In the first part of this series, I investigated information the Alberta Investment Management Corporation (AIMCo) supplies to the Securities and Exchange Commission on their quarterly Form 13F filing. Some unusual findings were cited about AIMCo’s U.S. holdings, that to my knowledge, have not been publicized before. In Part 2, I looked at AIMCo’s total portfolio and performance metrics which are disclosed in its 2022 annual report, the latest available. I concluded that Alberta taxpayers and citizens deserve much better financial reporting on the significant assets managed by the Government of Alberta and its agencies. Indeed, given AIMCo’s performance on its fixed income portfolio, I argued that it would be prudent for Treasury Board and Finance to consider repatriating managing short term cash reserves from AIMCo.
In this part, I investigate the question of how much of the Heritage Fund’s investment income is from regular coupon clipping (interest and dividends) as opposed to realized or unrealized capital gains or losses. The reason for this distinction is that capital gains and losses, whether realized or unrealized, are more volatile than dividend or interest income. However, from reading financial statements and notes to the financial statements I was only able to piece together an imperfect view of these two basic sources of investment income..
Background
AIMCo manages all its clients’ funds on a pooled basis for efficiency reasons that go with buying and selling large blocks of securities. The Heritage Fund has units in various pools as would other AIMCo clients. The value of these units, much like a mutual fund, is based on the underlying value of the financial assets usually calculated daily. It should be noted however that financial assets include the fair market value of underlying derivative products such as the controversial VOLTs strategy. Derivative products owned and traded within the Heritage Fund include equity-based, foreign currency, interest rate, and credit risk derivative contracts.
My first approach was to look at the reported income by 8 categories – these investment categories are:
- Interest bearing securities,
- Equities-Canada;
- Equities -Global;
- Equities – Private ;
- Real Estate
- Infrastructure;
- Renewable resources; and
- Strategic, tactical and currency.
In Annual Reports going back to 2011-12, I found the following breakdown in the distribution of income allocated to the various pools AIMCo uses to service its clients. Figure 1 shows the income attributed to the various investment categories. In this chart I have collapsed all equity income (Canada, Global and Private) into one category. The figure shows that investment income of the Heritage Fund is being driven primarily from income derived from equities. The 2022-23 fiscal year was a particularly bad year for equity investments. Fixed income and real estate are less volatile as investments.
Heritage Fund Investment Income (Figure 1| In 2022-23, changes to the Alberta Heritage Savings Trust Fund Act eliminated the requirement for annual net income to be transferred out of the Fund to the General Revenue Fund where the money can be used for general government purposes. However, Treasury Board still retains the power to make further transfers, to be completed by the end of the next fiscal year end. (Alberta Heritage Savings Trust Fund, Annual Report 2022-23, p.27.) |
Figure 2 compares unrealized gains with Net investment income. The darker blue colour displays unrealized gains which are much more variable. The figure also shows that Net Investment income has been quite variable and significantly affected by changes in securities values.
Figure 2But net investment income does not necessarily go to the General Revenue Fund each year. As Figure 3 below illustrates transfers are lower because of the income retained by the Fund for inflation-proofing. With amendments made last year, transfers which had become highly variable will likely be a thing of the past. That is, unless oil prices deteriorate dramatically, which would leave the door open to Treasury Board tapping the investment earnings of the Fund once again.
Figure 3Another perspective on the reliance on realized gains (losses) or unrealized gains (losses) is to examine the trading that goes on in the investment operations for the Heritage Fund. Trades crystallize gains or losses in the portfolio. Figure 4 below shows that except in 2018-19, the investment managers have been turning over roughly one fifth to one-quarter of the Heritage Fund’s total assets. The solid line shows that net purchasing of assets has increased in recent years as the Heritage Fund’s assets have grown.
Heritage Fund Investment Income (version 1)Figure 5 compares the Fund’s net investment income with the size of the Fund.
Fibure 5Often scale is thought to be important in improving overall investment performance. However in the case of the Heritage Fund there is a negative 0.5 correlation between investment income and the slowly growing size of the Fund.
Bottom line
The Heritage Fund has been through two distinct stages and may be entering a third as the government desires to build up the Fund. The first phase was province-building where the Fund was essentially used to lend money to other parts of the government including large loans to Alberta Government Telephones, for agriculture lending and social housing. Also in the early years, the Heritage Fund’s Capital Projects Division was the source of funding for various projects including the Walter C. Mackenzie Health Science Centre and the Kananakis golf course.
In 1997, the Fund made a transition to a traditional investment management style which relied more upon the acumen of investment specialists than political direction. This has lead to more variable investment income which in my opinion was a poor approach to providing steady, reliable income for government operations.
That said, given the current government’s desire to build up the Fund and rely more heavily on taxation, fees, and resource revenue to fund government operations, absent a sustained global equity market meltdown, this approach is consistent with other large investment managers.