 |
Alberta
Heritage Savings Trust Fund |
|
|
|
|
Alberta
Heritage Savings Trust Fund |
|
|
|
Released: August 27, 2003 If you would prefer to download
this file in pdf format, click here. Index
World stock markets surged ahead this
quarter. Better than expected corporate profit reports and low interest
rates helped fuel the recovery in the stock market. The information
technology, health care and telecommunications sectors posted the
strongest gains of the ten industry sectors in Canada, recording increases
of 21.7%, 21.2% and 20.1% respectively.
The Fund recorded net income of $199 million during the first quarter of 2003-04. The Fund earned $95 million from investments in equity markets, $77 million from investments in bonds, notes and short-term paper, $10 million from real estate investments and $17 million from absolute return strategies.
The forecast net income for the year ended March 31, 2004 is $440 million. On a consolidated basis, the forecast net income is $426 million. The consolidated forecast net income excludes income from holdings of 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 income on a fair value basis for the three months ended June 30, 2003 totals $786 million.
Transfers to General Revenue Fund 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 net income determined by the cost basis of accounting and therefore not transferred to the General Revenue Fund. The Fund’s net income for the quarter ended June 30, 2003, amounted to $199 million of which $110 million was transferred to the General Revenue Fund in June and $89 million remains payable to GRF. The cash transfer of $110 million during the quarter is based on one quarter of forecast income for 2003-04 of $440 million.
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. For cost-based accounting, the Fund’s policy is to write down the cost of those securities where the decline in value below cost is not considered temporary. On a quarterly basis, management reviews the Fund’s investment portfolio to identify those securities where the fair value has declined significantly below cost. The Fund’s net income of $199 million for the quarter ended June 30, 2003 includes write-downs of public equities totaling $1.7 million.
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 2003-06 business plan. For the 2003-04 fiscal year, the policy asset mix for fixed income securities remains the same as the previous year at 35%. The policy mix for public equity investments decreases from 50% to 45% due to a reduction in Canadian equity investments by 5%. Real estate investments remain unchanged at 10%. Private equities and absolute return strategies are each expected to increase to 5% of total portfolio holdings. The actual investment mix changed over the past quarter. Fixed income securities declined from 35.8% to 34.2%. Public equity investments increased from 52.9% to 54.7%. Real estate investments decreased from 7.9% to 7.7% of the Fund’s total investment portfolio. Absolute Return Strategies also declined from 2.6% to 2.5% of the Fund’s investment portfolio while private equity investments increased from 0.8% to 0.9%. These changes were largely due to the increase in market value of public equity investments over the quarter relative to other investments.
The Heritage Fund posted an overall positive rate of return of 7.1% this quarter, 40 basis points better than the benchmark return of 6.7%. The Fund earned positive returns from all asset classes. 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 1.7%. The Heritage Fund is expected to generate a real rate of return of 5.0% at an acceptable level of risk over a moving four-year period.
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 following sections describe the performance of the Fund’s major asset classes in relation to their benchmarks.
The Canadian bond market performed well this quarter. The Scotia Capital (SC) Bond Universe Index measures the performance of marketable Canadian bonds with terms to maturity of more than one year. Over the past quarter, the SC Bond Universe Index increased by 5.1% while the short term SC 91-Day T-Bill Index increased by 0.8%.
The Fund’s actual rate of
return over the quarter from Canadian bonds was 5.3%, 20 basis points
better than the benchmark SC Bond Universe Index. The Fund’s return from
short-term securities was 0.8% the same as the benchmark SC 91-Day T-Bill
Index. Over four years, returns from long-term and short-term securities
exceeded their benchmarks by 60 and 20 basis points respectively. The
out-performance over four years was primarily due to a higher weight in
corporate bonds and duration management. The Heritage Fund’s total fixed
income portfolio is internally managed through various pools and direct
holdings.
During the quarter, there were economic concerns related to SARS, BSE disease and a strengthening of the Canadian dollar against the US dollar. Despite these factors, the Canadian stock market had strong performance in the quarter. The Toronto Stock Exchange (S&P/TSX) Composite Index which measures the performance of Canada’s top companies in ten industrial sectors, increased by 10.6% for the three months ending June 30, 2003.
The Heritage Fund’s Canadian equity portfolio is held in various investment pools managed by internal and external managers. Over the quarter, the Fund’s actual return from Canadian equities was 10.3% or 30 basis points below the benchmark S&P/TSX, due to an underweight position in technology securities. Over four years, the fund’s return from Canadian equities was 1.5% or 80 basis points less than the benchmark S&P/TSX. Over the longterm, the under-performance was due to an over-weight position in growth oriented equities. At June 30, 2003, investments in Canadian public equities totaled 22.3% or $2.6 billion of the Heritage Fund investment portfolio compared to 21.4% or $2.4 billion at March 31, 2003.
The United States equity market showed positive gains this quarter. Better than expected corporate profit reports contributed to the increase in market prices. The Standard & Poor’s 500 Index (S&P 500), which measures the performance of the top 500 American companies, increased by 6.5% over the quarter in Canadian dollars.
The Fund’s actual rate of return over the quarter from US equities was 7.6% or 110 basis points better than the S&P 500. The out-performance was primarily due to a positive currency hedge return, a weighting towards US small capitalization stocks and good stock selection in US active mandates. Over four years, the Fund’s US equity portfolio returned a negative 8.2%, 70 basis points better than the benchmark S&P 500 Index.
Non-North American Equity Investments The Non-North American equity market recorded strong gains this quarter. The Morgan Stanley Capital International Index for Europe, Australasia and the Far East (MSCI EAFE Index) measures the performance of approximately 1,000 companies on 21 stock exchanges around the world. The index increased by 10.0% over the year in Canadian dollars.
The Fund’s actual return over the quarter from Non-North American equities was 11.3% or 130 basis points better than the MSCI EAFE Index. The out-performance was due to superior stock selection. Over four years the Fund’s Non-North American equity portfolio returned a negative 7.0%, 170 basis points better than the benchmark MSCI EAFE Index. The out-performance was due to superior stock selection for pacific region investments. At June 30, 2003, investments in non-North American equities totaled 16.5% or $1.9 billion of the Heritage Fund investment portfolio compared to 15.7% or $1.7 billion at March 31, 2003.
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. Approximately 70% of real estate holdings are located in Ontario, 28% in Alberta and 2% in British Columbia. The Fund’s real estate portfolio earned 1.3% this quarter and 8.3% over 4 years. For the current quarter, the real estate portfolio returned 30 basis points above the benchmark. The real estate portfolio returned 150 basis points below the benchmark over four years due to a relatively larger position in lower performing Ontario and Alberta office properties. However, the market dominant nature of these properties make them highly sought after and lower yielding.
At June 30, 2003, investments in real estate totaled 7.7% or $901 million of the Heritage Fund investment portfolio compared to 7.9% or $870 million at March 31, 2003.
Absolute return strategy investments were initiated late in the second quarter of last year. These strategies encompass a wide variety of investments with the objective of realizing positive returns regardless of the overall market direction. A common feature of many of these strategies is buying undervalued securities and selling short overvalued securities. Over the quarter, absolute return strategies generated a return of 2.8%, 160 basis points better than the benchmark Consumer Price Index (CPI) plus 6.0%.
At June 30, 2003, investments in absolute return strategies totaled 2.5% or $291 million of the Heritage Fund investment portfolio compared to 2.6% or $283 million at March 31, 2003.
Administrative expenses include investment management, cash management, custodial and other expenses. External management and custodial fees are deducted directly from the income of externally managed investment pools. Internal administrative expenses are deducted from the internally managed pooled funds and also directly from the Fund. In the first quarter of 2003-04 year, the administrative expenses charged directly to the Fund were $665 thousand compared to $420 thousand in the first quarter of 2002-03. The Fund’s total administrative expense for the three months ending June 30, 2003, including amounts deducted from the investment income of the pooled funds, amounted to $5.518 million or 0.047% of the Funds net assets at fair value compared to $3.98 million or 0.034% of net assets for the quarter ended June 30, 2002.
The increase in expenses related to externally managed investment pools was primarily due to the new Absolute Return Strategy Pool which was initiated in the second quarter of 2002-03. Administrative expenses of this pool totaled $1.5 million for the three months ended June 30, 2003 (June 30, 2002: nil). The increase in expenses from direct and internally managed investment pools resulted from additional staffing requirements and system improvements.
Business Plan Performance Measures
|
Alberta Heritage Savings Trust Fund Financial Statements June 30, 2003 (unaudited)
Statement of Changes in Financial Position
Notes to the Financial Statements June 30, 2003 (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 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 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. (c) Foreign Currency (d) Investment Valuation
(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, 2003, 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 three years. As at June 30, 2003, securities held by the Fund have an average effective market yield of 3.18% per annum (March 31, 2003: 3.23% 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 June 30, 2003, securities held by the Pool have an average effective market yield of 4.66% per annum (March 31, 2003: 5.41% per annum) and the following term structure based on principal amount: under 1 year: 2%; 1 to 5 years: 38%; 5 to 10 years: 33%; 10 to 20 years: 7%; over 20 years: 20%. (c) As at June 30, 2003, fixed-income securities held directly by the Fund have an average effective market yield of 3.50% per annum (March 31, 2003: 4.36% per annum). As at June 30, 2003, fixed-income securities have the following term structure based on principal amount: 1 to 5 years: 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 (95.1%) and provincial bond residuals (4.9%). 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 June 30, 2003, securities held by the Pool have an average effective market yield of 5.94% per annum (March 31, 2003: 6.43% per annum) and the following term structure based on principal amount: under 1 year: 3%; 1 to 5 years: 30%; 5 to 10 years: 21%; 10 to 20 years: 29%; and over 20 years: 17%. (e) As at June 30, 2003, Provincial corporation debentures have an average effective market yield of 7.32% per annum (March 31, 2003: 7.83% per annum) and the following term structure based on principal amounts: 5 to 10 years: 100%. (f) Investment 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 June 30, 2003, investment in loans, at cost, include the Ridley Grain loan amounting to $91,245,000 (March 31, 2003: $91,245,000) and the Vencap loan amounting to $6,114,000 (March 31, 2003: $6,114,000).
(g) The Domestic Passive Equity Pooled Fund is managed on a passive approach with the objective of providing investment returns comparable to the S&P/TSX Index. A portion of the portfolio is comprised of both publicly traded Canadian equities and structured investments replicating the S&P/TSX 100 Index and the S&P/TSX 60 Index. The other portion of the portfolio fully replicates the S&P/TSX. 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. (h) The Canadian Large Cap Equity Pool consists of multiple portfolios of publicly traded Canadian equities. Each portfolio is actively managed by an external manager 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 Index over a four-year period. Return volatility is reduced through multiple manager investment style and market capitalization focus. (i) The Canadian Pooled Equity Fund is managed with the objective of providing competitive returns comparable to the total return of the S&P/TSX 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. (j) The Canadian Small Cap Equity Pool consists of multiple portfolios of publicly traded Canadian equities with market capitalization of .15% of the S&P/TSX Index total market capitalization at time of purchase. Each portfolio is actively managed by an external manager with expertise in the Canadian small cap equity market. The performance objective is to provide returns higher than the total return of the S&P/TSX Index over a four-year period and returns higher than the Nesbitt Burns Small Cap Index over shorter time periods. Return volatility is reduced through multiple manager investment style and small capitalization focus. (k) 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). (l) 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. (m) 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. (n) 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. (o) The externally managed EAFE Passive Equity Pool consists of one portfolio of non-North American publicly traded equities that replicate 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. (p) 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. (q) 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. (r) Private Equity and Income 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, Foreign Private Equity Pool 2002 and the Private Income Pool. 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 allows unit holders to participate as equity investors in infrastructure related projects. (s) 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 are 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. 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 June 30, 2003.
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 2003-2004 business plan proposes the following asset mix policy for the Fund:
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 Revenue. 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
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 three months ended June 30, 2003 includes writedowns of public equities totalling $1,706,000 (June 30, 2002: $98,330,000). 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 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, 2003 presentation. NOTE 10 APPROVAL OF FINANCIAL STATEMENTS These financial statements were approved by the Deputy Minister of Revenue.
|
||
 |
|
|
Copyright © 2003 Government of Alberta. Revenue.Webmaster@gov.ab.ca |
||
