Wyoming’s investments: Barriers to growth

Wyoming’s Permanent Mineral Trust Fund is often mentioned alongside the Alaska Permanent Fund, and for good reason: Both are in sparsely populated, minerals-rich states, where they were set up to preserve the benefits of mineral wealth for future generations. They were created around the same time; Wyoming (1974) actually beat Alaska (1976) to the punch by two years. And in both cases, legislators carefully weighed how to keep future generations of investment managers and political leaders from squandering the funds.

As Gregg Erickson, an economist who helped start Alaska’s fund, put it in an interview with Wyofile: “You want to tie the hands of the future so they don’t fuck it up.”

Wyoming cinched those knots a little tighter than Alaska. Forty-six years later, by the most basic measure, the strictures placed on Wyoming’s fund at its founding have been a success. The PMTF survives. It has never imploded due to investment miscalculation or legislative overspending. But it is also clear that without the constitutional restrictions placed on the PMTF, the $8-billion fund might have become far bigger — perhaps twice its current size, or more.

Similar beginnings, divergent paths

Both Alaska and Wyoming invested only in bonds initially — but in Alaska that limitation was simply a policy, whereas in Wyoming the fixed-income requirement was enshrined in the state Constitution.

Alaska was able to make a quick pivot when the stock market began to revive in the 1980s. Alaska started investing some assets in stocks in 1983; Wyoming didn’t get approval from voters to invest in stocks until 1996. The delay was costly for Wyoming: The S&P 500, with dividends reinvested, rose 15% per year over that period.

Another remnant of its founding continues to hurt returns for the PMTF. The severance taxes deposited into the PMTF are considered “inviolate” — they can never be spent. Wyoming has long interpreted that policy to mean that the only money that can be spent are interest, dividends and realized capital gains. As we’ve discussed elsewhere in this series, that policy has led to Wyoming’s inordinate focus on income — and on selling winning stocks quickly — since increases in market value that haven’t been cashed out don’t count toward what can be paid out of the fund.

This continues to drive investing decisions that do little to maximize long-term returns. Wyoming’s permanent funds have long prohibited direct investments in commodity-related companies — which makes sense, considering that a major goal of the permanent funds is to diversify the state’s revenue sources away from oil, gas and coal. 

When he was treasurer, Gov. Mark Gordon successfully sought an exception that made it possible for Wyoming to invest in energy master-limited partnerships — a structure often used by pipeline companies that transport oil and gas. Gordon’s rationale was that since MLPs are primarily focused on transportation, they would be less exposed to commodity prices than other minerals companies, so the state’s prohibition against investing in minerals companies shouldn’t apply.

But why the interest in MLPs in the first place? One major reason: They pay big dividends, and dividends can be spent by the state’s budgeters under Wyoming’s policy. 

What’s less clear is whether the MLPs will provide an adequate long-term return. In the 20 months that Wyoming has owned them (through March 2020, the latest figures available), Wyoming’s holdings in MLPs have dropped sharply, just like other energy stocks, losing 38% per year.

The state’s need for spendable income is also part of the calculus in its decision to use permanent investments in the controversial bid to purchase land and mineral rights from Occidental Petroleum. Some critics see the attempted purchase as doubling down on oil and gas. The state contests that charge — Gordon sees it more as a trona play — but the state also believes the purchase would eventually contribute more income than low-yielding stocks and bonds.

“In this low-rate environment, how can we improve the risk-adjusted return?” Chief Investment Officer Patrick Fleming asked.

An archaic approach, and other options 

Wyoming’s approach to what can be paid out from the PMTF is archaic —  and may be unnecessary. 

Alaska has far more flexibility around spending than Wyoming does, in spite of being set up with similar protections for the principal contributed.  Following sharp stock-markets drops in 2000-02 and 2008-09, the state of Alaska sought legal rulings that would permit the state to spend even if the value of the fund dipped below the principal that had been contributed, write Erickson and a co-author in “Alaska’s Permanent Fund Dividend: Examining its Suitability as a Model.” The state Attorney General found that principal was not a “fixed, notional number” but instead could vary up and down with the market. 

Alaska doesn’t face the same caps on spending, either — that is, it’s not limited like Wyoming is to paying out only realized gains — since Alaska’s stronger historical investment performance has produced a large reserve account that can be appropriated at will.

That freedom with regard to spending means Alaska can approach investing with greater focus on long-term returns. And it’s one reason that over long periods, Alaska’s returns tend to exceed Wyoming’s. For the decade ending last June, the Alaska Permanent Fund earned 9.2%, compared with just 7.15% for the PMTF.

In addition to hurting investment returns, the restrictions on what can be paid out of the PMTF also add unnecessary variability to what Wyoming spends.

The PMTF has a 5% spending policy, which means that the maximum amount available to the Legislature to spend is 5% of a 5-year average of the PMTF’s market value. But recall the restriction that only income, dividends and realized capital gains can be spent. In the fiscal year that ended in June, those amounted to just $243 million. That means the state will only be able to spend $243 million in the coming fiscal year — a 3.2% spending rate and a $136 million hit to the amount the state would have been able to spend ($379 million) under the 5% spending policy if income and realized capital gains had been higher.

In other words, Fleming, the state’s chief investment officer, has bizarre budgeting power that he never requested — if he had, say, sold three real-estate funds with unrealized gains of more than $136 million by the end of June, legislators would have had that much more to spend.

Around the same time that Wyoming started the PMTF, other funds with similar goals — such as college and nonprofit endowments — were moving toward a more flexible approach. Today, most endowments invest as they please and payouts are determined based solely on a recent average of the fund’s market value. That smooths spending, and also reduces what a fund pays out when market values drop, which helps to ensure that the portfolio survives. 

At a time when spending from the PMTF makes up about 25% of general-fund revenues, moving to a model in which spending is based strictly on the fund’s market value, rather than arbitrary figures like income and realized gains, seems like a wise move. 

It would allow Wyoming to seek out the best investment opportunities available, rather than focusing so heavily on income-producing assets. And it would still require that spending be cut — helping to preserve the PMTF corpus — if market values were to drop.

But such a shift is extremely unlikely to happen, since it would most likely require a constitutional amendment. Two-thirds of Wyoming voters would have to sign off on removing language from the state Constitution that describes the principal of the PMTF as “inviolate.”

“I think the people of Wyoming would say, ‘These guys are just wanting to spend their seed corn,’” Treasurer Curt Meier said. “That would be a real hard one to sell, and it’s not one I would like to try to sell. If we can figure out a way to get some more flexibility and still remain an inviolate corpus, that’s what I’d like to see.”

An uncertain future

One reason the treasurer’s office may be hesitant to take capital gains now is that the state is already struggling to inflation-proof the PMTF — that is, preserve its value for future generations.

In the fiscal year ending this June, for example, the PMTF’s principal rose $124 million, thanks to incoming severance taxes, while the fund’s market-value rose just $69 million, which means that funds that are supposed to be preserved in perpetuity lost value in real terms — not even counting inflation.

The PMTF has a small reserve fund that theoretically can transfer some of its value back into the PMTF for “inflation-proofing,” but there’s rarely much left for that.

“Our Legislature, bless their hearts, has essentially said we’re going to count all the dividends, interest and capital gains, and spend it,” Gordon said. “There’s a discipline problem when you look at something like PMTF.”

The typical Wyoming resident might see the state’s $20 billion in savings as a rescue plan for the current budget crisis. That’s actually the approach in New Mexico right now; Gov. Michelle Lujan Grisham has said she’s willing to use some of New Mexico’s $18 billion Land Grant Permanent Fund to help fill the state’s enormous budget holes.  

But tapping the PMTF to fill a budget hole in Wyoming would likely be blocked on legal grounds, since the fund’s principal is constitutionally protected. And taking a big chunk out of the investments would also be self-defeating, since investment income is a key source of annual revenue for paying the state’s bills.

“Investments aren’t the backup plan,” Rep. Jerry Obermueller (R-Casper) said. “They are the plan.”

It won’t get easier from here. Fleming said the combination of low-yielding debt and high-flying stocks bodes poorly for future returns, as well.

Wyoming’s safest bonds — 10-year Treasury bills — now pay just two-thirds of 1% per year. Meanwhile, U.S. stocks are selling for a historically high multiple of their earnings — a level Fleming hardly sees as a bargain.

Fleming believes diversified investors like Wyoming should prepare for returns of 2.5% to 5% a year — an amount that’s unlikely to cover the state’s current 5% spending policy for the PMTF and the $4.1-billion Common School Permanent Land Fund. If interest rates go negative — a phenomenon that’s happened elsewhere — the challenge for Wyoming becomes all the greater.

“This is the worst investing environment I’ve seen in 40 years,” Fleming said. “I’ve been banging on the desk for two years now — if we go to zero interest rates or negative interest rates, like the rest of the world, how are we going to spend 5%? There is no free lunch here. Something’s got to give.”

The concern about future returns is why Meier proposed cutting the PMTF’s spending rate to just 3.75% — 25% less than what it paid out in the fiscal year that ended in June.

“I understand that … it may be difficult to make these changes even if they move the State towards better long-term financial health,” Meier wrote last November to the Select Committee on Capital Financing & Investments.

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The proposal would be especially painful now — trimming total general-fund revenues in a typical year by about 6%, and exacerbating the painful budget cuts that Gov. Gordon outlined in July.

Legislators didn’t embrace the idea. Spending from the PMTF is scheduled to stay at 5%–when interests, dividends, and realized gains permit–for the next two years before dropping modestly.

Even so, some legislators say the grim prognosis for the state’s investments, on top of the massive revenue deficit created by declines in the energy sector, will require new tax revenue, bigger spending cuts or both.

“Good news obscured lots of things,” Senate Revenue Committee Chairman Cale Case (R-Lander) said. “That’s gone.”

This is part four of a four-part story package analyzing Wyoming’s investments and their impact on state spending. Read part one, Wyoming’s missed investment fund opportunities cost it billions, part two, Wyoming’s investments: Why returns have lagged, and part three, Wyoming’s investments: Plenty of activity, but to what end?