Tuesday, September 2, 2014

Staying Mum on Corporate Expats?

Andrew Ross Sorkin of the New York Times reports, Public Pension Funds Stay Mum on Corporate Expats:
In the outcry about the recent merger mania to take advantage of the tax avoidance transactions known as inversions, certain key players have been notably silent: public pension funds.

Many of the nation’s largest public pension funds — managing trillions of dollars on behalf of police and fire departments, teachers and others — have major stakes in American companies that are seeking to renounce their corporate citizenship in order to lower their tax bill.

While politicians have criticized these types of deals — President Obama has called them “wrong” and he is examining ways to end the practice — public pension funds don’t appear to be using their influence as major shareholders to encourage corporations to stay put.

In the past six months, some of the nation’s largest companies have announced plans to move abroad. AbbVie, a pharmaceuticals company based in Illinois, has agreed to acquire a smaller British rival, Shire, so the combined company can relocate to Britain for tax purposes. Another drug company, Mylan, which is based outside Pittsburgh, has proposed buying the international generic drug business of Abbott Laboratories so the company can relocate to the Netherlands. Medtronic, a medical device company based in Minneapolis, has agreed to acquire Covidien of Ireland. Applied Materials has agreed to buy Tokyo Electron so it, too, can move to the Netherlands. And last week, Burger King announced it was buying Tim Hortons, the Canadian chain of coffee-and-doughnut shops, in a deal that would make Burger King a corporate citizen of Canada.

The California Public Employees’ Retirement System, the nation’s largest public pension fund and typically one of the most vocal, has remained silent.

“We don’t have a view on this from an investor standpoint — we’re globally invested, as you know, and appreciate that tax reform is a government role,” Anne Simpson, Calpers’s senior portfolio manager and director of global governance, told me. “We do expect companies to act with integrity, whatever the issue at hand — that goes without saying. We also want to see a focus on the long term.”

When I pressed for more, her spokesman wrote to me, “We’re going to have to take a pass on this one.”

Public pension funds may be so meek on the issue of inversions because they are conflicted. On one side, the funds say they care about the long term and the implications for their state. Calpers’s “Investment Beliefs” policy states that the pension system should “consider the impact of its actions on future generations of members and taxpayers,” yet most pension funds are underfunded and, frankly, desperate to show investment returns. Mergers for tax inversion can prop up share prices of the acquirers and clearly help pension funds, at least in the short term, show improved performance.

Some pension managers say that their job is strictly about generating cash for pensioners and that they shouldn’t take other issues into consideration. Ash Williams, the executive director and chief investment officer of the Florida State Board of Administration, which manages more than $150 billion, explained it to me this way: “If you’re in my seat, you’re thinking about it not only as an investor, but you’re thinking about it as a fiduciary, which sort of walls out a lot of the political considerations that might otherwise be there.” He went on: “You just have to think, ‘O.K., so I’m guarding the economic interest of my beneficiary. That is my duty, and that’s the start, the middle and the end of it.’ ”

When I pressed him about whether he felt he needed to consider the impact of these deals on the American tax base, which would affect pensioners, he said, “I guess I’d have to say what’s best for the company, what therefore maximizes the value of the ownership relationship I have to the company.” He added, “I mean, my gut is, as an American you’d like to keep businesses here.”

Mr. Williams’s approach appears to be the norm among most investors. However, Mark Cuban, the investor and owner of the Dallas Mavericks, took to Twitter with the kind of view you’d expect from a public pension fund, not a free-market evangelist.

“If I own stock in your company and you move offshore for tax reasons, I’m selling your stock,” Mr. Cuban wrote on Twitter in July. “When companies move offshore to save on taxes, you and I make up the tax shortfall elsewhere,” he said, encouraging investors to “sell those stocks and they won’t move.”

Last month, Shirley K. Turner, a Democratic New Jersey state senator, introduced a novel piece of legislation in an effort to make inversion deals less attractive. She proposed that the state’s pension board be forbidden to invest in companies that are involved in inversion deals. She said the state of New Jersey “ranks sixth among public pension funds investing in corporate inverter AbbVie, holding more than 1.5 million shares of the company’s common stock, valued at $81.9 million.”

It is unclear how such legislation would work. For example, would the state immediately be forced to sell its holdings in a company involved an inversion?

Not all officials who oversee pension funds are focused only on the immediate bottom line.

“Our fiduciary duty to our members is to vote our economic interest — and that means making an individualized determination of whether a given transaction is in our best interests as long-term share owners,” said Scott M. Stringer, the New York City comptroller. “As a result, we don’t merely look at the offer price on the day of closing but instead take into consideration everything from potential influence on shareholder rights to whether a merger places short-term gain over long-term growth.” Still, as Pfizer, one of the largest companies in New York, has continued to contemplate a merger with AstraZeneca that would make the combined corporation a British entity, neither Mr. Stringer nor any other investor acting on behalf of pensioners has spoken out. Perhaps not surprisingly, the only people who appear to be concerned are a small but growing group of politicians in Washington.

After Burger King announced its deal with Tim Hortons, Senator Carl Levin, Democrat of Michigan, declared, “If this merger goes through, there could well be a strong public reaction against Burger King that could more than offset any tax benefit it receives from a tax avoidance move,” suggesting customers take up the cause.

Indeed, the Walgreen Company, which had been considering a tax inversion transaction with Alliance Boots of Britain, voted against changing its corporate citizenship because the American pharmacy chain’s board and management worried about an outcry from customers, according to people close to the board, and were concerned that pressure from customers could spill over to the government.

Where are the investors? Happily watching their returns rise. When I asked Mr. Williams, the Florida pension manager, what he would do if he had to vote on a deal involving a Florida company pursuing an inversion that would hurt the state’s tax base, he sighed and said: “This issue is new enough — and fortunately, at this point, it’s small enough — that it hadn’t reached those dimensions. And I would just hope that we can get something done at the policy level to resolve it. That’s the best outcome.”
Not one to shy away from controversy, let me give you my take on corporate tax inversions and what U.S. public pension funds should be doing. Absolutely nothing! The reality is U.S. corporate taxes are too high relative to the rest of the world, including Canada, which is why this debate is best left for Congress and the President to tackle.

Having said this, the public needs to be informed of a few giveaways to corporations that is going on right under their noses. For example, in my comment last week on what will derail the endless rally, I wrote:
Of course, nobody really knows where the stock market is heading. A million things can derail this rally and cause jittery investors to pull the plug and sell their stocks. But with pension deficits rising as bond yields fall, pensions will be forced to take on more, not less risk. And where will they be taking that risk? Stocks, corporate bonds and alternative investments like real estate, private equity and hedge funds.
I also provided a clip where Charles Biderman, TrimTabs Investment Research CEO, analyzes current market conditions saying the market is essentially rigged and you have to "ride the tide and hope to get out before it ends."

In that clip, Biderman explains why corporations are buying back their shares. With interest rates at zero, it pays to borrow and buy back shares. While this is true, he ignores another aspect of share buybacks which I've discussed on my blog, namely, it helps corporations boost the bloated pay of their senior executives further exacerbating inequality that Thomas Piketty has brought to the world's attention.

In fact, while I am in the camp that the Fed did the right thing to move quickly and forcefully to lower interest rates to zero and engage in quantitative easing, I was also conflicted because it was a dead giveaway to banks and the alternative investment industry.

Why? Because a zero interest rate policy (ZIRP) spells disaster for U.S. pension funds teetering on collapse, as their liabilities explode up, forcing them to invest in riskier alternative investments like private equity and hedge funds. Importantly, ZIRP is a boon for the alternative investment industry and big banks collecting big fees from hedge funds and private equity funds.

But if the Fed didn't lower interest rates to zero and engage in QE, it would have been a disaster for the global economy, virtually ensuring a protracted period of virulent deflation and high and unacceptable unemployment.

Public pension funds have a role to play on the bloated compensation of U.S. corporate titans and they need to bring the issues I discuss above out in the forefront. Sadly, everyone is staying mum on these issues because discussing inequality is perceived as being "anti-American," which is total bullocks!

Below, my favorite economist, Michael Hudson, unzips America in the latest installment of the Hudson-Keiser interview series on Russian sanctions and the affect on the US dollar subsidy (fast-forward to minute 13:40). I don't agree with everything Michael says but listen to his comments on the bubble and the aftermath and how share buybacks and corporate buyouts are enriching corporations, banks and LBO funds.

And don't forget, as I've previously discussed, big banks have aided hedge funds avoid taxes, and many public pension funds stayed mum on that scandal too. It's high time Americans take a closer look at what is driving inequality and start implementing sensible and fairer tax policies (like reducing corporate taxes but closing other loopholes favoring hedge funds and private equity funds).

Friday, August 29, 2014

Avoid the Hottest Hedge Funds?

Lawrence Delevingne of CNBC reports, Why you should avoid the hottest hedge fund hands:
Investors who don't have money with Pershing Square Capital Management are likely salivating at the hedge fund's industry-leading 26 percent return from January through July.

But investing with Bill Ackman and other top-performing managers after a great run is probably a bad idea, according to a new study of long-term hedge fund industry performance.

A white paper by Commonfund, which manages nearly $25 billion for close to 1,500 endowments, pensions and other institutions, shows that putting money with the hottest hedge fund managers can work in the short term, but that sticking with them for three years or more is worse than picking managers at random. Picking up losing hedge fund strategies can even produce slightly positive performance.

"Not only does positive-return persistence tend not to work as a selection strategy, but it is especially ineffective in the medium-to-long-range horizons that institutional investors may prefer, and indistinguishable from a strategy of selecting losers," authors Kristofer Kwait and John Delano wrote.

Kwait and Delano found that picking winning hedge funds produced returns of 13.29 percent after 18 months, versus an average of 10.62 percent for all funds. But the same group held for 36 months gained the same as the average; over 48 and 60 months, they rose just 9.49 percent and 8.48 percent, respectively.

In theory, hedge fund allocators could invest with the best managers and then quickly cash out within 18 months. But the vetting and subscription process to get in can take months or even years, especially for cautious institutional investors. Plus, hedge funds often require that their investors commit money for at least a year, and then restrict redemptions by spreading them out over several quarters.

Commonfund said its findings were consistent with a point made by Cliff Asness of AQR Capital Management.

The hedge and mutual fund manager has written that investors often try to catch short-term results in various asset classes but use a multiyear time frame, which often means they instead get hit with losing reversals—or miss winning ones—when the trade inevitably reverts to the mean. Asness declined to comment on the Commonfund study.

Ackman, for example, underperformed stock indexes in 2013 with a 9.3 percent gain, hurt by losses on J.C. Penney (JCP) and a short position on Herbalife (HLF). But Pershing Square has rocketed back this year with wins on Allergan, Canadian Pacific, a reversal in fortune for Herbalife and others, according to a recent letter to investors.

Another famous example of a hedge fund reversal is Paulson & Co. John Paulson saw his client base increase dramatically after he scored huge returns with bets against the housing market before it crashed. But heavy losses in 2011 and 2012 from too-early bets on the U.S. economic recovery caused investors to pull their money (Paulson's hedge funds snapped back in 2013).

The study also found that teasing out manager skill, or "alpha," from the general market ups and downs, or "beta," is critical to selecting hedge fund managers who will outperform.

"For an allocator, that this relationship between observed alpha and skill is not necessarily certain may leave a door open for inferring a sort of skill even from beta-driven returns, perhaps on the basis of a hard to define but powerful argument that a manager is 'seeing the ball,'" the paper noted.

The Absolute Return Composite Index, which aggregates hedge fund returns across all strategies, gained 3.79 percent this year through July. By comparison, the S&P 500's total return was 5.66 percent and Barclays Aggregate Bond Index gained 2.35 percent.

The challenge is parsing out what alpha really is; hedge fund managers are quick to attribute their gains to skill rather than market forces.

Large investors—and their teams of advisors—appear convinced they can draw the distinction. No less than 97 percent of 284 institutional investors surveyed recently by Credit Suisse said they plan to be "highly active" in making hedge fund allocations during the second half of 2014. That's even more than the 85 percent who already made allocations in the first half of the year.

According to industry research firm HFR, investors allocated $56.9 billion of new capital to hedge funds in the first half, pushing total global assets to more than $2.8 trillion, surpassing the previous record of $2.7 trillion from the prior quarter.
No doubt about it, the big money still loves hedge funds. You should all take the time to read the white paper by Commonfund, which is truly excellent.

And just to add evidence to the findings of this white paper, Michelle Celarier of the New York Post reports, Hedge funds’ all-wet profits nothing to party about:
The mood in the Hamptons isn’t likely to be too celebratory this Labor Day weekend for most hedge fund honchos.

With late August numbers starting to trickle in, some of the biggest stars are barely breaking even. Others are in the red in a year when the broader market is up 8 percent.

Take David Tepper, who turned in an astonishing 42 percent in 2013 to take home $3.5 billion.

That’s not likely in 2014 as his hedge fund was only up 2.3 percent through July, the latest numbers available. The fund fell 1 percent that month.

Richard Perry, another veteran star, is up a mere 1.3 percent through Aug. 22 — after falling 1.4 percent this month. Perry Partners gained 22 percent in 2013.

Leon Cooperman, always a bull market darling, had gained 2.25 percent for the year through July. His Omega Advisors fund rose 30 percent in 2013.

Nelson Peltz of Trian Partners is faring a bit better. His fund gained 6.6 percent through Aug. 22, with 1.9 percent coming in August. But last year, Trian was up 40 percent. That earned him a spot on the Top 20 list — alongside Tepper — published by HSBC.

Jeff Altman’s Owl Creek, which rose to fame last year with a 48.6 percent gain, has done an about face. The former top 20-hedge fund fell 3 percent through Aug. 22, with 2 percent of the loss in August.

Hedge fund legends Paul Tudor Jones and Louis Bacon are also in the red. Bacon’s main fund is down 5.5 percent through Aug. 14, after booking a 1.3 percent loss the first two weeks of the month.

Jones, meanwhile, has fallen 3 percent this year, following a .4 percent loss in the first three weeks of August.

I can't say I'm shocked by the findings. A long time ago, I wrote a comment on the rise and fall of hedge fund titans, where I wrote the following:
...I will tell you Paulson's rise and fall is nothing new. I've seen it many times before. Typically, hedge funds have a great track record, or an incredible year, consultants and brokers start spreading the word to institutional investors and in no time assets under management explode up.

That's when your antennas should go up and you need to start thinking of pulling out. Whenever I see assets explode up, from $5 billion to $40 billion, I pay very close attention because it usually spells trouble ahead.

That's exactly what happened with Paulson. He was riding the coattails of his outsized returns, assets under management mushroomed and returns subsequently faltered. Seen this so many times and yet the institutional herd keeps piling onto yesterday's winners like moths to a flame.
....
Should you always add more when a hedge fund or external manager gets clobbered? Of course not. Most of the time you should be pulling the plug way before disaster strikes. You need to look at the portfolio, assets under management, people, process, and risk management and make a quick decision.

This isn't easy but if you don't, you'll end up holding on and listening to a bunch a sorry ass excuses as to why you need to be patient. And no matter who he is, I would never accept any hedge fund manager 'chiding' me for redeeming from their fund. That's beyond insulting, but in an era where hedge fund superstars are glorified, this is what routinely happens.

Been there, done that, it's a bunch of BS. The media loves glorifying hedge fund managers but the bottom line is all these 'superstars' are only as good as their last trade. Institutional investors should stop glorifying these managers too and start grilling them hard.

The problem is too many institutions don't have clue of what they're doing when it comes to investing in hedge funds or private equity, so they end up listening to the useless advice of their brainless investment consultants.

I know that might sound harsh but it's the truth which is why I continuously poke fun at how dumb the entire hedge fund love affair has become. Sure, there are some good consultants, but the bulk of them are totally useless.

I used to go to these silly hedge fund conferences where institutional investors were getting all hot and horny over hedge funds and think to myself what a total waste of time. Most of these people don't have a clue of the underlying strategies and more importantly the risks of these strategies.

So what do they end up doing? They all chase performance, getting bamboozled by some hedge fund manager with his head up his ass, telling them to "hurry up and invest because they are setting a soft close at $X billions and a hard close $Y billions."

I used to get phone calls all the time when I was managing a portfolio of directional hedge funds at the Caisse. The pressure tactics were a total joke. I ignored third party marketeers and any arrogant hedge fund manager who was trying to pressure me into investing.

I recall my first meeting with Ron Mock at Teachers back in 2003 when he explained his hedge fund strategy and the way they allocate and redeem. Teachers was and remains very active in hedge funds. I recall specifically asking him about redemptions and how hedge funds react. Ron told me flat out that while "most hedge funds don't like it, if you do it in a professional manner, they'll understand and won't take it personally."

I also asked him what happens if they threaten not to allow him to invest with them ever again or if they act arrogant with him? He told me: "I have no time for arrogance and typically what happens in this industry is when the tide turns, the arrogant managers come back to plead for money. I've seen it happen many times. When they need money, they will come back to you and embrace you with open arms."

And even Ron Mock, who I consider to be one of the best hedge fund allocators in the world, experienced a few harsh hedge fund lessons in his career as a hedge fund manager and as an allocator. Following the 2008 crisis, Ontario Teachers now invests the bulk of their hedge fund assets into a managed account platform (they use Innocap), but they still invest a small portion in less liquid hedge funds (the flip side of transparency is liquidity; no use putting an illiquid hedge fund onto a managed account platform).

Allocating to external managers isn't easy, especially when you're dealing with overpaid and over-glorified hedge fund managers. This is one reason why there is a hedge fund revolt going on out there, led by CalPERS which announced it was chopping its hedge fund allocation back in May and recently confirmed it was rethinking its risky investments.

Most investors, however, aren't backing away from hedge funds. Instead, they're rethinking the way they allocate to hedge funds. For example, co-investments are entering the hedge fund arena. And Katherine Burton of Bloomberg reports, Hutchin Hill, Citadel See Assets Jump as Pensions Call:
Neil Chriss is hitting his stride.

The math doctorate turned hedge-fund manager founded Hutchin Hill Capital LP more than six years ago and built it to cater to large investors. After posting annualized returns of 12 percent, about six times the average of his peers, he finds himself in the sweet spot for fundraising. Hutchin Hill’s multistrategy approach is the most popular hedge fund style this year, helping the New York-based firm double assets by attracting $1.2 billion.

Chriss, 47, is one of the prime beneficiaries as investors are on track to hand over the most cash to hedge funds since 2007, driven by a search for steady returns and protection from market declines. The biggest firms, such as Citadel LLC, Och-Ziff (OZM) Capital Management Group LLC and Millennium Management LLC are bringing in the biggest chunks of money, yet a select group of smaller firms like Hutchin Hill have collected more than $1 billion each.

“There are huge sums of money being put to work,” said Adam Blitz, chief executive officer at Evanston Capital Management LLC, an Evanston, Illinois-based firm that farms out $5 billion to hedge funds. “You are getting some big checks coming into a fairly small universe of brand-name managers who want to grow and are on the approved list of hedge-fund consultants.”

Hedge funds attracted a net $57 billion in the first half of this year, compared with $63.7 billion for all of 2013, according to Hedge Fund Research Inc. Ten firms, including Hutchin Hill, gathered about a third of that amount, investors in the funds said.
Assets Swell

Industry assets have swelled to a record $2.8 trillion even though funds, on average, have posted 7 percent annualized returns since the financial crisis, compared with 12 percent over the previous 18 years, according to the Chicago-based research firm.

Inflows are coming from pension plans, sovereign wealth funds and high-net worth investors. Some of the institutions, such as the Hong Kong Jockey Club, are making direct investments in hedge funds for the first time, rather than going through funds of funds. The club, which controls horse-racing in the city, said in April it gave money to Och-Ziff and Millennium.
Multistrategy Popularity

Multistrategy firms, which use a range of tactics to invest across asset classes are the most popular this year after collecting a net $29.5 billion, according to Hedge Fund Research. The funds returned 4.4 percent through July 31, compared with 2.5 percent for hedge funds overall.

“Pension funds see multistrategy hedge funds as a one-size-fits-all investment,” said Brad Balter, head of Boston-based Balter Capital Management LLC. “It’s very difficult right now to identify attractive opportunities, so they are letting the manager make the tactical decisions rather than wait for their own investment committees to re-allocate capital.”

Hutchin Hill, which employs more than 60 investment professionals, uses five main strategies, including equities, credit and one that makes trading decisions based on quantitative models.

Chriss’s goal is to provide better and more consistent returns than he might using just one approach. His background is in computers and math: He taught himself to program at age 11 and sold a video game to a software company when he was a high-school sophomore.
Lured Away

After obtaining his Ph.D. from the University of Chicago, he was lured away from a teaching job at Harvard University in 1997 to go to Wall Street. He set up his firm in 2007 after working for Steve Cohen’s SAC Capital Advisors LP with early backing from Renaissance Technologies LLC founder Jim Simons.

Hutchin Hill has gained 8 percent this year, according to a person with knowledge of the performance, who asked not to be identified because the results are private.

While firms like Hutchin Hill are beginning to climb the ranks of multibillion-dollar managers, the domination of the biggest funds in raising assets hasn’t slowed, even when they report bad news or post mediocre returns.

Och-Ziff, the biggest U.S. publicly traded hedge-fund firm with $45.7 billion under management, pulled in a net $3 billion into its hedge funds this year, even as it warned shareholders that the Securities and Exchange Commission and the U.S. Department of Justice were investigating the firm for investments in a number of companies in Africa. Its main fund returned 2 percent in the first seven months of the year, less than half the average of multistrategy funds tracked by Bloomberg.
Sovereign Wealth

Chicago-based Citadel, run by billionaire Ken Griffin, helped spark a backlash against multistrategy funds after it lost 55 percent in 2008, one of the worst hedge fund declines stemming from the financial crisis. Six years later, its $22 billion in assets have surpassed its previous peak in 2008.

Its main hedge fund, which is up 9.9 percent this year, has pulled in a net $1.2 billion in 2014, even though it’s limiting inflows primarily to sovereign wealth funds, according to an investor. The firm’s Global Fixed Income fund, run by Derek Kaufman, attracted $2.7 billion.

Millennium, founded by Israel “Izzy” Englander, has collected a net $2.6 billion this year, after only taking in enough money to replace client withdrawals in 2013. The New York-based firm, which manages $23.5 billion, decided to raise money again because it’s adding more teams to the 150 that currently work at the firm. The fund has climbed about 4.2 percent this year and has posted an annualized return of 14.6 percent since January 1990, said investors, who asked not to be named because the fund is private.
Balyasny Assets

The popularity of the multimanager, multistrategy approach that Millennium helped pioneer a quarter-century ago has been a boon to some smaller managers. Dmitry Balyasny’s Chicago-based Balyasny Asset Management LP attracted $1.5 billion this year, bringing total assets to $5.9 billion, while Jacob Gottlieb’s New York-based Visium Asset Management LP pulled in $700 million into its multistrategy fund this year, after raising $1 billion in 2013.

Event-driven funds, which include managers who take activist roles at the companies in which they invest, continue to attract investors this year as the strategy gained 6 percent through July.
Loeb, Solus

P. Schoenfeld Asset Management LP climbed to $4.1 billion in assets as clients invested a net $1 billion and Solus Alternative Asset Management LP attracted $1.25 billion. Dan Loeb’s $15 billion Third Point LLC, which is known for taking activist positions, had been closed to new investments since 2011 and returned capital last year. It recently told investors it would open Oct. 1 for a limited amount of capital that clients expect will be about $2 billion, they said.

A few start ups have also received a billion dollars or more this year, in part because they are coming out of firms with strong track records that are closed to new investments. Herb Wagner, who started FinePoint Capital LP this year and raised $2 billion, was a co-portfolio manager at Baupost Group LLC, the Boston-based firm run by Seth Klarman. Matthew Sidman opened Three Bays Capital LP, another Boston firm, in January and is now managing $1.2 billion. He worked at Jonathon Jacobson’s Highfields Capital Management LP for 14 years.

Spokesmen for all the firms declined to comment on inflows and performance.

Big Money Raisers 2014

Firm PM Net AUM
Inflows

Citadel Ken Griffin $3.9 bln $22.0 bln
Och-Ziff Dan Och $3.0 bln $45.7 bln
Millennium Israel Englander $2.6 bln $23.5 bln
FinePoint Herb Wagner $2.0 bln $ 2.0 bln
Balyasny Dmitry Balyasny $1.5 bln $ 5.9 bln
Solus Chris Pucillo $1.25 bln $ 4.6 bln
Hutchin Hill Neil Chriss $1.2 bln $ 2.5 bln
Three Bays Matthew Sidman $1.2 Bln $ 1.2 bln
Passport John Burbank $1.0 bln $ 3.9 bln
P. Schoenfeld Peter Schoenfeld $1.0 bln $ 4.1 bln
It looks like I'm going to have to update my quarterly updates on top funds' activity to include new funds and to reclassify others. For example, Visum used to specialize in healthcare stocks and Balyasny was a L/S Equity and global macro fund. Now they've rebranded themselves as multi-strategy shops because they see the potential of garnering more assets.

I suspect you'll see more and more funds rebranding themselves into multi-strategy shops to boost their assets under management and start collecting that all important 2% management fee on multi billions. The name of the game is asset gathering which is understandable but also troubling.

I like managers like Neil Chriss and think he has the potential of being another great multi-strategy hedge fund manager. I'm not worried about Ken Griffin or Izzy Englender as they have proven track records and still deliver great results despite their enormous size.

But I'm warning all of you, even these great multi-strategy shops are not immune to a severe market shock and most of them got clobbered in 2008 and some made matters worse by closing the gates of hedge hell. Of course, Citadel came back strong, as I predicted back then because most fools didn't understand why the fund was hemorrhaging money, but it doesn't mean that it can't suffer another major setback.

When you're investing with hedge funds, you really need to have a smart group of people who can drill down into their portfolio and understand the risks and return drivers going forward. Stop chasing returns, you'll get burned just like those who blindly chase the stocks top hedge funds are buying and selling.

By the same token, don't invest in hedge fund losers thinking they're going to be tomorrow's winners. Volatility in commodities is shaking up many hedge funds in that space and I expect this trend to continue. Some will adapt and survive but most will close up shop.

It doesn't matter which fund you're investing with, you've got to ask tough questions and grill these managers. If they start acting arrogant or cocky, grill them even harder. I mean it, don't be intimidated and don't fall in love with some hedge fund manager because he's a billionaire and fabulously wealthy. Trust me, you're just a number to them and that's exactly what they should be to you.

Finally, while many of you are getting ready to write a big fat ticket to your favorite hedge fund manager, I kindly remind you that I work very hard to provide you with timely and frank insights, so take the time to click on the donation or subscription buttons on the top right-hand side. You simply aren't going to find a better blog on pensions and investments out there so please take the time to show your appreciation and contribute.

Below, a couple of clips providing a rare glimpse Citadel, one of the best multi-strategy hedge funds that is also the world's biggest market maker (h/t, Zero Hedge). For better or for worse, quants have forever changed the landscape of the investment management industry (see my comments on the Wall Street Code and the Great HFT Debate).

And Gregory Taxin, president of Clinton Group Inc., talks about hedge-fund investor Bill Ackman's plan to raise money in a public sale share this year of his Pershing Square Capital Management LP. Taxin speaks with Betty Liu on Bloomberg Television's "In the Loop.”

I've got an emerging manager up here in Canada who I think has the potential to be a really great activist manager if someone is willing to step up to the plate and seed him. I can't share details on my blog but if you're interested in discovering a real gem, email me at LKolivakis@gmail.com and I'll put you in touch with him. Enjoy your long weekend and please remember to contribute to my blog.




Thursday, August 28, 2014

What Will Derail the Endless Rally?

Gene Marcial of Forbes reports, Ride With The Bulls Even As Warnings Of A Big Correction Are On The Rise:
With the market’s major indexes continuing to climb to new all-time highs, investors are getting increasingly jittery about the incorrigible bears’ warnings that the huge correction they have been predicting is on its way. The selloff will signal the market has hit its peak, they assert. What to do?

Ride with the bulls — and face any pullback with enough cash firepower to buy the battered shares of fallen angels with proven track records. The proven antidote to a massive pullback is to embrace it and prepare to buy shares of companies that are fundamentally sound and equipped to thrive after a market pullback. The key is to be prepared – not by selling but to be an opportunistic buyer as prices plummet.

“The bears keep seeing market tops as the bull charges ahead,” notes Ed Yardeni, president and chief investment strategist at Yardeni Research. Even some of the bulls had warned about an imminent correction but instead, after a 3.9% drop from July 24 through Aug. 7, the S&P 5000 made a new record high on Monday, Yardeni points out.

But should perplexed investors really worry about the coming of a Big Correction? Not if you listen to savvy market watchers and analysts who recommend running with the bulls. True, the bull market is over five years old now, but Yardeni looks at it this way: “It seems to be maturing rather than aging. It is certainly less prone to anxiety attacks, and has treated buying dips as buying opportunities.”

Indeed, although the market continues to gain and treks to higher grounds, it appears more persistent in climbing walls of worries in the U.S. and overseas.

“While the bears continue to look for signs that the bull market is about to break up, I don’t see any significantly bearish divergences, or decoupling, between key internal stock indicators and the overall market,” says Yardeni. “It’s a well-adjusted bull,” is how Yardeni describes it.

The market’s technical picture looks particularly healthy, according to some veteran technical analysts. “The trend remains bullish and an extension above 2,000 (in the S&P 500) would favor a strong push higher into 2030, where we would expect some initial profit taking,” says Mark D. Arbeter, chief technical analyst at S&P Capital IQ. He notes that the S&P 500 has been in an uptrend within an ascending trend channel for the last few years.

So where is the index headed from here?

“The long-term outlook is pointed higher, while above support at 1,838 – 76. Only a drop below the lower trend channel boundary and support at 1,738 would substantially damage the structure of the big picture rally,” says the analyst.

And based on the fundamentals, the market’s outlook seem as positive, as well. “Indeed, the market may be feeding off of consensus expectations for a near 11% climb in yearly earnings-per-share growth through the second quarter of 2015, as compiled by Capital IQ,” says Sam Stovall, chief investment strategist at S&P Capital IQ. He sees the S&P 500′s “fair value around 2,100 a year from now, based on earnings per share growth forecasts, the expectation that inflation will remain around 2%, and that we get a meaningful digestion of gains along the way,” says Stovall.

Meanwhile, the bears aren’t getting much confirmation for their bearishness, notes Ed Yardeni – not even from the Dow Theory, which postulates that the Dow industrials and transportation groups should both be moving higher in a sustained bull market. Well, both the Dow Jones Transportation and the S&P 500 Transportation indexes rebounded to record highs in recent days, notes Yardeni.

Now that the S&P 500 is almost at our 2014 yearend forecast of 2014 for the S&P 500, well ahead of schedule, we remain bullish and continue to favor financials, health care, industrials and information technology.

These groups appear to be the stocks of choice for continued strength and stamina in this long-running bull market? As the S&P Investment Policy Committee sees it, the energy, health care, industrials, and information technology are the attractive sectors, which they recommend to clients to overweight in their portfolios. The committee rates the financial sector as “underweight.”
In my last comment on the real risk in the stock market, I discussed why I believe the real risk in the stock market right now is a melt-up, not a meltdown that many bears are warning about.

Admittedly, my thinking centers around the big picture, meaning there is an abundance of liquidity in the global financial system -- even if the Fed continues tapering -- and some risky sectors of the stock market are going to take off.  If the ECB finally engages in quantitative easing to combat the euro deflation crisis, it will unleash another massive dose of liquidity which will further bolster global equities and other risk assets.

Soon after I finished writing my comment yesterday, permabear David Tice,  President of Tice Capital, came onto CNBC calling quantitative easing a "short-term economic fix" and warning that a 50% correction in coming. Abigail Doolittle, Peak Theories founder, also appeared on CNBC proclaiming that the range has started to reverse the QE 3 uptrend, and a major move down is coming.

Another permabear, SocGen's Albert Edwards, wrote a note to clients warning the S&P is running on fumes:
With U.S Federal Reserve policy easing drawing to a close, Societe Generale's uber-bearish strategist Albert Edwards predicts that a bubble in stock markets is on the verge of bursting.

"Is that a hissing I can hear?" Edwards quipped in his latest research note, published on Thursday.

Edwards claimed the "share buyback party"—which some analysts see as the key driver for recent record Wall Street highs—was now over.

"Companies themselves have been the only substantive buyers of equity, but the most recent data suggests that this party is over and as profits also stall out, the equity market is now running on fumes," Edwards said.

Buybacks occur when firms purchase their own shares, reducing the proportion in the hands of investors. Like dividend payments, buybacks offer a way to return cash to shareholders, and usually see a company's stock push higher as shares get scarcer.

According to Societe Generale's research, share buybacks fell by over 20 percent the second quarter versus the first quarter. However, TrimTabs Chief Executive David Santschi said in a research note on Sunday that buyback announcements were "solid" as earnings season wrapped up.

Some firms borrow cash to buy back their shares, taking advantage of ultra-low interest rates in the U.S. and other developed nations. Edwards warned that as companies had issued cheap debt to buy expensive equity, a "gargantuan" funding gap could yet emerge.

"The equity bubble has disguised the mountain of net debt piling up on U.S. corporate balance sheets. This is hitting home now QE has ended. The end of the buyback bonanza may well prove to be decisive for this bubble," Edwards wrote.

Edwards is known for his markedly pessimistic predictions, and regularly touts the idea of an economic "Ice Age" in which equities will collapse because of global deflationary pressures.

Some analysts remain unconvinced. MacNeil Curry, head of global technical strategy at Bank of America Merrill Lynch, sees no imminent hit to equities. He predicts further upside for the S&P 500—currently near all-time highs—over the next few weeks, and sees the benchmark index reaching 2,050-to-2,060 points by late September.
Global deflation is coming and the bond market knows it, but Edwards is wrong if he thinks the S&P is running on fumes and won't continue to grind higher. Some of the riskiest sectors, like biotech, are booming again after a spring selloff. When the ECB starts engaging in massive quantitative easing, risk assets (and gold) will really take off.

Of course, nobody really knows where the stock market is heading. A million things can derail this rally and cause jittery investors to pull the plug and sell their stocks. But with pension deficits rising as bond yields fall, pensions will be forced to take on more, not less risk. And where will they be taking that risk? Stocks, corporate bonds and alternative investments like real estate, private equity and hedge funds.

I leave you with an interesting clip below. Charles Biderman, TrimTabs Investment Research CEO, analyzes current market conditions saying the market is essentially rigged and you have to "ride the tide." You sure do but make sure you're in the right sectors because some tides will be a lot bigger than others.

Wednesday, August 27, 2014

The Real Risk in the Stock Market?

Alex Rosenberg of CNBC reports, The strange dynamic that’s guiding stocks higher:
The S&P 500's surge past the 2,000 level this week for the first time ever is just the latest milestone for the great rally that stocks have enjoyed over the past 5½ years. But Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, doesn't think the latest splashy market headlines will do anything to bring in the many retail investors who have long been staying on the sidelines.

Individual investors are "still nervous, they're concerned," Silverblatt said on CNBC's "Futures Now" on Tuesday. "Even though we're into this rally over five years now, and they're getting very little if they're sitting in a bank or some alternatives, they are not moving back into the market." And he said the S&P's crossing of 2,000 won't lure retail investors.

After all, many small investors will not soon forget the market collapses of 2000/2001 and 2008/2009, which robbed them of their confidence in stocks. And in fact, the S&P has taken more than 16 years to get from 1,000 to 2,000—yielding a mere 6.2 percent annualized compound return, including dividends, from then to now.

So if that's the case, what explains the market's drumbeat of new highs? Silverblatt looks to the other key group in the market.

"On the other side you've got institutions, who are sitting in the market. They're reallocating somewhat, but they're not pulling out. These institutions appear to be more concerned with missing out on potential gains than the market declining."

"Both of these groups are just sitting tight," Silverblatt added. "And the market, in between, has taken small steps upward."

So what will shake the confidence of institutions or the reticence of retail investors?

"I'm not sure what kind of event, ... but it's going to be major," Silverblatt said. These two groups are "really difficult to move."
I'll tell you what I'm positioned for, a major melt-up in stocks, especially in biotech and social media sectors, which ironically are the two sectors Fed Chair Janet Yellen warned about. There will be a few more corrections along the way but they will be bought hard as we're fast approaching the "Houston, we have lift off!" phase of another historic parabolic move in stocks that will likely be the Mother of all bubbles.

Why am I so sure? Because there is unprecedented liquidity in the global financial system and the European Central Bank (ECB) is getting ready to crank up its quantitative easing to counter low growth and slowing inflation. Never mind Fed tapering, the baton has been passed to ECB President Mario Draghi, and there is plenty of liquidity to drive risk assets much, much higher.

And that scares the hell out of institutional investors, especially nervous hedge funds that are turning defensive on concerns over asset prices:
Equity long-short managers cut net exposures on average to 40%-45% from 50%, said Anthony Lawler, who manages portfolios of hedge funds at GAM.

Some managers are also using put options—the right to sell at a predetermined price—to protect against market falls, taking advantage of what some investors say is low pricing in these instruments.

Anne-Sophie d'Andlau, co-founder of Paris-based investment firm CIAM, bought puts at the end of June, citing market nervousness over the timing of a rise in U.S. interest rates and possible "negative surprises" in the European Central Bank's review of euro-zone bank assets, which is set to be completed later this year.

Ms. d'Andlau, whose fund is up 12.3% in the year to the end of July, said she was "not so confident on the direction of the market."

"Our analysis is that the current environment is more unstable on a macroeconomic level," she said. "You're buying puts for almost nothing."

Pedro de Noronha, managing partner at London-based Noster Capital, which runs $100 million in assets, has owned default protection on emerging-market sovereign debt for some time but recently sold some stocks and is holding more cash. He said he wanted "to make sure I have dry powder for a tough September/October. I see the market as offering very little value, and this is one of the times where the opportunity cost of sitting on the sidelines isn't so big."

But while funds have generally reduced their bets on rising prices, few believe that markets are in a speculative bubble such as the dot-com boom of the late 1990s, which preceded tumbles in stock markets.

"This isn't a greedy rally," said Chris Morrison, portfolio manager on Omni Partners LLP's Macro hedge fund, which made 5.8% in July as a call against U.S. small-cap stocks paid off. "I don't see people high-fiving. They're not saying 'get your moon boots, this stock is going to the moon.' It has been driven by a desperate need to earn a return."
This isn't a greedy rally? Maybe not but check out some of the monster moves in the biotech sector which are worrying some market watchers, and you'll see the beginning of the next major bubble brewing. And wait, Janet Yellen hasn't seen anything yet. By the time it's all over, she'll need a bottle of the next anti-anxiety biotech breakthrough to calm her nerves.

But be careful with all this bubble talk on biotechs and social media stocks. I happen to think we're at the cusp of  a major secular uptrend in these sectors and talk of bubbles just scares many retail and institutional investors away. I see plenty of great biotech stocks that have yet to take off and Twitter (TWTR) remains my favorite social media stock (it can easily double from here).

Which biotechs do I like at these levels? My biggest position remains a small cap biotech, Idera Pharmaceuticals (IDRA), a company that has revolutionary technology that is grossly underestimated by the market. But there are others I like a lot at these levels like Biocryst Pharmaceuticals (BCRX), Catalyst Pharmaceutical Partners (CPRX), Progenics Pharmaceuticals (PGNX), Synergy Pharmaceuticals (SGYP), Threshold Pharmaceuticals (THLD), TG Therapeutics (TGTX),  XOMA Corp (XOMA).

The thing with biotech is there is a lot of hype which is why it's best to track the moves of top funds that specialize in this space. For example, Perceptive Advisors' top holding is Amicus Therapeutics (FOLD), a stock that has taken off in recent weeks. The Baker Brothers which focus exclusively on biotechs made a killing when InterMune (ITMN) got bought out by Roche for a cool for $8.3 billion earlier this week. I track their portfolio closely but be careful as all these biotechs are very volatile.

Big pharma is hungry for the next big blockbuster drugs. Just like big hedge funds, they are large and lazy, so they'll be looking to gobble up smaller and more productive biotech players which are actually discovering amazing drugs which are more specific and have less side-effects.

But it's not just about biotech and social media. The big deal earlier this week was Burger King's (BKW) acquisition of Tim Hortons (THI), sending both stocks way up. Hedge fund manager Bill Ackman, who runs Pershing Square Capital, had a huge payday on Monday, cementing his top spot among large hedge funds this year.

And maybe there won't be any parabolic move in stocks, just a slow, endless grind up. One pro who appeared on CNBC earlier this week said we're only 5 years in a 20-year bull stock market:
As the S&P 500 topped 2,000 for the first time Monday, Chris Hyzy said that the stock market is just five years into a 20-year bull market.

"I know it sounds easy to say," U.S. Trust's chief investment officer said on CNBC's "Halftime Report." "When you really think about this, this is an elongated business cycle. You're going to have fair value through most of it. You're not going to get a lot of overvaluation."

Hyzy identified what he saw as key for the continued bull market.

"You're going to have some very big opportunities inter-sector and themes. M&A is running wild. But the key to all of this is the manufacturing in the next decade," he said. "It's already happening. You've got energy independence on its way. The private sector's piercing through whatever restrictions are being put out there, and you've got technological advancement that we haven't seen since the early 1990s.

"That sets us up for an elongated business cycle, which is about five years into a pretty long secular market."

Hyzy, who expects GDP growth of 3 percent to 3.25 percent for the United States this year, said that he liked the financial sector best of all, with selected technology and oil-service plays.

Europe, he added, resembled Japan at the outset of its 20-year deflationary spiral. With credit growth contracting, weakness in Germany and French bond yields below that of the U.S., European Central Bank President Mario Draghi "has to act at some point, and it's a little too late."

"I would argue that the first movement on QE in Europe is a good thing for low-quality assets," Hyzy said. "You'll get the big rally. And then you'll levitate for a while if growth doesn't get there."
Are we only 5 years into another 20-year bull cycle? I doubt it but with bond yields at historic lows, stocks are the only real game to play but you have to pick your spots right or you won't make money.

That's why it's increasingly important to really drill down and understand the portfolio moves of top funds. Ignore Goldman Sachs' top fifty stocks hedge funds are shorting like crazy or the top fifty hedge funds love the most. Most of the time, you're better off taking the opposite side of these trades, and the Goldman boys don't tell you the top fifty stocks hedge funds should be buying going forward (like Twitter!).

There is a lot of garbage out there, stock market porn, and it's no wonder very few retail and institutional investors make money actively managing their portfolios. And it's not just about picking stocks right, you got to get the macro calls right, which very few people seem to be doing.

Just yesterday, I watched and interesting interview with Ambrose Evans-Pritchard posted on Zero Hedge (see below). I agreed with him that the U.S. will remain the economic superpower over the next century but was baffled by his call that rates will rise because "wage pressures" will pick up significantly.

I've said it before and I'll say it again, after we get a huge liquidity driven spike in stocks, we'll see asset prices across public and private markets deflate and a long period of deflation will settle in. There is simply too much debt out there and it won't end well (listen below to Chris Martenson's interview with Hoisington's Lacy Hunt to understand why).

But remember the wise words of John Maynard Keynes, "markets can stay irrational longer than you can stay solvent." The events I'm describing above won't happen in the next year or even five years. So while the Zero Hedge bears keep posting scary clips, relax and mark my words, the real risk in the stock market is a melt-up, not a meltdown, and institutions betting on another crash will get clobbered.


Tuesday, August 26, 2014

The Myths of Shared-Risk Plans?

Hassan Yussuff, President of the Canadian Labour Congress, wrote a special for the Financial Post, Why there’s no benefit in target benefit pensions:
So-called ‘shared risk’ plans have nothing to do with sharing

Every child grows up learning the importance of sharing. It’s also fundamental to the labour movement. Unions bargain with employers to ensure that workers share in the fruits of their labour. This makes for a stronger, stable economy and a fairer society.

Sharing is also at the heart of workplace pensions. Part of the wages and salaries that unions bargain get deferred until retirement, in the form of pensions. When our negotiated pension plans experience funding shortfalls, as they have in the last six years, unions have stepped up and agreed to pay more into the pension fund, even temporarily cutting back on benefit levels. In return, unions expect that employers will live up to their commitments and pay retirees the pensions they’ve earned over a working lifetime – the essence of the defined-benefit (DB) pension deal.

Even as our pensions return to health, however, employers are looking for ways to rid themselves of the cost and headache of pension plans altogether. And the federal government is lending a hand. In April, the federal government announced that it is proposing target-benefit plans or so-called “shared risk” pension plans in the federal private sector, and for Crown corporations.

In fact, so-called “shared risk” plans have nothing to do with sharing. Let’s look at some of the myths around these plans:

Myth 1: “Shared-risk” plans split the risk and rewards between employers and employees.

These plans don’t “share” risk; they dramatically reduce employers’ risk by shifting it onto plan members and pensioners. Employers would enjoy cost-certainty and strict limits on future risk, while plan members face an open-ended risk of benefit cuts, even when retired. Employers converting their existing DB plans would be able to turn promised pension commitments (once a legal obligation that could not be revoked) into fully reducible “target benefits” that may or may not be delivered.

Myth 2: “Shared-risk” plans strike a balance between worker-friendly DB plans and the defined-contribution (DC) plans that employers prefer.

For employers, switching to a “shared-risk” plan brings significant advantages: Employer contributions are capped, no pension guarantees of any kind are made to employees, and no pension liabilities appear on the employer’s financial statements. Plan members, however, experience a massive loss of security: The legal protection for already-earned benefits is taken away, and everything can be reduced, including pension cheques being mailed to retirees.

Myth 3: If benefits are reduced in a “shared-risk” plan, they will only be temporary reductions.

In fact, there is no requirement in a “shared risk” plan that benefit reductions only be temporary. Permanent benefit reductions are indeed a possibility in this model. This means, absurdly, that temporary shortfalls in the plan could lead to permanent reductions in benefits.

Myth 4: The “shared-risk” plan is a hybrid, in which some benefits are guaranteed and some (like inflation protection) are conditional.

Not true. There are no legal benefit guarantees of any kind in “shared risk” plans. All benefits (whether basic pension benefits, or additional benefits like inflation indexing) can be legally reduced without limit.

Myth 5: Unions have embraced the “shared-risk” model.

The vast majority of unions do not support the conversion of DB plans into “shared-risk” plans. Faced with the distinct possibility that their pension plan would be wound up, a small number of New Brunswick bargaining units supported “shared risk” plan conversions for a few severely-underfunded pension plans. By contrast, “shared risk” conversions are now being proposed for healthy and sustainable pension plans, across the country.

The fact of the matter is that the “shared-risk” approach is about one thing: reducing employers’ risk and cost. But Canadians cannot allow the conversation to be restricted to just employers’ costs. We have to talk about adequacy and security of retirement income, and in that respect, we’re not making progress. Access to pensions at work continues to dwindle as a share of the working population, and a growing number of families face a retirement plagued by financial insecurity.

Over 60% of working Canadians have just one pension plan at work: the Canada Pension Plan or the Quebec Pension Plan. These plans are truly shared, paid for equally by employers and employees. The Canadian Labour Congress calls on the federal government to expand the Canada Pension Plan and Quebec Pension Plan. The government’s misguided shared-risk initiative will only further undermine the retirement security of Canadians.
In my last comment on whether Quebec is pulling a Detroit on pensions, I argued that it's about time Quebec tackles its pension deficits and introduces real risk-sharing in their municipal and other public pension plans.

In his comment above, Mr. Yussuff argues that shared-risk plans have nothing to do with sharing and only benefit employers, while severely undermining the retirement security of employees who could potentially face "permanent" cuts to their retirement benefits which they are legally entitled to.

Is Mr. Yussuff right? Yes and no and let me explain why. I went over New Brunswick's pension reforms and followed up in another comment where I revisited these reforms, discussing why Bernard Dussault, the former Chief Actuary of Canada working for the Common Front, thought New Brunswick's shared-risk was nothing more than risk-dumping:
  • although not properly identified and designed in Bill C-11, the proposed increase in PSPP members’ contribution rates and the proposed increase from 60 to 65 in the age at which PSPP members become entitled to a normal (unreduced) retirement pension, respectively, are the only areas of remedies that are relevant to the unfavourable financial findings identified in the April 1, 2012 actuarial report on the PSPP;
  • it is unfair, as it does make pension indexation, both active and pensioned members, dependent upon the ongoing financial experience of the PSSA through the use of inappropriate actuarial and accounting mechanisms that properly account for indexation in the contributions and assets of the PSPP but not at all in its liabilities;
  • it fails to show the proportion of the PSPP cost that will be shared by active PSSA members; and
  • it is too complex, which was publicly acknowledged by the Minister of Finance, as he did himself publicly stated that he does not fully understand it, and as its implementation, management and day to day administration would be an overly expensive and intricate endeavour.
In this case, I agreed with Bernard, there were irregularities in the terms for pension indexation and what proportion of the PSPP cost will be shared by active PSSA members.

But that doesn't mean that shared-risk plans should be scrapped because they are inherently unfair to employees. This is pure rubbish and I have a bone to pick with Mr. Yussuff and the Canadian Labour Congress for spreading some blatant lies and falsehoods in the comment above.

A perfect example of a defined-benefit plan that is fully-funded and has implemented a shared-risk model is the Healthcare of Ontario Pension Plan (HOOPP). In fact, HOOPP is now overfunded and looking at ways to increase benefits to its members, which can include cuts in contributions or better indexation. In this case, shared-risk doesn't mean risk-dumping on employees; it goes both ways.

Another example is the Ontario Teachers' Pension Plan (OTPP), which has also adopted a shared-risk model with its members. For all effective purposes, OTPP is fully-funded, which is quite remarkable given the Oracle of Ontario uses the lowest discount rate in the world among public pension plans to discount its future liabilities.

But both these plans did implement some forms of risk-sharing in the past to temporarily deal with their shortfalls when times were tough. In particular, they temporarily cut the cost of living adjustments to members for a period of time until their plan became fully-funded again.

In doing so, both employers and employees benefited because the contribution rates stayed the same. Pensioners temporarily suffered a marginal cut in cost of living adjustments but it wasn't a huge or permanent hit to their benefits.

There is another problem with Mr. Yussuff's comment, one that really irks me. Sometimes I feel like these unions live in a bubble, completely and utterly oblivious to what is going on in the private sector and completely clueless about how unfunded liabilities are a debt and can severely impact a country's debt rating. And he completely ignores the demographic shift and the rising challenge of measuring and managing longevity risk.

Once again, let me go back to what happened in Greece. In order to avert a full default, which would have been catastrophic to Greece and spelled the end of the eurozone, Greece had to accept savage cuts in wages and pensions forced upon them by troika which represented bondholders.

And in Greece, public employee unions were living in a bubble, completely oblivious to the plight of the private sector and the economic realities of a country living way beyond its means. What happened? The private sector in Greece had to borne the brunt of the savage cuts and only later did public employee unions succumb and accept cuts to pensions and wages.

But till this day, hardly any public sector employee in Greece lost their job. Sure, their wages and pensions were cut in half or by two-thirds, but the massive unemployment that Greece experienced in the last few years was all in the private sector. This is where troika and the bondholders really screwed things up with their myopic and idiotic austerity measures. When 50% of the Greek working population has a public sector job with the benefits that go along with these jobs, there is a serious problem. The cuts should have been in the public sector, not the private sector.

Anyways, don't get me started on Greece and troika, my blood boils. Let me get back to Canada and Mr. Yussuff's comment above. I think he's intentionally exaggerating his points and spreading lies and falsehoods to make public sector employees be the victims of shared-risk plans, but this is pure rubbish.

One area where I do agree with Mr. Yussuff and the Canadian Labour Congress is that it is high time the boneheads in Ottawa enhance the CPP for all Canadians, regardless of whether they work in the public or private sector.

I have a vision for Canada's retirement security. In my ideal world, OTPP, HOOPP, AIMCo, OMERS, Caisse, bcIMC, and other large public and private defined-benefit pensions will be working for all Canadians, just like CPPIB is doing right now. It's akin to what they have in Sweden where you have a series of large, well-governed state plans serving all Swedes but even better because the Swedes didn't get everything right.

In my ideal world, you'll have true shared-risk among all Canadians and the benefits that go along with that. There will be pushback by some banks, mutual funds and insurance companies but in time, even they will see the benefits of this approach which brings true retirement security and pension portability to all Canadians.

Below, Angela Mazerolle, Superintendent of Pensions and Superintendent of Insurance at New Brunswick's Financial and Consumer Services Commission, shares insights from her session "Shared-Risk Pension Plans" while at the International Foundation's 46th Annual Canadian Employee Benefits Conference in San Francisco. Listen to her comments and keep an open mind on share-risk plans, they aren't as bad as Mr. Yussuff claims.

Monday, August 25, 2014

Quebec Pulling a Detroit on Pensions?

Don Pittis of CBC reports, Workers not to blame for Quebec pension problem:
A deal's a deal, right? Well, not when it comes to the province of Quebec and the pensions of its municipal employees.

And if Quebec gets away with cutting municipal worker pensions, which have been eaten away through mismanagement by the very people doing the cutting, then watch this phenomenon spread.

Quebec is pulling a Detroit. About a year ago, I pointed out that the shattered dreams of Detroit pensioners should be a warning to the rest of us. But unlike Detroit, Quebec is trying to snatch back promised pension money by fiat through its proposed Bill 3 pension reform legislation, without the inconvenient legal process of bankruptcy.

To read many of the stories about these Quebec pension cuts you would think that it was the pensioners' fault. The same kind of thing happened in Detroit. Outraged taxpayers inveigh against government employees for sucking money out of the public purse for a cushy retirement. It's as if by choosing a job with a pension and keeping to their side of the contract, the workers are taking advantage.

"Right now, municipalities are taking all of the risk on the payouts and employees are taking relatively none of the risk," said economist and McGill Professor Brett House on CBC's Montreal's radio morning show.

Such comments anger Bernard Dussault, the architect of the Canada Pension Plan and former Chief Actuary for the Government of Canada. The CPP is well known around the world because, unlike many government plans, it is properly funded and can pay out forever (as I've mentioned before, the flaw with the CPP is the actual payout is too small, barely covering rent in many Canadian cities). In fact, this week the chief executive of Hong Kong's social services said he is studying CPP as a model for the reform of the territory's pension system.

As an actuary, Dussault is a sort of super statistician who studies lifespans, average investment yields and the cost of risk. He says that if you do your calculations right, update them frequently and set enough money aside, there is almost no risk involved with pensions.

He says "risk" is not the reason Canadian pension plans are facing problems, and he points out that Quebec is not an exceptional case.

"There are plans with problems all across Canada," says Dussault.

In every case, he says, the problem is a simple failure to set enough money aside.

Many blame the market crash of 2008 for shortfalls in pension plan investment returns. Dussault agrees that was a setback, but adds that it's a weak excuse, because as I write this the Toronto stock exchange has just hit another all-time record high. Yes, it's higher than the peak before the crash. And any pension contributions invested since the crash have seen extraordinary gains.

That assumes, of course, that the pension plans have collected enough money in contributions from both employer and employees, and have actually invested it. And therein lies the flaw.

In Quebec's case, the pension deficit can be traced back, in part, to a previous attempt to balance the province's books. Back in the nineties, Quebec downloaded hundreds of millions in costs to the municipalities. To help them deal with those expenses, since pension plan investment returns were strong at the time, municipalities were permitted to take a pension-contribution holiday.

Brett House agrees that pension holidays were a mistake, and regular contributions should have continued. "By any historical measure, those were exceptional surpluses that should have been saved rather than disbursed."

Actuaries know that even if things look really good one year, that only makes up for other years when things look really bad.
In the dark

And unless they did some serious homework, the workers wouldn't even know the pension pot wasn't full.

Their monthly contributions would come off their paycheques. They would get periodic pension statements showing their accrued benefits based on the promises in their contract, but the accounting in those documents was imaginary. By this year the province, which is ultimately responsible for municipal debts, was in the hole by almost $4 billion for municipal pension deficits.

Just like Detroit, just like the car companies, Quebec and its cities negotiated these pension contracts with their unions with their eyes wide open. Now they are planning to walk away from those deals. Years after you've signed a deal with the bank you can't go and say, "You charged me too much for my mortgage; I'm taking it back." Try it and see what happens. But that is what the province is saying to city workers.

And in their negotiations for improved pensions, the workers traded away other benefits, like better pay. "We’d rather have taken our salary raises," says the head of the Gatineau police union.

"It is terrible because it is stealing money that has already been accrued," says Dussault.

He adds that Canada has a good financial reputation because it regulates banks, insurance companies and pension funds.

"So now we allow pension plans to renege on their obligations," he says. "We will next allow banks and insurance companies to renege on their obligations?"

Dussault points out that Quebec is not the first to take away pensioners' accrued benefits. New Brunswick did the same thing and pensioners are still not happy about it. And he says if Quebec succeeds, it won't likely be the last.

Perhaps the most underfunded pension plan in the country belongs to the federal government. Federal employees have pension contributions deducted and they go into a "fund," but that fund is based on what Dussault calls "notional bonds." Essentially, the contributions are on the government's books, but they go into general revenue and no outside assets are purchased to cover them — ultimately the payment to the pensioner will come out of future general tax revenue.

"All this accounting is theoretical. It is not real money," says Dussault. "I don't see the federal government reneging on its obligations, but there are more and more pressures. And that frightens me."

Despite the theoretical accounting, Canada's federal government more or less has its financial house in order. But as we saw in Detroit, other governments — and many companies — have shown a willingness to hide disturbing amounts of financial trouble by sweeping it under the carpet of pension deficits.

It may be a painful process, but it appears that Quebec workers will be forced to negotiate a new pension deal. As they do so they should study other arrangements, such as the Ontario municipal pension fund OMERS and the Ontario Teachers Pension Plan. Those pension plans are fully funded and about as well managed as any pensions anywhere.

The difference? It's certainly not risk. They were exposed to the same market crash as everyone else.

What is different is where the money goes and who manages it. Contributions from both the employees and employer go straight into a fund. No notional bonds. No deficits. No promises to pay later.

And the fund is invested and controlled by the employees. The only way the government will get that money back is in the income tax those pensioners pay as they live out a comfortable retirement.
In her article, Ingrid Peretz of the Globe and Mail reports, Quebec pension status quo ‘no longer option’ says Montreal mayor Coderre:
Montreal Mayor Denis Coderre said he would “never give in to thugs” as the province’s political leaders appeared ready to take on restive public-employee unions over Quebec’s controversial pension-reform plans.

Hearings into the Liberal government’s pension legislation opened in Quebec City against a backdrop of heightened security and noisy street protests by municipal workers furious about the bill.

As employees protested outside, Mr. Coderre and the mayor of Quebec City, Régis Labeaume, both outspoken proponents of the pension changes, said taxpayers couldn’t keep sustaining the current pension regime.

“The status quo is no longer an option,” Mr. Coderre said. “We’re now confronted with a financial reality we can no longer ignore.”

Pension costs in Montreal have more than quadrupled since 2002 and now eat up 12 per cent of the municipal budget, the mayor said. Mr. Coderre said he was open to compromise with the unions but wouldn’t countenance the rowdy spectacle that unfurled at City Hall Monday night, when protesting firefighters and other municipal employees surged into the historic building and littered it with papers and other debris.

“The last few weeks have been hectic and even emotional for many people,” Mr. Coderre said. “But now, time has come to work together.”

The pension legislation, Bill 3, seeks to have municipal employees in Quebec assume a larger share of their pensions by requiring workers and cities to split the cost of covering their plans’ $4-billion deficit.

The proposal has morphed into the first major test for Premier Philippe Couillard, who has made belt-tightening a byword of his four-month-old government. He has vowed to stand firm on pension reform.

As expected, unions are up in arms over the proposals. Serge Cadieux, secretary-general of the Fédération des travailleurs du Québec, told the hearings Wednesday the bill was inequitable, set a bad precedent and was probably unconstitutional.

City unions in Montreal have never shied from a forceful fight with their bosses. Blue-collar workers have a track record of militancy: A former, high-profile union leader, Jean Lapierre, appeared at a demonstration in Montreal on Wednesday to announce that protest actions would get more “radical” and this was “only the beginning of hostilities.” Police officers in camouflage pants and fire trucks plastered with stickers have become routine in labor conflicts.

But it’s unclear whether the public will side with the unions this time. Several observers say Monday’s vandalism at City Hall may have cost the unions some public sympathy; police officers were seen on site standing by without reining in the rowdy demonstrators.

The head of Montreal’s police union, Yves Francoeur, defended his members on Wednesday, saying they never got the green light from senior officers to step in and carry out crowd control. Even after the boisterous mob had entered City Hall, police sought the go-ahead from their superiors to do their job, Mr. Francoeur said. But the rank-and-file officers were told no, because city hall had not requested police intervention. Mr. Francoeur referred to the incident as a “comedy of errors.”

Hearings into Bill 3 continue on Thursday.
There is a lot to cover in these articles. First, let me agree with Bernard Dussault, Canada's former Chief Actuary, Quebec's pension deficits were exacerbated by the 2008 crisis, but the real problem can be traced back to balancing the books by neglecting to top up pensions. These "contribution holidays" sounded good at the time because markets were roaring and interest rates were much higher, so many pension plans had surpluses instead of deficits.

However, contribution holidays ended up being a disaster for many Quebec, Canadian and U.S. plans. In fact, fast forward to 2014. While stocks and other risk assets pensions invest in (like corporate bonds) have soared to record highs in the last five years, interest rates keep declining to historic lows, and that spells trouble for pension plans.

Why? Because the decline in interest rates is a much more important factor in terms of impact on pension deficits than soaring asset prices. And if rates keep falling because global deflation takes hold, watch out, asset prices and interest rates will tumble, and pension deficits will explode throughout the world (like 2008 only much worse because it will last a lot longer).

Why is the decline in interest rates a bigger factor on pension shortfalls than soaring asset prices? Because future liabilities on pensions are typically discounted using market rates and if interest rates decline, pension deficits widen even if stocks and corporate bonds are doing well. In finance parlance, the duration of pension liabilities is a lot longer than the duration of pension assets, so a decline in interests rates will disproportionately impact liabilities a lot more than a rise in asset values. 

This is where I part ways (somewhat) with my good friend, Bernard Dussault. Given where we are now in 2014, and given the immense risks of global deflation that I see ahead, I'm not at all comfortable with the current risk-sharing aspects of Quebec's pension plans and have expressed my concerns here and here.

In my opinion, if Quebec doesn't slay its pension dragon once and for all, it will head the way of Greece where bond vigilantes rammed through savage cuts on public (and private) pensions and wages.

This is very important and I want people to fully comprehend the point I'm trying to convey here. Quebec is a lot richer than Greece but there are eery parallels in the way public finances have been mismanaged between the two and the insane power that public employee unions hold. In fact, one of my friends is dead serious when he warns me: "Mark my words, when the shit hits the fan, Quebec is the next Greece."

This might sound crazy but to those of us who know Greece and Quebec very well, there were a lot of promises made over the last three decades to buy votes from public employee unions, and everyone knew these promises cannot be kept in the future. But politicians being politicians were only thinking of gaining political power, not the powder keg they were creating in the future.

It's nice to retire at 55 or 60 after 30 years of working with a guaranteed pension till you die but is it affordable and realistic? These promises were made at a time when the demographics were favorable to pension plans, ie. when you had more active workers relative to pensioners and people weren't living as long as they do now. This is no longer the case. As the baby boomers retire, we will see a lot more pensioners relative to active workers and these pensioners are living longer. The ongoing jobs crisis plaguing the developed world will only exacerbate this trend.

Of course, it's not all driven by demographics because the reality is that investment gains in well governed defined-benefit plans account for 2/3 of most pension pots, and only 1/3 comes from employee and employer contributions. 

So what do we need to do now? We need to consolidate many municipal and city plans in Quebec to create a new municipal employee retirement system akin to OMERS in Ontario.Then we need to implement world class governance, adopting best practices from around the world, not just Canada.  Lastly and most importantly, we need to implement real risk-sharing so employees and employers share the risks of these plans equally so taxpayers don't foot the bill if pension deficits explode.

If you look at most fully-funded pension plans in Canada, whether it's HOOPP, Ontario Teachers or CAATT, the employees and employers share the risk of their plan. This means, if markets go sour, they implement measures to reduce the pension deficit by increasing contributions or decreasing pension benefits (like cost-of-living adjustments).

This is where a funding policy is critically important. I recently discussed PSP"s funding policy, going over some of the problems mentioned above with the federal government's pension plans. It's not yet clear what the federal government will do but my advice would be to have PSP manage the assets and liabilities accrued before 2000 of these federal plans and adopt risk-sharing measures. If that happens, the funding policy will be even more critical.

I know this is a long comment and pensions are an emotional subject for many people who have contributed to their pension plan over many years and expect the pension promise to be delivered. But the pension chicken has come home to roost, not only in Quebec but all around the world. 

I agree with Denis Coderre and Philippe Couillard, pension reforms cannot wait. If public employee unions don't sit and negotiate some form of risk-sharing in good faith, there will be a day of reckoning for pensions, and when it comes it will be too late. The bond vigilantes will impose savage cuts on public pensions and wages just like they did in Greece.

I'm not being a scaremonger here. I'm being brutally honest. While I agree with many of the comments of Bernard Dussault, the economic and political reality is that pension reforms cannot wait any longer. I'm all for defined-benefit plans but you have to get the governance and risk-sharing right or else they are doomed to fail spectacularly.

If you have any comments, feel free to email me at LKolivakis@gmail.com. Please remember to contribute to this blog via PayPal at the top right-hand side. I thank the institutions that have contributed and ask many more to do so.

Below, as Quebec workers vow to keep up the pressure over a proposed increase in their pension costs, I embedded an older clip where thousands of Greek pensioners have taken to the streets of the capital Athens to protest against government cuts to their income.

If you think this will never happen in Quebec or Canada, you're dreaming.  When the money runs out, Quebec and the rest of the world will head the way of  Detroit and worse still, Greece where savage austerity measures have been imposed by the bond vigilantes.

Of course, I agree with France's economy minister, German austerity is not the answer and it will only exacerbate the euro deflation crisis. It's time for Quebec, Canada and the U.S. to implement real pension reforms before we reach a critical point of no return, leaving the decision up to bondholders.