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Alberta
Heritage Savings Trust Fund |
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Alberta
Heritage Savings Trust Fund |
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Released: August 27, 2002 If you would prefer to download this file in
pdf format, click here. Index
Volatility in world equity markets over the past two years continued this quarter. The Canadian stock market measured by the Toronto Stock Exchange, S&P/TSX, declined by 8.6% this quarter, while US stocks measured by the Standard & Poor 500 declined by 17.4%. Information technology and telecommunication services sectors lead the decline in value of share prices on most world stock markets. Declining investor confidence in corporate governance, corporate accounting and corporate earnings forecasts contributed to the fall in share prices of major public corporations.
Investments and investment income are recorded on the financial statements of the Heritage Fund at cost in accordance with government accounting policies. The fair value of the Fund and its investments are provided for information purposes. Management uses fair value to assess the investment performance of the fund against market-based benchmarks.
The Fund recorded a net loss of $84 million for the three months ended June 30, 2002. Realized capital losses from declining world stock markets, primarily in the information technology and telecommunication services sectors, contributed to the loss. Over the quarter, losses from equity investments of $165 million were offset by income from bonds, notes and short term paper of $75 million and real estate income of $6 million. A summary of investment income (loss) follows:
Forecasted net investment income of the Fund for the fiscal year ending March 31, 2003 was reduced from $589 million to $61 million. On a consolidated basis, forecasted net investment income was reduced from $573 million to $46 million. Consolidated forecasted net income
excludes income from holdings of Alberta government securities and Provincial Corporation debentures.
The Heritage Fund accounts for its investments on a cost basis of accounting. Investment income on a cost basis excludes unrealized gains and losses. Investment income on a fair value basis includes unrealized gains and losses. The investment loss on a fair value basis for the first quarter is $582 million.
Transfers to General Revenue Fund The realized investment income earned by the Fund is not reinvested in the Fund. Instead, all of the net income is transferred to the Province's main operating fund, the General Revenue Fund (GRF), and used for Albertans' priorities like health care, education, roads, tax reductions and debt repayment. Changes in unrealized gains and losses are not included in amounts transferred to the General Revenue Fund. The Fund recorded a net loss of $84 million during the quarter. As a result, at June 30, 2002, the Fund’s total receivable from GRF amounted to $147 million, representing transfers made to GRF for the three months ended June 30, 2002 based on forecasted income The loss of $84 million reduces the Fund's equity on a cost basis and is carried forward to reduce transfers resulting from income earned during the remaining nine months of the year.
The investment strategy is to invest in a diversified portfolio to optimize long-term returns at an acceptable level of risk. The policy asset allocation is reported in the Fund's 2002-05 business plan as follows:
For the 2002-03 fiscal year, the policy asset mix for fixed income securities remains the same as the previous year at 35%. The policy mix for equity investments decreases from 58% to 55% while real estate investments increased from 7% to 10% of the total portfolio. The actual investment mix changed over the quarter. Fixed income securities declined from 43% to 39.1% as the transition portfolio was wound down. Equity investments increased slightly from 52.3% to 53.8% and real estate investments increased from 4.7% to 7.1%.
A decision was made a few years ago to invest in assets that provide higher long-term rates of return. This would mean a portfolio with a significant commitment to equities and real estate. Equity investments have a greater potential for variations in performance from year to year. However, during the three months ended June 30, 2002, the Heritage Fund posted an overall loss of 4.8%. Negative returns from Canadian, U.S. and non-North American equity investments were offset by positive returns from the fixed income investments and real estate. The performance of the Heritage Fund is measured over the long term. Over the past four-year period, the fund generated an annualized return of 3.1%.
The performance of the Heritage Fund investments is measured against various market-based indices. Value added by investment management is accomplished through asset mix decisions and security selection.
The Canadian bond market performed well this quarter. The Scotia Capital (SC) Universe Bond Index measures the performance of marketable Canadian bonds with terms to maturity of more than one year. Over the past quarter, the SC Universe Bond Index increased by 3.1% while the short term SC 91-Day T-Bill Index increased by 0.6%.
The Fund's actual return from short-term securities was 0.6%, equal to the benchmark. The Fund's actual rate of return over the quarter from long-term Canadian bonds was 3.2%, 10 basis points better than the benchmark SC Universe Bond Index. Over four-years, the returns from both short-term and long-term securities exceeded their benchmarks by 20 basis points and 50 basis points respectively. The out-performance was due to higher weight in corporate bonds and good duration management. At June 30, 2002, investments in fixed income securities totaled $4.6 billion or 39.1%, down from $5.4 billion or 43.0% at March 31, 2002, due to the phasing out of the transition portfolio.
The Canadian stock market declined over the quarter with the information technology sector leading the way. Declining investor confidence in corporate earnings forecasts, accounting information and corporate governance contributed to the decline. The Toronto Stock Exchange (S&P/TSX), which measures the performance of Canada's largest companies in ten industrial sectors, decreased by 8.6% over the quarter ending June 30, 2002.
The Heritage Fund's Canadian equity portfolio is held in various investment pools, which are managed by internal and external managers. Over the quarter, the Fund's loss from Canadian equities was 8.5%, 10 basis points better than the benchmark S&P/TSX. Over four years, the Fund's return from Canadian equities was 0.3%, 40 basis points less than the benchmark. At June 30, 2002, Canadian equity investments totaled $2.5 billion or 21.2% of the Heritage Fund investment portfolio compared to $2.6 billion or 20.7% at March 31, 2002.
The US equity market declined over the quarter. The Standard & Poor 500 Index, S&P 500, which measures the performance of the top 500 American companies, decreased by 17.4% over the quarter when measured in Canadian dollars.
The Fund's loss over the quarter from US equities was 16.9%, 50 basis points better than the S&P 500. Over four years, the Fund's return from US equities was negative 1.2%, equal to the benchmark. At June 30, 2002, US equity investments totaled $1.9 billion or 16.1% of the Heritage Fund investment portfolio compared to $2.0 billion or 15.8% at March 31, 2002.
Non-North American Equity Investments Various external managers who have expertise in foreign equity markets, manage the Heritage Fund's non-North American equity portfolio. The Morgan Stanley Composite Index for Europe, Australasia and the Far East, MSCI EAFE, measures the performance of approximately 1000 companies on 21 stock exchanges around the world. The index recorded a loss of 6.7% this quarter.
The Fund's actual loss from non-North American equities was 6.5%, 20 basis points better than the MSCI EAFE Index. Over four years, the Fund returned 0.7% from non-North American equities, 330 basis points better than the benchmark. At June 30, 2002, investments in non-North American equities totaled $1.9 billion or 16.5% of the Heritage Fund investment portfolio compared to $2.0 billion or 15.8% at March 31, 2002.
The real estate market in Canada continued to grow this quarter. The Fund's real estate investments are held in the internally managed Private Real Estate Pool. Nearly half of the real estate portfolio is invested in retail, half in office and a small portion in industrial and residential properties. Approximately two-thirds of the real estate portfolio is invested in Ontario, one quarter in Alberta and a small portion in British Columbia and Quebec. The Fund’s real estate portfolio earned 1.3% this quarter, 100 basis points less than the benchmark, CPI plus 5%. Over four years, the real estate portfolio returned 9.2%, 240 basis points less than the benchmark. Real estate investments are reported at their most recent appraised value. Real estate properties are appraised annually, on a staggered basis, by qualified external real estate appraisers.
At June 30, 2002, investments in real estate totaled $842 million or 7.1%, up from $594 million or 4.7% at March 31, 2002. Management intends to increase the Fund’s investment in real estate to the policy target of 10% of total investments as real estate investment opportunities become available.
Business Plan Performance Measures
The combined rate of return is determined by adding the proportionate market value returns of each portfolio and adjusting for the timing of cash flows from the Transition Portfolio to the Endowment Portfolio.
Administrative expense includes investment management, cash management, custodial fees and other expenses. External management and custodial fees are deducted directly from the income of the externally managed investment pools. Internal administrative expenses are deducted from the internally managed pooled funds and directly from the Heritage Fund.
The increase in administrative expense is related to an increase in U.S. and non-North American equity investments which are externally managed and more expensive to administer.
Alberta
Heritage Savings Trust Fund
Financial Statements
Statement of Changes in Financial Position
Notes
to the Financial Statements 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. NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND REPORTING PRACTICES These financial statements are prepared in accordance with generally accepted accounting principles.
(e) Valuation of Derivative Contracts
NOTE 3 PORTFOLIO INVESTMENTS
The majority of the Fund's investments are held in pooled investment funds established and administered by Alberta Revenue. 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 June 30, 2002, the Fund's percentage ownership, at market, in pooled investment funds is as follows:
(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 five years. As at June 30, 2002, securities held by the Fund have an average effective market yield of 3.0% per annum (March 31, 2002: 2.57% per annum).
(f) 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 (TSX) Index. A portion of the portfolio is comprised of both publicly traded Canadian equities and structured investments replicating the TSX 100 Index and the TSX 60 Index. The other portion of the portfolio fully replicates the TSX 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 ten years or less.
(r) A summary of investments held in the Endowment Portfolio and Transition Portfolio is as follows:
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. There are underlying securities supporting all swaps. Leveraging is not allowed. 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 June 30, 2002.
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 2002-2003 business plan limits investments of the Transition Portfolio to include only fixed-income securities other than securities transferred from the previous structure and proposes the following asset mix policy for the Endowment Portfolio.
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 (GRF) annually in a manner determined by the Minister of Revenue. The Fund's net loss for the three months ended June 30, 2002, amounting to $84,122,000 has been applied against retained earnings and is carried forward to reduce transfers to GRF resulting from income earned in the remaining nine months of the fiscal year ending March 31, 2003. As at June 30, 2002, the Fund's total receivable from GRF amounted to $147,000,000 representing transfers made to GRF for the three months ended June 30, 2002 based on forecasted income. Section 11(5) 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 Revenue is not required to retain any income in the Heritage Fund to maintain its value, but may retain such amounts as the Minister of Revenue considers advisable. NOTE 7 NET INCOME Administrative expense includes investment management, cash management, safekeeping costs and other expenses charged on a cost-recovery basis directly from Alberta Revenue. The Fund’s total administrative expense for the period, including amounts deducted directly from investment income of pooled funds is as follows:
Investment income 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 earned from externally and internally managed investment pools is net of administrative expenses incurred by the pools. (see Note 8). Investment income for the three months ended June 30, 2002 includes a net loss from disposals of investments and writedowns totalling $140,718,000 (June 30, 2001: net gain $4,236,000). A summary of investment income (loss) earned in the Endowment Portfolio and Transition Portfolio is as follows:
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 Revenue. The Fund's total administrative expense for the period, including amounts deducted directly from investment income of pooled funds is as follows:
NOTE 9 COMPARATIVE FIGURES Certain comparative figures have been reclassified to conform to June 30, 2002 presentation. NOTE 10 APPROVAL OF FINANCIAL STATEMENTS These financial statements were approved by the Deputy Minister of Revenue.
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