New Legacy Fund strategy expected to yield higher returns – InForum

BISMARCK — A new investment strategy for the North Dakota Legacy Fund is expected to generate higher returns by nudging up the stock portfolio and trimming bonds while holding fewer assets easily convertible to cash.

The new, somewhat more aggressive strategy is expected to yield an average annual return of 6.3% over the next decade, compared to the previous average annual return of 5%.

That 1.3% increase in average expected returns is significant when applied to the $9.38 billion Legacy Fund.

If realized, that higher return rate has the potential to grow to $20 billion in 10 years, an improvement of $800 million to $900 million over the previous, more conservative investment strategy, according to projections by RVK, financial consultants working with the state.

The Legacy Fund draws 30% of North Dakota’s oil and gas revenues to create a strategic investment fund to help finance state government operations when petroleum revenues, which pay for 53% of the state’s general fund, inevitably decline over time.

A major hindrance to growing the Legacy Fund has been a requirement to keep what are called liquid assets — cash or investments that can quickly be sold for cash — at up to 15% of the fund.

That requirement stems from a provision that the North Dakota Legislature, by a two-thirds vote, could withdraw up to 15% of the Legacy Fund’s principal.

In last year’s session, lawmakers passed a resolution that will be on the November ballot that would reduce the potential drawdown on the principal from 15% to 5%, enabling a bigger portion of the fund’s asset portfolio to be invested in assets yielding a higher return.

When the Legacy Fund was established, nobody thought the fund would be approaching $10 billion, so the amount of principal that could be withdrawn in the event of a budgetary emergency was set high, at 15%, said Rep. Glenn Bosch, R-Bismarck, a member of a Legacy Fund advisory committee.

The shift to a less liquid investment portfolio, more than a somewhat more aggressive investment strategy, is the biggest change in investment strategy, he said.

“That is really what’s driving the extra returns,” he said. “I don’t believe we’re overly aggressive right now.”

After voters approved the Legacy Fund in 2010, the fund was conservatively invested in low-return but very safe certificates of deposit, generating a return of 1.1% in its first year or so.

In the years since, the investment strategy for the Legacy Fund has become less risk averse in order to generate higher returns.

“We have made improvements,” said Scott Anderson, chief investment officer of the North Dakota Retirement and Investment Office, which administers the state’s $20 billion asset portfolio, which also includes pension and insurance funds.

The strategy aims to preserve the fund’s purchasing power in the face of inflation and maximize total returns while also allowing for capital preservation.

Still, Anderson added, “There’s a certain amount of liquidity that needs to be met.”

Initially, up to 25% of the Legacy Fund’s portfolio could be invested in illiquid assets, a proportion increased to up to 35% under legislation passed last year.

You can be aggressive to a point. … The idea is longevity. We’re really 20-year investors.

Keith Kempenich, R-Bowman

A portion of Legacy Fund earnings are transferred to the general fund every legislative session.

Monthly inflows into the fund from oil and gas revenues have ranged from $50 million to $75 million in recent months.

Over the last three two-year budgets, spanning 2017 to 2023, legislators have transferred more than $1.8 billion to the general fund.

Investments for the Legacy Fund must follow the prudent investor rule.

Since 2013, the Legacy Fund’s returns have ranged from -10.1% in 2021 to 22.7% in 2020, averaging 5.62%, according to state figures.

That compares to a benchmark return average of 4.89%, for a 0.73% “excess return” reflecting the value added by professional investment managers working for the state, Anderson said.

“It returned much higher than CD rates,” Anderson said, referring to certificates of deposit, “but not as high as it could with private equity investments.”

The Legacy Fund now can invest in private equity, a form of direct investment in companies that can take years to generate returns, but has the potential for high returns.

That is another reason for decreasing low-returning, liquid investments, said Rep. Keith Kempenich, R-Bowman, who serves on the Legacy Fund advisory committee.

The new investment strategy should increase the Legacy Fund’s 10-year earnings by $220 million, Anderson said.

“These changes take time to implement,” requiring time to choose the proper investments, he said. “We’re taking the appropriate amount of time.”

Because of the need to rotate assets gradually, the effects of the new Legacy Fund investment strategy, approved in June, likely won’t be fully evident until this summer, Kempenich said.

“We’ll see where we’re at in another few months,” he said.

The Legacy Fund is guided by a long-term investment strategy, with a 20-year horizon, Kempenich said.

“You can be aggressive to a point,” he said. “The idea is longevity. We’re really 20-year investors.”

As of Nov. 30, 2023, the most recent figures available, the Legacy Fund has returned 8.5%, year to date.

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