Monday, April 27, 2015

A New Deal For Greece?

Greece's Finance Minister Yanis Varoufakis wrote a comment for Project Syndicate, A New Deal for Greece:
Three months of negotiations between the Greek government and our European and international partners have brought about much convergence on the steps needed to overcome years of economic crisis and to bring about sustained recovery in Greece. But they have not yet produced a deal. Why? What steps are needed to produce a viable, mutually agreed reform agenda?

We and our partners already agree on much. Greece’s tax system needs to be revamped, and the revenue authorities must be freed from political and corporate influence. The pension system is ailing. The economy’s credit circuits are broken. The labor market has been devastated by the crisis and is deeply segmented, with productivity growth stalled. Public administration is in urgent need of modernization, and public resources must be used more efficiently. Overwhelming obstacles block the formation of new companies. Competition in product markets is far too circumscribed. And inequality has reached outrageous levels, preventing society from uniting behind essential reforms.

This consensus aside, agreement on a new development model for Greece requires overcoming two hurdles. First, we must concur on how to approach Greece’s fiscal consolidation. Second, we need a comprehensive, commonly agreed reform agenda that will underpin that consolidation path and inspire the confidence of Greek society.

Beginning with fiscal consolidation, the issue at hand concerns the method. The “troika” institutions (the European Commission, the European Central Bank, and the International Monetary Fund) have, over the years, relied on a process of backward induction: They set a date (say, the year 2020) and a target for the ratio of nominal debt to national income (say, 120%) that must be achieved before money markets are deemed ready to lend to Greece at reasonable rates. Then, under arbitrary assumptions regarding growth rates, inflation, privatization receipts, and so forth, they compute what primary surpluses are necessary in every year, working backward to the present.

The result of this method, in our government’s opinion, is an “austerity trap.” When fiscal consolidation turns on a predetermined debt ratio to be achieved at a predetermined point in the future, the primary surpluses needed to hit those targets are such that the effect on the private sector undermines the assumed growth rates and thus derails the planned fiscal path. Indeed, this is precisely why previous fiscal-consolidation plans for Greece missed their targets so spectacularly.

Our government’s position is that backward induction should be ditched. Instead, we should map out a forward-looking plan based on reasonable assumptions about the primary surpluses consistent with the rates of output growth, net investment, and export expansion that can stabilize Greece’s economy and debt ratio. If this means that the debt-to-GDP ratio will be higher than 120% in 2020, we devise smart ways to rationalize, re-profile, or restructure the debt – keeping in mind the aim of maximizing the effective present value that will be returned to Greece’s creditors.

Besides convincing the troika that our debt sustainability analysis should avoid the austerity trap, we must overcome the second hurdle: the “reform trap.” The previous reform program, which our partners are so adamant should not be “rolled back” by our government, was founded on internal devaluation, wage and pension cuts, loss of labor protections, and price-maximizing privatization of public assets.

Our partners believe that, given time, this agenda will work. If wages fall further, employment will rise. The way to cure an ailing pension system is to cut pensions. And privatizations should aim at higher sale prices to pay off debt that many (privately) agree is unsustainable.

By contrast, our government believes that this program has failed, leaving the population weary of reform. The best evidence of this failure is that, despite a huge drop in wages and costs, export growth has been flat (the elimination of the current-account deficit being due exclusively to the collapse of imports).

Additional wage cuts will not help export-oriented companies, which are mired in a credit crunch. And further cuts in pensions will not address the true causes of the pension system’s troubles (low employment and vast undeclared labor). Such measures will merely cause further damage to Greece’s already-stressed social fabric, rendering it incapable of providing the support that our reform agenda desperately needs.

The current disagreements with our partners are not unbridgeable. Our government is eager to rationalize the pension system (for example, by limiting early retirement), proceed with partial privatization of public assets, address the non-performing loans that are clogging the economy’s credit circuits, create a fully independent tax commission, and boost entrepreneurship. The differences that remain concern how we understand the relationships between the various reforms and the macro environment.

None of this means that common ground cannot be achieved immediately. The Greek government wants a fiscal-consolidation path that makes sense, and we want reforms that all sides believe are important. Our task is to convince our partners that our undertakings are strategic, rather than tactical, and that our logic is sound. Their task is to let go of an approach that has failed.
I read Mr. Varoufakis comment and was unimpressed. For a bright guy, he conveniently misses what is truly ailing the Greek economy. I left this comment on Project Syndicate's site:
"The pension system is ailing." I would say the Greek pension system is on the verge of collapse. The jobs crisis doesn't help but an even bigger problem is the total lack of proper governance surrounding Greek pensions. Instead of creating something akin to the Canada Pension Plan Investment Board, Greece has allowed their pensions to slowly wither away, much like its economy which is in desperate need of major reforms. Of course, the biggest problem in Greece remains its grossly over-bloated public sector which Syriza will fight for tooth and nail until its leaders are forced to implement drastic cuts (one way or another, cuts are coming, especially if Greece leaves the euro and goes back to the drachma). Mr. Varoufakis knows this. Tsipras knows this. They are playing a dangerous game with no leverage. Greeks are only fooling themselves if they can't see past Syriza's dangerous lies. It's time for Greeks to take responsibility for years of economic failure and finally bring their economy into the 21st century by implementing much needed reforms to make it more competitive and open to foreign investors. Varoufakis laments that Greece needs a new deal but he fails to see the world has its own problems to deal with and if Greece doesn't reform, it will be left out, or worse, thrown back into the Dark Ages.
Now, I realize there is only so much you can cover in a short comment, but my main points are all there. Either Greece reforms its antiquated economy -- which is being held back by a grossly over bloated public sector supported by powerful unions, special interests groups which includes lawyers and pharmacists that don't want foreign competition, and a handful of ultra wealthy families milking the Greek economy dry -- or it will die of a painful death. And going back to the drachma will only make this death more painful, something that Greeks know all too well.

Greece's creditors know this all too well too. They've implemented a united strategy to squeeze its leaders until they yield. Mr. Varoufakis is already feeling the heat. At last week's rumble in Riga, his  counterparts lost patience with him, calling him an "amateur" who constantly lectures them but has implemented no serious reforms:
When Yanis Varoufakis warned his fellow euro-area finance chiefs of the dangers of pushing his government in Athens too far, Peter Kazimir snapped.

Kazimir, Slovakia’s finance minister, launched a volley of criticism at his Greek counterpart, releasing months of pent-up frustrations among the group at the political novice. They’d had enough of what they called the economics professor’s lecturing style and his failure to make good on his pledges.

The others at the April 24 gathering in Riga, Latvia, took their cue from Kazimir -- they called Varoufakis a time waster and said he would never get a deal if he persisted with such tactics. The criticism continued after the meeting: eight participants broke decorum to describe what happened behind closed doors. A spokesman for Varoufakis declined to respond to their descriptions.

“All the ministers told him: this can’t go on,” Spain’s Luis de Guindos said the following day. “The feeling among the 18 was exactly the same. There was no kind of divergence.” The others who provided an account of the meeting in interviews asked not to be named, citing the privacy of the talks.

Varoufakis’s isolation raises the stakes, which include a potential default and keeping the euro indivisible. After more than five years as a ward of the European Union, Greece is virtually out of cash. The aid pipeline is shut until Prime Minister Alexis Tsipras, elected Jan. 25 promising to push back against budget cuts, bends to EU policy demands.

Alluding to the political conflict, Varoufakis borrowed a line from a 1936 speech by U.S. President Franklin D. Roosevelt. “They are unanimous in their hate for me; and I welcome their hatred,” Varoufakis said on his Twitter account on Sunday. The quotation is “close to my heart (& reality) these days,” he wrote.
Looming Payments

The breakdown came as Greece heads into a week of heightening fiscal tension. The first of two International Monetary Fund payments is due on May 6 and the government still doesn’t know if it has enough money to pay pensioners and state employees this week.

Varoufakis sought to squeeze aid from the rest of the euro area accepting the full slate of EU demands, a gambit rejected by the group’s leader, Jeroen Dijsselbloem.

Varoufakis described the talks as “intense” and said his country is ready to make “big compromises” for a deal.

“The cost of no solution would be enormous not only for us but also for all,” he said.

Varoufakis cut a lonely figure on Friday morning as he prepared for the meeting. The 53-year-old academic walked with no entourage through the lobby of the Radisson Blu Daugava Hotel clutching a mobile phone and a newspaper.
Pension Stalemate

In remarks to the assembled ministers, he defended protecting public pensions, a key sticking point in the negotiations. He threatened to walk away from talks if creditors pushed too hard.

When Dijsselbloem invited the group to respond, he was greeted by silence. He asked again, and Kazimir spoke up.

Varoufakis’s refusal to accept the conditions of its creditors particularly riled the Slovakian because his government has slashed the budget deficit and cracked down on tax evasion. His position also may have fallen on deaf ears among his hosts in Riga.

Latvia’s economy shrank by more than a fifth in 2008 and 2009 when the country was led by Valdis Dombrovskis, now vice president of the European Commission and a participant in the Friday meeting. Dombrovskis pushed through some of the world’s harshest austerity measures -- equivalent to 16 percent of gross domestic product. The Greek economy has shrunk by about a quarter since 2008.
Photo Shoot

Political gaffes have afflicted Varoufakis from the outset. He offended the Italian government, a potential ally, when he said Feb. 8 their country was close to bankruptcy. Most famously, he posed for a photo spread in Paris Match magazine, showing the minister and his wife on their roof terrace overlooking the Acropolis in Athens.

For any European governments sympathetic to the plight of Greeks, the picture made it harder to justify additional aid to their voters. The episode also hurt Varoufakis’s credibility and gave other ministers an easy way to needle him.

After his comments to the meeting in Riga, Varoufakis was approached by France’s Michel Sapin, a Socialist.

“I told him I had read Philosophie Magazine,” Sapin said, alluding to Varoufakis’s academic style. “It’s better than Paris Match.”

Varoufakis has the backing of a majority of Greeks, according to an Alco survey published in Proto Thema newspaper. Some 55 percent of respondents said they had a positive view of him, compared with 36 percent who said they viewed him negatively.

Still, the schadenfreude in ministers’ reactions was leavened with concern about the consequences of the policy deadlock.
Calls for Plan B

Greece needs to begin paying monthly salaries to civil servants and retirees on Monday, and faces a string of obligations leading up to a $770 million IMF payment on May 12.

Tsipras tried to bypass the finance ministers last week, who have to sign off on any aid disbursement, to make his case directly to German Chancellor Angela Merkel and French President Francois Hollande at a summit in Brussels.

With the prospect of a default hanging over the session, Slovenia’s Dusan Mramor urged the group to consider a “plan B” to mitigate the fallout if negotiations fail. Others echoed his calls. In their public comments, EU Economic Commissioner Pierre Moscovici and De Guindos both said there was no plan B, while Dijsselbloem refused to comment on the prospect, saying it would only fuel speculation in the media.

“Any mention of a plan B is profoundly anti-European,” Varoufakis said in an interview with Euronews.

Before the session broke up and Dijsselbloem briefed the media, Varoufakis implored him to say that progress had been made toward a deal on releasing aid.

“There are still wide differences to bridge,” Dijsselbloem said, standing alongside European Central Bank President Mario Draghi, Moscovici, and head of the European Stability Mechanism Klaus Regling. “Responsibility mainly lies with Greek authorities.”
Varoufakis's troubles with his counterparts have reached a boiling point. The Wall Street Journal reports Greece has shuffled the team involved in bailout talks with the country’s international creditors, a senior government official said Monday, in a move that may reduce the influence outspoken Greek finance minister Yanis Varoufakis has on the slow-moving negotiations.

The FT also reports that Greece’s dire financial position is forcing eurozone authorities to look beyond Mr Varoufakis to Alexis Tsipras, prime minister, much like in February when Jeroen Dijsselbloem, the Dutch finance minister who chairs the eurogroup, brokered an extension of the current bailout program:
According to two eurozone officials, Mr Dijsselbloem phoned Mr Tsipras from Riga in an effort to mend fences after Friday’s feisty eurogroup meeting, where Mr Varoufakis was rounded on by his eurozone colleagues.

In a sign that Mr Varoufakis’s combative approach is prompting concern in Greece as well, a senior Athens official said the Riga meeting was likely to lead to him being sidelined as Mr Tsipras and his deputy Yannis Dragasakis take a more hands-on role.

Amid the acrimony, differences over a new list of reforms that is to be agreed by Athens were barely discussed at the meeting, putting off indefinitely a deal to unlock access to the funds left from Greece’s €172bn bailout.
I want you to remember the name Yannis Dragasakis because when it comes to Greek politics, he is the most powerful man in Greece and Tsipras listens to him very closely. It looks like Dragasakis has had enough of Varoufakis's "rock star personality" and this means the finance minister will be quietly pushed out of the negotiations with EU partners (my buddy predicted this a long time ago saying "Varoufakis is being used and he doesn't even know it").

Still, changing the players doesn't change the sticking points. Greece is on the verge of collapse and Nicholas Economides is right, at this point, only a miracle can save it from disaster. Unless Tsipras, Dragasakis and the rest of Syriza agree to some major reforms which will be unpalatable to most of the party's left-wing base, it's hard to see how any agreement will take place. Creditors are demanding major reforms and Tsipras and company keep saying they've done all they can, which is an outright lie but given their mission to stay in power as long as possible, this is their stance.

But Greeks are finally waking up to Syriza's dangerous posturing. In a comment in Naked Capitalism, Wolf Richter argues the Greek people just destroyed Syriza's strategy, noting the government's "extortion strategy" is quickly losing popular support:
The approval rating for the government’s strategy has plunged to a measly 45.5%, from 72% just last month, according to a new poll. A terrible cliff dive.

On a scale of 0 to 10, the administration got whacked in its details, earning 4.6/10 on the economy, 3/10 on immigration, 3.7/10 on crime-fighting and security, 4.2/10 on education, 5.5/10 on foreign policy and defense, 4.5/10 on public administration, and 4.4/10 on health.

Only 3% of the Greeks were confident their household finances would improve over the next 12 months, while 26.5% expected their situation to get worse, and another 15% were certain it would get worse.

How did they feel about a “Grexit” – and a return to the drachma? “Fear!” That’s what 56% said – up from 45.5% in March. Only 23% claimed they were indifferent, down from 26.5% last month. And just 9% thought there was no chance of it happening, down from 17% in last month.

Greece’s exit from the Eurozone and return to the drachma, of which it could print an endless amount to pay its bills and salaries and other schemes, would entail a vertigo-inducing devaluation, and all that comes with it.

The Greeks know how that program works. They have experienced the drachma. They see it as a tool by which the government tries to steal from them. They don’t trust their government with the administration of a currency any more than they trust their banks. And Greek parliamentarians don’t want the drachma either. They want their rich pensions to be paid in euros, not in devalued drachmas.

Thus, a Grexit is off the table as far as threats is concerned. It might happen, but it can’t be used as a threat to extort better terms from donor countries. The Greek game-theoreticians can evoke it all they want to, through leaks and on the record, and they can bandy about the threat of blowing up the world markets, but if they want to stay in power and if they want to face their people at home, they can’t go down that road.

Alas, all their negotiating partners know that too. The global financial markets know that. They all could digest a Grexit, but the Syriza government could not. Time to stop playing games and start talking in earnest. Or face some very, very angry folks at home.
I can only hope Greeks finally wake up and boot the clowns running Greece out of office before it's too late, but my fear is that the damage Syriza has done is so severe that the end game is coming no matter what and it won't be pretty. If Greeks thought austerity under Troika was bad, then they haven't seen anything yet. It will be much worse if Greece exits the eurozone and returns to the drachma (never mind what Nobel-prize winning economists claim).

And if Greece falls, no one wants their prints on the murder weapon, but the reality is every member of the eurozone will be responsible for this failure, especially Germany which has thus far profited the most off the euro crisis and endless Greek tragedy. It too will eventually feel the economic pain of others as its leaders were incapable of taking the leadership they had to in order to solidify this fragile union.

As far as the bigger picture, Greece's lose-lose game is yet another reminder that things aren't as solid as many economists and financial analysts claim. The global economy is a lot weaker than we think, and if the China bubble bursts, watch out, we're in for a prolonged period of global deflation. Ironically, this is why I don't agree with hedge fund managers who think it's time to short the mighty greenback.

In an environment of heightened global uncertainty, investors will flock to U.S. bonds, stocks and real estate to seek refuge but if deflation comes to America, there will be a lot more pain ahead as the mother of all carry trades unwinds. At that point, we won't be discussing a new deal for Greece, but a new deal for the world.

For now, all is calm as greenshoots are talking up global recovery. But mark my words, this is the calm before the storm, which is why I keep trading the liquidity rally focusing my attention mostly on tech and biotech stocks but very nervous about what happens if big investors start shorting the Fed.

Below, Yanis Varoufakis and Joseph Stiglitz discuss the eurozone crisis at the latest New Economic Thinking forum. Take the time to listen to their comments but keep in mind, the Greek economy is a beast that Stiglitz and Krugman fail to understand. Even Varoufakis fails to understand what truly ails the Greek economy and his antics cost him as he will be pushed out of negotiations.

Also, Constantine Michalos of the Greek Chamber of Commerce and Industry, recently discussed the best course of action to boost Greek business. Those of us who often travel to epicenter of the euro crisis know what Greece needs but my fear is that until Syriza is ousted and new, courageous leaders take the helm, the country will be mired in an endless depression.

There is an old Greek expression "Η Ελλάδα ποτέ δεν πεθαίνει" (Greece never dies), which we Greeks play on by saying "Η Ελλάδα ποτέ δεν πεθαίνει , αλλά πάντα κουτσαίνει" (Greece never dies but always limps along). It's time Greece's leaders stop playing the same narrow politics which have slowly but surely suffocated the Greek economy over the past 40 years and start thinking of how they will improve the opportunities for future generations who don't want to emigrate from Greece in search of a better life. 

Greece is the most beautiful country in the world but its leaders are hopelessly corrupt and dangerous demagogues who have never seen past their obsession of holding on to power at all cost. I look forward to the day when this vicious cycle is broken once and for all. That's a new deal for Greece those of us who love the country are all looking forward to as we anxiously watch this crisis unfolding. 

Friday, April 24, 2015

Big Pensions Against Big Payouts?

Euan Rocha of Reuters reports, Fresh opposition to Barrick Gold Corp’s executive pay structure from Canada’s largest pension fund manager:
The Canada Pension Plan Investment Board, the country’s largest pension fund manager, on Friday joined a slew of other investors opposing Barrick Gold Corp’s executive pay structure.

Toronto-based CPPIB said it plans to come out against the advisory vote on executive compensation that Barrick will be having at its annual shareholder meeting next week.

It also said it plans to withhold support from Brett Harvey, one of Barrick’s board members and the chair of its compensation committee. CPPIB own roughly 8.1 million Barrick shares, or less than a per cent of the company’s outstanding stock.

Last week, two smaller Canadian pension funds, the British Columbia Investment Management Corp (BCIMC) and the Ontario Teachers’ Pension Plan Board, said they plan to withhold support from Barrick’s entire board in light of their concerns with Barrick’s executive compensation package.

This marks the second time in three years that Barrick is facing heat over its executive pay. The company lost an advisory vote on its executive pay structure in 2013, prompting it to lay out a new compensation program last year. However, the company’s recent disclosure that Executive Chairman John Thornton was paid $12.9 million in 2014 unleashed fresh complaints.

Barrick contends that with its new pay structure, its senior leaders’ personal wealth is directly tied to the company’s long-term success.

But its detractors including well known proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis contend that Thornton’s pay is not clearly tied to any established and measurable long-term performance metrics.

Separately, CPPIB’s much smaller pension fund rival OPTrust also expressed its dismay with Barrick’s pay structure, stating that it also plans to come out against the advisory vote on the pay structure.

“Where it comes to Mr Thornton, we cannot easily discern any link between pay and performance … OPTrust has decided to also withhold votes from returning compensation committee members,” said a spokeswoman for the pension fund manager.

The investor outrage comes amid a growing outcry about large pay packages for senior executives at some Canadian companies.

Canadian Imperial Bank of Commerce lost its advisory vote on its executive compensation structure on Thursday, in the face of blowback over mega payments to two retired executives.
A quick look at Barrick Gold Corp's (ABX) five-year chart below tells me these investors are right to question executive pay at this company (click on image):

And it's not just Barrick. If you look at Canada’s top 100 highest-paid CEOs, you will find other examples of overpaid CEOs whose executive compensation isn't tied any established and measurable long-term performance metrics. It's not as egregious as the U.S., where CEO pay is spinning out of control no thanks to the record buyback binge, but it's getting there.

And Canada's big pensions aren't shy to vote against excessive compensation packages. Geoffrey Morgan of the Financial Times reports, CIBC shareholders vote down compensation-plan motion over CEO payout:
CIBC shareholders had their say on executive pay at the bank’s annual meeting Thursday and they let it be known they weren’t happy — voting down the bank’s resolution on its compensation plan.

Shareholders voted 56.9 per cent against the bank’s executive pay plan, but outgoing CIBC chairman Charles Sirois said that he didn’t believe the vote was a commentary “on our overall approach to compensation.”

“Based on feedback, we believe this year’s vote result on CIBC’s advisory resolution was significantly impacted by one specific item: the post-retirement arrangement provided to our former CEO,” Sirois said at the meeting in Calgary, his last with the bank before John Manley takes over as board chair.

CIBC’s former CEO, Gerald McCaughey, was paid $16.7 million this year when the bank accelerated his retirement date. Similarly, the lender paid former chief operating officer Richard Nesbitt $8.5 million when it also sped up his departure from the company.

Analysts and investors have criticized both severance packages.

“Our belief is that shareholders were using the say-on-pay vote to express their dissatisfaction with the severance packages,” CIBC spokesperson Caroline van Hasselt said in an interview.

The vote marks the first time a Canadian company has failed a say-on-pay vote since 2013, according to Osler, Hoskin and Harcourt LLP. Sirois said a special committee would review the results of the vote, which is non-binding.

Two of the banks’ larger shareholders have said as much. The Canada Pension Plan Investment Board, which owns 404,000 shares of CIBC, and the Ontario Teachers’ Pension Plan, with 220,000 shares, voted against the motion.

Teachers said it “did not support the structure of the post-employment arrangements [with McCaughey and Nesbitt], believing them to be overly generous and not in the best interests of shareholders.”

For the same reason, Teachers’ also withheld its votes for the company’s nominated slate of directors – all of whom were re-elected although two with significantly less support than their peers.

Luc Desjardins and Linda Hasenfratz were both re-elected with 86 per cent and 85 per cent support, respectively. By contrast, every other member of the 15-person board was elected or re-elected with more than 90 per cent support.

Hasenfratz chaired the committee that oversaw executive compensation matters, of which Desjardins was also a member.

“We cannot support the members of the Management Resources and Compensation Committee based on our concerns with the succession planning process and post-employment arrangements made to both Mr. McCaughey and Mr. Nesbitt,” a statement from Teachers’ reads.

The CPPIB declined a request for comment.

Despite their dissatisfaction with CIBC’s executive compensation, shareholders voted down three additional resolutions, put forward by Montreal-based Movement d’éducation et de défense des actionnaires, that would have altered the bank’s pay policies.

Shareholders voted more than 90 per cent against resolutions that aimed to close the gap between executive pay and that of frontline staff, rework the retirement benefits of all executives and restrict the use of stock options as compensation.
You might recall CIBC's former CEO Gerry McCaughey was warning about a retirement savings crisis in Canada and even said Canadians should have the choice to make additional, voluntary contributions to the Canada Pension Plan in order to avoid facing a significant decline in living standards when they retire. Of course, when it comes to his own retirement, Mr. McCaughey doesn't have to worry one bit. CIBC paid him a nice, cushy package.

Things are slowly but surely changing at Canadian banks. BNN reports that Canada’s new bank CEOs are making less money than their predecessors as banks cut salaries and reduce CEO pensions in the face of shareholder pressure to curb super-sized executive pay:
A report on bank CEO pay by Toronto compensation consulting firm McDowall Associates shows base salaries for the new CEOs of Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Toronto-Dominion Bank are all down 33 per cent compared with the outgoing CEOs’ salaries, while the base salary for the new CEO of Royal Bank of Canada is down 13 per cent compared with his predecessor.

Targeted total direct compensation – which includes grants of share units and stock options – is down between 11 per cent and 25 per cent for all four CEOs, the report shows. For example, the analysis shows Scotiabank CEO Brian Porter earned $8-million in total direct targeted compensation (excluding pension costs) in 2014, which is 25 per cent less than the $10.7-million that predecessor Rick Waugh earned in total targeted compensation in 2013.

Bernie Martenson, senior consultant with compensation firm McDowall Associates and previously vice-president of compensation at Bank of Montreal, said it is too soon to conclude that the banks have permanently lowered CEO pay because it is common for CEOs to get raises as they spend more time in the job.

But she said a number of current pay practices, including reducing the proportion of pay awarded in stock options, suggest overall pay is likely to be lower for the new CEOs over the long-term.

“You would naturally think there would be a difference between someone of long tenure and someone who is new in the role,” Ms. Martenson said.

“But I think the reduction of stock options in the last few years is starting to have an impact in terms of wealth accumulation. If you were to look out eight or 10 years for these new CEOs and compare the value of their total equity to that of their predecessors, I think it would be lower.”

Bank CEOs are still well compensated of course, but restraint is increasingly evident. Ms. Martenson points to the CEO pension plans at all four banks. Toronto-Dominion Bank CEO Ed Clark, for example, has the largest pension of departing CEOs at $2.5-million a year, while his replacement, Bharat Masrani, will have a maximum possible pension of $1.35-million a year when he retires.

At Scotiabank, Mr. Waugh’s pension plan was capped at a maximum of $2-million a year at age 63, while Mr. Porter is eligible for a maximum pension of $1.5-million available at 65. Royal Bank’s Gord Nixon had a $2-million maximum pension at 60, while his successor David McKay will have a maximum pension of $700,000 at 55, increasing to a final maximum of $1.25-million at 60.

Retired CIBC chief executive Gerry McCaughey had no cap on the size of his pension, but his pensionable earnings that formed the base for his pension calculation were capped at $2.3-million. His successor, Victor Dodig, has his annual pension capped at $1-million.

A number of shareholder groups – including the Canadian Coalition for Good Governance – have urged companies to reform pension plans because they create expensive funding obligations that last for decades.

Michelle de Cordova, director of corporate engagement and public policy at mutual fund group NEI Ethical Funds, said bank CEOs continue to have very generous pensions “that most people can only dream of,” but she sees a sense of moderation in the trends.

Ms. de Cordova, whose fund has lobbied the banks to curb their executive pay and link CEO pay increases to those of average Canadians, hopes the pay reductions in 2014 are not a temporary trend.

“It does suggest that there is some sense that the levels that pay and benefits had reached were perhaps too high, and boards have decided they need to do something about that,” she said. “I’d say they are still very generous arrangements, but it does seem that there is a sense that there needs to be some moderation, which is welcome.”

The report says all five of Canada’s largest banks have cut the proportion of stock options they grant their CEOs in recent years.

Banks previously decided how much equity they wanted to grant CEOs each year, and split the amount evenly between grants of stock options and grants of share units. In 2014, however, stock options accounted for 20 per cent of total new equity grants at the median for the five banks, while share units accounted for 80 per cent of new equity grants.

Ms. Martenson said banks faced pressure from regulators to reduce stock options following the financial crisis in 2008 because they were deemed to encourage executives to take risks by quickly pushing up the company’s share price to reap a windfall from quickly exercising options. Share units, which track the value of the company’s shares and pay out in cash, are considered less risky because they must be held for the long-term or even until retirement, creating incentives to build long-term growth.
Anyways, don't shed a tear for bankers. Having worked as an economist at a big Canadian bank a while ago, I can tell you there are still plenty of overpaid employees at Canada's big banks, and many of them are hopelessly arrogant jerks working in capital markets or investment banking. And the irony is they actually think they merit their grossly bloated payouts (their arrogance is directly proportional to their bonus pool!).

Those of you who want to read more on executive compensation in Canada run amok should read a paper by Hugh Mackenzie of the Canadian Center for Policy Alternatives, All in a Day's Work?. It's a bit too leftist for my taste but he definitely raises important points on tying CEO compensation to long term performance.

As far as Canada's large public pensions putting the screws on companies to rein in excessive executive compensation, I think this is a good thing and I hope to see more, not less of this in the future. Of course, the CEOs and senior managers at Canada's top ten enjoy some pretty hefty payouts themselves and sizable severance packages if they get dismissed for any other reason than performance.

But nobody is voting on their compensation, some of which is well deserved and some of which is just gaming private market benchmarks to inflate value added over a four year rolling period. Critics will charge these pensions going after big payouts as a case of the pot calling the kettle black. Still, I welcome these initiatives and hope to see other large pension and sovereign wealth funds join in and start being part of the solution to corporate compensation run amok.

Below, Ken Hugessen of Hugessen Consulting discusses trends in executive compensation (try not to fall asleep). All I know is I'm writing on overpaid CEOs, pension fund managers, hedge fund and private equity managers but nobody is paying me my fair share for all my hard work. And make no mistake, researching and writing daily blog comments on pension and investments is very hard work, especially when you're trading these schizoid markets to make a living!

Thursday, April 23, 2015

Time To Short the Mighty Greenback?

Netty Idayu Ismail of Bloomberg reports, Hedge Fund That Made 18% on Dollar Strength Now Bets on Drop:
Charlie Chan, a former Credit Suisse Group AG proprietary trader who now runs his own hedge fund, reduced bets the dollar will strengthen and added trades that would profit from a decline.
Chan said he trimmed his fund’s long dollar position versus the yen last week after the U.S. currency’s rally stalled following gains of more than 10 percent in each of the past three years. He’s now betting the greenback will weaken against Asian currencies including Singapore’s dollar, South Korea’s won and India’s rupee, the founder of Singapore-based Charlie Chan Capital Partners said.
A gauge of the dollar has slumped 0.9 percent in April, halting a nine-month rally that propelled it to the highest on record. U.S. retail sales, manufacturing and jobless claims have all missed estimates, leading traders to push back estimates for when the Federal Reserve will raise interest rates.
“The long dollar story was getting a little stale,” Chan said in an interview on Wednesday. “Then the U.S. numbers were coming out not as strong as it was anticipated initially.”
Chan said his Splendid Asia Macro Fund has returned more than 8 percent this year, adding to its 18 percent gain in 2014. Bets on a stronger dollar and an advance in Japanese stocks boosted its performance, he said. The fund invests in bonds, currencies and stocks in Asia. 
‘Probably Time’
The dollar has fallen almost 2 percent from a seven-year high of 122.03 yen reached on March 10 to trade at 119.65 at 8:32 a.m. in London. Chan predicts it will extend its decline to as low as 118. Strategists surveyed by Bloomberg estimate the dollar will appreciate about 4 percent versus the yen this year.
“The yen has weakened quite a lot and Japan has eased quite a lot,” Chan said. “So, it’s probably time to let all this easing work its way through the market. I’ve always held the view the dollar wouldn’t go much beyond 120.”
The Bank of Japan kept its record asset-purchase plan unchanged this month as Governor Haruhiko Kuroda sought to spur inflation that has stalled with the tumble in oil prices. Kuroda has made a 2 percent inflation target central to his campaign to revive the economy after two decades of stagnation.
Hedge funds and money managers cut bets to the least since October that the dollar will strengthen, according to data from the Commodity Futures Trading Commission. Net futures positions betting on a stronger greenback against eight major counterparts dropped to 329,939 as of April 14 from 361,335 a week earlier.

The currencies of Taiwan, Korea and India are among the top seven performers this year out of 31 major peers tracked against the U.S. dollar. Developing Asian economies are set to expand by 6.6 percent this year, outpacing global growth of 3.5 percent, according to April forecasts by the International Monetary Fund.
“I’m still mildly optimistic on Asia,” Chan said.
Back in October 2014, I explained why the mighty greenback will keep surging to new highs, especially relative to the euro. I said that "I wouldn't be surprised if [the euro] goes to parity or even below parity over the next 12 months. There will be countertrend rallies in the euro but investors should short any strength."

I also stated the following:
... if you ask me, there is another reason why the USD is rallying strongly versus all other currencies and it has little to do with Fed rate hikes that might come sooner than the market anticipates. When global investors are worried about deflation and another crisis erupting, they seek refuge in good old U.S. bonds. This has the perverse effect of boosting the greenback (USD) and lowering bond yields, which is why I'm not in the camp that warns the bond market is more fragile than you think.
My thinking hasn't changed since I wrote that comment. While everyone is talking about a recovery in Europe, they fail to understand this is a temporary boost due to the decline in the euro. Barry Eichengreen wrote an excellent comment in Project Syndicate, Europe’s Poisoned Chalice of Growth, outlining why the underlying conditions that produced the eurozone crisis remain unaddressed.

Worse still, the situation in Greece is going from bad to downright ugly. The Greek government has resorted to confiscating money from municipalities to make its payments. Merkel will keep pressing Tsipras on reforms and he will keep telling her Greece has done its part, which is a complete joke and an insult to other countries like Slovakia which did implement harsh reforms.

Meanwhile, while intelligent investors like Warren Buffett think Grexit 'may not be a bad thing', they fail to appreciate the contagion effects that go along with it. Sober Look wrote a great comment examining why Bank of Greece expulsion from the Eurosystem could be especially damaging to the currency union. Anyone who thinks Grexit will be easy and painless is just fooling themselves.

Of course, dealing with the clowns running Greece is downright frustrating. All Greek politicians are dangerous demagogues, and Syriza's leaders are no different. They're a complete travesty and a total disgrace to Greeks around the world. I've had it with their stall tactics and refusal to implement serious reforms. They can schmooze up to Russia all they want, at the end of the day, they're going down. It's a matter of time now, and I think Merkel and the rest of the eurozone leaders will keep squeezing them hard until they're forced to implement proper reforms or more likely, until they do something stupid like tax bank accounts in Greece, pretty much ensuring they will be thrown out with pitchforks.

Of course, all this endless political posturing is a lose-lose game for Europe, Greece and the world. While the world is subjected to the endless Greek saga, the underlying structural problems plaguing the eurozone remain unaddressed. Kicking Greece out of the eurozone will only temporarily shift the focus away from this fragile union (problems in Spain, Italy, Portugal and even France will surface).

And by the way, there are underlying structural problems that remain unaddressed everywhere, including the United States of America. While I still believe the U.S. leads the world, I discussed the ongoing jobs crisis and pension crisis hitting that country with Gordon T. Long a couple of weeks ago (click here to listen to our conversation). My biggest fear remains that global deflation will eventually hit America when it least expects it, and the Fed will be making a monumental mistake if it starts raising rates too soon.

In fact, DoubleLine Capital’s Jeffrey Gundlach, the bond manager who has beaten 99 percent of his peers over the past five years, said the full impact of the Federal Reserve’s “extreme policies” have yet to be felt in the market:
The Fed has been “very well-intentioned,” Gundlach said, speaking in an interview on Sunday on Wall Street Week. “The ultimate consequences of all these extreme policies have yet to be felt and will be felt.”

The central bank has kept rates in the U.S. near zero and embarked on unprecedented monetary stimulus since the 2008 financial crisis. Known for his contrarian views and top returns, Gundlach said rating the Fed very highly at this point is “sort of like a man who jumps out of a 20-story building, and after falling 18 stories, says, ‘So far, so good.’”

Gundlach, who manages the $46.2 billion DoubleLine Total Return Bond Fund, has beaten 99 percent of peers over the past five years, according to data compiled by Bloomberg. He said last month that if the Fed increases interest rates by mid-year, they would have to reverse course. On Sunday, he said that the probability of a rate increase by the Fed in June is very low, because the economic data doesn’t support such a move.

“I think the Fed would like the data to corroborate their ability to raise interest rates but it isn’t there yet,” he said.

Gundlach reiterated caution on high-yield bonds, saying that default rates could go higher. He also cautioned investors that some mall real estate investment trusts are in a “death spiral.”

Gundlach started Los Angeles-based DoubleLine in 2009 after he was ousted as chief investment officer of TCW Group amid a dispute that led to a legal battle.
By the way, I completely disagree with the former bond king, Bill Gross of Janus Capital, who recently stated betting against German government debt is the trade of a "lifetime." Really? Good luck with that trade Bill, you'll be under water for a very long time.  

When it comes to currencies, it's a relative game. The U.S. is in much better shape than the rest of the world which is why its currency keeps surging. And unlike Charlie Chan and Stan Druckenmiller,  I'm not optimistic on Asia and fear when the China bubble bursts, it will wreak havoc in the region and on the global economy.

As far as Japan, Sober Look's latest looks at the BoJ's monetary expansion and its impact on the yen, and states the following:
In the long run however, further yen weakness seems inevitable. The reason has to do with the sheer relative size of Japan's quantitative easing. Based on the latest projections, the BoJ's balance sheet will be above 90% of Japan's GDP within a year or so. This dwarfs other major central banks' monetary expansion efforts, including that of the ECB. Furthermore, given the scope and size of this program, it is unclear if the Bank of Japan can ever effectively exit it without a massive disruption to the nation's economy. While we could see the yen strengthen briefly in the near-term, the currency will remain under pressure for some time to come.
I couldn't agree more, Japan has huge structural issues it has yet to deal with, like an aging population and no immigration to help address a low birth rate.

All this to say when I look at the big picture, it's not hard to understand why the mighty greenback keeps surging higher. And while unwinding the mother of all carry trades will be brutal, I just don't see it happening anytime soon. The world remains a mess and everyone is hoping the U.S. will lead it out of this mess but my fear is the worst is yet to come.

And if my fears come true, global investors will scramble to buy good old U.S. bonds (TLT), propelling the greenback even higher, which ironically will ensure a prolonged period of global deflation. This will decimate pensions and individual retirement accounts that remain a great failure for savers.

Of course, optimists will point out to rising oil prices (USO) and the dead cat bounce in iron ore stocks like Vale (VALE) as a sign the global recovery is on its way. Let's hope so but I remain very skeptical and would short any countertrend rally in energy (XLE), oil services (OIH), commodities (GSG), including metals and mining (XME). Still, I'm playing the liquidity rally in stocks, trading a few tech and biotech names and ready to pull the trigger at any time. These markets make me very nervous.

Below, Doug Oberhelman, Caterpillar chairman & CEO, discusses the company's quarterly results, and how a strong U.S. dollar is impacting the top and bottom line. I listened carefully to Oberhelman earlier today and he is cautiously optimistic on Europe but he hardly sounded too enthusiastic on global growth and basically said there's no strength in mining whatsoever.

Wednesday, April 22, 2015

Shift Toward Smaller Hedge Funds?

Matt Wirz of the Wall Street Journal reports, Small Hedge Funds Get Bigger Share of Investors’ Money:
Hedge-fund upstarts attracted as much money as the titans of the industry last year, a shift for investors who have long favored larger firms.

Managers with assets of less than $5 billion took in roughly half of the $76.4 billion committed to hedge funds after collecting 37% of new capital invested in 2013. That reversed an imbalance of the previous four years, when investors put $93 billion into larger funds while pulling $63 billion from small and mid-size funds, according to data collected for The Wall Street Journal by HFR Inc., which first started tracking the flows in 2009.

Some pension funds and endowments said they are investing with smaller managers such as Hutchin Hill Capital LLC and Birch Grove Capital LP in search of better performance and lower fees compared with celebrity-run megafunds that are typically viewed as safer bets.

“I’d rather invest in funds that are small or midsize where managers are highly motivated and more aligned with us,” said Jagdeep Singh Bachher, chief investment officer for the University of California, which has about $91 billion in investment assets.

Mr. Bachher added that he is negotiating investments in two first-time fund managers launching funds of less than $1.5 billion each and is looking for more such opportunities.

Investors aren’t abandoning large hedge funds altogether, and some of the largest, such as Och-Ziff Capital Management Group LLC, continue to get bigger. During periods of economic turmoil in 2009 and 2012, clients pulled money from smaller funds, according to the HFR data.

By some measures, megamanagers are the better performers. Funds managing more than $5 billion have returned 9% on average since 2007, compared with about 6% for funds below that threshold, according to HFR.

But in a separate analysis of 2,827 hedge funds that specialize in stock picking, investment consultant Beachhead Capital Management found that funds with assets of $50 million to $500 million showed returns that were 2.2 percentage points higher over 10 years than larger funds.

“There have been a number of recent studies that have demonstrated consistent outperformance of smaller funds compared with large hedge funds,” said Mark Anson, head of billionaire Robert Bass’s family investment firm. Mr. Anson has more than half of his hedge-fund investments in firms with less than $1 billion in assets.

Long revered in financial circles for their trading smarts, hedge funds have lost some of their exalted status amid a difficult stretch for the industry. They performed better than many investments during the 2008 financial crisis but struggled to repeat that success in recent years. Returns of HFR’s hedge-fund index have trailed the S&P 500 index every year since 2008 by an average of 10.31 percentage points.

Large backers responded by taking a more skeptical look at hedge funds and comparing their performance to more traditional investment managers who charge lower fees. Some decided to pull their investments. The California Public Employees’ Retirement System, the largest U.S. pension plan, said last year it would exit from hedge funds altogether in part because of concerns about expenses. Hedge-fund managers typically charge higher fees than other money managers, historically 2% of assets under management and 20% of profits.

Others are shifting allocations to more diminutive hedge funds even as they cut back.

The Public Employees Retirement Association of New Mexico decided to reduce hedge funds to 4% of assets from 7.7% but give more money to smaller managers because they rely more on performance fees for their own compensation than larger competitors that collect big management fees, said chief investment officer Jonathan Grabel.

The $14 billion public pension system made the adjustments after a review found its absolute-return hedge-fund investments had underperformed a benchmark index by 1.64 percentage points since inception, according to an internal report reviewed by The Wall Street Journal.

“There’s nothing magical in hedge funds,” Mr. Grabel said. “We have to hold them as accountable as any other managers—in fact I think the level of scrutiny has to be higher because of the fees we’re paying them.”

One firm benefiting from the flood of money into smaller funds is Hutchin Hill, founded by former SAC Capital Advisors LP trader and mathematician Neil Chriss in 2008. The New York fund had averaged 11% annual returns since its inception, a person familiar with the matter said, but it wasn’t until last year that inflows took off as assets expanded to $3.2 billion from $1.2 billion.

New launches also are taking advantage of the surge. Jonathan Berger started his Birch Grove Capital hedge fund in August 2013 with $300 million of seed capital.

Since then the fund has more than doubled to over $700 million, “with half the growth from large institutions and family offices attracted by 20 consecutive positive months of performance,” he said.

Smaller funds chasing the influx of new money are committing more on infrastructure to lure big investors. When Mark Black left Tricadia Capital Management LLC in 2013 to start his own firm, Raveneur Investment Group, he spent a year building accounting and disclosure systems and hired his chief financial officer from hedge-fund giant Fortress Investment Group, people familiar with the matter said.

The work delayed launch of the fund to mid-2014 but ensured he could meet the requirements of public pension funds and large asset managers. Blackstone Group Inc. has invested $150 million in Raveneur, the people say.

“Smaller managers understand that in order to attract allocations from bigger investors they have to be more flexible,” said Melissa Santaniello, founder of the Alignment of Interests Association, a nonprofit group that serves hedge-fund investors.
This article raises many excellent points I've been hammering away at for a very long time. First and foremost, smaller hedge funds are a lot more focused on performance than asset gathering, which is why they typically outperform their larger rivals over very long periods.

Second, most investment consultants are useless because their focus is exclusively on large well known megafunds. These consultants have hijacked the entire investment process in the United States and they basically cater to the needs of the trustees of U.S. public plans which practice cover-your-ass politics and will rarely if ever take risks with smaller managers. To be fair to these trustees, there is no upside for them to take risks on smaller managers, which is part of a much bigger governance problem at U.S. public pension funds.

Third, it's high time institutional investors transform hedge fund fees, especially for larger funds run by overpaid hedge fund gurus which are much more focused on gathering assets than on delivering top performance. I have said this plenty of times, many of these large multi billion dollar hedge funds shouldn't be allowed to charge any management fee whatsoever or a small nominal one (25 basis points or less).

Fourth, take this shift to smaller hedge funds with a grain of salt. The reality is small hedge funds are withering away as the world's biggest investors don't have the time or resources to run around after them so they prefer writing large tickets ($100 million+) to large funds which are trading in scalable strategies (like global macro, CTAs, and Long/ Short Equity, or large multi strat funds).

The article above mentions the Public Employees Retirement Association of New Mexico is shifting more of its absolute return program into smaller funds, but when I looked at its latest monthly board meeting packet, I noticed mostly large brand name funds which are well known to most hedge fund investors (from page 33, click on image below):

Now, perhaps they don't list all their funds, but this group of hedge funds above makes up the bulk of their assets in their absolute return program and most of these funds are very well known, large funds (some are better than others).

At least they publicly publish in detail a list of all their major hedge fund, private equity and real estate partners, along with the performance of the programs, which is a must in terms of transparency. They also publish minutes of their board minutes, which is something else all public pensions should be doing (don't get me started on good governance, I'll eviscerate public pension funds, including Canada's revered top ten which provide none of this information).

As far as Jagdeep Singh Bachher, chief investment officer for the University of California and the former CIO at AIMCo, and Mark Anson, the man who basically launched CalPERS into hedge funds, then moved over to Hermes and now runs Robert Bass’s family investment firm, I think they are both on the right track. Bachher is right to seed new funds which are very hungry and performance driven, and Anson is right to put the bulk of the Bass family's investments in smaller hedge funds.

Go back to read my comment on Ron Mock when he became Ontario Teachers' new CEO, where he told me flat out:

...the "sweet spot" [for Teachers] lies with funds managing between $500M and $2B. "Those funds are generally performance hungry and they are not focusing on marketing like some of the larger funds which have become large asset gatherers." He told me the hedge fund landscape is changing and he's dismayed at the amount of money indiscriminately flowing into the sector. "Lots of pension funds are in for a rude awakening."
Ron has experienced a few harsh hedge fund lessons so he knows what he's taking about. And he's right, a lot of pensions are in for a rude awakening in hedge funds, mostly because they don't know what they're doing and are typically at the mercy of their useless investment consultants shoving them in the hottest hedge funds they should be avoiding at all cost.

No doubt about it, there are excellent large hedge funds, but my message to you is don't get carried away with any superstar hedge fund manager even if their name is Ray Dalio, Ken Griffin, David Tepper or whatever. You've got to do your job and keep grilling your hedge fund managers no matter how rich and famous they are. And if they don't want to meet you, redeem your money fast and find a manager whose head is not up his 'famous ass' and is more than happy to meet you and answer your tough questions.

Let me end by plugging an emerging hedge fund manager who I really like and is getting ready to launch his new fund with some super bright people. Gillian Kemmerer of Hedge Fund Intelligence reports, Visium, Sabretooth alum Bryan Wisk preps quant fund with ex-GS, JPM techs:
Former Visium Asset Management and Sabretooth Capital Management alumnus Brian Wisk is prepping a quantitative trading fund that aims to profit from market dislocations. His recently launched firm, Asymmetric Return Capital, has contracted with Kirat Singh and Mark Higgins, the architects of prop desk trading and risk management systems at Bank of America, Goldman Sachs and JPMorgan, to design its risk management system.

"I was one of the last clerks to join the floor of the Chicago Options Exchange in the midst of everything becoming electronic," Wisk told Absolute Return. "When I went to the buy-side, I found a serious drop-off in the level of technology. It was something people were playing catch-up with, particularly in the options and derivatives space." Wisk aims to bring the capabilities of a large bank’s derivatives desk to his fund, which will capture data, such as macroeconomic indicators, down to a millionth of a second.

"Many institutional investors are still running their derivatives business in Excel. It’s unfortunate. Our specialized skillset post Dodd-Frank should be available to a large pension fund."

Wisk began his career as a primary market marker for Citigroup on the Chicago Board Options Exchange. He departed in 2006 for Visium Asset Management, where he served as a senior derivatives trader. He worked as an analyst at Tiger Management-seeded Sabretooth Capital Management in 2011, and departed in 2012, when the fund liquidated, to launch ARC.

According to portfolio manager Adam Sherman, ARC is poised to take advantage of increased volatility across asset classes as quantitative easing measures slow. "We are starting to see market dislocations as central bank policies shift," he said. "Correlations are starting to break down."

The fund will trade futures and options across asset classes, including commodities, equity indices, rates, and individual stocks. The portfolio will manage twenty to thirty themes—the differential between commodity and equity volatility was one example given—and will trade multiple securities within that theme (in the previous example, the fund may trade individual options on the S&P 500, WTI and Brent crude oil futures). The fund may hold up to 200 individual positions, and aims to balance exposure across asset classes. The fund will take long-term volatility bets, as well as conduct intra-day and episodic trading around volatility spikes.

Kirat Singh and Mark Higgins—the men Wisk has contracted to design his fund’s trading platform—have modernized Wall Street’s prop desks for over a decade.

Singh was the architect of SecDb (Securities Database) in the late nineties, Goldman Sachs’ framework for real-time derivatives pricing and risk management. SecDb has been touted as one reason why the bank made it through 2008 relatively unscathed, and Higgins co-implemented the platform while running Goldman’s foreign exchange and New York interest rate strategies teams.

The pair departed for JPMorgan Chase in 2006, pioneering the Athena program, a cross-asset trading and risk management system. Singh built the core group that deployed Athena, which began in the fixed income business and was later rolled out across the trading desks in JPMorgan’s investment bank. Higgins implemented the trading system while running the FX, commodities, and global emerging markets (GEM) quantitative research team. The pair parted ways in 2010 when Singh departed for Bank of America Merrill Lynch to design Quartz, a derivatives and securities trading and risk analytics platform. Higgins remained at JPMorgan, rising to co-head of the quantitative research group, and moved to the foreign exchange desk as a managing director in 2012.

The duo reunited in 2014, co-launching Washington Square Technologies, a consulting firm that delivers trading and risk management systems. While the pair are not in-house, they have reached an exclusive deal with Asymmetric Return Capital to design the fund’s risk management infrastructure.

Wisk eyes a June launch for Asymmetric Return Capital, which is based in Manhattan and has five employees, including chief executive Daniel King, who previously served as a managing director and head of the financial institutions group for interest rate sales at Bank of America Merrill Lynch; chief operating officer Steven Gilson, former director of operations at Visium Asset Management; portfolio manager Adam Sherman, who most recently served as a founding partner at Quantavium Management, a systematic fixed income fund; and portfolio manager Andrew Chan, a former portfolio manager at Chicago Trading Company .

The firm will launch with a founder’s share class, the terms of which were not disclosed.
I highly recommend all my institutional readers investing in hedge funds contact Bryan Wisk and the folks at Asymmetric Return Capital. When I first met Bryan in New York City a while ago, I was very impressed with his deep knowledge of the hedge fund industry and the dangers of group think.

Another emerging manager that really impressed me is an activist / event-driven fund manager in Toronto. I met an associate of his yesterday and he told me things are moving along and this manager, who has great experience running a previous fund in California, is on his way to managing his own fund for a big alternatives outfit in Toronto.

As for Quebec, last I heard the SARA fund is closing due to poor performance and they lost a pile of dough for their investors which included the Caisse. This is hardly surprising as these are brutal markets for hedge funds, especially start-ups. And to be brutally honest, most Quebec and Canadian hedge funds stink, they simply can't compete with the talent pool in the U.S. or England where emerging managers come from pedigree funds (there might be a few exceptions but in general, avoid Canadian hedge funds, they truly stink!).

There is another problem in Quebec and rest of Canada, we simply don't have the ecosystem to support start-up hedge funds. The Desmarais and Weston families are too busy worrying about mutual funds, insurance companies and their bread and butter businesses, they're not interested in seeding hedge funds. Canada desperately needs a Bass family but we got a bunch of risk averse billionaires up here and I don't really blame them given the talent pool just isn't here.

Having said this, Ontario Teachers is seeding a multi strat fund up here and even though the SARA fund blew up, there is a new initiative going on in Quebec. In particular, Fiera Capital, Hexavest and AlphaFixe Capital set up a $200 million fund to seed Quebec's emerging managers. It remains to be seen how this new venture will work out but I wish them a lot of success and will be glad to talk to Jean-Guy Desjardins and Vital Proulx about talented managers worth seeding (no bullshit, I'll give it to them straight up!).

Of course, this is Quebec, and Quebecers are terribly jealous and petty when it comes to people succeeding in finance or business. Look at the media circus surrounding the sale of Cirque du Soleil to private equity firm TPG. Some idiots in Quebec are lambasting the founder Guy Laliberté for cashing out and selling his stake but if I ever see him at LeMéac restaurant again, I'll be the first to shake his hand and tell him bravo!! (don't know the man but he sat behind my girlfriend and I one brutally cold winter night a couple of months ago).

Below,  Keith Meister, CEO of Corvex, explains why activism has proven to be a key tool for unlocking value. Meister is going against powerful investors, including CPPIB's CEO Mark Wiseman, who has been critical of activists. Meister was a protege of Carl Icahn and I believe he got seed capital from Soros Fund Management (best seeders are hedge fund gods like Soros, Druckenmiller and Robertson).

Interestingly, the $191 billion California State Teachers' Retirement System (CalSTRS), which has less than one percent of its investments in alternatives like hedge funds, just invested $100 million in Red Mountain Capital Partners, raising the Los Angeles-based activist hedge fund's total assets to $500 million (guarantee you CalSTRS squeezed them hard on fees).

Also, Cirque du Soleil founder Guy Laliberté explains in his own words why he is cashing out of the business (but still holding a minority stake). He worked for 31 years building up a great global brand and he is making the best decision for the company, himself and his family. Good move from a true Quebec entrepreneur. He should ignore all the losers here criticizing this deal and Quebecers should do a lot more to support home grown talent to develop our dying financial industry.

On that note, I will be doing my part on Thursday evening, attending a cocktail at the McCord Museum to support Quebec's emerging managers. Once again, I remind all of you to contribute to my blog by donating or subscribing via PayPal at the top right-hand side (under the click my ads pic) to show your support.

And by the way, I don't work for free. If you want something from me, including a meeting or phone conversation, the least you can do is donate or subscribe to my blog.

Tuesday, April 21, 2015

Is Wall Street Robbing Pensions Blind?

Dan Davies, a senior research adviser at Frontline Analysts, wrote a comment for The New Yorker, Is Wall Street Really Robbing New York City’s Pension Funds?:
Most any fee, even a fraction of one per cent, will come to look big if it’s multiplied by tens of billions of dollars. So when New York City Comptroller Scott Stringer wanted to make a point recently about the fees the city’s public-sector pension system had paid to asset managers between 2004 and 2014, he didn’t have to work very hard to find an outrageous number. Over the past ten years, New York City public employees have paid out two billion dollars in fees to managers of their “public market investments”—that is, their securities, mainly stocks and bonds. Gawker captured the implication as well as any media outlet with its headline: “Oh My God Wall Street Is Robbing Us Blind And We Are Letting Them

Stringer’s office was barely more restrained, sending out a press release that called the fees “shocking.” The comptroller also issued an analysis that spelled out the impact of fees on the investment returns of the five pension funds at issue: those of New York’s police and fire departments, city employees, teachers, and the Board of Education. Though the comptroller didn’t specify which firms had managed the funds, they were likely a familiar collection of financial-industry villains. “Heads or tails, Wall Street wins,” Stringer said.

The rhetoric tended to brush past the fact that the pension funds didn’t actually lose money. In the analysis, their performance was being measured relative to their benchmarks, essentially asking, for every different class of asset, whether the funds performed better or worse than a corresponding index fund would have. For reasons unclear, the city’s pension funds have been recording their performance without subtracting the fees paid to managers, but the math shows that New York City’s fund managers outperformed their benchmarks by $2.063 billion across the ten-year period under review, and charged $2.023 billion in management fees.

Compared with the average public pension fund’s experience on Wall Street, this is actually, frighteningly, pretty decent. All too often, when researchers investigate pension-fund performance, they find that management fees have eaten up more than any outperformance the managers have generated. A study published in 2013 by the Maryland Public Policy Institute concluded that the forty-six state funds it had surveyed could save a collective six billion dollars in fees each year by simply indexing their portfolios.

I covered the institutional-fund-management industry as an analyst for ten years, and was never given specific information on the pricing of individual deals, but I would estimate, based on the growth of the funds from 2004 to 2014, the variance in the market (especially the crash of 2008), and the total fees, that New York City paid, on average, about 0.2 per cent, or what a fund manager would call “twenty basis points.” You would expect the trustees of such a large portfolio to strike deals on fees, and indeed twenty basis points is much lower than the average paid to managers of most actively managed mutual funds (between seventy-four and eighty basis points, according to the Investment Companies Institute). It is still far more, though, than the five basis points charged by the Vanguard index tracker fund to large institutional investors.

For extremely large pools, fees for equity funds tend to be between twenty and twenty-five basis points, and those for fixed-income funds potentially reach into the high single digits. New York’s pension portfolio is large and mature, so it ought to have a relatively high fixed-income weighting, which means that the city was probably paying too much. The fact that the funds were reporting their returns with the fees included shouldn’t fill the city’s public pension holders with confidence that the tendering and monitoring process was very sharp, either—$2.063 billion, gross of fees, is an inflated way of presenting the actual gains of forty million dollars, net of fees.

The bigger question is whether New York, and other places dealing with large public pension funds, ought to be paying these kinds of fees at all. The safest alternative, per the Maryland study, would be to index the pension funds at, say, five basis points. Following the presentation used by Stringer, this would mean, with close to certainty, that over a ten-year period New York City’s pension funds would pay five hundred million dollars to Wall Street and get no outperformance—a net cost of five hundred million dollars. A second possibility would be to keep the same fund managers and try to bargain down the fees, say to fifteen basis points. From 2004 to 2014, that would have meant one and a half billion dollars of fees paid for two billion dollars of outperformance, a net benefit of five hundred million dollars. But there would be no guarantee of outperformance in the future, and a considerable risk of underperformance.

There is a third possibility, one that Stringer’s office, in its disdain for Wall Street, might well be considering. To provide a little perspective, if the city’s pension pool were a sovereign wealth fund, its current value—a hundred and sixty billion dollars—would make it the twelfth biggest in the world, just below Singapore’s Temasek and quite a ways above Australia’s Future Fund. When you’re that big, it’s fair to ask why you’re paying external managers at all. (It’s sure not like New York City lacks fund managers to hire.) The Ontario Teachers’ Pension Plan, which is roughly the same size, carries out nearly all of its fund management in-house, and historically it has seen very good results.

Some—notably, Michael Bloomberg, in 2011—have proposed that the city move to a system along these lines. In 2013, Stringer himself identified a “yearning” among union trustees for this. Could it be that by directing public anger toward Wall Street, the comptroller is trying to move the debate in this direction?

There is a catch, though: however the funds are structured, outperformance won’t come cheap. The O.T.P.P. pays high salaries to attract its in-house managers. Its expenses were four hundred and eight million Canadian dollars in 2014 alone, well above the two hundred million dollars the New York funds averaged over ten years. That figure includes investments in private-equity operations such as 24 Hour Fitness and Helly Hansen, but this level of expense isn’t uncommon. Looking at a few sovereign-wealth funds, I didn’t find a single one of comparable size to New York City’s pensions that had paid as little as twenty basis points, whether their management was outsourced or not.

Which is to say that, while bashing Wall Street might help a shift toward another model, the city could end up paying just as much, or more, to generate the returns it wants. And if history teaches us anything, it’s that Americans tend to get upset when public employees are paid millions of dollars—unless, of course, they’re college-football coaches.
I already covered New York City's fee debacle in my comment on all fees, no beef where I commended the city's comptroller Scott Stringerfor for providing a detailed study on value added after fees.

In his article above, Davies delves deeper into the subject, looking at just how well New York City's pensions have performed relative to others and then exploring other alternatives like squeezing external manager fees down to a more appropriate size or adopting an Ontario Teachers' model where they compensate pension fund managers appropriately to manage more of the assets internally.

This is where I think his analysis is lacking. Instead of exploring the benefits of the Canadian governance model where independent investment boards operating at arms-length from the government oversee our large public pensions, he just glares over it. And this is where his analysis falls short of providing readers the true reason why Canada's top ten have grossly outperformed their U.S. counterparts over the last ten and twenty years.

Davies states the expenses at Ontario Teachers were twice as much as the average of the New York funds over the last ten years, but he fails to understand the different composition of the asset mix. Ontario Teachers and other large Canadian funds moved into private markets and hedge funds way before these New York City pensions even contemplated doing so.

And despite paying fees to private equity and hedge funds, Ontario Teachers still manages to keep its costs way down:
The plan’s expense rate is a miniscule 0.28 per cent. The average Canadian mutual fund has a management expense ratio of about 2 per cent.

Investment returns account for more than three-quarters, about 78 per cent, of the pension payouts that teachers receive in retirement. Member contributions account for 10 per cent and the Ontario government, as their employer, contributes 12 per cent.
As far as why Ontario Teachers pays fees to external managers at all, it has to do with their risk budgeting which their CIO oversees. Whatever they can do internally, like enhanced indexing or even private equity or absolute return strategies, they will and whatever they can't replicate, they farm out to external managers and squeeze them hard on fees. Also, given their size and that they manage assets and liabilities, they need to invest in external funds for their liability hedging portfolio.

And because of their hefty payouts, Ontario Teachers' was able to attract fund managers that have added billions in active management over their indexed portfolio, lowering the cost of the plan and more importantly, keeping the contribution rate low and benefits up. This active management combined with risk-sharing is why the plan enjoys fully funded status. But again, their governance model allowed them to attract top talent to deliver these strong results.

Another world class pension plan in Canada is the Healthcare of Ontario Pension Plan (HOOPP), which pretty much does everything internally and has delivered top returns over the last ten years while remaining fully funded. HOOPP pays virtually no fees to any external managers but as Ron Mock, CEO of Ontario Teachers, explained to me: "if it was twice its size, HOOPP would have a hard time not investing in external managers or maintaining such a high fixed income allocation."

The discussion on fees is gaining steam. In recent weeks, I've covered why it's time to transform hedge fund fees to better align interests. The same goes for private equity where some think it's time to stick a fork in it. Even in public markets, a significant chunk of institutional investors plan on increasing their use of exchange-traded funds (ETFs) and exchange-traded notes (ETNs).

What is going on is nothing less than a major awakening. Chris Tobe sent me a paper from CEM benchmarking, The Time Has Come for Standardizing Total Costs in Private Equity, and told me "typically pro industry, CEM used by many public pension plans documents excessive PE fees" and added "the number 382 bps is important."

An expert in private equity shared these insights with me on CEM's study:
I look at a partnership as an investment like any other company investment, like for eg. a listed operating company. Does one buy into an IPO and separate the underwriter fee or the CEO and executive team compensation? So the key question is whether you try to make a partnership look like a traditional public securities asset manager, or is it like an operating company whose business is the creation and operation of a portfolio, like a holding company styled business. It's really about what bias you bring when looking at this. CEM is just following its asset management industry bias, and trying to fit a PE partnership into that model.

Another way to look at things is since all costs in most partnerships must be recovered before carry, the base fee is really an advance against a profit share.

Either way, I find the CEM type of info good to know and measure for sure, but I do not find value in the total "cost" data aggregated across all activities in eg. a pension plan like CEM advocates.
All excellent points but we need to develop standards for reporting fees and performance (internal and external) across all investment portfolios. When it comes to pensions, we need a lot more transparency and accountability across the board.

Below, Neil Weinberg of Bloomberg discusses how Wall Street may threaten your pension but I don't like this discussion because mutual funds still charge fees and they typically underperform markets. Still, Weinberg who co-authored an article with Darell Preston on how private equity is gaming pensions, raises many excellent points.

Also, with nearly $200 billion under management, CalSTRS CIO Christopher Ailman, outlines current asset allocation and remains bias to the U.S. (March 4th, 2015).