derivative contract represents the amount to which a rate
or price is applied in order to calculate the exchange of cash
flows.
(i) A swap is a contractual agreement between two counter-parties
to exchange a series of cash flows based on a notional amount.
An equity or bond index swap involves the exchange of a floating
interest rate cash flow for one based on the performance of a
market index. For interest rate swaps, parties generally exchange
fixed and floating rate interest cash flows based on a notional
amount. Cross-currency interest rate swaps are contractual obligations
in which the principal amounts of Canadian fixed-income securities
denominated in foreign currency are exchanged for Canadian currency
amounts both initially and at maturity. Over the term of the cross-currency
swap, counter-parties exchange fixed to fixed and fixed to floating
interest rate cash flows in the swapped currencies. A credit default
swap allows counter-parties to buy and sell protection on credit
risk inherent in a bond. A premium is paid, based on a notional
amount, from one counter party to a second counter party in exchange
for a contingent payment should a defined credit event occur with
respect to the underlying security. There are underlying securities
supporting all swaps. Leveraging is not allowed.
(ii) Forward foreign exchange contracts are contractual agreements
to exchange specified currencies at an agreed upon exchange rate
and on an agreed settlement date in the future.
(iii) An equity index futures contract is an agreement to receive
or pay cash based on changes in the level of the specified stock
index.
The following is a summary
of the Fund's proportionate share of the notional amount and fair
value of derivative contracts held by pooled funds at December
31, 2004.
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(a) The method of determining
the fair value of derivative contracts is described in note 2
(e).
NOTE
5 INVESTMENT RISK MANAGEMENT
Income and financial
returns of the Fund are exposed to credit risk and price risk.
Credit risk relates to the possibility that a loss may occur from
the failure of another party to perform according to the terms
of a contract. Price risk is comprised of currency risk, interest
rate risk and market risk. Currency risk relates to the possibility
that the investments will change in value due to future fluctuations
in foreign exchange rates. Interest rate risk relates to the possibility
that the investments will change in value due to future fluctuations
in market interest rates. Market risk relates to the possibility
that the investments will change in value due to future fluctuations
in market prices.
The Standing Committee on the Alberta Heritage Savings Trust
Fund reviews and approves the business plan of the Fund. In order
to earn an optimal financial return at an acceptable level of
risk, the 2004-2007 Business Plan proposes the following asset
mix policy for the Endowment Portfolio.
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Risk is reduced through
asset class diversification, diversification within each asset
class, quality and duration constraints on fixed-income instruments,
and restrictions on amounts exposed to countries designated as
emerging markets. Controls are in place respecting the use of
derivatives (see Note 4). Forward foreign exchange contracts may
be used to manage currency exposure in connection with securities
purchased in foreign currency (see Note 4).
NOTE
6 FUND EQUITY
Section 8 (2) of the
Alberta Heritage Savings Trust Fund Act (the Act) states
that the net income of the Heritage Fund less any amount retained
in the Fund to maintain its value shall be transferred to the
General Revenue Fund annually in a manner determined by the Minister
of Finance.
Section 11(4) of the Act states that for fiscal years subsequent
to 1999 and until the accumulated debt is eliminated in accordance
with the Fiscal Responsibility Act, the Minister of Finance
is not required to retain any income in the Heritage Fund to maintain
its value, but may retain such amounts as the Minister of Finance
considers advisable.
NOTE
7 NET INCOME (LOSS)
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Investment income (loss)
is comprised of interest, dividends, amortization of discount
and premiums, swap income, security lending income and realized
gains and losses, net of write-downs, on investments. The Fund's
share of income (loss) earned from externally and internally managed
investment pools is net of administrative expenses incurred by
the pools. (See Note 8).
The investment income for the nine months ended December 31,
2004 includes writedowns totalling $23,966,000 (December 31, 2003:
$2,535,000).
NOTE
8 ADMINISTRATIVE EXPENSES
Administrative expense
includes investment management, cash management, safekeeping costs
and other expenses charged on a cost-recovery basis directly from
Alberta Finance. The Fund's total administrative expense for the
period, including amounts deducted directly from investment income
of pooled funds is as follows:
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NOTE
9 INVESTMENT PERFORMANCE
The following is a summary
of the investment performance results attained by the Fund determined
on a fair value basis:
NOTE
10 APPROVAL OF FINANCIAL STATEMENTS
The Ministry of Finance,
Deputy Minister of Revenue approved these financial statements.
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