SEAN FIELER: Hello, I'm Sean Fieler, CIO of Equinox Partners. I'm pleased to be on Real Vision with Marcus Frampton, the CIO of the Alaska Permanent Fund. Marcus is an independent thinker in what is generally regarded as a very conventional sector. Marcus, welcome. Thank you for joining me today.
MARCUS FRAMPTON: Thanks, Sean. Thanks for having me.
SEAN FIELER: Let's get right to it. What is the Alaska Permanent Fund?
MARCUS FRAMPTON: The Alaska Permanent Fund was set up in the late 1970s after oil was found in Prudhoe Bay in Alaska, which at the time was the largest North American discovery of oil. The fund since inception in the late 1970s receives 25% of the royalty deposits earned by the state for production here. We've grown from an initial deposit of 700,000 to today, we're at 75 billion.
We invest that fund globally across asset classes. Then we transfer each year about 5% of the fund to the state, which is used for dividends, and to residents of the state. Alaska is actually the only long standing universal basic income instance I'm aware of. There's this dividend. There's no state income taxes if you live here, and then a portion of that transfer funds state government.
SEAN FIELER: Do you have a specific mandate in terms of the return or capital preservation that you're expecting here on a long term or annual basis?
MARCUS FRAMPTON: Yes. We target a real return of 5%. That ends up at nominal, around 7% if you believe the inflation forecasts, it could be higher if there's higher inflation. Real return of 5%, that ends up putting us right about where most state pension funds target that seven to eight area and most endowments target it. You have pretty much the whole institutional investment community targeting the 7% return, and we're at that same level. For us, it's because we want to support the state with 5% a year and then maintain the inflation-adjusted value of the fund into the future.
SEAN FIELER: If I think about your peers, and I think as Americans, maybe we're not that familiar with state-based sovereign wealth funds, which you are, are your peers, really other sovereign wealth funds internationally, or are they more the state pension fund, or is that a distinction without a meaningful difference?
MARCUS FRAMPTON: The way we're set up, tends to look a lot like the state pension funds. Like, if you look at our investment policy statement, if you look at the way we work our board, and our general consultant, and others, we look and feel like a state pension fund. However, more and more, we've been trying to emulate some of the international sovereign wealth funds, and they run the gamut. The largest is the Norway fund. Then there's obviously GIC and Temasek and others, which tend to have a broader remit more international investments, more direct private equity versus all through funds. We've been moving a little bit in that direction, except if you compare us in terms of our policies and our setup, etc., it probably looked like a state pension fund.
SEAN FIELER: Then you mentioned your consultants, you use consultants, I presume, like most other pension funds and sovereign wealth funds, can you give us some insight into how useful that is? What addition they provide, investment insights to what you guys do announced?
MARCUS FRAMPTON: Yes. We have consultants working on most of our areas, and in the alternatives area, they help with manager selection. There's another consultant that's our board consultant, Callan Associates, they do our annual asset allocation review with our board, which I think is probably the most critical decision that gets made year to year. Then the rest is execution throughout the year. They're pretty impactful on that front and in the investing environment or in today, that work on asset allocation is what's driving large flows in markets, because similar advices is given across the state pension fund world.
I think one of the most interesting things that have come up recently is they came out with their 10-year forecasts, which they do every year for the asset classes, and then they apply it to what we invest in. It has real implications if you're running a state pension fund. That's the basis for your underfunded status is the actuarial discounting and then what you own. They have to build a portfolio that can earn a 7% return.
In this last year, the global equities on that study was under a 7% return, which implies a 100% equity portfolio would not achieve most institutional investors' objectives, and private equity was the one asset class at 8.5%. There's false precision and all these numbers, but real decisions get made off of them. That's why I think you're seeing just such rapid growth in private equity is at this point, it's the only asset class that at least in Callan's case, and I think similar in other consultants, even gets you to on a forecasted basis to what people are targeting.
SEAN FIELER: Unlike your peers, I think you are a little less conventional or a little more independent in terms of investing in asset classes and making allocations that your peers don't. Can you give us some background or insight into why that is? Why you are a little bit of an outlier or differentiated from your peers in terms of some of your investment decisions?
MARCUS FRAMPTON: Yeah. Well, I think our Achilles' heel and all institutional allocators in the US targeting similar return Achilles' heel is periods of low growth, and periods of high inflation. If you look at a 60/40 portfolio, or you look at our portfolio through the 1970s, it was a period of zero to negative real return with inflation where it was and then, in the 2000s, a decade with two recessions and a flat stock market again was a period of basically zero real return for a 60/40 portfolio. The alteration that I've made that we implemented this year was that gold is the asset that does particularly well in periods of recession and low growth or inflation, so we've added a gold allocation.
Hedge funds is another area that I think should be emphasized by allocators, and back to the consultant forecast that drives so much stuff, they assume a 0.8 correlation and a 4% return for hedge funds, which probably maps to what the HFRI will do, or what they have done in the past, but I look at hedge funds and absolute return is you can, with some effort and skill, it's not unreasonable to think that you can find uncorrelated managers that hit a 0.7 Sharpe ratio with 10 to 12 vol. Then right there, you have an uncorrelated return that's getting up near what we're targeting for the total fund.
It's such a valuable return stream that I think has been like deemphasized by institutional investors, at least state funds, [?] endowments in the last decade, that if you use the broad HFRI numbers or at least the capital market forecasts that were given, you wouldn't have any hedge funds. There's no value to the asset class, and it's going to be 4% return when [?] correlation, but that's not what we're trying to do. We just try to come up with our own independent views on these areas and apply that and it's led us to do some things that I think are common sense, like owning some gold and targeting uncorrelated managers, whereas others, I think have just continually gravitated to more equity and more private equity.
SEAN FIELER: What kind of return expectations do the consultants give you on gold?
MARCUS FRAMPTON: Inflation.
SEAN FIELER: Inflation?
MARCUS FRAMPTON: Yeah, and so when you score our portfolio, it only hurts us when we had gold, but in their inflation forecasts, like if you use my inflation forecasts or yours, you might actually--
SEAN FIELER: Be okay.
MARCUS FRAMPTON: Callan's latest last year, they had the 10-year outlook for inflation at 2.25%. Then this year, it came in-- and this is a couple months ago that the new forecast came out, so this is post COVID, post 20% money printing, the new number is 2%. I don't know what went into that. There's certainly a deflation camp and an inflation camp and to lower your inflation outlook in the last 12 months is a little stunning to me, but that's the forecast that's used for gold and so it's diluted to our expected real return.
SEAN FIELER: What size investment did you make in gold, and how did you do it?
MARCUS FRAMPTON: We own it in a couple different ways. Over the last few months, we've owned in the neighborhood of 400 million to 500 million of gold miners stocks. We've implemented that to the ETFs, the primary, VanEck ETFs. I think it's an area that active management is ripe to add value but to get the positions on in the time we wanted, we did the ETFs. Then we also own IAU, the gold ETF that-- an issue we have, and everyone in our industry have, is really the asset classes and the bucketing.
What we've changed in our investment policy was that we could hold a portion of our cash in IAU and we could put a portion of our hedge fund portfolio in IAU and we didn't set it up like a dedicated commodities allocation, which might make sense at some point. We have somewhere around 5% to 10% of our hedge fund portfolio in the ETF IAU. It's an odd fit there, from a portfolio role standpoint, that's where it made the most sense for us.
SEAN FIELER: How did you pick amongst the various gold ETFs, and in terms of doing the ETFs, versus doing the physical, I guess, implicitly, you're comfortable that the gold is there, and it's just the cheaper, more efficient way to execute it, or if you can walk through that.
MARCUS FRAMPTON: I think as an individual investor, it makes a lot of sense to own physical gold. As an institutional investor, the ETF made the most sense for us, and there's five or six of them out there. GLD is the most well-known. I've actually owned that in the past and in my personal account, and then we did just a little bit of work, and IAU was half the fee and similar liquidity. I think GLD is maybe twice the management fee. They were the first mover but IAU makes a little bit more sense, I think for institutional investors.
SEAN FIELER: Let's go back to the point about stagnation you made, Marcus, and won't stocks protect portfolios against inflation, or it's a particular type of stagflation, where gold does better than stocks? How do you think through that, because a lot of your peers haven't gotten to the point where they're owning gold and certainly not gold miners yet. Maybe they're dipping their toe in the water but have not really done what you guys have done yet.
MARCUS FRAMPTON: I think it depends on the level of inflation, and the data isn't great. I went back and tried to look at how different assets correlate to inflation or deflation, and it's actually hard with gold to do the analysis, since for most the last two or three years, we were on the Gold Standard. Then gold exploded in price in the 1970s. I think that from the studies I've seen, I don't think stocks are a great inflation hedge. I think that they do better than fixed income does, but particularly when there's unexpected rapid inflation, a lot of companies, I think, struggle to pass that through.
That's why stocks didn't do that great on a real return basis in the 1970s whereas gold did. I think that inflation that's driven by an economy running really hot, and output being near potential, and that resulting in inflation flowing through, and then there's like monetary inflation from printing money and that can be, I think, a little less predictable, so I think the type of inflation we get probably will matter but from what I've looked in the studies I've seen, gold is the best asset to own across both those types of inflation.
SEAN FIELER: Did you have a look at silver as you got to your gold thesis? Obviously, another monetary metal high correlation to gold, but obviously different much smaller market in a lot of ways.
MARCUS FRAMPTON: Yeah, I think silver is the natural second investment. Clearly, in the miners portfolio that we have, we're getting some other precious metal exposure. Gold is the classic one and the most time tested one and I think probably makes the most sense but an investor could add silver for sure.
SEAN FIELER: Maybe just a question or two about the miners. How do you think about gold mining, is it a way to invest in gold with more leverage? Are they undervalued in general, or how do you think about it from a top-down perspective?
MARCUS FRAMPTON: It's a sector that I think makes sense for its own reasons aside from just the macro environment we're in. I think there's some similarities to the EMP space where over the last 10 or 20 years, there wasn't always the capital discipline, and people are starting to see that now out of some of the producers. It's definitely levered exposure to the commodity. If you just look at the NPV of the miners holdings, and if they have a certain marginal cost, when gold's below that, it's a negative NPV, but then it just exponentially increases as the price exceeds the marginal cost for a mine. I know you know that well.
I think that that is a different exposure, and one that if you're taking it from a beta standpoint, it's easy to put on. If you're actively managing, it probably requires some expertise that we don't have in-house in the fund.
SEAN FIELER: What about all the ESG issues involved in mining? I presume you have mining elsewhere in your portfolio as well. Is there any unique or different take or special processes or considerations you have to go through and investing in mining as a sector, given some of the issues that come up?
MARCUS FRAMPTON: Yeah, it's one of the reasons why we went with the broad market ETF as we didn't necessarily want to get into judging which ESG factors we wanted exposure to versus the others. I think on a broad ESG basis, we're not avoiding certain sectors. We like the oil and gas sectors outlook right now. Certainly, want to be investing in companies that are good corporate citizens and following the law, but we haven't moved away from resources, and that would include mining.
SEAN FIELER: You mentioned having your inflation concern, the rate of money growth in the United States, and if you look at fiscal and monetary policy, I think your average observer just take shot where we are. Are we in an extraordinary times both from a fiscal and monetary perspective, and is there any going back to anything normal?
MARCUS FRAMPTON: Well, that's a good question. I think that you can identify things that are happening in the last decade, and then accelerating in the last year or two that are unprecedented. I always ask economists and macro hedge fund managers that we invest with this very topic, it's hard to ignore. There's a camp of economists and investors that focus on the Japan example, and look at them for a very long time. They've been monetizing their debt and printing money, and they haven't be able to get inflation.
I don't think that episode's complete, and it is one country that we don't know how that story ends, because they're still in the middle of it. I think some people similarly were surprised we didn't have inflation in the last decade here in the US. Again, I would say that this episode's not complete, and so I think that they're now testing the limits of QE and money printing and maybe MMT. I think that the end result, all the roads lead to inflation in the end, because these limits are going to keep getting tested every time we have a drawdown in the markets, every time the economy's soft, I think we'll continue to test it.
We saw a glimpse in late 2018 when Jerome Powell wanted to start tapering and the markets threw up on it. I think we're in the middle of this episode here and Japan is in the middle of theirs, and as we build up debt levels, in the end, there's got to be some austerity and some control over the money supply, or there's going to be inflation. I'm in that camp, and a lot of very smart, macro investors and economists I talked to are as well, but there's no consensus around it I would say at this point.
SEAN FIELER: When do we find out? Bernanke got on 60 Minutes and told us that this is 2010. If the Fed had to raise rates, they could do it in 15 minutes, and we should all go worry about something else. Now for I guess 11 years or a little over 10 years, it seems like there hasn't really been a problem. They haven't really had to do it. At some point, we find out, is there any sense in terms of the timing and what we're going to find out is if he was right or if we should actually be concerned about this inflationary pressure and the monetary and fiscal policy?
MARCUS FRAMPTON: Well, I think that if they hadn't moved the goalposts to an extent on when we would start raising rates, if they have moved to the average inflation targeting, we'd be there right now and we'd find out if Ben Bernanke was correct. I don't think they know what's going to happen when they start raising interest rates. I think that it's an unknown, because it's unprecedented. We'd be at that point right now if it were not changing the average inflation targeting because we were coming out of the COVID, unemployment is trending to a reasonable place, and inflation is trending up over 2%.
We've seen a big move in inflation breakevens in the last three months, and in the 10-year Treasury yield, so the market is in a normal environment. We'll be ready I think for rates to start coming up, and it's probably going to get delayed a year or two because of average inflation targeting, but we'll be there pretty darn soon. I don't think that people really know how the market's going to react to that. That's a concern, and I think it's a reason to own gold.
SEAN FIELER: And the fiscal policy, how does that fit into all of this? Because I guess now, we just spent 1.9 trillion. Now, we're going to spend another 2 trillion on top of the 6 plus trillion we're already spending. The numbers are unimaginable in some sense. Is that part of it, or is that secondary to monetary policy in the way you think about it?
MARCUS FRAMPTON: I think it's the same concept so to speak. We've had very low rates for a long time. Powell and others have said it's time for fiscal policy to play a bigger role. It's a similar effect. You're talking about deficit spending, with the deficit financed with Treasurys, and those Treasurys are purchased by the Fed if the market won't bear it. I think it'll be the same effect. I think a lot of people, when there were the Trump tax cuts, felt like it was a