2006-07
Quarterly Report:
Alberta
Heritage Savings Trust Fund
Second Quarter
Update
Released: November
15, 2006
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Index
Quarter
in Review
The net assets of the Alberta Heritage
Savings Fund (the Fund) increased by $995 million in the second
quarter of 2006-07. Contributions, inflation-proofing and unrealized
capital gains accounted for the increase during the quarter. Taking
into account unrealized capital losses and inflation-proofing
in the first quarter, the total increase over six months was $573
million. At September 30, 2006, the fair value of the Fund's net
assets totalled $15.4 billion compared to $14.4 billion at June
30, 2006 and $14.8 billion at March 31, 2006.
In September, the Government transferred
$650 million into the Fund from the General Revenue Fund (GRF).
In addition, $71 million this quarter and $142 million over six
months was retained in the Fund to protect its value from inflation.
All of the Fund's investment income is transferred to the Province's
general revenues except for the amount retained in the Fund for
inflation-proofing. The Fund's unrealized capital gain on investments
totalling $274 million during the quarter partially offset last
quarter's unrealized capital loss of $493 million, resulting in
a net overall unrealized capital loss of $219 million over six
months.
The Fund's second quarter
investment income of $331 million and unrealized capital gain
of $274 million accounted for the investment return of 4.1% this
quarter compared to 3.4% for the same period last year. Over six
months, the Fund's investment income of $503 million and unrealized
capital loss of $219 million accounted for the investment return
of 1.9%. In the first six months of last year, the Fund reported
investment income of $646 million and unrealized capital gain
of $196 million for a return of 6.9%. The market correction in
the first quarter of 2006-07 and decline in value of investments
resulted in lower investment income and returns over six months
compared to the same period last year.
The following table
summaries the change in major world equity and bond market indices
during the quarter and six months ended September 30, 2006.
The Canadian stock market,
represented by the S&P;/TSX Index, increased by 1.9% this quarter.
The increase partially offset last quarter's decrease of 3.5%
for an overall net decrease of 1.7% over six months.
In the S&P;/TSX Index,
the telecommunication services and information technology sectors
had the greatest increases while the health care and energy sectors
had the largest declines. While unemployment, inflation and interest
rates remain relatively low, the manufacturing industry in central
Canada struggled amid a stronger Canadian dollar and increased
overseas competition. Oil prices continued to slip; West Texas
Intermediate closed the quarter at $62.91 U.S. per barrel compared
to $73.93 U.S. per barrel at the beginning of the quarter.
The Canadian dollar
remained largely unchanged from the beginning of the quarter but
was stronger overall since the beginning of the year. One U.S.
dollar purchased $1.12 Canadian at September 30, 2006 compared
to $1.17 Canadian at March 31, 2006. When the Canadian dollar
is stronger, the value of the Fund investment in U.S. equities
decreases when translated into Canadian dollars, resulting in
lower investment returns. Over the past three months, the U.S.
market measured by the S&P; 1500 Index increased by 4.9% when translated
into Canadian dollars.
The non-North American
market measured by the MSCI EAFE Index increased by 4.0% this
quarter in Canadian dollars.
Change
in Net Assets
The Fund accounts for its investments
and investment income using the cost basis of accounting. Investments
and investment income recorded on a cost basis exclude unrealized
gains and losses. Investment income on a fair value basis includes
changes in unrealized gains and losses during the period. The
investment income on a fair value basis for the three months
and six months ended September 30, 2006 was $605 million and
$284 million respectively.
At September 30, 2006, the fair
value of investments was $15.4 billion compared to the cost
of investments of $14.3 billion (see page 17). The accumulated
unrealized gain of $1.107 billion was up $274 million from June
30, 2006 and down $219 million from March 31, 2006.
Investment
Income
The Fund's net income of $503 million
over the first six months of fiscal 2006-07 was lower than the
income of $646 million recorded for the same period last year.
Over six months, interest, dividends, real estate income and security
lending income totalled $293 million net of administrative expenses,
compared to $236 million for the same period last year. Net realized
capital gains from sale of securities and gains and losses from
derivative transactions totalled $210 million over six months,
compared to $410 million for the same period last year.
2006-07
Government Estimates
Forecast
Income
The Fund's forecast income is reviewed
and updated as the year progresses. The estimated forecast income
for the year is currently $1.154 billion. This represents an
increase of $237 million from the Fund's original budgeted income
at the beginning of the year totalling $917 million, which is
included in the 2006-07 Government Estimates. The increase is
due to an improvement in world equity markets in the second
quarter and higher than expected realized capital gains. On
a consolidated basis, after the elimination of income from Alberta
provincial corporation securities, the forecast income is $1.117
billion.
Heritage Fund
Investment Income
Forecast
Inflation Proofing
In order to maintain
the value of the Fund, the 2006-07 Government Estimates provided
for inflation proofing of the Fund in the amount of $242 million.
The inflation-proofing forecast was subsequently increased by
$41.4 million to $283.4 million due to an increase in the estimate
of inflation for the year. Half of this amount or $141.7 million
has been accrued for the first six months of fiscal 2006-07.
The net income earned by the Fund, less the amount retained
in the Fund for inflation proofing is transferred to the Province's
main operating fund, the General Revenue Fund.
Forecast
Transfers into the Fund
The 2006-07 Government
Estimates included $1 billion to be transferred into the Fund
from the Government's allocated surplus. In September, $400
million of this amount was transferred from GRF to the Fund.
Also in September, an additional $250 million was transferred
into the Fund from GRF under the Access to the Future Act
(see Note 6 (a) to the financial statements). Transfers from
GRF are recorded when received.
Transfers
to the General Revenue Fund
At September 30, 2006,
the outstanding transfers payable to the GRF totalled $39 million.
Investments
Asset
Mix
The investment strategy is to invest
in a diversified portfolio to maximize long-term returns at
an acceptable level of risk. The policy asset allocation is
reported in the Fund's 2006-09 business plan as follows:
Investments are made
within a range of the long-term policy asset mix, taking into
account the specific asset class and transition period required.
The longterm policy asset mix for the Fund consists of fixed
income securities (30%), public equities (45%), real estate
(10%) and alternative investments (15%). Alternative investments
include absolute return strategies, private equities, private
income and timberland. These investments are in a relatively
illiquid asset class and require time to build up to their target
asset mix.
The actual investment
mix for fixed income securities decreased slightly to 32.8%
from 33.3% at the beginning of the year while public equity
investments decreased to 49.4% from 50.6%. Real estate investments
increased to 10.1% from 9.6% of the Fund's total investment
portfolio. Absolute return strategies increased to 4.2% from
3.8%. Private equity investments increased to 2.2% from 1.7%.
Private income investments increased to 0.9% from 0.6%. Timberland
investments were unchanged from the beginning of the year at
0.4%.
Investment
Valuation
Investments and investment income
are recorded on the financial statements of the 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'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.
Based on management's review this quarter, additional writedowns
of $12.82 million were recorded, bringing total write-downs
for the first six months of 2006-07 to $22.99 million.
Administrative
Expenses
Income from pooled investment funds
is net of internal management expenses and external management
fees. Internal management expenses include those expenses recovered
by Alberta Finance for management of the Fund and investment pools.
External fees include fees charged to investment pools by external
investment managers based on a percentage of net assets under
management at fair value and committed amounts in the case of
private equity and private income pools.
The Fund's total administrative expenses
for the six months ended September 30, 2006, including amounts
deducted from the investment income of the pooled funds, amounted
to $23.54 million or 0.15% of the Funds net assets at fair value
compared to $21.66 million or 0.17% of net assets the previous
period.
Internal expenses decreased
by $1.15 million compared to the same period last year. The decrease
was due to the timing and recognition of expenses rather than
an actual decrease in costs. Internal expenses billed to the Fund
during the past six months are based on actual costs to date.
In the previous period, internal expenses were charged to the
Fund based on equal monthly billings. External fees increased
by $3.027 million compared to the same period last year. The increase
in external manager fees is due to the increases in the fair value
of investments and increases in alternative investments.
Performance
Measurement
Heritage
Fund Rate of Return
The Fund's return
of 4.1% this quarter offsets the negative return of 2.2% last
quarter resulting in an overall return of 1.9% in the first
six months of 2006-07. The investment return of 4.1% this quarter
and 1.9% over six months exceeded their respective policy benchmarks
by 20 basis points.
The performance of
the Fund is measured over the long term. Over the past five-year
period, the Fund generated a nominal annualized return of 8.0%
compared to the expected nominal long-term rate of return of
6.7%.The expected nominal
annualized return of 6.7% includes the real rate of return of
4.5% plus annualized inflation of 2.2% over a moving fiveyear
period.
The performance of
the Fund investments is measured against various market-based
indices. Value-added by investment management is accomplished
through asset mix decisions and security selection.
Fixed
Income Investments
The Scotia Capital
(SC) Universe Bond Index measures the performance of marketable
Canadian bonds with terms to maturity of more than one year.
The SC Universe Bond Index increased by 4.9% over the quarter
and 3.8% over six months while the short term SC 91-Day T-Bill
Index increased by 1.1% over the quarter and 2.1% over six months.
The Fund's actual
rate of return over the quarter from long-term Canadian fixed
income securities was 5.0%, 10 basis points better than the
benchmark SC Universe Bond Index. Over six months, the return
from long-term fixed income securities was 4.1% or 30 basis
points better than the benchmark of 3.8%. The Fund's return
from short-term securities was 0.7% over three months and 1.6%
over six months. The Fund's fixed income portfolio is internally
managed through various pools and through direct holdings.
At September 30, 2006,
investments in deposits, bonds, notes, short-term paper, provincial
corporation debentures and loans totalled 32.8% of total portfolio
investments or $5.051 billion compared to 33.3% or $4.993 billion
at March 31, 2006.
Canadian
Equity Investments
The Toronto Stock
Exchange S&P;/TSX Index, which measures the performance of Canada's
largest companies, by market capitalization, increased by 1.9%
for the quarter ending September 30, 2006. The index recovered
from last quarter's decline of 3.5%, resulting in an overall
net decrease of 1.7% over the past six months.
The 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 actual return from Canadian equities increased by
2.6%, 70 basis points better than the benchmark return from
the S&P;/TSX Index. Over six months, the Fund's return from Canadian
equities was negative 0.8%, 90 basis points better than the
benchmark return of negative 1.7%.
At September 30,
2006, investments in Canadian public equities totalled 16.2%
or $2.499 billion of the Fund investment portfolio compared
to 17.0% or $2.572 billion at March 31, 2006.
United
States Equity Investments
The U.S. equity market
closed out the quarter posting a negative return. The Standard
& Poor's 1500 Index, S&P; 1500, which measures the performance
of the largest 1,500 U.S. companies, increased by 4.9% in Canadian
dollars.
The Fund's actual
rate of return over the quarter from U.S. equities was 5.0%
in Canadian dollars or 10 basis points better than S&P; 1500
Index. Over six months, the Fund's U.S. equity portfolio returned
negative 1.5%, the same as the benchmark.
At September 30,
2006, investments in U.S. equities totalled 16.9% or $2.616
billion of the Fund investment portfolio compared to 16.8% or
$2.513 billion at March 31, 2006.
Non-North
American Equity Investments
The Morgan Stanley
Capital International Index for Europe, Australasia, and the
Far East, MSCI EAFE Index, measures the performance of approximately
1,200 companies on 25 stock exchanges around the world. Over
the quarter, the index increased 4.0% in Canadian dollars.
The Fund's actual
return from non-North American equities was 4.0%, the same as
the MSCI EAFE Index. Over six months the Fund's non-North American
equity portfolio returned negative 1.3%, 130 basis points less
than the benchmark MSCI EAFE Index.
At September 30,
2006, investments in non-North American equities totalled 16.3%
or $2.504 billion of the Fund investment portfolio compared
to 16.8% or $2.520 billion at March 31, 2006.
Real
Estate Investments
The Fund's real estate investments
are held in the internally managed Private Real Estate Pool
and the Foreign Private Real Estate Pool. Real estate investments
earned 4.7% over the quarter and 8.8% over the past six months.
Approximately 50%
of the real estate portfolio is invested in retail, 34% in office,
11% in industrial and 5% residential. Approximately 61% of the
real estate holdings are located in Ontario, 28% in Alberta,
9% in Quebec and 2% in British Columbia.
At September 30,
2006, investments in real estate totalled 10.1% or $1.554 billion
of the Fund investment portfolio compared to 9.6% or $1.441
billion at March 31, 2006.
Absolute
Return Strategies
Absolute return strategy investments
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 positive
return of 1.3%, 90 basis points better than the benchmark Hedge
Fund Research Inc. (HFRX) Global Hedged Index. Over six months,
absolute return strategies returned 2.6%, 310 basis points better
than the benchmark.
At September 30, 2006,
investments in the Absolute Return Strategies Pool totalled
4.2% or $647 million of total Fund investments compared to 3.8%
or $572 million at March 31, 2006.
Private
Equity Investments
At September 30, 2006, private
equity investments comprised 2.2% or $339 million of the Fund's
total investment portfolio compared to 1.7% or $258 million
at March 31, 2006. During the quarter, private equity investments
returned 1.4%, 60 basis points less than the benchmark Consumer
Price Index (CPI) plus 8%. Over six months private equity investments
returned 4.8%, 70 basis points less than the benchmark.
Private
Income Investments
Private income investments comprised
0.9% or $142 million of overall investments compared to 0.6%
or $82 million at March 31, 2006. Private income investments
returned 1.1% this quarter, 40 basis points less than the benchmark
CPI plus 6%. Over six months private income investments returned
4.3%, 20 basis points less than the benchmark.
Timberland
Investments
The timberland investment is a
partnership interest in forestry land in British Columbia. Timberland
investments comprise 0.4% or $54 million of overall investments
compared to 0.4% or $56 million at March 31, 2006. Timberland
investments returned 0.8% this quarter, 30 basis points less
than the benchmark CPI plus 4%. Over six months, timberland
investments returned 3.0%, 60 basis points less than the benchmark.
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Notes
to the Financial Statements - September
30, 2006 (unaudited)
NOTE
1 - AUTHORITY AND MISSION
The Alberta Heritage Savings Trust
Fund (the 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
The recommendations of the Public
Sector Accounting Board of the Canadian Institute of Chartered
Accountants are the primary source for the disclosed basis of
accounting.
The accounting policies of significance
to the Fund are as follows:
(a)
Portfolio Investments
Fixed-income securities,
public and private equities, real estate, absolute return
strategies, timberland and private income 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 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,
as reported in Note 7, 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 expenses
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.
Where a hedge relationship is designated, the
hedge is documented at inception. The documentation identifies
the specific asset being hedged, the risk that is being hedged,
type of derivative used and the matching of critical terms
of both the hedged security and the hedging derivative for
purposes of measuring effectiveness. The derivative must be
highly effective in accomplishing the objective of offsetting
either changes in the fair value or cash flows attributable
to the risk being hedged both at inception and over the life
of the hedge.
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
Portfolio investments
are recorded in the financial statements at cost. The fair
value of investments is provided for information purposes
and is disclosed in Note 3.
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.
Measurement uncertainty
exists in the fair values reported for certain investments
such as private equities, private income, private real estate,
loans, absolute return strategies and timberland investments.
The fair values of these investments are based on estimates
where quoted market prices are not readily available. Estimated
fair values may not reflect amounts that could be realized
upon immediate sale, nor amounts that ultimately may be realized.
Accordingly, the estimated fair values may differ significantly
from the values that would have been used had a ready market
existed for these investments.
Fair value of investments
held either directly by the Fund or by pooled investment funds
are determined as follows:
- 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.
- 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.
- 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.
- 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
replacement cost, direct comparison, direct capitalization
of earnings and the discounted cash flows.
- The fair value of Absolute Return Strategy Pool investments
is estimated by external managers.
- The fair value of loans is estimated by management based
on the present value of discounted cash flows.
- The fair value of timberland investments is appraised
annually by independent third party evaluators.
- The fair value of deposits, receivables, accrued interest
and payables is estimated to approximate their book values.
- The fair value of investments and any other assets and
liabilities denominated in a foreign currency is translated
at the period-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:
- Equity and bond
index swaps are valued based on changes in the appropriate
market-based index net of accrued floating rate interest.
- Interest rate
swaps and cross-currency interest rate swaps are valued
based on discounted cash flows using current market yields
and exchange rates.
- Credit default
swaps are valued based on discounted cash flows using current
market yields and calculated default probabilities.
- Forward foreign
exchange contracts and equity index futures contracts are
valued based on quoted market prices.
NOTE
3 - PORTFOLIO INVESTMENTS
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 September 30, 2006, the Fund's percentage ownership, at
market, in pooled investment funds is as follows:
- 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 September 30, 2006, securities held by the Fund have
an average effective market yield of 4.37% per annum (March
31, 2006: 3.96% per annum).
- 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 September 30, 2006, securities held by
the Pool have an average effective market yield of 4.5% per
annum (March 31, 2006: 4.7% per annum) and the following term
structure based on principal amount: under 1 year: 2% (March
31, 2006: 2%); 1 to 5 years: 36% (March 31, 2006: 34%); 5
to 10 years: 32% (March 31, 2006: 33%); 10 to 20 years: 11%
(March 31, 2006: 12%); and over 20 years: 19% (March 31, 2006:
19%).
- 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
(93.6%) and provincial bond residuals (6.4%). 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,
2006, securities held by the Pool have an average effective
market yield of 5.02% per annum (March 31, 2006: 5.27% per
annum) and the following term structure based on principal
amount: under 1 year: 5% (March 31, 2006: 2%); 1 to 5 years:
17% (March 31, 2006: 19%); 5 to 10 years: 50% (March 31, 2006:
50%); 10 to 20 years: 7% (March 31, 2006: 10%); and over 20
years: 21% (March 31, 2006: 19%).
- As at September 30, 2006, Provincial
corporation debentures have an average effective market yield
of 8.02% per annum (March 31, 2006: 8.00% per annum) and the
following term structure based on principal amounts: 5 to
10 years: 100% (March 31, 2006: 100%).
- 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
September 30, 2006, investment in loans, at cost, include
the Ridley Grain loan amounting to $100,000 (March 31, 2006:
$100,000) and the Vencap loan amounting to $2,309 (March 31,
2006: $2,219).
- 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 $100,000 and deferred interest is repayable
on or before July 31, 2015. Deferred interest at September
30, 2006 amounted to $90,161 (March 31, 2006: $90,161).
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, is due July 2046
and bears no interest. The increase in the carrying value
of the Vencap loan resulted from amortization of the loan
on a constant yield basis.
- The Currency Alpha Pool is managed
with the objective of providing a fair return over a four-year
moving period while reducing return volatility through multiple
manager investment style and strategies. The return is achieved
through active currency management with currency positions
established primarily through forward foreign exchange contracts.
Participants deposit into the Pool a modest amount of cash
to minimize rebalancing of cash flows in or out of the Pool
when the forward foreign exchange contracts settle.
- The Tactical Asset Allocation
Pool provides participants with a quick, effective and efficient
way to earn excess returns, on an opportunistic basis, by
altering the portfolio weights of broad asset classes using
synthetic instruments. At September 30, 2006, the Pool is
comprised of a long position through United States equity
index futures contracts and a short position through Canadian
equity index futures contracts. Cash and short-term securities
held by the Pool support approximately 5% to 10% of the Pool's
notional exposure in Canadian and United States equity index
futures contracts.
- 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-tomaturity of five years or
less.
- 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 while remaining sector neutral.
- The 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.
- 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.
- The Growing Equity Income Pool is managed with the objective
of providing a steady and growing stream of dividend income
by investing in mature Canadian and U.S. 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 a custom S&P;/TSX Composite Index for dividend paying
stocks.
- 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. The Pool's investment in
units of the FRNP are used as the underlying securities to
support the index swaps of the pool (see Note 3 (h)).
- Publicly traded U.S. 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 FRNP are used as the
underlying securities to support the index swaps of the pool
(see Note 3 (h)).
- The U.S. 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 U.S. equity market. The performance
objective is to provide returns higher than the total return
of the Russell 2500 Index over a four-year period.
- 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 S&P; 500 Index over a four-year period.
- The Europe, Australasia and Far East (EAFE) Active Equity
Pool consists of multiple portfolios of publicly traded non-North
American equities. Portfolios are actively managed by external
managers with European and Pacific Basin mandates. 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.
- The EAFE Passive Equity Pool and the EAFE Structured Equity
Pool are managed with the objective to provide returns comparable
to the total return of the MSCI EAFE Index over a four-year
period. The EAFE Passive Equity Pool consists of one portfolio
of non-North American publicly traded equities that replicates
the MSCI EAFE Index. The EAFE Structured Equity Pool provides
exposure to EAFE markets through the use of structured investments
such as foreign equity index swaps. The structured pool also
invests in the FRNP to generate the floating rate cash flows
needed for its equity swap obligations (see Note 3 (h)).
- The 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 MSCI Emerging
Markets Free (MSCI EMF) Index over a four-year period.
- The Private Real Estate Pool is managed with the objective
of providing investment returns higher than the IPD Large
Institutional All Property Index. 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.
- The Foreign Private Real Estate Pool is managed with the
objective of providing investment returns higher than the
IPD Large Institutional All Property Index. The Pool provides
diverse exposure to nondomestic real estate by investing in
foreign real estate backed securities and assets.
- The Absolute Return Strategy Pool is managed with the objective
of providing investment returns higher than the Hedge Fund
Research Inc. Global Index. The Pool uses external managers
who employ various investment strategies. These strategies
are expected to produce absolute positive investment returns
with lower volatility.
- 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, the Foreign
Private Equity Pool 2002 and the Foreign Private Equity Pool
2005. 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%.
- The Timberland Pool provides high current income and long
investment horizons. The timberland investment is a partnership
interest in forestry land in British Columbia. The performance
objective is to earn a return higher than CPI plus 4%.
- 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, based on the cyclical nature of stock markets,
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.
- 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.
- 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.
- 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 September 30, 2006:
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 2006-2009 Business Plan proposed
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 - NET ASSETS
Net assets represent the difference between the
carrying value of assets held by the Fund and its liabilities.
The following table shows accumulated net income and transfers
from (to) the General Revenue Fund (GRF) since the Fund was
created on May 19, 1976:
NOTE
7 - NET INCOME
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).
The investment income
for the six months ended September 30, 2006 includes writedowns
totalling $22,991 September 30, 2005: $23,261).
NOTE
8 - ADMINISTRATIVE EXPENSES
External management
fees and internal management expenses are deducted directly
from the income from pooled investment funds. Alberta Finance
charges direct fund and internal management expenses on a cost
recovery basis. External management fees are based on a percentage
of net assets under management at fair value and committed amounts
in the case of private equity and private income pools.
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 Deputy Minister
of Finance approved these financial statements.
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