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Alberta
Heritage Savings Trust Fund |
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Alberta
Heritage Savings Trust Fund |
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Released: February 25, 2004 If you would prefer to download
this file in pdf format, click here. Index
World stock markets continued their upward trend this quarter, marking the third consecutive quarter that markets have risen. Low interest rates, steadily improving corporate earnings and increasing investor confidence continue to fuel the recovery in the stock market. The rebound in the global economy is being driven primarily by strong growth in the United States. After three years of belt tightening, companies are once again posting solid profits and increasing capital expenditures. As a result, the fair value of the Heritage Fund increased by $753 million this quarter and $2.0 billion over the past nine months. While gains in equity markets over the past nine months have been significant, the Heritage Fund maintains a long-term investment strategy and holds a diversified portfolio of assets to avoid over exposure to any particular asset class.
At December 31, 2003, the fair value of the Heritage Fund stood at $12.4 billion up from $11.9 billion at September 30, 2003 and $11.1 billion at March 31, 2003. Over the past nine months, the fair value of the Fund increased by $2.0 billion of which $703 million was transferred or payable to the General Revenue Fund resulting in a net increase in fair value of $1.3 billion. Overall, the Fund returned 6.3% from its investments this quarter and 18.0% over nine months. Fund equity, at cost, remained unchanged at $11.4 billion because all of the Fund’s net income is transferred to the General Revenue Fund.
The Canadian stock market rose again this quarter despite the appreciation in the Canadian dollar that has made exports more expensive and constrained growth. The S&P/TSX increased by 11.3% during the quarter and 31.4% over nine months. The materials, energy and financials sectors led all ten stock market industry sectors this quarter. Over nine months the technology sector posted the largest increase. The Canadian economy continued to generate new jobs. December marked the fourth consecutive month of employment growth in Canada. The housing market was particularly strong, setting new records in 2003 due in large part to low interest rates and job growth. The US economy accelerated this quarter. The US service sector grew while US factories expanded at a healthy pace. Worker productivity also rose, however employment is lagging. The strong increase in the non-North American market over nine months was fueled primarily from a stronger US economy.
The Fund recorded net income of $317 million this quarter bringing total net income over nine months to $703 million. Over nine months, the Fund earned $412 million from investments in equity markets, $228 million from investments in bonds, notes and short-term paper, $42 million from real estate investments and $21 million from absolute return strategies.
The Fund's forecast net income for the year ended March 31, 2004 is $979 million, an increase of $539 million from the original budget forecast of $440 million. On a consolidated basis, the forecast investment income is $964 million. The consolidated forecast income excludes income from holdings of Alberta 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 December 31, 2003 totals $753 million and $1,975 million over nine months.
Transfers to the General Revenue Fund 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 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 nine months ended December 31, 2003, amounted to $703 million of which $330 million was transferred to the General Revenue Fund and $373 million remains payable to GRF. Actual cash transfers of $330 over nine months or $110 million per quarter are based on one quarter of the original budget estimate of income of $440 million for fiscal year 2003-2004.
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 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.
The Heritage Fund posted an overall positive rate of return of 6.3% this quarter, 40 basis points better than the Fund's benchmark return of 5.9%. Over nine months, fund investments returned a healthy 18.0%, or 70 basis points better than the benchmark of 17.3%. The Fund earned positive returns from all asset classes.
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 posted lower returns 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 0.9% while the short term SC 91-Day T-Bill Index increased by 0.6%.
The Fund's actual rate of return over the quarter from Canadian bonds was 1.1%, 20 basis points better than the benchmark SC Bond Universe Index. The Fund's return from short-term securities was 0.7%, 10 basis points better than 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.
The Canadian stock market increased this quarter. The materials and energy sectors led the increase among the ten industry sectors. The Toronto Stock Exchange (S&P/TSX) Composite Index measures the performance of Canada's top companies in ten industrial sectors. The S&P/TSX Index increased by 11.3% for the three months ending December 31, 2003 and 31.4% over nine months.
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 11.3% equal to the benchmark S&P/TSX. Over four years, the fund's return from Canadian equities was 1.7% or 70 basis points better than the benchmark S&P/TSX. Good stock selection in small cap and large cap investment pools resulted in the out-performance.
The United States equity market recorded gains this quarter. Materials and energy stocks led the increase in the US market over the quarter. The Standard & Poor's 500 Index, S&P 500, which measures the performance of the top 500 American companies, increased by 7.4% during the past three months and 16.9% over nine months in Canadian dollars.
The Fund's actual rate of return over the quarter from US equities was 7.4%, equal to the benchmark S&P 500. During the year, currency hedges added approximately 27 basis points to the performance of US equities. Over four years, the Fund's US equity portfolio returned a negative 7.3%, 70 basis points better than the benchmark S&P 500 Index. Over the long term, the out-performance was due to a weighting towards US small capitalization stocks.
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 12.1% this quarter in Canadian Dollars and 32.8% over the past nine months.
The Fund's actual return over the quarter from Non-North American equities was 11.9%, 20 basis points less than the benchmark MSCI EAFE Index. Over four years the Fund's Non-North American equity portfolio returned a negative 8.5%, 10 basis points better than the benchmark MSCI EAFE Index.
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 74% of real estate holdings are located in Ontario, 24% in Alberta and 2% in British Columbia. The Fund's real estate portfolio earned 2.7% this quarter or 130 basis points better than the benchmark. Over four years the Fund's return from real estate was 7.8% or 170 basis points less than the benchmark.
At December 31, 2003, investments in real estate totaled 7.4% or $936 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 3.6%, 200 basis points better than the benchmark Consumer Price Index (CPI) plus 6.0%. Over nine months, absolute return strategies returned 7.8%, 300 basis points better than the benchmark. The out-performance of the Absolute Return Strategy managers over nine months was protected by a currency hedge.
At December 31, 2003, investments in absolute return strategies totaled 2.9% or $365 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 or directly from the Fund.
Over the past nine months, expenses of direct and internally managed investment pools increased by $1.586 million over the same period last year. The net increase in expense for the internally managed pools was due to additional staffing requirements, system improvements and the transfer of US passively managed investments from external managers to internal managers.
Business Plan Performance Measures
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Alberta Heritage Savings Trust Fund Financial Statements December 31, 2003
Statement of Changes in Financial Position
Notes to the Financial Statements December 31, 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. NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND REPORTING PRACTICES These financial statements are prepared in accordance with generally accepted accounting principles. (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 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 December 31, 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 December 31, 2003, securities held by the Fund have an average effective market yield of 2.38% per annum (March 31, 2003: 3.23% per annum).
(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. 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. 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. 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 December 31, 2003.
(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.
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. NOTE 7 NET INCOME (LOSS)
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 9). NOTE 8 INVESTMENT PERFORMANCE The following is a summary of the investment performance results attained by the Fund determined on a fair value basis:
NOTE 9 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 10 COMPARATIVE FIGURES Certain comparative figures have been reclassified to conform to December 31, 2003 presentation. NOTE 11 APPROVAL OF FINANCIAL STATEMENTS These financial statements were approved by the Deputy Minister of Revenue.
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