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State Investment Council prepared for market downturn

ALBUQUERQUE, N.M. — With stock markets in flux and oil prices dropping fast, New Mexico’s permanent funds could take a beating in coming months, but the State Investment Council is ready.

The 11-member SIC has spent eight years diligently diversifying permanent fund investments out of volatile stocks and into more stable bonds, as well as alternative assets like real estate, infrastructure, energy and even timber.

During bull markets, those things earn lower returns than soaring public equities. But when stock markets go south, they provide a lot more portfolio stability, helping sustain the overall value of New Mexico’s funds, said Peter Frank, one of the SIC’s four legislative appointees.

“We’ve been positioning ourselves for downturns in the stock market for awhile,” Frank said. “We’ll face some declines in the current situation, but we’re prepared for it.”

Eric Sanchez, 9, left, and Alexis Carmona, right, and classmates from George I. Sanchez Collaborative Community School participated in a rally earlier this year to tap more of the state’s Land Grant Permanent Fund for early childhood education spending. The fund is among those managed by the State Investment Council. (Eddie Moore/Albuquerque Journal)

Linda Eitzen, one of four council members appointed by the governor, said the SIC could not only ride out the latest market storm, but also take advantage of it by buying low-priced equities, using returns earned from non-stock assets.

“Bring it on,” Eitzen said. “We know it will be a bad market for awhile, but we’re ready. We have the protections in place, and we’ll have liquidity to buy into bargain markets.”

That’s a huge change from the last major recession in 2008, when the state’s permanent funds plummeted by nearly 30 percent, from $16.1 billion to $11.68 billion. Apart from the severity of that recession, the losses reflected backward structures at the SIC that produced poor, high-risk investment decisions with a heavy concentration in volatile stocks.

Most decisions at that time were made solely by the state investment officer with little input or oversight by council members. Extensive reforms since 2010, however, have fundamentally altered the SIC makeup and management, leading to broad portfolio-diversification and vetting of all decisions by the entire council. And that, in turn, has stabilized investment returns and fund growth, allowing the permanent funds to weather two other markets dips in 2011 and 2015, plus a crash in oil prices in late 2014 that endured through mid-2017.

That’s put the permanent funds on solid footing as incoming Gov. Michelle Lujan Grisham takes office, despite the latest stock market turmoil and a new plunge in oil prices.

“We view the permanent funds as an engine for the state, and right now the engine is running very well,” said SIC spokesman Charles Wollmann.

As of June 30, the SIC had a record $24 billion under management, up $11 billion since 2010, before the SIC reforms took effect.

That reflects nearly 100 percent growth in the Land Grant Permanent Fund since 2010, from $8.8 billion that year to $17.5 billion as of last June. The Severance Tax Permanent Fund also increased 50 percent in the same period, from $3.4 billion to $5.1 billion.

That’s welcome news as the next legislative session begins in January, since annual distributions from the land grant and severance tax permanent funds together account for about 15 percent of the state’s general operating budget.

Each year, the land grant fund pays out 5 percent of the average value of the corpus over a period of five years, while the severance tax pays out 4.7 percent. Given the growth of both funds since 2010, general fund distributions for the current fiscal year will reach $968.1 million, up 36 percent, from 2010, when the funds contributed $712.6 million to the state budget.

“The more the funds grow, the bigger the annual benefit,” Wollmann said. “This year, it’s paying close to $1 billion in benefits. There’s a lot happening in the markets now, but we project we’ll cross the $1 billion threshold in payouts from the permanent funds for the first time in FY 2020.”

That depends, of course, on the impact of stock market and oil price performance.

About 95 percent of all money in the permanent funds comes from oil and gas leases, royalties and taxes for activities on state lands, which are paid into the land grant and severance tax funds, plus returns earned from SIC investments of that money. The remaining 5 percent comes from water, tobacco and client funds managed by the SIC.

Notwithstanding ups and downs in the oil industry, much of the permanent-fund growth since 2010 has come from high oil prices and record volumes of crude produced in the Permian Basin in southeastern New Mexico. Prices remained above $100 per barrel before crashing in late 2014. And despite the nearly three-year bust that followed, prices rebounded again in mid-2017, climbing above $70 a barrel by last summer.

That drove monthly, oil-related income flowing into the land grant fund to a record peak of $83.5 million in October, up from $38 million in October 2017, when prices were just beginning to rebound, Wollmann said.

At the same time, good returns on SIC investments have helped boost growth in the permanent funds during up years in the oil industry, while offsetting losses during the down years.

Now, however, the SIC faces a double whammy of declining oil prices, which dipped below $45 a barrel in late December, and extreme volatility on the stock markets. Those things will certainly slow growth in the permanent funds, and possibly cut some of the value, depending on how long the volatility lasts.

But the SIC expects its portfolio diversification to buffer the slide, as alternative, income-generating assets continue to produce returns. The council has lowered its holdings in public equities from about 62 percent of total investments in 2010 to about 45 percent today.

Trader Gregory Rowe works at the New York Stock Exchange in New York. (Mark Lennihan/Associated Press)

About 25 percent of investments are now in bonds, with another 28 percent divided among hard assets like timber and energy, real estate, and private equity investments in businesses. That has included holdings in such iconic real estate as One Times Square and Chelsea Market in New York, infrastructure like Scotland’s Edinburgh Airport, and diverse businesses such as the Detroit Pistons basketball team.

The diversification has helped push permanent fund returns beyond SIC targets to outperform many others nationwide.

“We’re now in the top quartile compared with other funds for returns over one year and seven years,” Wollmann said. “And we’re above the median for three-year and seven-year returns.”

Only 10-year returns remain below the median as the council continues to shed the legacy of poor investment decisions made prior to council reforms in 2010.

“We’ve over performed this year compared with our benchmarks,” Eitzen said. “Things are on a good course and running smoothly. It’s a good story for New Mexico.”