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Balance
Sheet
Statement
of Operations
Statement
of Cash Flows
Notes
to the Financial Statements
December
31, 2005 (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
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, mortgages, equities, real estate investments,
absolute return strategies and timberland 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, absolute return strategies and timberland
investments that is other than a temporary decline, the investment
is written down to recognize the loss. The written down value
is deemed to be the new cost.
(b)
Investment Income
Investment income is recorded on the accrual basis where there
is reasonable assurance as to its measurement and collectability.
When a loan becomes impaired, recognition of interest income in
accordance with the terms of the original loan agreement ceases.
Any subsequent payments received on an impaired loan are applied
to reduce the loan's book value.
Gains and losses arising
as a result of disposals of investments are included in the determination
of investment income.
Income and expense from
derivative contracts are included in investment income. Certain
derivative contracts, which are primarily interest rate swaps
and cross-currency interest rate swaps, are designated as hedges
of market risks for purposes of hedge accounting. Hedge accounting
recognizes gains and losses from derivatives in the statement
of income in the same period as the gains and losses of the security
being hedged. As a result, income and expense from derivative
contracts designated as hedges are recognized in income on an
accrual basis with gains and losses recognized in income to the
extent realized.
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 values of investments
held either directly by the Fund or by pooled investment funds
are determined as follows:
(i)Public fixed-income
securities and equities are valued at the period-end closing
sale price, or the average of the latest bid and ask prices
quoted by an independent securities valuation company.
(ii) Mortgages, provincial corporation debentures and private
fixed-income securities are valued based on the net present
value of future cash flows. These cash flows are discounted
using appropriate interest rate premiums over similar Government
of Canada benchmark bonds trading in the market.
(iii) The fair value of private equities is estimated by managers
or general partners of private equity funds, pools and limited
partnerships. Valuation methods may encompass a broad range
of approaches. The cost approach is used to value companies
without either profits or cash flows. Established private companies
are valued using the fair market value approach reflecting conventional
valuation methods including discounted cash flows and multiple
analysis.
(iv) The fair value of real estate investments is reported at
the most recent appraised value, net of any liabilities against
the real property. Real estate properties are appraised annually
by qualified external real estate appraisers. Appraisers use
a combination of methods to determine fair value including replacement
cost, direct comparison, direct capitalization of earnings and
the discounted cash flows.
(v) The fair value of Absolute Return Strategy Pool investments
are estimated by external managers.
(vi) The fair value of loans is estimated by management based
on the present value of discounted cash flows.
(vii) The fair value of timberland investments are appraised
annually by independent third party evaluators.
(viii) The fair value of deposits, receivables, accrued interest
and payables are estimated to approximate their book values.
(ix) The fair value of investments and any other assets and
liabilities denominated in a foreign currency are 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:
(i) Equity and bond
index swaps are valued based on changes in the appropriate market
based index net of accrued floating rate interest.
(ii) Interest rate swaps and cross-currency interest rate swaps
are valued based on discounted cash flows using current market
yields and exchange rates.
(iii) Credit default swaps are valued based on discounted cash
flows using current market yields and calculated default probabilities.
(iv) Forward foreign exchange contracts and equity index futures
contracts are valued based on quoted market prices.
NOTE
3 PORTFOLIO INVESTMENTS
The majority of the
Fund's investments are held in pooled investment funds established
and administered by Alberta Finance. Pooled investment funds have
a market based unit value that is used to allocate income to participants
and to value purchases and sales of pool units. As at December
31, 2005, 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, 2005, securities held by the Fund have an average effective
market yield of 3.62% per annum (March 31, 2005: 2.79% per annum).
(b) The Canadian Dollar Public Bond
Pool is managed with the objective of providing above average
returns compared to the total return of the Scotia Capital Universe
Bond Index over a four-year period while maintaining adequate
security and liquidity of participants' capital. The excess return
is achieved through management of portfolio duration and sector
rotation. The portfolio is comprised of high quality Canadian
fixed-income instruments and debt related derivatives. As at December
31, 2005, securities held by the Pool have an average effective
market yield of 4.47% per annum (March 31, 2005: 4.48% per annum)
and the following term structure based on principal amount: under
1 year: 3% (March 31, 2005: 3%); 1 to 5 years: 34% (March 31,
2005: 38%); 5 to 10 years: 31% (March 31, 2005: 31%); 10 to 20
years: 12% (March 31, 2005: 12%); and over 20 years: 20% (March
31, 2005: 16%).
(c) As at December 31, 2005, fixed-income
securities held directly by the Fund have an average effective
market yield of 3.76% per annum (March 31, 2005: 3.18% per annum).
As at December 31, 2005, fixed-income securities have the following
term structure based on principal amount: under two years: 100%
(March 31, 2005: 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 (94.5%) and provincial
bond residuals (5.5%). To limit investment risk, mortgage loans
are restricted to first mortgage loans, diversified by property
usage and geographic location, and include a small portion of
NHA insured loans. As at December 31, 2005, securities held by
the Pool have an average effective market yield of 5.05% per annum
(March 31, 2005: 5.29% per annum) and the following term structure
based on principal amount: under 1 year: 2% (March 31, 2005: 2%);
1 to 5 years: 16% (March 31, 2005: 22%); 5 to 10 years: 53% (March
31, 2005: 43%); 10 to 20 years: 10% (March 31, 2005: 12%); and
over 20 years: 19% (March 31, 2005: 21%).
(e) As at December 31, 2005, Alberta
Social Housing Corporation debentures have an average effective
market yield of 7.83% per annum (March 31, 2005: 7.51% per annum)
and the following term structure based on principal amounts: 5
to 10 years: 100% (March 31, 2005: 100%).
(f) Investments in loans are recorded
at cost. The fair value of loans is estimated by management based
on the present value of discounted cash flows. As at December
31, 2005, investment in loans, at cost, include the Ridley Grain
loan amounting to $91,245 (March 31, 2005: $91,245) and the Vencap
loan amounting to $2,177 (March 31, 2005: $2,053). The increase
in the carrying value of the Vencap loan resulted from amortization
of the loan on a constant yield basis.
- Under the terms of the loan to
Ridley Grain, 11% Participating First Mortgage Bonds due July
31, 2015, interest is compounded semi-annually and payable annually
to the extent of available cash flow and any shortfall is to
be deferred and capitalized. The principal of $91,245 and deferred
interest is repayable on or before July 31, 2015. Deferred interest
at December 31, 2005 amounted to $98,916 (March 31, 2005: $92,517).
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.
(g) 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.
(h) The Overlay Pool provides participants
with a quick, effective and efficient means to achieve tactical
asset allocation opportunities without incurring undue transaction
costs in the underlying investments. Long or short exposures to
respective asset classes are obtained through synthetic instruments
on a largely unfunded basis using equity index futures contracts.
Approximately 5% to 10% of the Pool's notional exposure in Canadian
and U.S. futures contracts is supported by cash and short-term
securities. The Overlay Pool is comprised of the "long"
position through U.S. futures contracts, the "short"
position through Canadian futures contracts, and the "cash
securities" position through money market securities. Taken
together these three positions reduce exposure to Canadian equities
and increase exposure to U.S. equities.
(i) The Domestic Passive Equity Pooled
Fund is managed on a passive approach with the objective of providing
investment returns comparable to the Toronto Stock Exchange S&P/TSX
Composite Index. The portfolio is comprised of publicly traded
Canadian equities and structured investments replicating the S&P/TSX
60 Index. The Pool's investment in units of the Floating Rate
Note Pool (FRNP) are used as the underlying securities to support
the index swaps of the pool. FRNP is managed with the objective
of generating floating rate income needed for the swap obligations
in respect of structured investments in foreign equities, domestic
equities and domestic bonds. Through the use of interest rate
swaps, FRNP provides investment opportunities in high quality
floating-rate instruments with remaining term-to-maturity of five
years or less.
(j) 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.
(k) 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.
(l) 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.
(m) 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.
(n) 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 (i)).
(o) 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 (i)).
(p) 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.
(q) The Portable Alpha United States
Equity Pool consists of futures and swap contracts which provide
exposure to the U.S. equity market by replicating the S&P
500 Index and investments in value added absolute return strategies.
The performance objective is to provide returns higher than the
total return of the Standard & Poor's S&P 500 Index over
a four-year period.
(r) The Europe, Australasia and Far
East (EAFE) Active 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.
(s) 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 (i)).
(t) 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 Morgan
Stanley Capital Index Emerging Markets Free (MSCI EMF) Index over
a four-year period.
(u) 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.
(v) 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 non-domestic real estate by
investing in foreign real estate backed securities and assets.
(w) 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.
(x) Private Equity Pools are managed
with the objective of providing investment returns higher than
the Consumer Price Index (CPI) plus 8.0%. The Private Equity Portfolio
consists of the Private Equity Pool, PEP98, PEP02, PEP04 and the
Foreign Private Equity Pool 2002. Private equity investments are
held in institutionally sponsored private equity pools. Risk is
reduced by avoiding direct investments in private companies and
by limiting holdings in any single pool. The Private Income Pool
invests in infrastructure related projects that are structured
to yield high current income with the objective of providing investment
returns higher than the CPI plus 6.0%.
(y) 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 4.0%.
(z) Where there has been a loss in
value of an investment that is other than a temporary decline,
the cost of the investment is written down to recognize the loss
(see Note 2(a)). Where the fair value remains less than cost,
after recording a writedown, it is management's best judgement
that the decline in value is caused by short-term market trends
and is temporary in nature.
NOTE
4 DERIVATIVE CONTRACTS
Derivative contracts
are financial contracts, the value of which is derived from the
value of underlying assets, indices, interest rates or currency
rates. The Fund uses derivative contracts held indirectly through
pooled investment funds to enhance return, manage exposure to
interest rate risk and foreign currency risk and for asset mix
management purposes. The notional value of a derivative contract
represents the amount to which a rate or price is applied in order
to calculate the exchange of cash flows.
(i) A swap is a contractual agreement
between two counter-parties to exchange a series of cash flows
based on a notional amount. An equity or bond index swap involves
the exchange of a floating interest rate cash flow for one based
on the performance of a market index. For interest rate swaps,
parties generally exchange fixed and floating rate interest
cash flows based on a notional amount. Cross-currency interest
rate swaps are contractual obligations in which the principal
amounts of Canadian fixed-income securities denominated in foreign
currency are exchanged for Canadian currency amounts both initially
and at maturity. Over the term of the cross-currency swap, counter-parties
exchange fixed-to-fixed and fixed-to-floating interest rate
cash flows in the swapped currencies. A credit default swap
allows counter-parties to buy and sell protection on credit
risk inherent in a bond. A premium is paid, based on a notional
amount, from one counter party to a second counter party in
exchange for a contingent payment should a defined credit event
occur with respect to the underlying security. There are underlying
securities supporting all swaps. Leveraging is not allowed.
(ii) Forward foreign exchange contracts
are contractual agreements to exchange specified currencies
at an agreed upon exchange rate and on an agreed settlement
date in the future.
(iii) An equity index futures contract
is an agreement to receive or pay cash based on changes in the
level of the specified stock index.
The following is a summary
of the Fund's proportionate share of the notional amount and fair
value of derivative contracts held by pooled funds at December
31, 2005:
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 2005-2008 Business Plan proposed
the following asset mix policy for the Fund:
Subsequent to the release
of the 2005-08 Business Plan, the long-term asset mix policy for
2007-08 was amended. Fixed income securities were reduced from
32.5% to 30.0%, absolute return strategies were reduced from 7.5%
to 6.0%, private equities are reduced from 5.0% to 4.0%, private
income and timberland investments are added at 3.0% and 2.0% respectively.
Risk is reduced through asset class
diversification, diversification within each asset class, quality
and duration constraints on fixed-income instruments, and restrictions
on amounts exposed to countries designated as emerging markets.
Controls are in place respecting the use of derivatives (see Note
4). Forward foreign exchange contracts may be used to manage currency
exposure in connection with securities purchased in foreign currency
(see Note 4).
NOTE
6 FUND EQUITY
Section 8(2) of the
Alberta Heritage Savings Trust Fund Act (the Act) states
that the net income of the Heritage Fund, less any amount retained
in the Fund to maintain its value, shall be transferred to the
General Revenue Fund annually in a manner determined by the Minister
of Finance.
The estimated amount retained from
income of the Fund for the nine months ended December 31, 2005
is determined by multiplying the total equity of the Fund before
the amount retained for inflation proofing by the estimated percentage
increase in the Canadian gross domestic product price index (GDP
Index) for the period.
If the net income of the Heritage
Fund is less than the amount required to be retained, the net
income, if any, shall be retained. If the percentage increase
of the GDP Index is a negative number, the negative number shall
be treated as if it were zero.
During the quarter, the Fund received
$750 million from the General Revenue Fund, pursuant to Section
4(5) of the Access to the Future Act.
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 investment pools is net of administrative
expenses incurred by the pools (see Note 8).
The investment income for the nine
months ended December 31, 2005 includes writedowns totalling $27,230
(December 31, 2004: $23,966).
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. Comparative
figures have been restated to include estimated indirect external
management fees deducted directly from income of private equity
and private income investments, real estate, timberland and absolute
return strategies.
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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