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Open Letter: To the Alaska Legislature
By James R. Dahl & Mary Lynne Dahl


November 28, 2005

We read with dismay that the Alaska Permanent Fund Corporation board of trustees has approved increasing the amount of money in alternative investments from $292 million to as much as $2.5 billion of the $31.7 billion perm fund. That would increase the allocation of higher risk investments to 7.88% of the total perm fund portfolio. (Ref:
Anchorage Daily News 11/19/05 article by Matt Volz of the Associated Press)

Even more alarming is the quote from chief executive Michael Burns, in which he said that alternative investments have typically had a high rate of return and the same or lower risk levels as other investments . We disagree.

The Alaska legislature apparently believes that allowing the perm fund to invest in alternative investments adheres to the prudent investor rule . A more widely-accepted standard than the prudent investor rule is the prudent man rule , which is a long-standing rule that requires that fiduciaries act as a prudent man or woman would be expected to act when handling the assets of others - namely, they must exercise discretion and intelligence as they seek reasonable income and the preservation of capital. By definition, the prudent man or woman will avoid speculation when making investments . (Ref: College for Financial Planning Glossary of Terms)

Further, the Dictionary of Finance & Banking has something to say about the prudent man rule . It defines it as a US criterion for managing investments, especially in relation to pensions, that is designed to avoid reckless speculation. It requires that a fiduciary behave as a notional prudent man or woman would when making investments . The Handbook of International Financial Terms is even more succinct; it says of the prudent man rule that it is a criterion for managing money adopted in some states. It requires those entrusted with handling other people s affairs to act as a prudent person would (i.e. conservatively) {their words}. It also is used to govern the type of investments considered acceptable .

So, given these rules, how do we define "speculative" and "prudent"? The Oxford English Dictionary defines prudent as "careful, sagacious, exercising sound judgment, discreet, wise, judicious." These terms clearly indicate a trend towards being conservative. The Oxford English Dictionary defines speculation , as referring specifically to stock and/or securities investments, as abstract or hypothetical reasoning, conjecture, a risky business venture, chance.

In other words, a prudent man or woman is held to a high standard of conservative investing, taking care to preserve the money being managed and strive to produce an income that is stable and reliable.

So now the Alaska Perm Fund wants to allocate more money to hedge funds. According to the Wall Street Words publication, a hedge fund is a very specialized, volatile, open-end investment company that permits the manager to use a variety of investment techniques usually prohibited in other types of funds. These techniques include borrowing money, selling short and using options. Hedge funds offer investors the possibility of extraordinary gains with above-average risk . In addition, hedge funds are illiquid; you cannot get out easily. Does Mr. Burns really believe that a volatile hedge fund using normally prohibited, illiquid investment strategies widely accepted as being above-average risk is, in fact, at the same or lower risk levels than other investments ?

Collins Dictionary of Business shines more light on the subject of hedge funds. It defines a hedge fund as a pool of capital which fund managers (for example, international banks) used to speculate on the foreign exchange, stock and commodity markets. Fund managers aim to make windfall profits by correctly guessing future price movements. Their activities, which have become increasingly global and largely unsupervised by regulatory frameworks, have, on occasion, served to destabilize the financial markets .

Although some hedge funds have, in fact, done very well, you might end up in a hedge fund run by inexperienced managers put into position by some of the trendy investment banks on Wall Street who would like to come to the feeding trough. There is also the risk of getting into one run by scam artists looking for an opportunity to jump on the big money bandwagon, because managing a hedge fund is very lucrative, indeed. Hedge funds typically charge a 1% fee on the total assets in the fund, but they also take 20% of the profits.

Hedge funds do not meet the criteria of the prudent man rule. Although the perm fund board of trustees probably does not consider themselves unsophisticated investors, most of the general public is, and it is their money, not the board s money alone, being managed. Hedge funds claim that they make money by not losing when the market is down . That s like saying that I plan to stay young by not getting old. The fact is that hedge funds are only suitable for very sophisticated, high net-worth individual investors. Trustees of Alaska permanent fund are charged with the ethical responsibilities of being a fiduciary, and should not subject the public s money to illiquid, expensive, high-risk alternative investment strategies.

Recently, the US Securities & Exchange Commission (SEC) concluded that hedge funds posed unregulated risks to the public. As of November, 2004 they had lodged 5 cases of fraud against hedge funds, bringing their 5 year total case load to 51, with $1.1 billion in investor losses alleged. As a result, the SEC and the states now are requiring all hedge funds to register as investment advisors, a move which the majority of hedge funds strongly oppose and are reported to be very slow in doing. According to Robert Plaze, the associate director of the investment management division of the SEC, One of the issues is the mispricing of securities in order to hide failures from investors . Mr. Plaze is referring to the fact that hedge funds invest in securities and assets that often cannot be valued on a daily basis, so the potential is high for showing a misleading price when a fund is experiencing financial difficulties. This is yet another area of concern that makes hedge funds unsuitable investments for the Alaska perm fund in our opinion.

As investment professionals for over 21 years each, we have seen many investment fads and schemes that hurt people and wasted money that could have been conservatively invested in an ethical and suitable manner. Allocating Alaska Permanent Fund dollars to go into alternative investments which are routinely known for high degrees of volatility, illiquidity, higher risk, non-disclosure, high fees, and speculative characteristics is not only unwise, but should be legislatively prohibited, not allowed. We understand the desire of the perm fund board of trustees to make as much money as possible for the fund; that is commendable. However, we caution the board not to fall prey to the greed factor.

We strongly encourage the Alaska legislature and the Permanent Fund Board of Directors to revisit this issue before the Alaska Permanent Fund joins in the list of investment clients hurt by hedge funds and private equity firms.


James R. Dahl
Mary Lynne Dahl
Ketchikan, AK - USA



NOTE: Although James and Mary Lynne Dahl have written this letter as private taxpayers and Alaska residents, it may interest the reader to be aware that each of them has over 21 years of experience in finance. Both are professional investment advisor representatives with their own firm, Otter Creek Partners in Ketchikan, Alaska, which is registered as an investment advisor firm in Alaska and Washington. A stock broker for many years, James reports the stock market nightly on KRBD Community Radio, Ketchikan. Mary Lynne is a certified financial planner who works with James to manage investments for their clients. A copy of this letter was sent to every member of the Alaska House of Representatives and every Alaska State Senator.


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