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Dangers of Investing Permanent Fund in Hedge Funds
By Jim & Mary Lynne Dahl


September 26, 2006

To All Alaska Residents:

In November 2005 we wrote a letter to the Alaska State Legislature, reprinted in Sitnews, warning of the dangers of allowing the Alaska Permanent Fund to be invested in hedge funds and private equity investments. In February 2006 and again in March 2006, we again wrote of the dangers of hedge fund investing. We got very few responses from any state legislators or senators, causing us to assume that they either did not understand what we were referring to or do not care about investment risks to the Alaska Permanent Fund.

As a brief review, a hedge fund is a fund that uses complicated and secretive methods of investing, usually very volatile and higher risk techniques suitable for high net worth clients, called accredited investors. Hedge funds are illiquid, do not publish data about their methodology, returns or fees, charge very high fees for investments in their funds and are highly leveraged.

Now, about a year after the Alaska legislature agreed to allow the Board of Trustees of the Permanent Fund to invest in these secretive, high risk hedge funds, the Wall Street Journal reports this week on the crashing failure of one of the very largest of the hedge funds, Amaranth Fund. This would not be so surprising if Amaranth Fund was not such a huge hedge fund, but it was gigantic, almost $10 billion in size, a month ago. Today, it is pegged at less than half that value.

Amaranth Fund was supposed to be a multi-strategy fund, one that reduced risks by being widely diversified, hedged against losses, cautiously managed by conservative traders. It was sold as being a disciplined relative-value fund . Because hedge fund management is secretive, it did not become known until just this week that this fund was not diversified at all and not multi-strategy or cautiously managed. It was, in fact, invested mostly in energy futures contracts which crashed, resulting in the Amaranth Fund losing 65% its value in less than one month, according to the September 22, 2006 issue of the Wall Street Journal. That amounts to a loss of $6 billion, out of the total of over $9.5 billion that Amaranth Fund invested on behalf of its clients, most of whom are pension funds and large institutional clients.

The $7.7 billion San Diego pension fund had $175 million invested in Amaranth Fund. 3M Company's $9 billion pension plan had slightly less than $100 million invested. At around $30 billion, the Alaska Permanent Fund is one of the largest public trust funds in the world and had a whopping $732+ million committed to hedge funds as of 6/30/06 (Alaska Permanent Fund published financial reports); that's almost three-quarters of a billion dollars! Although Amaranth Fund did not show up on the 6/30/06 list of hedge funds owned by the Alaska Permanent Fund, it is very possible that one or more of the 34 hedge funds it owns did invest in Amaranth Fund, as this is common hedge fund practice.

On a broader note, why would the Alaska Permanent Fund even want to risk investing in a hedge fund, anyway? With a stated Alaska Permanent Fund investment goal of an annual total return of 5%, wouldn t safer, more conservative, publicly-traded, fully disclosed mutual funds, real estate, stocks and bonds be better? Why would any sensible, prudent investor takes these kinds of risks and pay the huge fees charged by hedge funds, when the S&P 500 s market average of around 11.6% (Ibbotson, 12/31/1994 to April 2006) was available with far less risky stocks and bonds?

The answer to why is that the Board of Trustees of the Alaska Permanent Fund wants to keep up with the Joneses. They have succumbed to envy, and have listened for too long to the guys in suits from New York, who talk a mighty convincing story about multi-strategy investing and modern portfolio theory and low correlation . Are you getting the picture?.

Well, back to Amaranth; we now know how this fund operated, by saying one thing and doing another; investors paid big-time for the privilege of being lied to. It lost 65% in a flash and is scrambling now just to stay afloat. Amaranth is not the first hedge fund to lie, or scam, or cheat. The US Securities and Exchange Commission is investigating more hedge fund cases of suspected fraud than it can probably handle, reporting over 50 suspected cases last March of 2006. More hedge funds are closing monthly than being opened, due to lack of performance and losses. Amaranth Fund may only be the tip of the iceberg, but if so, it is very significant tip, as it is a very large fund, with a lot of investor s money now down the drain.

Let's hope that none of the 34 hedge funds in the Alaska Permanent Fund investment portfolio were invested in Amaranth Fund. Let's also hope that the Alaska legislature will wake up, review the Amaranth Fund debacle and direct the Board of Trustees of the Permanent Fund to get out of hedge funds and private equity investments entirely. It just is not worth the risks.

Jim & Mary Lynne Dahl
Ketchikan, AK - USA

About: "Jim & Mary Lynne Dahl are residents of Ketchikan, Alaska and have spent over 20 years each giving financial planning and investment advice professionally. They are partners in their own firm, Otter Creek Partners, a investment advisor firm registered in Alaska and Washington. Mary Lynne has been a certified financial planner since 1984 and Jim is a former stock broker. They are very interested in the long term fiscal health of the state and the prudent management of the Alaska Permanent Fund."


Related Viewpoint:

letter Open Letter: To the Alaska Legislature By James R. Dahl & Mary Lynne Dahl
November 28, 2005

letter Hedge funds and the Permanent Fund By James R. Dahl
November 28, 2005

letter Investing public money secretly By Mary Lynne Dahl
February 28, 2006




Note: Comments published on Viewpoints are the opinions of the writer
and do not necessarily reflect the opinions of Sitnews.


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