Wednesday, April 23, 2014

CAAT Gains 13.9% Net in 2013

Benefits Canada reports, CAAT posts 13.9% return for 2013:
The Colleges of Applied Arts and Technology (CAAT) Pension Plan reported a 13.9% net return for the year that ended on December 31, 2013.

The DB plan’s net assets climbed to $7.1 billion, up from $6.3 billion the previous year.

In its valuation filed as of Jan. 1, 2014, the pension plan is 105% funded on a going-concern basis and has a funding reserve of $525 million.

The plan returned 14.5% before investment management fees. Since the 2008 economic meltdown, the CAAT Pension Plan’s investment portfolio has produced an average annual return of 11.7% gross and 11.1% net of investment management fees.

Last year, contributions to the CAAT plan, which are shared equally by employees and employers of the Ontario college system, amounted to $368 million. Income from investments was $860 million. The plan paid $344 million in pension benefits for the year.

The CAAT plan has 22,000 members working in the Ontario college system, which is made up of 24 colleges and seven affiliated non-college employers. It also has 15,000 members who are retired or have a deferred pension.

For every dollar paid in pension, at least 70 cents come from investment income. The remaining 30 cents come from equal member and employer contributions.
CAAT pension plan posted a press release last week, CAAT Pension Plan earns 13.9% net:
The CAAT Pension Plan today announced a 13.9% rate of return net of investment management fees for the year ended December 31, 2013.The Plan’s net assets increased to $7.1 billion from $6.3 billion the previous year.

In its valuation filed as at January 1, 2014, the CAAT Pension Plan is 105% funded on a going-concern basis with a funding reserve of $525 million.

The Plan returned 14.5% before investment management fees totaling 60 basis points. Since the economic crisis of 2008, the CAAT Pension Plan’s well-diversified investment portfolio has earned an average annual rate of return of 11.7% gross and 11.1% net of investment management fees.

Contributions to the CAAT Plan, shared equally by employees and employers of the Ontario college system, were $368 million in 2013, while income from investments was $860 million. The Plan paid $344 million in pension benefits for the year.

The CAAT Pension Plan has 22,000 members employed in the Ontario college system, which is made up of 24 colleges and seven affiliated non-college employers, and 15,000 members who are retired or have a deferred pension.

For every dollar paid in pension, at least 70 cents comes from investment income. The remaining 30 cents comes equally from member and employer contributions.

The average annual lifetime pension for all retired members and survivors is $23,700. In 2013, members on average retired at age 62 after 24 years of pensionable service. The 730 members who retired last year collected an average annual lifetime pension of $37,400.

The CAAT Plan seeks to be the pension plan of choice for single-employer Ontario university pension plans interested in joining a multi-employer, jointly sponsored plan in the sector. The postsecondary education alignment and similar demographic profile of university and college employees makes the university plans an ideal fit with the CAAT Plan’s existing asset and liability funding structures. The CAAT Plan has been in discussions with individual universities, employer and faculty associations, and with government officials, about the feasibility of building a postsecondary sector pension plan that leverages the Plan’s infrastructure and experience, reducing costs and risks for all stakeholders.

“We believe the merger of interested university pension plans with the CAAT Plan would benefit all stakeholders by delivering predictable costs and more secure benefits at a lower risk,” says Derek Dobson, CEO of the CAAT Pension Plan. “We can achieve this through an alignment of interests within the sector that provides the added advantage of seamless portability of pensions between colleges and universities.”

Created at the same time as the Ontario college system in 1967, the CAAT Plan assumed its current jointly sponsored governance structure in 1995. The CAAT Plan is a contributory defined benefit pension plan with equal cost sharing. Decisions about benefits, contributions and investment risk are also shared equally by members and employers. The Plan is sponsored by Colleges Ontario, OCASA (Ontario College Administrative Staff Association) and OPSEU (Ontario Public Service Employees Union).
There is not much to say on my end except that CAAT is doing an outstanding job in managing their pension plan. It's delivering excellent investment results and the shared risk model of this plan is a major reason why the plan remains fully funded and a true testament as to why well governed defined-benefit plans are the way to go.

Last year I wrote about the CAAT and Optrust edge, praising Julie Cays, CAAT's chief investment officer. Julie is an exceptional pension fund manager and in a male dominated industry, she doesn't receive the recognition she rightfully deserves. Posting 13.9% net in 2013 after posting 11.3% net in 2012 and remaining fully funded is outstanding and this is why I say CAAT is one of the best Canadian public pension plans you never heard of.

CAAT's Annual Report is not available yet but it will be released in May and you can click here to view it once it's released. Julie Cays did share this with me:
Our annual report will be out in a few weeks with a lot more detail but in short, our 13.9% net return in 2013 was driven by positive absolute performance in all of our asset classes (with the exception of bonds of course), the strongest coming from our 30% weighting in non-Canadian equities. It was also a good year for positive relative performance – again in virtually all asset classes. Added value was 210 bps net of fees or $130 million over the year.
I congratulate Julie and the entire staff at CAAT for another great year. I urge all universities, especially my alma mater, McGill University, to join CAAT's Pension Plan. McGill recently hired Sophie Leblanc away from Bombardier to be their new CIO of their pension and endowment fund. I don't know much about Ms. Leblanc except that Bombardier was one of the worst Canadian corporate plans (not entirely her fault, the place is a bureaucratic nightmare). You can read McGill Pension Plan 2013 Annual Report here.

Below, Derek Dobson, CEO of the CAAT Pension Plan, discusses the benefits of the plan. I also urge you to watch a video on inflation protection CAAT posted on their website.

Tuesday, April 22, 2014

Michael Castor on Investing in Healthcare

Over the weekend, Dr. Michael Castor, Founder and Managing Portfolio Manager of SIO Capital Management, shared his thoughts with me on investing in healthcare (added emphasis is mine):
Persons interested in allocating/investing their assets tend to have two different schools of thought regarding investing in healthcare. The first line of thinking, which seems to be more common, is that healthcare is a great area in which to invest because there exist: (1) unmet medical needs yet to be addressed, (2) amazing scientific technologies that were not in existence just a few years ago, and (3) an aging demographic globally and commensurately an increasingly large pool of consumers of healthcare goods and services.

All of these are true, but they fail to recognize other truths that are equally important. First, there has been a trend toward aging demographics for decades. Second, while technologies are better, the hurdles for discovering new drugs and therapies are much higher. Over the past few decades, there have been incredible, life-saving discoveries including drugs to lower blood pressure, drugs to treat high cholesterol, drugs to treat various cancers, artificial joints and heart valves, pace makers, and diagnostic tools such as MRIs and PET scanners. Arguably, these were low hanging fruit, but they have made enormous impacts on health and longevity. Incremental discoveries that will provide further benefits become increasingly challenging to find.

Further, economic pressures augur against sustained growth in healthcare. At present, healthcare currently consumes over 17% of U.S. GDP, up from about 7% in 1970 (sources: The World Bank; CMS; CMS again). At such a level, there is a need for payers, whether they be governments or private companies, or insurers, to push back against further growth. It is likely not economically bearable. As a result, healthcare becomes a zero-sum game constrained to GDP growth rates (meaning that increases in spending in one area must be offset by decreases in other areas). Part of the growth in spending over past decades has arisen because of the complex nature of delivery of healthcare. There are inefficiencies in the market and information failures. The involved parties (payers, decision makers, and users/patients) all have different agendas, different pressures, and different levels of information. I have written about the economics of healthcare delivery on my blog (see: The problems inherent to healthcare economics and Healthcare economics – Medical billing: an arcane, problematic system and More on generic Viagra: inefficiency within healthcare).

Since the mid 1990s, price increases have been meaningful drivers of the growth in healthcare (here are some things I’ve written on my blog about drug prices: Should prescription drugs cost as much as they do? and Drug price inflation). Specifically on that point, the launch of a single new hepatitis drug (called Sovladi) has triggered a cascade of scrutiny about the high prices of certain drugs. Similarly, the American Society of Clinical Oncology (the leading medical group that focuses on treating cancer) is reportedly discussing an initiative to encourage doctors to consider the prices of medications as they decide on treatment regiments. Stories such as these are also garnering attention in the media, such as in the recent New York Times article Cost of Treatment May Influence Doctors.

I favor a second line of thinking about investing in healthcare, namely that this sector is highly specialized, complex, and esoteric. This complexity and specialization leads to mispricing of stocks and opportunities to invest in individual, specifically-selected equities (as opposed to seeking indiscriminate exposure to the healthcare universe broadly). The complexities are multifold, with scientific issues, regulatory dynamics, political machinations, and intellectual property matters variably influencing individual companies. These exist on top of the already arcane delivery of healthcare and the complex business operations of the companies involved. Any or all of these issues can drive mispricing of stocks. Indeed, even if one takes the view that secular trends will drive growth in healthcare, such an outlook might already be reflected in stock prices. Moreover, investors can become overly optimistic and bid prices up to inappropriately high levels. Behavioral biases exist for healthcare stocks, with exuberance and fear driving prices and creating opportunities.

On the topic of exuberance, healthcare can generate excitement for scientific reasons (the promise of curing cancer or any number of reasons) and economic reasons (the prospect of investing in a growth area not leveraged to the economy when investors become concerned about recessions or economic slowdowns). Markets become frothy at times. Wall Street analysts find reasons to justify higher stock prices (such as lowering their discount rates for future earnings or ascribing higher probabilities of success to early-stage, speculative drugs or unproven business models). These types of scenarios are not infrequent. As a result, there are excellent opportunities to find ‘short’ investments in healthcare, not just long investments. Catalysts for individual ‘short’ investments can run the gamut from disappointing earnings to the emergence of competition to failed clinical trials to decelerating revenues. Further, holding individual short investments that are intended to generate alpha/returns also serves to protect a portfolio of long investments in periods of stock price volatility, especially when investors become complacent and prices become frothy and excessive.

On the topic of investing in healthcare, it is worth noting that “biotech” as a subsector tends to garner headlines, but healthcare is far broader. (Philosophically, we believe that there are compelling reasons to invest in select biotech stocks, but many stocks are driven by hype and/or emotion and, as such, are generally not good investments.) There are approximately 2,000 public healthcare companies across the globe. There are hospitals, managed care organizations/HMOs, service companies, business-to-business providers, consumer healthcare companies, drug stores, medical device companies, pharmaceutical companies, healthcare IT companies, etc. The sector is large, diverse, heterogeneous, and filled with uncorrelated investment opportunities. By focusing on this sector continuously and consistently, we are able to find opportunities, both long and short. One constant seems to be that new opportunities continue to arise. This makes healthcare an attractive universe in which to invest.
I thank Michael Castor for sharing this extremely informative piece on investing in healthcare. I invite all of you to read his blog, Quintessential. For those interested in Sio’s monthly letters, they are available to people who request a logon to the Sio Capital Management website.

Michael and I had a chance to talk on Saturday morning. It was my "Big Fat Greek Easter" this weekend so I was busy going to church and then stuffing my face with lamb and all sorts of delicious Greek food, which I'll have to burn off over the next month (argh!). But I'm glad we had a chance to talk so I can learn more about him, his fund and his thoughts on investing in healthcare.

You'll recall I first discussed Sio Capital Management in a post covering 2013's best hedge fund manager. The first thing that struck me about Michael is how bright and dedicated he is. He literally works seven days a week and has an unparalleled passion for investing in healthcare. And he really knows his stuff. I've met a ton of hedge fund managers in my life and very few really impressed me (most of them are marketing geniuses). I even told him so straight out: "If I had a dollar for every time some slick hedge fund manager told me they had a 'niche strategy', I'd be a multi millionaire."

Michael is impressive because he's extremely knowledgeable and has constructed his portfolio to manage downside risk and target positive returns in all market environments. In other words, not only is he investing in a field where the barriers to entry are naturally high because it requires specialized knowledge, he also understands how to properly construct his portfolio to limit serious drawdowns.

In fact, in 2008, SIO Capital was up 10.8%. Since inception (June 2006), the fund is up 14% on an annualized basis, handily beating the S&P 500 and MSCI World Healthcare index. Their only losing year was 2010.

Even more impressive is the fund's risk profile. They achieved these results on the long and short side with little net exposure and the standard deviation (a measure of volatility) of their returns was half that of the S&P 500 (7.9% vs 16.2%) and less than that of the MSCI World Healthcare index (13.6%).

I did ask Michael about 2010 and why Sio was down 6.1% (always ask tough questions about losing years). He replied:
 “In 2009, I hired three analysts. They had different styles. I did not have a full appreciation of the challenges of growing the team this quickly and the degree to which maintaining Sio’s style was critical. For example, some of the analysts gravitated toward more speculative investments than I was comfortable. Ultimately, as the portfolio manager, the track record and the responsibility lie with me. Looking back, 2010 was a year where the analysts, despite being good people, were distractions in aggregate rather than overall contributors to generating performance. I made the hard decision to part with all of these analysts in late 2010. It was the right thing for the team at Sio and for our investors. Despite a challenging year, I look back and assert that not only do I now have a better understanding of who is the right team for me, I also know how I will perform in a challenging environment. I rebuilt the team with extraordinary people who share and embrace Sio’s approach. I believe our results since that time suggest that this was the right course of action.”
During 2010, four funds of funds that made up close to 70% of the assets pulled out. Sio currently manages approximately $100 million. Michael speaks fondly of his early investors, who have mostly remained with the fund since inception. Several are doctors Michael knows well, including his professors (shows you the vote of confidence they have in him).

I told Michael to forget about funds of funds. They're on the verge of extinction and charge an extra layer of fees which is why they're nothing more than hot money chasing the next home run (there are a few exceptions). I told him to focus on pension investors.

It should be noted that Sio Capital has a capacity of roughly $750 million and Michael will stick to this. I mention this because a lot of the pension funds I know won't look at any fund they can't write a minimum ticket of $100 million. He told me: "That's fine, we are not going to grow assets at the expense of performance." I liked that answer a lot because it shows me his focus is 100% on performance.

We also talked about markets. I told him I saw the latest biotech selloff as a huge buying opportunity and was focusing on stocks the Baker Brothers own which got sliced in half and more. I used the selloff to add to my holdings of Idera Pharmaceuticals (IDRA), which is up 17% today on heavy volume. I told him "I'm a biotech beta junkie" but admittedly have to withstand crazy, CRAZY swings in my portfolio which would give heart attacks to any retail or institutional investor (given me plenty of anxiety attacks too!).

He told me that Sio's exposure to biotech varies depending on the opportunity set. In general, Sio’s weight in biotech is in the range of 20-25% of the portfolio. This includes some early stage companies as well as established, large-cap biotech companies such as Biogen (BIIB) and Amgen (AMGN). I asked Michael to name a few of the early stage companies he finds interesting. He told me he likes TG Therapeutics (TGTX), which the Baker Brothers are top holders of, and Retrophin (RTRX), a company started by Martin Shkreli, a notorious short seller. He also told me he was skeptical that Neuralstem (CUR) was going to succeed in their stem cell trial for ALS and felt similarly about Inovio Pharmaceuticals (INO), a company that macro king Louis Bacon bought in the last quarter.

Sio's portfolio is diversified across healthcare. Sio invests in healthcare service companies, medical equipment manufacturers, drug makers and other healthcare stocks. They have 40 longs and 40 shorts. Michael told me they now have no HMOs because they find them fully valued but that can change in the future if opportunities arise.

For full disclosure purposes, Sio reached out to me to introduce themselves after I first mentioned them on my blog. After being impressed by Michael when we spoke, I asked him to provide me with his thoughts on investing in healthcare. The fund has not provided me a dime for this post.

Lastly, as often is the case with smaller funds, Sio Capital has “manager risk.” God forbid a bus runs over Michael Castor, they're screwed! they will have to liquidate holdings and return money to their investors. Michael understands this. The fund documents contain a “key-man” clause which states that if Michael becomes incapacitated or otherwise unable to manage the portfolio, the fund will be liquidated and money will be returned to investors. Michael told me, “Sio’s responsibility is to always protect and do right by our investors.”

Please remember to donate and/or subscribe to this blog by going to the top right hand side of this page. All you need is a PayPal account and your financial support is very appreciated (takes a lot of time and energy to do these blog posts!!!).

Below, Michael Castor, founder of SIO Capital Management, talks about ways his portfolio is being impacted by the Supreme Court's decision to uphold the majority of President Barack Obama's health-care overhaul. Castor, speaking with Deirdre Bolton on Bloomberg Television's "Money Moves," also talks about the decision's effect on the medical community (June 2013).

Monday, April 21, 2014

Has Capitalism Failed The World?

Andrew Hussey of The Guardian writes, Occupy was right: capitalism has failed the world:
The École d'économie de Paris (the Paris School of Economics) is actually situated in the most un-Parisian part of the city. It is on the boulevard Jourdan in the lower end of the 14th arrondissement, bordered on one side by the Parc Montsouris. Unlike most French parks, there is a distinct lack of Gallic order here; in fact, with lakes, open spaces, and its greedy and inquisitive ducks, you could very easily be in a park in any British city. The campus of the Paris School of Economics, however, looks unmistakably and reassuringly like nearly all French university campuses. That is to say, it is grey, dull and broken down, the corridors smelling vaguely of cabbage. This is where I have arranged an interview with Professor Thomas Piketty, a modest young Frenchman (he is in his early 40s), who has spent most of his career in archives and collecting data, but is just about to emerge as the most important thinker of his generation – as the Yale academic Jacob Hacker put it, a free thinker and a democrat who is no less than "an Alexis de Tocqueville for the 21st century".

This is on account of his latest work, which is called Capital in the Twenty-First Century. This is a huge book, more than 700 pages long, dense with footnotes, graphs and mathematical formulae. At first sight it is unashamedly an academic tome and seems both daunting and incomprehensible. In recent weeks and months the book has however set off fierce debates in the United States about the dynamics of capitalism, and especially the apparently unstoppable rise of the tiny elite that controls more and more of the world's wealth. In non-specialist blogs and websites across America, it has ignited arguments about power and money, questioning the myth at the very heart of American life – that capitalism improves the quality of life for everyone. This is just not so, says Piketty, and he makes his case in a clear and rigorous manner that debunks everything that capitalists believe about the ethical status of making money.

The groundbreaking status of the book was recognised by a recent long essay in the New Yorker in which Branko Milanovic, a former senior economist at the World Bank, was quoted as describing Piketty's volume as "one of the watershed books in economic thinking". In the same vein, a writer in the Economist reported that Piketty's work fundamentally rewrote 200 years of economic thinking on inequality. In short, the arguments have centred on two poles: the first is a tradition that begins with Karl Marx, who believed that capitalism would self-destruct in the endless pursuit of diminishing profit returns. At the opposite end of the spectrum is the work of Simon Kuznets, who won a Nobel prize in 1971 and who made the case that the inequality gap inevitably grows smaller as economies develop and become sophisticated.

Piketty says that neither of these arguments stand up to the evidence he has accumulated. More to the point, he demonstrates that there is no reason to believe that capitalism can ever solve the problem of inequality, which he insists is getting worse rather than better. From the banking crisis of 2008 to the Occupy movement of 2011, this much has been intuited by ordinary people. The singular significance of his book is that it proves "scientifically" that this intuition is correct. This is why his book has crossed over into the mainstream – it says what many people have already been thinking.

"I did deliberately aim the book at the general reader," says Piketty as we begin our conversation, "and although it is obviously a book which can be read by specialists too, I wanted the information here to be made clear to everyone who wants to read it.' And indeed it has to said that Capital in the Twenty-First Century is surprisingly readable. It is packed with anecdotes and literary references that illuminate the narrative. It also helps that it is fluently translated by Arthur Goldhammer, a literary stylist who has tackled the work of the likes of Albert Camus. But even so, as I note that Piketty's bookshelves are lined with such headache-inducing titles as The Principles of Microeconomics and The Political Influence of Keynesianism, simple folk like me still need some help here. So I asked him the most obvious question I could: what is the big idea behind this book?

"I began with a straightforward research problematic," he says in elegant French-accented English. "I began to wonder a few years ago where was the hard data behind all the theories about inequality, from Marx to David Ricardo (the 19th-century English economist and advocate of free trade) and more contemporary thinkers. I started with Britain and America and I discovered that there wasn't much at all. And then I discovered that the data that did exist contradicted nearly all of the theories including Marx and Ricardo. And then I started to look at other countries and I saw a pattern beginning to emerge, which is that capital, and the money that it produces, accumulates faster than growth in capital societies. And this pattern, which we last saw in the 19th century, has become even more predominant since the 1980s when controls on capital were lifted in many rich countries."

So, Piketty's thesis, supported by his extensive research, is that financial inequality in the 21st century is on the rise, and accelerating at a very dangerous pace. For one thing, this changes the way we look at the past. We already knew that the end of capitalism predicted by Marx never happened – and that even by the time of the Russian revolution of 1917, wages across the rest of Europe were already on the rise. We also knew that Russia was anyway the most undeveloped country in Europe and it was for this reason that communism took root there. Piketty goes on to point out, however, that only the varying crises of the 20th century – mainly two world wars – prevented the steady growth of wealth by temporarily and artificially levelling out inequality. Contrary to our perceived perception of the 20th century as an age in which inequality was eroded, in real terms it was always on the rise.

In the 21st century, this is not only the case in the so-called "rich" countries – the US, the UK and western Europe – but also in Russia, China and other countries which are emerging from a phase of development. The real danger is that if this process is not arrested, poverty will increase at the same rate and, Piketty argues, we may well find that the 21st century will be a century of greater inequality, and therefore greater social discord, than the 19th century.

As he explains his ideas to me with formulae and theorems, it still sounds a little too technical (I am someone who struggled with O-level maths). But by listening carefully to Piketty (he is clearly a good and patient teacher) and by breaking it down into bite-sized chunks it does all start to make sense. For this beginner he explains that income is a flow – it moves and can grow and change according to output. Capital is a stock – its wealth comes from what has been accumulated "in all prior years combined". It's a bit like the difference between an overdraft and a mortgage, and if you don't ever get to own your house you'll never have any stock and always be poor.

In other words, in global terms what he is saying is that those who have capital and assets that generate wealth (such as a Saudi prince) will always be richer than entrepreneurs who are trying to make capital. The tendency of capitalism in this model is to concentrate more and more wealth in the hands of fewer and fewer people. But didn't we already know this? The rich get rich and the poorer get poorer? And didn't the Clash and others sing about it in the 1970s?

"Well actually, we didn't know this, although we might have guessed at it," says Piketty, warming to his theme. "For one thing this is the first time we have accumulated the data which proves that this is the case. Second, although I am not a politician, it is obvious that this movement, which is speeding up, will have political implications – we will all be poorer in the future in every way and that creates crisis. I have proved that under the present circumstances capitalism simply cannot work."

Interestingly, Piketty says that he is an anglophile and indeed began his research career with a study of the English system of income tax ("one of the most important political devices in history"). But he also says that the English have too much blind faith in markets which they do not always understand. We discuss the current crisis in British universities, which having imposed fees now find that they are short of cash because the government miscalculated what students would have to pay and is now unable to ensure that the loans handed out to cover the fees will ever be repaid. In other words, the government thought it was on to a sure money-maker by introducing fees; in fact, because it could not control all the variables of the market, it was gambling with the nation's money and looks set to lose spectacularly. He chuckles: "This is a perfect example of how to inflict debt on to the public sector. Quite extraordinary and quite impossible to imagine in France."

For all that he is keen on Britain and the United States, Piketty says that he only really feels at home in France. Capital in the Twenty-First Century is constructed out of a plethora of French references (the historian François Furet is key), and Piketty declares that he understands the French political landscape best of all. He was brought up in Clichy in a mainly working-class district and his parents were both militant members of Lutte Ouvrière (Workers' Struggle) – a hardcore Trotskyist party which still has a significant following in France. Like many of their generation, disappointed by the failure of near-revolution of May '68, they dropped out to raise goats in the Aude (this was a classic trajectory for many babacools – leftist hippies – of that generation). The young Piketty worked hard at school, however, studying in Paris and finishing up with a PhD from the London School of Economics at the age of 22. He then moved on to Massachusetts Institute of Technology, where he was a noted prodigy, before moving back to Paris to finally become director of the school where we are now sitting.

His own political itinerary began, he tells me, with the fall of the Berlin Wall in 1989. He set out to travel across eastern Europe and was fascinated by the wreckage of communism. It was this initial fascination that led him towards a career as an economist. The gulf war of 1991 also influenced him. "I could see then that so many bad decisions were taken by politicians because they did not understand economics. But I am not political. It is not my job. But I would be happy if politicians could read my work and draw some conclusions from it."

This is slightly disingenuous as Piketty did actually work as an adviser to Ségolène Royal in 2007, when she was the socialist candidate in the presidential elections. This was not a happy period for him – his love affair with the politician and novelist Aurélie Filipetti, another Royal acolyte, ended around then with acrimonious accusations on both sides. Fair enough, after this murky business, that Piketty might want to distance himself from the everyday rough and tumble of real politics.

But no matter. What have we learned? Capitalism is bad. Hooray! What's the answer? Socialism? Hope so. "It is not quite so simple," he says, disappointing this former teenage Marxist. "What I argue for is a progressive tax, a global tax, based on the taxation of private property. This is the only civilised solution. The other solutions are, I think, much more barbaric – by that I mean the oligarch system of Russia, which I don't believe in, and inflation, which is really just a tax on the poor." He explains that oligarchy, particularly in the present Russian model, is quite simply the rule of the very rich over the majority. This is both tyrannical and not much more than a form of gangsterism. He adds that the very rich are not usually hurt by inflation – their wealth increases anyway – but the poor suffer worst of all with a rising cost of living. A progressive tax on wealth is the only sane solution.

But for all that he is talking sense, much of it common sense, I put to him that no political party in Britain or the United States, of left or right, would dare to go to the polls with such idealistic ideas. The present government of François Hollande is widely despised not because of the president's sexual peccadilloes (in contrast, these are pretty much widely admired) but because of the punitive tax regime he has been seeking to impose.

"This is true," he says. "Of course it is true. But it is also true, as I and my colleagues have demonstrated in this book, that the present situation cannot be sustained for much longer. This is not necessarily an apocalyptic vision. I have made a diagnosis of the past and present situations and I do think that there are solutions. But before we come to them we must understand the situation. When I began, simply collecting data, I was genuinely surprised by what I found, which was that inequality is growing so fast and that capitalism cannot apparently solve it. Many economists begin the other way around, by asking questions about poverty, but I wanted to understand how wealth, or super-wealth, is working to increase the inequality gap. And what I found, as I said before, is that the speed at which the inequality gap is growing is getting faster and faster. You have to ask what does this mean for ordinary people, who are not billionaires and who will never will be billionaires. Well, I think it means a deterioration in the first instance of the economic wellbeing of the collective, in other words the degradation of the public sector. You only have to look at what Obama's administration wants to do – which is to erode inequality in healthcare and so on – and how difficult it is to achieve that, to understand how important this is. There is a fundamentalist belief by capitalists that capital will save the world, and it just isn't so. Not because of what Marx said about the contradictions of capitalism, because, as I discovered, capital is an end in itself and no more."

Piketty delivers this speech, erudite and powerful, with a quiet passion. He is, one would guess, a relatively modest and self-effacing character, but he loves his subject and it is indeed a delight to find oneself in the midst of a private seminar on money and how it works. His book is indeed long and complicated but anyone who lives in the capitalist world, which is all of us, can understand the arguments he makes about the way it works. One of the most penetrating of these is what he has to say about the rise of managers, or "super-managers", who do not produce wealth but who derive a salary from it. This, he argues, is effectively a form of theft – but this is not the worst crime of the super-managers. Most damaging is the way that they have set themselves in competition with the billionaires whose wealth, accelerating beyond the economy, is always going to be out of reach. This creates a permanent game of catch-up, whose victims are the "losers", that is to say ordinary people who do not aspire to such status or riches but must be despised nonetheless by the chief executives, vice-presidents and other wolves of Wall Street. In this section, Piketty effectively rips apart one of the great lies of the 21st century – that super-managers deserve their money because, like footballers, they have specialised skills which belong to an almost superhuman elite.

"One of the great divisive forces at work today," he says, "is what I call meritocratic extremism. This is the conflict between billionaires, whose income comes from property and assets, such as a Saudi prince, and super-managers. Neither of these categories makes or produces anything but their wealth, which is really a super-wealth that has broken away from the everyday reality of the market, which determines how most ordinary people live. Worse still, they are competing with each other to increase their wealth, and the worst of all case scenarios is how super-managers, whose income is based effectively on greed, keep driving up their salaries regardless of the reality of the market. This is what happened to the banks in 2008, for example."

It is this kind of thinking that makes Piketty's work so attractive and so compelling. Unlike many economists he insists that economic thinking cannot be separated from history or politics; this is what gives his book the range the American Nobel laureate Paul Krugman described as "epic" and a "sweeping vision". Piketty's influence indeed is growing well beyond the small enclosed micro-society of academic economists. In France he is becoming widely known as a commentator on public affairs, writing mainly for Le Monde and Libération, and his ideas are frequently discussed by politicians of all hues on current affairs programmes such as Soir 3. Perhaps most importantly, and unusually, his influence is growing in the world of mainstream Anglo-American politics (his book is apparently a favourite in the Miliband inner circle) – a place traditionally indifferent to French professors of economics. As poverty increases across the globe, everyone is being forced to listen to Piketty with great attention. But although his diagnosis is accurate and compelling, it is hard, almost impossible, to imagine that the cure he proposes – tax and more tax – will ever be implemented in a world where, from Beijing to Moscow to Washington, money, and those who have more of it than anyone else, still calls the shots.
Thomas Piketty recently received rock star treatment in the United States. Nobel Laureate Paul Krugman, a columnist for The New York Times, predicted in The New York Review of Books that Mr. Piketty’s book would “change both the way we think about society and the way we do economics.”

The issue of income inequality and the limits of capitalism always fascinated me. I think Marx's devastating critique of capitalism remains a tour de force and while I agree with Piketty that a progressive tax on wealth is the only sane solution, I simply do not see this happening for several reasons, chief of which is that capitalism thrives on inequality.

Go back to read my comment on whether pensions and capitalists can afford recovery. I discuss the important work of Shimshon Bichler and Jonathan Nitzan (see their archives here). In that comment, I shared my thoughts between Jonathan Nitzan and myself and concluded:
There is a lot to ponder in their paper and the exchange above. In particular, can capitalists afford a recovery and if not, at what point does their regime crumble and bring about major social upheaval? And are pensions held hostage to the "conflictual power logic of capitalism" and therefore contributing to increasing inequality instead of reducing it?

I hope enhanced public pensions will be a "game changer" in terms of redistributing income downward but so far the evidence does not support this assertion. In fact, the evidence shows pensions are contributing to greater inequality.
More recently, I discussed Michael Hudson's latest article, P is for Ponzi, I shared some more thoughts on what the future holds for capitalism and pensions:
I have a slightly different view of the so-called "pension pyramid" or "pension Ponzi." I remain an ardent defender of well governed defined-benefit plans and believe smart politicians understand that pensions pay political dividends. But as I wrote in that comment:
Shifting employees to a defined-contribution plan is basically condemning them to pension poverty. America's 401 (k) nightmare is proof that the current system is a failure and it's far from over. The worst is yet to come but by that time, it will be too late. In many respects, it's already too late.

What we are witnessing now is the end phase of financial capitalism. I touched upon it when I went over New Jersey's Pensiongate. You have a bunch of rich and powerful hedge fund and private equity managers contributing to their favorite Democratic and Republican candidates in order to secure more money to manage from public pension funds relying on useless investment consultants shoving them into alternative investments. These pension funds are all praying for an alternatives miracle that will never happen. It's great for Wall Street, which effectively carries a license to steal, but not great for Main Street.

Let me be blunt. I love America and think it's the best country in the world. My grandfather fought with the U.S. Army in WWI and my grandmother received a pension from them even after he died. The U.S. has always been and will remain the tail that wags the global economy. But U.S politicians have to get their collective heads out of their asses and start implementing real reforms on their healthcare and pension systems, including reforms on governance that will bolster public pension plans.
One U.S. politician who gets it is Senator Bernie Sanders of Vermont. He's a bit too leftist and cooky for my taste but he brings up many excellent points and regularly tweets on income inequality. Here is one of his tweets which caught my eye (click on image):

And a lot of these rich hedge fund managers are collecting huge fees for delivering mediocre performance. They have basically become large, lazy asset gatherers profiting from dumb public pension funds paying alpha fees for beta or sub beta performance.

If you don't think America has an inequality problem, read this New Yorker article by John Cassidy, it will blow you away. Unfortunately, inequality in the U.S. and elsewhere will only get worse.
I don't mince my words and I don't hold anything back. Ask yourself this, who benefits the most from the current system in the United States? Is it Main Street or Wall Street? Is it Joe and Jane Working Class or powerful rich hedge fund and private equity titans?

And Michael's book, The Bubble and Beyond, is must reading for anyone who wants to understand what happens next. As I stated in my Outlook 2014, once the mother of all liquidity rallies dissipates, we will have the mother of all liquidity hangovers, but we won't have to worry about that until 2015 or 2016. We are still in a private debt crisis, which is the primary reason why less and less people are investing in the stock market, something which all three participants in the great HFT debate didn't touch upon.
There is a lot to ponder in this post. As always, I welcome intelligent feedback but from my vantage point, deflation will hit capitalists and pensions very hard in the next twenty years.

Having said this, nobody including Thomas Piketty and yours truly, really knows how capitalism will evolve over the next twenty years. Will pensions put on the pressure in terms of corporate governance and rein in exorbitant compensation? Will technology become a solution and not a nemesis to job creation? Will Joseph Schumpeter's creative destruction take precedence over Marx's revenge? Admittedly, this is an optimistic view, one that can easily fail if policymakers don't tackle the ongoing jobs crisis plaguing the global economy.

Below, Thomas Piketty discusses Capital in the Twenty-First Century. Also, make sure you read Shimshon Bichler and Jonathan Nitzan's latest, Profit from crisis on why capitalists do not want recovery and what that means for America. I have included a presentation by Jonathan Nitzan on whether capitalists can afford recovery. Take the time to listen to this presentation, it's excellent. 

Friday, April 18, 2014

Resurrecting Your Portfolio?

Marc Lichtenfeld, the Oxford Club’s Chief Income Strategist and author of Get Rich with Dividends, wrote a great article last March, Three Simple Moves to Resurrect Your Portfolio:
This week is a big one for the Jewish and Christian faiths.

On Monday and Tuesday, Jewish people celebrated Passover, commemorating their ancestors' escape from slavery by the Egyptians. The story, immortalized on film in the classic movie The Ten Commandments, features Moses (played by Charlton Heston) telling the Egyptian Pharaoh (Yul Brynner) to "let my people go."

On Friday and Sunday, Christians celebrate Good Friday and Easter, marking the crucifixion and resurrection of Jesus.

Investors can use the themes of the holidays to resurrect their portfolios if they aren't getting the performance they want.

Like the slaves in Egypt whose hard work benefitted someone else, many investors' capital doesn't work hard for the owner, but instead makes big profits for mutual fund companies.

It's time to tell your mutual fund, "Let my money go."

Mutual funds are easy places to invest in if someone has neither the time nor willingness to conduct their own research.

The problem, however, is most mutual funds underperform the market or their benchmark index. In 2012, the S&P 500 was up 16%. According to Goldman Sachs, 65% of large-cap core mutual funds rose less than 16%.

In 2011, a mind blowing 84% of mutual funds underperformed the index. Over the past 10 years, the average number is 57%.

That means in any given year, you have less than a one-in-two chance of being invested in a mutual fund that simply keeps pace with the market.

And for the privilege of likely not making as much money as you should, you get to pay the funds a management fee that reduces your returns even more. Sometimes, you're even forced to pay a load, which is a fee just to enter the fund. For example, some funds, often bought through brokers, come with loads as high as 4.75%. So if you give the fund $10,000 to invest, it takes $475 right off the top and only invests $9,525. It's going to be tough to beat the market when, on day one, you're down nearly 5%.

Even if in the past your portfolio has been crucified by the large Wall Street institutions, you can still achieve solid returns over the long term.

Here are three steps for resurrecting your portfolio:

If you want to stick with mutual funds, own index funds.

They are much cheaper to own and will only cost you a few tenths of a percentage point. Plus, they tend to outperform their more actively managed peers.

For example, let's say you want to invest in emerging markets. The Vanguard Emerging Markets Index Fund (VEIEX), a member of The Oxford Club's Gone Fishin' Portfolio, has an expense ratio of just 0.33%. Compare that to the average emerging market fund fee of 1.64%. Over the past 10 years, the Vanguard fund's annual return has averaged 15.89%, nearly half a percentage point better than the average of all funds in the category.

If you invest $10,000, the Vanguard fund saves you $131 in fees per year. Doesn't sound like much, does it? But if you're saving that money every year and the fund returns 15.89% like it has historically, that's an extra $3,220 in your pocket over 10 years.

Take control of your money.

If you use a full-service broker or financial planner who does nothing but buy and sell investments based on what inventory his bosses tell him to move, or what stocks his firm's analysts rate a "Buy," you need to close your account as fast as you can.

A broker or financial planner who understands your needs and really works with you to achieve your financial goals can be well worth the fees you pay – especially if you don't like to do the work yourself. If the advisor helps you sleep better at night, stick with him or her.

Unfortunately, many brokers and advisors are more like the one described in the first scenario. They are salesmen, and the widgets they happen to sell are financial advice and products. If you suspect that describes the person you're working with, save yourself a bunch of money and frustration and move your money somewhere else.

Invest in conservative stocks that grow their dividends every year.

By purchasing and hanging on to stocks that I call Perpetual Dividend Raisers, you slash your fees. (You can buy stocks for $10 or less with most online discount brokers.)

Perpetual Dividend Raisers are stocks that grow their dividends every year, which gives you an annual raise as the dividends increase. Those dividends help you ride out a bear market as your dividends make up for some declines in stock price – plus, dividend stocks tend to fall less during bear markets.

By investing in stocks that raise their dividends every year, over time your yield increases, and what starts out as a 4% or 5% yield eventually becomes a 10% to 11% yield.

Those kinds of yields alone will be enough to beat the market in most years, regardless of how much the stock price climbs.

Since no financial messiah is coming to save your portfolio, consider taking these three steps to save yourself boatloads of money and improve your performance.

For those who celebrate, I hope this week's holidays are happy and meaningful.
This is the best advice I've read on how the average investor should invest their own money. And I bring this up because I received a nice email from one of my blog readers which I will share with you:
I just wanted to say thanks for the Pension Pulse! It is amazing and very well written and researched. I am one of those Canadians in my early 60's that do not have a defined benefit plan or any pension at all other than CPP and of course OAS when I reach 65. I do have a large sum of RRSPs that I have been buying since I was 30. However, my retirement account is not yet large enough in order to allow me to retire.

However much I enjoy your articles with jaw dropping respect and admiration, there is nothing there for the average Canadian that does not have a DB plan. Please give us some ideas on investing, asset allocation, tax splitting and anything else that the average person can use who does not make a six figured salary. You are amazingly brilliant....start using your gift and knocking it down a notch for the rest of we poor folk.

Sincerely, Mike Turner in rural Nova Scotia, Canada
Well, I decided it's high time I bring it down a notch and give hard working folks like Mike some sound advice on how to invest their retirement savings.

First rule is never underestimate the power of diversification and always remember to rebalance your portfolio. Many years ago, I gave one of my buddies, a cardiologist at Stanford, a copy of Bill Bernstein's book, The Intelligent Asset Allocator.

This is one of the best books and should be required reading for anyone looking to invest over the long run. Bernstein explains why low cost ETFs are the way to go but he also explains why it's crucial to rebalance your portfolio so you don't get caught concentrated in any one sector or geographic region.

Unfortunately, in the historic low interest rate environment we are in, and with everyone chasing yield, the truth is diversification isn't as powerful as it used to be. Nowadays, computers run markets, which means that sectors and regions all move in unison in a flash. Still, don't underestimate the power of diversification and always rebalance your portfolio at the end of every year.

Second rule is to stick with high quality dividend stocks but don't chase high dividends. In the current low interest rate environment, everyone wants yield, especially people looking to retire. The problem with some high yielding stocks is they can fall hard fast and you'll lose more on capital than you gain on yield. Also, a lot of high yielding companies have yields that are unsustainable, and when they cut them, watch out below!

As such, it's best to focus on solid and profitable companies that grow their dividends gradually every year. If you need ideas on top dividend paying stocks, I recommend a site called Top Yields, but I warn you if you chase the highest yields, you'll get burned. Instead, have a look at what the top value funds I regularly track every quarter are buying and selling. They don't churn their portfolio as frequently as hedge funds or mutual funds and they seek high quality companies which grow their dividends gradually.

For example, check out Leon Cooperman's high dividend picks or the holdings of Letko, Brosseau and Associates, one of the top value funds in Canada. You will see solid companies like BCE, Sun Life, Suncor, Bank of Montreal, etc. The added advantage of dividend shares for Canadians and U.S. investors is you get taxed less on dividends than on capital gains. My dad once told me Lord Thompson, one of the richest men in Canada, used to clip millions in dividends every day. The ultra wealthy make money off dividends, not speculating in stocks.

The third rule is to forget about market timing. Unless you're a born trader who has a consistent and outstanding track record, forget about market timing. Even the best of the best will get the wind knocked out of them on any given year, especially in these markets dominated by dark pools and high-frequency trading.

Go back to read my comment on why market timing is a loser's proposition. You might be tempted to trade momentum stocks and buy out of favor stocks or sectors thinking your timing is impeccable, but nine out of ten times your timing will be way off and you'd be better off following the first two rules above.

How do I know? Go back to read my comment on hot stocks of 2013 and 2014. With few exceptions, almost all of these hot momentum stocks got clobbered hard in the last market selloff. Biotech stocks, the sector I now trade, got hit the worst because it led the NASDAQ on the way up. As I wrote in my recent comment on The Big Unwind, I think this presents a huge buying opportunity but I am not God and have no idea when or if they will turn up in the short term.

Fourth, bonds aren't dead and they might save you when disaster strikes. Even though market strategists have been bearish on bonds forever, the reality is if you invested in zero-coupon bonds in the last ten years, you did a lot better than most people. Bonds are what saves your portfolio when disaster strikes. Also, if deflation does hit, a lot of people investing in the iShares 20+ Year Treasury Bond (TLT) will do just fine, but if inflation hits, they will get hit hard as long bond yields rise.

Fifth, macro matters now more than ever. I find it amusing when people tell me macro doesn't matter when investing in stocks. Nothing can be further from the truth. If you don't have a firm hold on inflation, deflation, the Fed, central banks, currencies, sovereign bond risk, you're going to get killed investing in these markets. Now more than ever, macro matters a lot.

I'm constantly reading to understand the macro environment and relate it back to markets. I have tons of links on my blog, many of which need to be updated but the key point is that markets aren't static, they're constantly evolving to reflect changes in macro expectations. One strategist I like reading is Michael Gayed, co-CIO at Pension Partners. I don't always agree with him (read my Outlook 2014) but I find his comments on MarketWatch are well written ad give me good macro food for thought which I can relate back to investment themes.

But I'm constantly reading articles on macro, hedge funds, private equity, real estate and a lot more to gain insights on markets. I like seeing where top funds in private and public markets are placing their money and ignore what they say on television.

Finally, take control of your money but if you can, find a good broker. It might sound counter-intuitive but taking control of your money and finding a good broker aren't mutually exclusive. There are good brokers out there who offer good advice but there are far too many sharks looking out for themselves, not your portfolio. In a perfect world, there would be complete alignment of interests between brokers and clients but we don't live in such a world so be careful and be skeptical.

If you don't want a broker, do what a smart buddy of mine does and buy the iShares Growth Core Portfolio Builder (XGR.TO). It's a low cost ETF based on many ETFs and uses sophisticated factor modelling to rebalance. He told me it produces steady returns with low volatility which is what he wants. I don't know the U.S. version, but I can also recommend the Global X Guru Index ETF (GURU) for retail clients who can't afford to invest with top hedge funds but want a portfolio that wraps up their best ideas in terms of stocks.

Drilling down into stocks. I love tracking and trading stocks. I now track over 2000 stocks in over 80 industries (focus mostly on U.S.). At the end of each trading day, I look at the most active, top gainers and losers and add to my list of stocks to track. I also like to know which stocks are making new 52-week highs and lows, which stocks are being heavily shorted, and which ones offer the highest dividends.

I don't recommend anyone trade stocks, options or futures for a living but if you can stomach the swings, go for it. You will only learn to make money when you trade and lose your own money. Period. You can pick up all the trading books in the world but in my opinion, nothing beats getting your head handed to you a few times to learn how to trade.

Finally, read Marc Lichtenfeld's most recent article, his advice on the "coming crash," and enjoy the long weekend. Happy Passover and Easter and please remember to kindly donate to this blog because I do put a lot of time and effort in informing you on what is going on in markets and offer a unique perspective you simply won't find elsewhere. You can donate or subscribe by going to the right-hand side at the top of this website. All you need is a PayPal account.

Below,  S&P Capital IQ 's Scott Kessler discusses the outlook for tech stocks with Julie Hyman on Bloomberg Television's "Bottom Line."

Wednesday, April 16, 2014

Bridgewater's Dire Outlook For Pensions?

Lawrence Delevigne of CNBC reports, Outlook for pensions is pretty awful: Bridgewater:
Here's a scary retirement prediction: 85 percent of public pensions could fail in 30 years.

That's according to the largest hedge fund firm in the world, Bridgewater Associates, which runs $150 billion for pensions and other institutions like endowments and foundations.

Public pensions have just $3 trillion in assets to cover liabilities that will balloon to $10 trillion in future decades, Bridgewater said in a client note last week obtained by USA Today.

To make up the difference, the firm said pensions will need to earn about 9 percent per year on their investments. But Bridgewater estimates pension funds are more likely to make 4 percent. If that's true, the vast majority—85 percent—of retirement systems will run out of money because they will continue to pay out more than they take in.

The report comes as pensions wrestle with what rates of return to assume given their implications on future financial health.

The city of Detroit, for example, has reportedly agreed to increase its pensions' projected return to 6.75 percent on its pension funds, up from 6.25 percent and 6.5 percent, according to a separate USA Today report. The change is part of ongoing pension cut negotiations for the city to exit bankruptcy.

To test the broad financial health of public pensions, Bridgewater simulated the effect of various market environments on retirement system funding using 100 years of data on how stocks, bonds and other assets performed in the past, plus current projections of future long-term yields. Public pensions will run out of money in 20 years in 20 percent of those scenarios; they'll fail in 50 years in 80 percent of the situations.

A leading academic center for retirement and pension research criticized the report.

"These are inflammatory numbers which can create an enormous amount of anxiety," said Alicia Munnell, director of the Center for Retirement Research at Boston College. "The pension issue is not a game. Pensions represent the future security of today's public employees and those are real people."

Munnell, also the Peter F. Drucker professor of management sciences at BC's Carroll School of Management, believes Bridgewater's 4 percent return projection is far too low.

"If we live in a world where 4 percent nominal returns is the only returns people can get, it implies a really horrible economy with high unemployment, very slow growth and a big gap between potential and actual output," Munnell said.

"A cynic could say that these projections suggest that plans are going to earn only 4 percent unless they shift some of their investments to alternatives," Munnell added. She called on Bridgewater to release the full report.

The report was one of Bridgewater's daily notes to clients, called "Daily Observations." The communications are not public, but Bridgewater told it plans to release an explanation of the study in the future.

"Just as we stress test banks by running multiple scenarios through their future conditions to assess what might happen, we think it makes sense to stress test pension funds," Bob Prince, Bridgewater's co-chief investment officer, said in an interview.

"That's in contrast to the common approach, which is to determine sufficient funding by asserting a certain return and discounting that back to a present value and comparing that to your assets. We think that you can have a much more robust assessment by running stress tests based on multiple scenarios."

Bridgewater acknowledges that its 4 percent return projection—based on current asset prices like low bond yields and an already-elevated stock market—is just one potential outcome to consider and any long-term projection is inherently difficult.

Munnell said most public pensions assume long-term returns on their investments of about 7.75 percent annually. Her center regularly studies the impact of lower expectations, around 6 or 6.5 percent.

Bridgewater, founded in 1975 by now-billionaire Ray Dalio and based in Westport, Conn., has long attracted pensions and others with two types of products: "Pure Alpha" hedge funds that bet on broad macroeconomic themes, and a more conservative "All Weather" product that is designed to protect assets in any economic environment (also known as a "risk parity" strategy).

The firm's Pure Alpha II fund has gained 13.6 percent net of fees on average since inception in 1991. All Weather has produced average annual returns of 8.9 percent since inception in 1996.

Public retirement systems were 73 percent funded overall at the end of 2012, according to the latest data available from Boston College's retirement center. The numbers are based on the present liabilities value of $3.8 trillion, which uses a baseline projection of 7.75 percent stock market returns from 2013 to 2016.

"States and localities also continued to fall short on their annual required contribution payments," the report said. But it also noted that "the funded ratio is projected to gradually move above 80 percent, assuming a healthy stock market."
So, Bridgewater is now a leading expert on public pension deficits? Well, they regularly read my blog so let me commend them before I rip into them for being part of a much bigger problem.

First, Alicia Munnell doesn't have a clue of what she's talking about. Pension funds are more likely to see long-term returns of 4% than 7.5% or even 6.5%. This isn't scaremongering on Bridgewater's part, it's called being realistic and not hopelessly optimistic.

Go back to read an older comment on what if  8% is really 0% where I wrote:
Mr. Faber then asks a simple question:
Are funds prepared for a lengthy bear market in equities like when stocks declined nearly 90% in the 1930’s? Are funds prepared for both raging inflation of the 1970’s and 1980’s and sustained deflation like Japan from 1990 to the present? It is our opinion that most funds do not consider these outcomes as they are seen as extraordinary and beyond the scope of either feasible response or possibility.
He's absolutely right, the majority of pension funds are hoping -- nay, praying -- that we won't ever see another 2008 for another 100 years. The Fed is doing everything it can to reflate risks assets and introduce inflation into the global economic system. Pension funds are also pumping billions into risks assets, but as Leo de Bever said, this is sowing the seeds of the next financial crisis, and when the music stops, watch out below. Pensions will get decimated. That's why the Fed will keep pumping billions into the financial system. Let's pray it works or else the road to serfdom lies straight ahead. In fact, I think we're already there.
Now, Leo de Bever isn't the best market timer and I totally disagree with him on a bear market for bonds. I think all the bond panic of  last summer was way overblown and the real threat that lies ahead is a prolonged period of debt deflation which will expose a lot of naked swimmers.

I've been worried about deflation for a very long time. I even went head to head with the great Ray Dalio back in 2004 in front of PSP's president and CEO, Gordon Fyfe, and pushed Ray on this until he finally blurted out: "son, what's your track record?!?"

Well Ray, thanks for asking because my track record has been pretty lousy on some stock picks but right on the money when it comes to calling the big picture. I warned Gordon Fyfe and PSP's senior managers of the collapse of the U.S. housing market and the credit crisis back in the summer of 2006 when I was researching CDO, CDO-squared and CDO-cubed issuance and was petrified. I got promoted in September 2006 and then abruptly fired a month later for "being too negative" (a euphemism for you're not towing the line so we will fire your ass). PSP lost billions in 2008 selling CDS and buying ABCP (and they weren't the only ones "investing" in structured crap in their portfolios). 

The analysts at Goldman Sachs I was talking with tried to reassure me that all is well but I never trusted those hypocrites and knew they were taking the opposite side of the trade, betting against their Muppets. Sure enough, Goldman made a killing off the financial crisis. Ray Dalio and Bridgewater also performed well as they understood the dangerous dynamics of deleveraging but they overstayed their welcome on that trade and underestimated the resolve of politicians and central banks to deal with the European and global debt crisis. 

Things haven't being great for macro funds since the financial crisis. Central banks have effectively clipped their wings and many are not bringing home the bacon they once used to. Apart from Abenomics, which spurred a global macro lovefest and cemented George Soros as the ultimate king of hedge fund managers, there hasn't been much going on in terms of returns in the global macro world. Maybe that's why Soros is pleading with Japan's PM to get their giant pension fund to crank up the risk. He sees the future and it ain't pretty (I threw a bone at global macro funds back in December when I recommended shorting Canada and its loonie...still waiting for a small cut of their management and performance fee). 

But rest assured the Ray Dalios of this world are doing just fine, charging 2 & 20 to their large institutional clients, many of whom are more than happy being raped on fees even if the performance of these large hedge funds has been lackluster as assets under management mushroom. 

Now, before I get a bunch of angry emails telling me how great Ray Dalio and Bridgewater are, save it, I was among the first to invest in them in Canada when I was working at the Caisse as a senior portfolio analyst in Mario Therrien's team covering directional hedge funds. I have nothing against Ray Dalio and Bridgewater, but I think they've become large lazy asset gatherers like many others and their alpha has shrunk since their assets under management have mushroomed to $150 billion.

My beef with all hedge fund gurus managing multi billions is why are they charging any management fee? To be more blunt, why are dumb institutions paying billions in management fees to Ray Dalio or anyone else managing multi billions? Management fees are fine for hedge funds ramping up operations or for those that have strict and small capacity limits but make no sense whatsoever when you're dealing with the larger hedge funds all the useless investment consultants blindly recommend. 

And Alicia Munnell is right on one front, why doesn't Bridgewater publicly release this study? In fact, there are other studies from Bridgewater that magically disappeared from public record, like hedge funds charging alpha fees for disguised beta (I used to have a link on my blog to that study, which was excellent). Another good point Munnell raises is that alternatives funds love talking up their game but public pension funds praying for an alternatives miracle that will never happen are only enriching Wall Street

Go back to read Ron Mock's comments on OTPP's 2013 results as well as Jim Keohane's comments on HOOPP's 2013 results. Ron and Jim both attended HOOPP's conference on DB pensions and they know the next ten or twenty years will look nothing like the last twenty years. They understand why it's important to closely match assets with liabilities and how important it is to manage downside and liquidity risk. The Oracle of Ontario uses one of the lowest discount rates in the world, something which they think reflects reality. 

And Bridgewater is right, the outlook for U.S. pensions is awful. They're not the only ones sounding the alarm. The Oracle of Omaha recently warned that U.S. public pensions are in deep trouble. I'm concerned too but as I wrote in the New York Times, my chief concern remains on the lousy governance model that plagues most U.S. public pensions. Pension reforms have thus far been cosmetic. Until they reform governance, nothing will change. 

Finally, it is worth remembering that even though pensions aren't perfect, they're way better than 401 (k) plans, RRSPs or PRPPs. A new study finds that the typical 401(k) fees — adding up to a modest-sounding 1% a year — would erase $70,000 from an average worker's account over a four-decade career compared with lower-cost options. To compensate for the higher fees, someone would have to work an extra three years before retiring. When it comes to retirement, most people need a reality check on pensions.

On that note, I welcome all comments by Bridgewater and anyone else who has something intelligent to contribute to the outlook for pensions. Feel free to email me your thoughts at

Below, once again, a 2009 report which explains America's 401(k) nightmare. As the default retirement plan of the United States, the 401(k) falls short, argues CBS editor-in-chief Eric Schurenberg. He tells Jill Schlesinger why the plans don't work. The same thing is happening in Canada, which is why now is the time to act to bolster defined-benefit plans for many Canadians that are staring at a retirement crisis.

Tuesday, April 15, 2014

The Big Unwind?

Matthew Boesler of Business Insider reports, The Big Unwind: Here's How Hedge Funds Drove The Brutal NASDAQ Selloff:
Volatility has returned to the markets, and growth stocks in information technology and health care have led the way down.

The chart above (click on image), from Deutsche Bank strategist Keith Parker, shows the extent to which fund positioning has helped fuel the recent decline in the stock market.

"Performance over the last month across stocks and sectors has been driven by position covering," says Parker in a report on recent investor positioning and flows.

"Through the first two months of the year, long/short equity hedge funds and mutual funds were neutral the market but long growth stocks, which helped underpin outperformance through the January-February sell-off. The rotation out of growth and into value starting in early March hurt and funds were forced to unwind positions."

Chart 2 provides a visual display (click on image below).

Coming into the first quarter of 2014, growth stocks and the stocks with the highest hedge fund ownership were one and the same.

Funds were loaded up on health care, consumer discretionary, and tech stocks (think biotech and social media), and the "momentum" trade did well in February following the big market sell-off in late January.

As chart 3 shows, the growth stocks were significantly outperforming the broader market until March (click on image below).

Since then, nearly all of the outperformance of this group of hot stocks has been erased as hedge funds have rebalanced, a process Parker says is probably almost over.

However, the unwind is "now spilling over to mutual funds that are still long growth, with outflows from growth funds exacerbating performance."

In the week through Wednesday, April 9, equity funds oriented toward growth stocks were hit with $1.7 billion of investor redemptions, following an outflow twice the size in the previous week. Flows into value funds, on the other hand, are accelerating — they took in $1.9 billion in the week through April 9 and $1.7 billion the week before. As one might expect from chart 1, consumer goods, utilities, and energy funds are receiving inflows while tech, health care, and financials funds are losing investor money.

David Kostin, chief U.S. equity strategist at Goldman Sachs, says the parallels between recent market action and that in March 2000, when the tech bubble burst, "dominated client discussions" last week.

"The current sell-off in high growth and high valuation stocks, with a concentration in technology subsectors, has some similarities to the popping of the tech bubble in 2000," says Kostin.

"Veteran investors will recall S&P 500 and tech-heavy Nasdaq peaked in March 2000. The indices eventually fell by 50% and 75%, respectively. It took the S&P 500 seven years to recover and establish a new high but Nasdaq still remains 25% below its all-time peak reached 14 years ago."

Kostin's take is that this time is different, as broad market valuations are not as stretched as they were then, and the "bubbly" parts of the market account for a much smaller portion of overall market capitalization today than then (tech accounted for 14% of overall S&P 500 earnings in 2000 but 33% of market cap, whereas today it accounts for 19% of both earnings and market cap).

While that is good news for the broader market, it's still bad news for these high-flying growth stocks (see chart 4, click on image below)).

"The stock market, but not momentum stocks, will likely recover during the next few months," says Kostin.

"Analysis of historical trading patterns around momentum drawdowns shows: (a) roughly 70% of the reversal is behind us following a 7% unwind during the last month; (b) an additional 3% downside exists to the momentum reversal during the next three months if the current episode follows the average historical experience; (c) if the pattern followed the path of a 25th percentile event a further 7% momentum downside would occur, or about double the reversal that has taken place so far; and (d) whenever the drawdown ends, momentum typically does NOT resume leadership."

On average, Kostin says, the S&P 500 has risen on average by 5% following momentum sell-offs like this, led by value stocks that underperformed as growth stocks were going up.

Jan Loeys, head of global asset allocation at JPMorgan, takes a similar view.

"Each of the market reversals of the past few weeks has in common that they represented widely held positions — long equities, overweight small caps, overweight tech, underweight emerging markets, and short duration," says Loeys.

"If there were greater worries about the economy or other downside risks, then we should have seen the dollar rise, credit and swap spreads widen, and emerging markets underperform. Correlations across risk assets should have risen. None of this has happened. There is no breadth to this sell-off."

Of course, there are, as always, reasons to be cautious. Many of them may relate to an optimistic scenario — one in which the economic recovery accelerates, causing the Federal Reserve to tighten monetary policy and interest rates to rise.

"S&P 500 price-to-earnings is demanding excluding mega-caps and likely dependent on interest rates staying low versus history," says David Bianco, chief U.S. equity strategist at Deutsche Bank.

Another factor to consider is corporate stock buybacks, which have restricted the supply of shares trading in the market.

"While everyone is focused on valuation and bubbles (to some degree rightfully so), the fact remains that the last few years have been supported by a low level of net equity issuance that has, all else equal, supported prices," says Dan Greenhaus, chief global strategist at BTIG.

This trend may now be poised to reverse as buyback activity slows, given the fact that shares have become more expensive as the market has headed higher.

"Rather than investing in new equipment and structures, businesses have used their cash positions to buy back stock or to grow through acquisitions," says Aneta Markowska, chief U.S. economist at Société Générale.

"This process, however, may be coming to an end. The ratio of the market value of equities to the replacement value of tangible assets (or the so-called Tobin's Q ratio) has increased significantly in the past year and now stands at the highest levels since 2000. With equity values currently estimated at 25% above replacement value, expanding organically seems to make a lot more economic sense than expanding through acquisitions or stock buybacks."

In other words, earnings per share have been boosted by a shrinking denominator — the amount of shares outstanding. If shares outstanding stop declining as buyback activity recedes and net equity issuance turns positive, it will put more onus on the numerator — the actual earnings — to propel earnings per share higher.

However, an acceleration in wage growth is a likely pre-requisite to Fed tightening. Such a development would pose a further headwind to earnings as corporations face rising employment costs.

"It now seems that what would be good for the recovery — higher labour income — will be detrimental for profit margins," says Gerard Minack, principal of Minack Advisors.

"This may be a good year for the economy, but profits may fall short of forecasts."
There is a lot of food for thought in the article above. First, the hedge fund curse is alive and well. When all the big hedge funds rush into hot stocks, looking for the big beta boost, these stocks tend to overshoot on the upside and downside. That is the nature of the momentum beast. If you can't stand volatility, forget high beta momentum stocks.

Nowhere is this more visible than the biotech sector which led the Nasdaq over the last few years and led the recent selloff. After peaking at 275 in late February, the iShares Nasdaq Biotechnology (IBB) which is made up of large biotech companies, now sits at 215, a 22% haircut in last few weeks. Worse still, the SPDR S&P Biotech ETF (XBI), which is made up mostly of smaller biotech names, got crushed, plunging from 172 in late February to 122, a near 30% haircut in the last six weeks.

Conversely, defensive sectors like utilities (XLU) have been on fire since the beginning of the year and they provide investors with a nice dividend yield so the total return is higher than just price appreciation. I can kick myself for not taking my profits in biotech and moving over to Exelon (EXC) at the end of January but hindsight is always 20/20.

Interestingly, as the article above alludes to, not all risk assets are being sold indiscriminately. Emerging market shares have staged somewhat of a decent comeback since the beginning of the year. The iShares MSCI Emerging Markets (EEM) is up 12% since late February and the iShares China Large-Cap (FXI) is up roughly 8% in last few weeks. Even more interesting, the iShares MSCI ACWI ex US Index (ACWX) has rallied nicely, up close to 8% since late February.

So what is going on? Nothing much except some profit taking and sector rotation. But there was also deleveraging and redemptions exacerbating the downswing as investors pulled out money from hedge funds at the fastest rate for more than four years in December, following a year in which many managers' performance disappointed.

Despite the massive selloff in growth and rally in defensive, emerging markets and ex-US shares lately, I maintain my views from my Outlook 2014 and hot stocks of 2013 an 2014. In fact, as I wrote last week when I warned my readers to beware of dark markets, this selloff in growth and biotech is overdone:
...let me just end this comment by stating that while tech stocks are getting whacked hard, the selloff in momentum stocks is overdone. The WSJ correctly notes that more investors are drawn into dividend stocks, but that's because they realize fears of Fed tapering are overblown and that more tapering will lead to deflation.

Why are momentum stocks selling off hard? A lot of it has to do with normal profit taking. Many of the hot stocks of 2013 ran up 300, 400 or 500 percent or more in the last couple of years so it's only normal they will get whacked hard from time to time. Regardless, I stick with my call in my Outlook 2014 and think all the bears getting greedy here will get their heads handed to them when these momentum stocks, including biotech stocks, snap back up violently. Admittedly, I am long biotech and this may be wishful thinking on my part as one of the smartest hedge fund talents in Canada recently told me he's very bearish on this market but I think he's timing is off (read my comment on the hedge fund curse).

Importantly, forget what all these overpaid strategists on Wall Street are recommending on television. When I see a Dennis Gartman on CNBC telling people he's scared and to "get out of stocks," (so his big hedge fund clients can buy them on the cheap), I know it's time load up on risk assets.

I am using the latest selloff to add to my positions in small biotech shares that got crushed recently, like Idera Pharmaceuticals (IDRA), my top small biotech pick. Interestingly, the drubbing in the biotech sector has been painful for Baker Bros. Advisors, the closely watched healthcare hedge fund with approximately $7 billion under management. Since March, the fund's portfolio holdings have been spanked hard (Baker Brother symbols to watch: ACAD, BCRX, IDRA, PCYC, PGNX, RTRX, XOMA).

There are plenty of other quality growth names in the Nasdaq 100 (QQQ) that are also set to soar higher after the latest selloff. For example, check out shares of Amazon (AMZN), Facebook (FB), Twitter (TWTR), Netflix (NFLX), and Tesla (TSLA), the most shorted Nasdaq stock.

The only thing going on is the Wall Street crooks are busy scaring retail investors using any means possible and creating all sorts of manufactured panic to buy shares on the cheap so they can ramp them up and dump them again at higher prices. This is what they'll do in the weeks and months ahead, get out of value/ dividend stocks and ramp up momentum stocks.

Bottom line is everyone needs to "CHILLAX" (a term I learned in Jamaica recently). There is no inflation, risks of deflation remain elevated, placing a cap on interest rates, and despite the gradual Fed tapering, there is plenty of liquidity to propel risk assets much, much higher.

To be sure, when the liquidity party ends, the titanic will sink. Momentum stocks will get crushed and stay down but value stocks will also be beaten badly. In a real bear market, there is literally nowhere to hide. Luckily, as Keynes famously quipped, "markets can irrational longer than you stay solvent," so all those bears betting on another 2008 right now are in for a nasty surprise as risk assets, especially growth and biotech, will surge much higher from these levels (and that's not wishful thinking).

Below, James Paulsen, Wells Capital Management, and David Blitzer, S&P Dow Jones Indices, share their outlook on the markets and bonds. Interesting discussion, well worth listening to.