Thursday, February 28, 2013

Caisse Gains 9.6% in 2012

Nicolas Van Praet of the National Post reports, Caisse racks up 9.6% return despite slowing economy:
The Caisse du dépôt et placement du Québec tallied a 9.6% return for its depositors last year as the global economy slowed, building more credibility for Caisse chief executive Michael Sabia in his effort to put the institution on solid footing and beat back critics.

Riding a strong performance in its stock holdings, which generated $8.8-billion in net earnings including roughly one quarter from its private equity portfolio, Canada’s second largest pension fund manager slightly beat the median 9.4% return for the country’s defined benefit pensions as estimated by RBC Investor & Treasury Services.

Net assets grew to $176.2-billion as both returns and deposits increased.

“[Equity markets] were buoyed by the actions of central banks everywhere” last year, Caisse chief investment officer Roland Lescure told reporters during a lockup to discuss the results. “It was like an oxygen ball,” for foreign-based banks in particular, he said.

Mr. Sabia, who was brought in by the former provincial Liberals to help reverse a crushing $40-billion loss for the Caisse in 2008, has managed to build $56.1-billion worth of new wealth since his arrival by simplifying investments, reducing leverage and maintaining a high level of cash. The pension fund plans to increase private equity investments, notably real estate, by $10-billion to $12-billion by the end of 2014.

Mr. Sabia has also managed to keep the new Parti Québécois government on side, largely by ramping up investments in Quebec-based companies.

Premier Pauline Marois has vowed to tighten the Caisse’s legally-instituted mandate in order to heighten its nation-building role, but the pension fund seems to be doing that on its own.

Mr. Sabia has spent $8.3-billion in new money on Quebec-based investments since 2009, and $2.9-billion last year alone, highlighted by a $1-billion investment in CGI Group. Plans for future Quebec investments include a new railway to serve the Labrador iron ore mining trough, together with Canadian National Railway Co (correction: the CNR project was abandoned).

Roughly 27% of the Caisse total assets are Quebec-based, representing $47.1-billion (correction: 22% of Caisse's total assets are in Quebec; reporter used net assets).

“We don’t have a quota for our Quebec investments,” Caisse executive vice-president Bernard Morency told reporters Wednesday. “We approach it as the opportunities present themselves.”

Mr. Lescure noted that global growth ran out of steam in 2012 as emerging markets slowed, Europe sustained continued recession and the United States staged a timid recovery. Canada and Quebec also slowed while the private sector recovered in the United States and an upturn began in China and certain emerging markets. Positive movement in those two areas, combined with stronger action by European policy makers to shore up the euro, allowed equity markets to finish the year on a stronger footing, he said.

The Caisse’s Canadian equity portfolio returned 6.6%, hampered by weakness in materials and pressure on Canada’s energy producers. The Caisse is heavily weighted in energy and materials investments, with stakes in companies such as Enbridge and Suncor.

There was a big gap in investment results between the Caisse’s different asset classes, Mr. Morency noted, which means different depositors also saw different returns as their portfolio mixes are different. At the low end, fixed income returned only 3.9% as interest income from bonds remain weak by historical standards. Towards the higher end, real estate returned 11.1% (correction: inflation-sensitive assets returned 11.1% and real estate 12.4%).

The pension fund controls real estate company Ivanhoe Cambridge, which has been rejigging its portfolio of assets over the past five years to focus on shopping centres, office buildings and residential complexes. Ivanhoe has sold 40% of its hotel assets so far. Plans to sell the entire portfolio of hotels are being delayed by weak market values at the moment, Ivanhoe president Daniel Fournier said.

“It will take a few more years” to sell them all, Mr. Fournier said. “We’ll be very patient.”
You can read the Caisse's highlights here and get all the details in the press release the Caisse issued here. I will focus on the press release as it contains the details on their performance. The full annual report comes out in April.

My overall impression was that 2012 results were good but not spectacular. They slightly underperformed OMERS, which gained 10% in 2012, and marginally beat the median 9.4% return for the country’s defined benefit pensions as estimated by RBC Investor & Treasury Services.

Once again, the bulk of the gains came from real estate and private equity, returning 12.4% and 13.6% respectively. A full breakdown of the results by specialized investment portfolio is available below (click on image):


A few things to note just looking at the returns of specialized portfolios:
  • First, Fixed Income outperformed its benchmark by 70 basis points (3.9% vs 3.2%), which is excellent.
  • Inflation-sensitive investments gained 11.1% led by Real Estate (12.4%) and then Infrastructure (8.7%). I spoke to a reporter yesterday and told him the Caisse has the best real estate team in Canada, which says a lot because there are other excellent teams.
  • Nonetheless, Real Estate underperformed its benchmark by 80 basis points and Infrastructure underperformed its benchmark by a whopping 6.3%. This tells me their benchmarks in these portfolios are extremely tough to beat (go back to read an older comment, It's All About Benchmarks, Stupid!)
  • Equities returned 12.2% led by gains in Private Equity (13.6%). But Private Equity also underperformed its benchmark by 50 basis points. Again, no free lunch in the Caisse's private market benchmarks.
  • In public markets, Global Equity slightly outperformed its benchmark (14% vs 13.6%) but Canadian Equity underperformed its benchmark (6.6% vs 7.7%) due to its overweight position in materials and energy.
  • Hedge Funds outperformed by 70 basis points (4.7% vs 4%)
  • I'm not sure of the $422M loss in Asset Allocation. Think this is an overlay TAA strategy but details were not provided in the press release.
  • The ABTN portfolio (old asset-backed commercial paper where they lost billions) was revalued up, adding $1.7B to overall results. Stéphane Rolland of  Les Affaires noted that without the gains in ABTN, the Caisse would have underperformed its overall benchmark. He also noted that the Caisse underperformed the median 9.9% return for the country’s defined benefit pensions managing over $1 billion as estimated by RBC Investor & Treasury Services.
That last point on the ABTN portfolio is contentious because cynics will claim it's a valuation call, not an actual mark-to-market gain. But the truth is these assets have gained in value since getting crushed during the crisis. Moreover, the Caisse retains an independent external firm to review the data and methodology used to establish the fair value of the ABTNs.

The Caisse also emphasized long-term results since revamping their portfolios in 2009:
In the first half of 2009, the Caisse reorganized its operations. In particular, it completed an extensive overhaul of its portfolio offering and risk management and it also repositioned the portfolios in the real estate sector. Since making these major changes, the Caisse has achieved an annualized return of 10.7%, equivalent to net investment results of $50.7 billion.
All true but I think they should have provided results relative to benchmark over a one, five and ten year period just like OMERS did. This is disappointing but I understand why they want to place the emphasis on results post-2009 after they implemented these changes (note: Caisse's Communications informed me that the 10-year return including 2008 was 6.7%, which is in line with depositors' target return).

One thing the Caisse did state is that operating expenses slightly declined in 2012:
In 2012, the Caisse continued to improve its efficiency and pay close attention to its operating expenses. Operating expenses, including external management fees, totalled $295 million in 2012. The ratio of expenses to average net assets was 17.9 basis points (18.0 basis points in 2011) and continues to place the Caisse among the leaders in its management category
This is a point most reporters completely ignore but it's crucial to understand overall performance by tracking the ratio of expenses to average net assets. The Caisse uses its clout to lower external fees and lowers costs by engaging in direct investments and co-investments.

Also, during 2012, the Caisse's financial position remained solid. As at December 31, the Caisse's available liquidity totalled $41.0 billion and leverage (liabilities over total assets) stood at 18.0%. It's important to note that the Caisse doesn't take on as much leverage as some of its large Canadian peers.

On investments in Quebec, Bertrand Marotte of the Globe and Mail reports that the Caisse puts its trust (and cash) in Quebec Inc. but one area which is dying in Quebec is the good old investment management industry and I blame the Caisse,  PSP Investments and a few other venerable financial institutions in Quebec for this sad sate of affairs.

Francis Vailles of La Presse wrote an article a couple of weeks ago discussing this issue, Le cri du coeur d'un vieux prof de finance:
Il a enseigné la finance pendant 33 ans, formé 4000 étudiants et géré des fonds de retraite pendant 17 ans. L'argent, il connaît ça. Mais aujourd'hui, Jacques Bourgeois s'inquiète avant tout d'une chose: le déclin de la finance à Montréal.

Au fil des ans, l'homme maintenant âgé de 72 ans a observé la lente érosion de la finance montréalaise au profit de Toronto, de New York ou de Londres. «Si on ne se réveille pas bientôt, c'est fini», dit le vieux prof, que nous avons rencontré à son bureau de HEC Montréal.

Il y a trois ans, Jacques Bourgeois a fait le tour des caisses de retraite du Québec pour savoir qui gère l'argent des Québécois. Résultat de son sondage: la part des fonds gérés par des gestionnaires québécois a fondu entre 2005 et 2009, passant de 63% à 53%.

Comme le total des fonds québécois était d'environ 400 milliards de dollars, il estime que ce sont 40 milliards de dollars de fonds qui ont échappé aux gestionnaires québécois sur cette période. Et depuis 2009, la saignée se poursuit, croit-il.

«Aujourd'hui, certains régimes de retraite d'université ont 0% de leurs avoirs placé entre les mains de gestionnaires québécois. Zéro pour cent! Tout est géré par Toronto, Boston, New York ou Londres. Ce sont pourtant des régimes cotisés à même les salaires des profs, payés avec l'impôt des Québécois», dit-il.

Selon lui, le déclin est généralisé. Il touche aussi les services de recherche des maisons de courtage du Québec, qui ont réduit le nombre de leurs analystes au Québec au profit de Toronto et Calgary. «Ce sont des jobs payants. Pas des jobs à 75 000$», dit-il.

Il n'y a pas de doute, les scandales des dernières années, Norbourg et Norshield en tête, ont ravagé les petites boîtes de gestion au Québec. Plusieurs particuliers et fonds institutionnels se sont dit: plus jamais je ne confierai mon argent à de petites boîtes. Vive les grandes firmes! Vive les banques! Vive les Fidelity, Trimark et autres fonds étrangers!

Ces scandales ont marqué l'inconscient collectif et ont nui à la finance montréalaise. Mais il faudra tôt ou tard tourner la page.

Pour tourner cette page, Jacques Bourgeois travaille dans l'ombre. «Dernièrement, j'ai finalement réussi à faire bouger un gros fonds de retraite pour l'inciter à donner des mandats de gestion au Québec. Une affaire de 200-300 millions. Mais ça m'a pris cinq ans», dit-il.

Les gestionnaires québécois sont-ils moins bons? Est-ce la raison du déclin? «Moins bons? Pas du tout. Aux HEC, notre fonds de retraite a obtenu le meilleur rendement des fonds universitaires au Canada sur 10 ans entre 2001 et 2011. Premier au Canada. Et 90% des fonds y sont gérés par des Québécois.»

Bien sûr, il y a une question de taille. Au Québec, les firmes capables d'accepter un mandat de 10 à 100 millions de dollars d'une caisse de retraite ne sont pas légion. Il y a Fiera Capital, Jarislowsky Fraser, Letko Brosseau et Hexavest, entre autres, mais après, la taille diminue rapidement.

Jacques Bourgeois croit que les grands investisseurs institutionnels devraient encourager la relève, comme aux États-Unis. Dans certains états au sud de la frontière, dit-il, les caisses de retraite sont encouragées à confier 1% de leur actif sous gestion à des gestionnaires émergents.

Ce n'est pas nécessairement le cas au Québec. À la Caisse de dépôt et placement, par exemple, environ 91% des fonds sont gérés à l'interne et le reste est géré par des gestionnaires externes établis au Québec (environ 0,8%) ou hors Québec (environ 8,2%), nous indique l'institution.

La Caisse a recours aux services de firmes externes du Québec pour gérer des investissements boursiers, des placements privés et des fonds de couverture, essentiellement. Il ne s'agit pas nécessairement de gestionnaires émergents, cependant.

Selon le porte-parole Maxime Chagnon, la Caisse connaît très bien le marché du Québec et du Canada, qu'elle gère donc à l'interne. C'est ce qui explique qu'elle a davantage recours à des gestionnaires hors Québec pour ses besoins, dit-il. «Notre choix est fonction de l'expertise, des besoins et des marchés qu'on couvre.»

Mais Jacques Bourgeois n'en démord pas. «Toutes les semaines, je reçois l'appel d'une jeune firme de gestion de fonds qui tente d'avoir des mandats institutionnels. Mais il n'y a rien à faire», raconte l'ex-professeur.

C'est clair, il y a des risques. Il y aura toujours des risques. Les fonds institutionnels devront faire leurs devoirs et enquêter avant de décaisser les fonds. Toutefois, favoriser des gestionnaires d'ici forme la relève et crée des emplois payants sans qu'il n'en coûte un sou de subvention au gouvernement. Et il met des PME locales sur le radar, explique M. Bourgeois.

En effet, le financier de Toronto à qui l'on confie la gestion des petites capitalisations a nécessairement une meilleure connaissance des entreprises locales. «L'univers du gestionnaire, c'est davantage son patelin. On connait mieux ce qui est proche. En faisant gérer les petites capitalisations à Toronto, nos PME retiennent moins l'attention et leur valeur boursière finit par être moindre», dit-il.

Bref, Jacques Bourgeois lance un cri du coeur. L'objectif n'est pas de faire gérer 100% de nos fonds par des Québécois, mais chaque pourcentage additionnel représente 4 milliards. Convaincu?
I wouldn't put a fixed amount of assets managed inside Quebec but kudos to professor Jacques Bourgeois for warning of the erosion of Montreal's investment management industry. The Caisse and others have to step up to the plate and support our home grown talent, investing in established and emerging managers. They should also support local brokers and force global banks to open up more offices here.

Below, for those of you who speak French, watch Michael Sabia's interview on Radio Canada last night. Michael rightly put the emphasis on long-term results when the reporter pressed him on one-year results and said there is still a lot of work ahead.

Michael also responded to a reporter's question, "Is there any kind of role for the Caisse in terms of financing things right here at home?", when he met the media to unveil the annual results (watch below).


Wednesday, February 27, 2013

Americans Anxious About Retirement?

Michael Fletcher of the Washington Post reports, Americans anxious about retirement (h/t, Suzanne Bishopric):
Even as the economy slowly improves, the vast majority of Americans remain deeply worried about their ability to achieve a secure retirement, according to a new survey.

The poll, to be released by the National Institute on Retirement Security (NIRS) at a conference on Tuesday, found that 55 percent of Americans are “very concerned” that the current economic conditions are harming their retirement prospects. An additional 30 percent reported being “somewhat concerned” about their ability to retire.

The level of anxiety Americans feel about their preparation for retirement has continued to peak in the recession’s aftermath, a finding that the poll’s sponsors said highlights the need for policymakers to bolster the nation’s retirement programs.

“People are anxious about retirement. We know that,” said Diane Oakley, president of NIRS, a Washington-based nonprofit organization. “The question is, how do you get people to act on that?”

As aging Americans are increasingly burdened by debt, spiraling health-care costs and diminishing pension coverage, an increasing number of researchers argue that a long era of improved living standards for the elderly is now in jeopardy.

The Senate’s Health, Education, Labor and Pension Committee says the nation faces a $6.6 trillion retirement-savings deficit. Meanwhile, a retirement security index developed by Boston College’s Center on Retirement Research as well as economists at the New School have found that a majority of Americans are at risk of being financially worse off than their parents in retirement.

The Service Employees International Union recently released a fact sheet saying that black and Latino workers are particularly at risk for seeing their standard of living significantly erode in retirement because they tend to have fewer assets, less retirement income and higher medical expenses.

NIRS is among a number of groups calling on the federal government to bolster Social Security benefits or to create a new layer of retirement help for future retirees. But those calls have been overshadowed by concern about the nation’s long-term debt, which has prompted many policymakers to focus on ways to reduce Social Security and other retirement benefits rather than increase them.

The high anxiety Americans feel about retirement has them clamoring for the protections that used to be common for workers, the survey found. More than four in five Americans, for example, have favorable views of traditional pensions, which pay a guaranteed amount to retirees for life. Americans hold that view even though many experts point out that 401(k)s and other defined contribution plans are actually better suited for American workers, who tend to change jobs frequently. The problem is Americans do not save enough in them, and too often tap them for non-retirement needs. Traditional pensions, meanwhile, are most lucrative for workers who retire after a long tenure on the job.

The poll found widespread support for protecting Social Security benefits at current levels, as well as for the idea of a new pension program that would stay with workers even as they changed jobs and offer a guaranteed lifelong income once they retire.

“What people really need is a paycheck for life,” Oakley said.

The telephone survey was conducted in December 2012 and involved 8,000 Americans ages 25 and older, NIRS said.
I've already covered America's new pension poverty and commend Michael Fletcher and other reporters for shining the spotlight on America's retirement crisis.

Importantly, even though the financial crisis is over, the retirement crisis will continue to weigh heavily on the minds of millions who cannot afford to retire in dignity and security.

Worse still, Allison Linn of NBC News reports, Not-So-Golden Years: Over 75, Burdened By Debt:
The golden years are supposed to be a time when you can live off the wealth you've accumulated over a lifetime, not feel like you have to take on more debt to make ends meet.

But a new batch of research shows that Americans ages 75 and over appear to have grown more burdened by debt in recent years, and experts say a likely culprit is medical expenses.

A new analysis of government data, released earlier this month by the Employee Benefit Research Institute, found that between 2007 and 2010 people who are 75 and older were more likely to have debt, and their average debt levels increased significantly.

That's in stark contrast to other older Americans in their 50s and 60s, who generally saw debt levels stabilize during that period.

In general, the good news is that people ages 75 and older are much less likely to have debt, and generally carry far less debt, than other older Americans. But Craig Copeland, a senior research associate with EBRI and the report's author, said it was still troubling to see that the trend for that group was toward increasing, rather than decreasing, debt burdens.

"It really looked like something wasn't going well for them," Copeland said.

He suspects that many Americans who are 75 and older have few options but to take on debt when a big unexpected expense arises, because many are living on fixed retirement incomes and don't work. That means they can't, say, work a few extra hours or take on a second job if they need to pay for something.

That unexpected expense may be health-related. Although most older Americans are covered by Medicare, Copeland noted that many are still on the hook for co-pays and other out-of-pocket expenses.

That means a person with a limited income can have their finances thrown into disarray by one unexpected event, such as a broken hip that requires significant co-pays or the sudden need for a very expensive prescription that isn't fully covered.

"In a lot of cases it seems to be that health care is a particularly vexing issue," he said.

The percentage of people 75 and above who had debt grew from 31.2 percent in 2007, the year the nation went into recession, to 38.5 percent in 2010, a year after the recession officially ended, according to the EBRI's analysis of Census data. The average amount of debt for those with debt also more than doubled, from $13,665 in 2007 to $27,409 in 2010.

The debt loads were far greater for people in their 50s and 60s, but the trend lines were far less troubling. The percentage of people ages 55 to 64 who held debt fell from 81.7 percent to 77.6 percent. For people ages 65 to 74, the percentage holding debt held steady at about 65 percent.

The average debt for 55- to 64-year-old debtholders fell from $112,075 in 2007 to $107,060 in 2010. For people ages 65 to 74, average debt fell from $72,922 in 2007 to $70,875 in 2010.

It makes sense for younger people to have more debt because they are still paying off big expenses, like houses, and they also are more likely to be bringing home a paycheck. By the time you reach your mid-70s, many would expect to have paid off the house and retired from regular work.

For people 75 and older, Copeland said his research showed that both median credit card and housing debt increased for those who had those types of debt.

Lucia Dunn, an economist at The Ohio State University, said her more recent research also has shown that older Americans have been taking on more credit card debt in recent years. She also suspects that unexpected medical expenses are a key problem for that group.

But in general, she said the really troubling finding she's seeing is that younger Americans appear to be taking on more debt than previous generations, and paying it off at slower rates.

That could mean that today's young people have even bigger problems than their parents and grandparents when they reach age 75 and older.

"The elderly are taking it in (but) not as fast as the younger ones," she said. "The really young cohorts are really digging a hole for themselves."
You can read the full research report from the Employee Benefit Research Institute by clicking here.  It's very worrisome and this disaster will impact younger Americans much harder when they reach their not-so-golden years.

What's even more depressing is the asinine policy response to the retirement crisis. Vancouver's News1130 reports, Washington state looking at aggressive pension reform:
While governments in this country grapple with pension reform, an aggressive idea is being fiercely debated just south of our border.

Politicians in Washington state are mulling over the idea of shifting government workers from pensions to RRSPs.

The plan would move current workers under the age of 45 away from defined benefit plans into defined contributions. New workers would also go into the RRSP plan.

Jordan Bateman of the Canadian Taxpayers Federation says that’s even more aggressive than what’s being discussed here in Canada.

“Right now, I think what needs to happen in Canada, [is] we need to change new employees over to the defined contribution plan or RRSP style. It’s the standard now in the private sector,” he tells us.

But Bateman feels something needs to happen in this country.

“We just can’t continue with these two classes of pensioners in Canada — one who happened to have a government job and one who have a private sector job paying for their own pension and paying for the government guy’s pension.”

Pension reforms are on the minds of governments all over this country these days, while a number of studies suggest Canadians are not saving enough for retirement.
With all due respect to Jordan Bateman, Bill Tufts and others who are concerned about the "crushing debt of public pensions," they really don't have a clue about what's in the best interest of all workers and the health of developed economies.

Importantly, shifting workers into 401(k)s, RRSPs or defined-contribution plans is effectively condemning them to  pension poverty. Moreover, instead of reducing public debt, you will see a worsening of the debt profile of many developed economies as taxpayers will bear the burden of exploding social welfare costs. It will also severely hamper productivity, the ultimate determinant of the wealth of a nation.

Finally, News1130 also reports, Canada’s pension system has room for improvement:
A new report is suggesting several ways the federal government could improve the country’s pension system. It includes expansion of the Canada Pension Plan (CPP) to allow larger contributions.

Critics of this strategy have complained about the impact on business, as expanding CPP would increase payroll taxes. Report co-author Jack Mintz with the University of Calgary’s School of Public Policy says there is a way to mitigate that problem.

“And there we suggest if we also increase the eligibility age from 65 to 67, which would make a lot of sense given that people are living much longer (…) that actually will mute any increase in payroll taxes to pay for additional benefits,” he says.

Mintz says the change also would allow retiring workers to draw a larger maximum pension, rather than having to rely on the guaranteed income supplement (GIS). The age increase would have to be phased-in to protect older workers who’ve been paying into the pension system for years.

“But it would be a real help for younger people today,” he adds. “At least when they do end up in the retired years they could count on a certain floor of income.”

The report makes several other recommendations, including making CPP contributions deductible from taxable income, like RRSP investments, to encourage workers to maximize contributions.

It suggests treating group RRSPs like defined-contribution registered pension plans (RPPs), another move that would reduce payroll taxes, and upping the age limit for RPP and RRSP contributions from 71 to 75 years to reflect the increase in life expectancies.

Also:
  • Allowing RRSP contributions to be altered to allow lifetime averaging, allowing workers to take advantage of additional contribution room.
  • Increased contribution limits on Tax-Free Savings Accounts
  • Creation of a capital-gains deferral account to allow investors to sell off underperforming assets, without fear of triggering a tax bill, as long as they reinvest the proceeds.
You can read the entire report here. I agree with all the recommendations above, especially expanding the CPP, which is in the news again after the head of CIBC recently came out to sound the alarm on our retirement crisis.

I would, however, go a step further and completely revamp our pension system to make sure pensions are a public good and managed by large, well governed public pension plans. Companies shouldn't be in the business of managing pensions. America's corporate pension gap is soaring and in Canada, things aren't better as Air Canada's pension relief could hurt competition.

Below, leave you once again with a new pension funding documentary, co-produced by Ontario Teachers' and Cormana Productions (also available here). Entitled Pension Plan Evolution - A New Financial Reality, the 23-minute video takes a global look at how pension plans are changing to meet economic and demographic challenges ranging from volatile markets to increasing longevity.

It includes interviews with thought leaders from around the world addressing important pension issues such as: How will pension plans meet their commitments to members? How will contributions and pension benefits be affected? This is a must watch for anyone concerned about their pension and the future of  retirement systems around the world.

Tuesday, February 26, 2013

Ontario Teachers' to Absorb More Risk?

Tara Perkins of the Globe and Mail reports, Deal will let Ontario Teachers’ Pension Plan shoulder more investing risk:
The Ontario Teachers’ Pension Plan is aiming to be more aggressive in its portfolio, its CEO says, after the provincial government and teachers’ union struck an unusual deal to tackle the plan’s deficit.

“It lowers our risk profile quite substantially, from the board’s perspective, such that we can absorb a little more risk in our investment strategy,” Teachers’ chief executive officer Jim Leech said in an interview Monday. That might mean, for example, new flexibility to bolster investments in emerging markets, do more private equity deals, or put more of its money into stocks.

Mr. Leech has been frustrated because, just as the pension plan needs to boost investment returns, chronic deficits over the past decade have forced it to maintain a highly conservative investment profile. That has meant restricting equities to 45 per cent of its portfolio, a lower weighting than most pension funds.

But the fund’s co-sponsors, the Ontario government and the Ontario Teachers’ Federation, have agreed to eliminate the guaranteed inflation protection that is paid on benefits to plan members, a move that will wipe out the plan’s $9.6-billion deficit (as of Jan. 1, 2012).

The province and union have also agreed to study ways to put a permanent stop to the fund’s deficits, research that will likely look at the balance between the number of years that teachers work and the number of years that they receive benefits. In 1990, teachers worked, on average, for 29 years and received retirement benefits for 25 years; by 2011, they worked for 26 years and drew pensions for 30 years. The profession skews toward women and tends to be healthy, resulting in long life expectancy.

The province and union reached the agreement to eliminate the deficit more than two weeks ago but it has remained under the public radar as Queen’s Park settles back in after a leadership change. One of the main issues the province has been contending with is contract negotiations with the teachers, in the wake of a bitter dispute that erupted when former premier Dalton McGuinty prohibited teachers from striking last fall and then imposed new contracts on them early last month.

“It is difficult; teachers did take a reduction in benefits, but I think that ensures the sustainability of the pension plan and weathers the storm created by low interest rates and changing demographics,” Terry Hamilton, president of the Ontario Teachers’ Federation, said in an interview. “The times didn’t help the situation but it shows how we continue to work effectively with the government.”

Mr. Leech says the agreement is one of the most significant of its kind in the industry. “Pension plans have to evolve,” he said. “Plans have to show that they can evolve to the new reality, and I think what these two sponsors have done – the government and the teachers – is shown that they can make that evolution.”

Former finance minister Dwight Duncan made it clear last spring that Teachers’ pension deficit would have to be tackled through benefit reductions, rather than contribution increases, since the province matches what teachers pay into the plan.

The government and union have agreed to numerous measures over the years to eliminate deficits, and the guaranteed inflation protection had already been cut from 100 per cent to 50 per cent.

But Mr. Leech says the changes should have a more permanent impact this time, characterizing this agreement as “a dramatic move.” While the goal will still be to pay inflation protection, the need to do so is removed entirely.

“It provides us with a tool to absorb some hiccups, if there are any, because you can float the inflation protection up and down,” Mr. Leech said, adding that the sponsors have “invoked it such that, going forward, 45 per cent will be paid until further notice.” That will take effect at the start of 2015, Mr. Hamilton said.

While Teachers has not yet disclosed its 2012 annual results, Mr. Leech said it has informed the co-sponsors that, since interest rates fell further during the year, the fund is likely to report a small deficit as of the start of this year – in the neighborhood of 97-per-cent or 98-per-cent funded, he said. “But it will be much smaller … and it is easily handled,” he said.
Looks like the Oracle of Ontario has done it again, striking a deal with its stakeholders to shoulder more investment risk. This is important because given historic low bond yields, Ontario Teachers' and other pension plans dealing with chronic deficits of the past decade need to absorb more investment risk to meet their actuarial target rate of return.

And unlike others, Ontario Teachers'  uses a discount rate of 5.4% to determine the value of future liabilities, the lowest discount rate in Canada and among the lowest in the world. The demographics of their plan is the reason why they use such a low discount rate but some experts have told me the discount rate they use is extremely conservative, overstating their liabilities and understating their funded status.

Nonetheless, Ontario Teachers' recently posted an update on their website going over the agreement reached to keep Teachers' plan on sound financial footing and how the change in inflation protection has small impact on recent retirees.

Keep in mind, Ontario Teachers', OMERS and HOOPP manage assets and liabilities. They are pension plans, not pension funds, so they need to carefully consider the macroeconomic environment and figure out ways to best match assets and liabilities.

As discussed yesterday, OMERS' ultimate strategy is to shift almost half their assets into private markets, which they will manage internally, to boost returns. Ontario Teachers' has a somewhat more diversified asset mix, which includes significant investments in internal absolute return strategies and external hedge funds.

Teacher's states the following in their asset mix overview:
We use bond repurchase agreements to fund investments in all asset classes because it is cost effective and allows us to retain our economic exposure to government bonds. For efficiency reasons, we also use derivatives to gain passive exposure to global equity and commodity indices in lieu of buying the actual securities. Derivative contracts and bond repurchase agreements have played a large part in our investment program since the early 1990s.

In addition, absolute return strategies enable us to earn positive returns that are uncorrelated to other asset groups. We employ these strategies internally to capitalize on market inefficiencies and we complement our own activity by using external hedge fund managers. The use of external hedge funds provides us with access to unique approaches that augment performance and diversify risk.
As previously stated in my comment on the Oracle of Ontario, HOOPP and Teachers' both use derivatives and repos extensively but there are key differences in their approach:
HOOPP does almost everything internally while Teachers' will often use external managers for investment activities they can't replicate internally. Both funds use repos extensively, leveraging up their stock and bond portfolios, saving millions in the process (instead of having some custodian do it off balance sheet, charging them insane fees).

The big difference, however, is Ontario Teachers' takes directional leverage whereas HOOPP doesn't (repos are matched by money market instruments, not invested in hedge funds, private equity and real estate). I have heard figures that Teachers' is leveraged up to 50%, which works well in good years, but goes against them in bad years like 2008, when they crashed and burned.
What will be interesting to see is whether the ability to increase investment risk will mean a cut in the directional leverage they take. Doubt it will but they have the right governance to oversee these risks.

One thing Teachers' did after the 2008 crisis is change compensation for senior managers to decrease 'blowup risk'. I discussed this recently in a comment on excessive risk-taking at public pension funds.

The other thing Ontario Teachers' did after 2008 was take a hard look at how they manage liquidity risk. Ron Mock, Senior VP, Fixed Income and Alternative Investments at Teachers', told me they manage it a lot more tightly, always looking ahead 18 to 24 months.

On this topic, Jim Keohane, President and CEO of Healthcare of Ontario Pension Plan (HOOPP), shared these wise insights with me in a recent comment on pensions taking on too much illiquidity risk:
I find this whole discussion quite interesting. Private assets are just as volatile as public assets. When private assets are sold the main valuation methodology for determining the appropriate price is public market comparables, so you would be kidding yourself if you thought that private market valuations are materially different than their public market comparables. Just because you don’t mark private assets to market every day doesn’t make them less volatile, it just gives you the illusion of lack of volatility.

Another important element which seems to get missed in these discussions is the value of liquidity. At different points in time having liquidity in your portfolio can be extremely valuable. One only needs to look back to 2008 to see the benefits of having liquidity. If you had the liquidity to position yourself on the buy side of some of the distressed selling which happened in 2008 and early 2009, you were able to pick up some unbelievable bargains.
Moving into illiquid assets increases the risk of the portfolio and causes you to forgo opportunities that arise from time to time when distressed selling occurs - in fact it may cause you to be the distressed seller! Liquidity is a very valuable part of your portfolio both from a risk management point of view and from a return seeking point of view. You should not give up liquidity unless you are being well compensated to do so. Current private market valuations do not compensate you for accepting illiquidity, so in my view there is not a very compelling case to move out of public markets and into private markets at this time.
Many pension funds learned the value of liquidity the hard way during the 2008 crisis. When they needed it the most, they didn't have it and were forced to sell public market assets at distressed levels to shore up their liquidity. Keep this in mind the next time someone tells you that pension funds are long-term investors and can take on unlimited amount of illiquidity risk. That's pure rubbish and smart guys like Jim Keohane and Jim Leech know it.

Finally, Jim Leech, President and CEO of Ontario Teachers' Pension Plan (Teachers'), recently issued a call to action in his keynote speech to the National Summit on Pension Reform in Fredericton. In his remarks, Leech introduced a new pension funding documentary, co-produced by Teachers' and Cormana Productions, entitled Pension Plan Evolution - A New Financial Reality (watch it below or here).

Also embedded a recent CNBC interview with Jim Leech where he discussed how an energy self-sufficient U.S. could cause a "seismic" market shift. Jim also discussed Teacher's asset allocation and where he thinks opportunities lie ahead.

Monday, February 25, 2013

OMERS Gains 10% in 2012

Tara Perkins of the Globe and Mail reports, OMERS posts 10 per cent return helped by private equity, real estate gains:
The Ontario Municipal Employees Retirement System has posted a 10-per-cent return for 2012, slightly above its benchmark, with private equity and real estate investments more than making up for losses in the oil and gas sector.

But, as with many pension funds, OMERS is still feeling the impact of the investment losses it racked up when the financial crisis hit. The estimate of all of the payments that its members will be entitled to is $10-billion higher than the actuarial measure of OMERS’ net assets.

“This deficit is based on a long-term projection going out several decades and in no way reflects our ability to pay pensions in the short term,” OMERS chief financial officer Patrick Crowley stated in a press release.

“Solid investment returns which have averaged 8.9 per cent per year in the four years since the financial crisis, and 8.24 per cent over the past 10 years, combined with contribution increases, are already having a positive impact on reducing the deficit,” he added. “Sustained returns at this level could bring the plan back to fully funded status earlier than anticipated.”

The fund collected $3.2-billion in contributions during 2012 and paid out $2.7-billion in benefits. Its net assets rose by $5.7-billion to $60.8-billion.

Its capital markets arm, which manages its publicly-traded investments such as stocks and bonds, posted a return of 7.5 per cent.

Its private market portfolio posted a 13.8 per cent return. Within that portfolio private equity investments returned 19.2 per cent, real estate (managed by its real estate business Oxford Properties) 16.9 per cent, and infrastructure 12.7 per cent. But its “strategic investments,” which are largely in the oil and gas sector, posted a return of negative 10.1 per cent because of falling oil and gas prices in 2012.

During a press conference OMERS CEO Michael Nobrega said the pension fund is now seeing a flood of opportunities to acquire oil and gas properties in Saskatchewan and Alberta, with junior oil and gas firms unable to finance.

“We’ve had more opportunities in the last two weeks than we’ve had in three years,” he said.

OMERS is in the midst of rebalancing its portfolio away from stocks and bonds towards more private market investments. Its goal is to ultimately have about 53 per cent of its assets in the public markets, and 47 per cent private. At the end of the year it had 60 per cent in public markets and 40 per cent in private, compared to 82 and 18 per cent, respectively, nine years ago.

About 88 per cent of the fund is now managed by OMERS employees, as opposed to external fund managers, up from 74 per cent five years ago, and OMERS is trying to take that figure to 95 per cent.
And Andrea Hopkins of Reuters reports that OMERS is eying global deals as assets rise again:
Canadian pension fund OMERS said on Friday it wants to diversify beyond its traditional strongholds in North America, Britain and Western Europe, but will remain focused on property, healthcare, infrastructure and energy assets as it seeks deals around the world.

OMERS, which manages the pension plan for Ontario's public-sector municipal workers and has become a global dealmaker by virtue of its deep pockets, said it is just looking for the right opportunities based on risk and reward.

"We'll be highly focused in terms of the sectors we're looking at. We have investments in energy, large infrastructure projects on a world-wide basis, in healthcare and in pipelines, and we'll continue to look for those kinds of opportunities around the world for the right risk-return," OMERS chief financial officer Patrick Crowley said in an interview.

"I don't think we want to restrict ourselves to any one particular jurisdiction -- we have a large fund and we're very active and we want to get the best return for our members."

OMERS has been a major buyer of private market assets for more than a decade, accelerating the pace of acquisitions after the onset of the global economic crisis of 2008-09.

It said Friday it notched a 10 percent return on investments in 2012 as its private equity, property and infrastructure portfolios made strong gains, offsetting losses on its investment in Alberta's oil and gas sector.

Net assets at the fund grew to C$60.8 billion last year from C$55.1 billion at the end of 2011.

"The C$5.7 billion increase in our net assets demonstrates the strength and robustness of OMERS business model with the capacity to generate growing investment cash yields and more than ample liquidity to withstand market shocks under stressed financial conditions," Michael Nobrega, OMERS president and chief executive, said in a statement.

The Toronto-based pension plan also said it rang up returns of 19.2 percent in OMERS Private Equity, 16.9 percent in Oxford Properties, 12.7 percent in Borealis Infrastructure and 7.5 percent in capital markets.

A negative 10.1 percent return in OMERS Strategic Investments, which represents less than 3 percent of OMERS net investments, was due to year-end valuations of its principal assets in Alberta's energy sector as oil and gas prices fell to their lowest levels in five years.

Crowley said he expects that investment to pay off down the road, as OMERS benefits from the patience and long investment horizon that competitors may not enjoy.

"This is an investment where the gas and the oil is still in the ground, we have the properties, we valued those properties based on forecasts of prices for next three to four years, but we believe longer-term this remains a very good investment, and it is something we're still committed to," Crowley said.

"Not only Alberta but also this sector, and we think this could be a big opportunity for us to take advantage of people who may not have liquidity to stay in the business."

The 2012 total investment return of 10 percent far outpaced the 3.2 percent return in 2011 and edged out the plan's benchmark return of 9.75 percent, the fund said.

OMERS said it was still working to overcome investment losses in 2008 stemming from the global financial crisis. Its five-year annualized rate of return is 3.56 percent, while its 10-year rate of return is 8.24 percent. In the last four years since the financial crisis, the plan has notched an 8.9 percent investment return.

Crowley said OMERS, which competes with sovereign wealth funds as well as other big pension funds for acquisitions and investment deals globally, would continue to rely on partnerships to minimize investment risks in equity deals that require "quite large" checks to be written.

"We've looked at bringing in people to co-invest along side with us, and that has worked out reasonably well," said Crowley, pointing to its move last year to team up with Japan's pension funds and some major conglomerates to form the world's largest infrastructure fund to invest in assets such as roads and airports with greater agility.

"If you have that in place you can take advantage of opportunities faster, more efficiently, and there is not as much negotiation among yourselves as to what you are going to bid, because all of that is settled up front. That is the advantage of this type of arrangement," said Crowley.

The partnership has been seen as an unprecedented effort to cut out asset managers as middle men in infrastructure investment and compete head-to-head with the handful of the world's biggest funds that have the capacity to lead their own investments in infrastructure assets.
No doubt about it, OMERS is leading the charge in terms of shifting into private markets and unlike most other public pension funds, they have developed the expertise to manage these assets internally, significantly lowering costs and being a lot more nimble so that their stakeholders enjoy the gains of direct investments.

But taking a primarily direct approach and ultimately splitting public and private assets almost in half carries its own set of risks. First, there are many who wonder whether pension funds are taking on too much illiquidity risk by shifting such a large portion of their assets into private markets.

Second, there is performance risk. While going direct and managing assets internally saves external costs and fees, you still need to post solid numbers. Over a 10-year period, OMERS has managed to deliver a decent return (8.24%) but their "strategic investments," which are largely a big bet on oil and gas sector, posted a return of negative 10.1% in 2012.

In their press release, OMERS downplayed the negative results of their strategic investments:
OMERS Strategic Investments, which represents less than two and a half per cent of OMERS net investments, has its principal assets in Alberta’s oil and gas sector. The year-end valuation of these assets was negatively impacted as oil and gas prices fell to their lowest levels in five years
All true but I still wonder how Canada's perfect storm will impact these investments over the next 5 to 10 years and how this could impact OMERS' overall results as these are long-term illiquid assets.

Still, despite these losses, private market investments led the charge in 2012. OMERS private market portfolio had a 13.8% investment return – with returns of 19.2% (OMERS Private Equity), 16.9% (Oxford Properties), 12.7% (Borealis Infrastructure) and negative 10.1% (OMERS Strategic Investments).

OMERS Capital Markets, which manages the public market portfolio including public equities, fixed income and debt investments, generated a 7.5% return in 2012. The performance in public markets is basically passive benchmark performance, underperforming the 8.8% median return (gross of management fees) of institutional balanced and severely underforming Canada's best performing balanced fund managers in 2012:
The numbers on the performance of the country’s balanced funds are preliminary, but clients of two firms — Connor Clark & Lunn and HughesLittle — have reason to be well pleased with their investment manager in 2012.

Based on data compiled by API Asset Performance Inc., the two managers posted returns of 16.6% and 16% respectively last year, making them the only two to post one year gains of at least 16%. (The Signature Enhanced Yield Fund, managed by CI was close: it was up by 15.7%.)

That performance by CC&L’s High Income Fund and by HughesLittle’s Balanced Fund – gave them a top quartile ranking in the 90-plus institutional balanced funds surveyed by API. To be ranked in the first quartile a return of at least 10.7% was required.

The two-star performing firms are no stranger to generating impressive results: over the past one, two and four years the two funds have been in the top quartile. Over two and four years, on an annual basis, CC&L is up by 11.5% and 19.0% respectively; over the same two time periods HughesLittle was up by 14.1% and 15.8% respectively.

For 2012, the preliminary results for the institutional balanced funds indicate that the median manager generated a return of 8.8% gross of management fees. In a note, API said that “the 8.8% median return generated for the year is welcome news for pension funds with typical liability discount rates between 4.5% and 6.5%”.

At 8.8%, the return for the media manager was 110 basis points higher than the 7.7% generated by the API Balanced Passive Index. According to API, its balanced passive index “weights asset class market indexes on the average asset mix of institutional managers, and can be viewed as a low cost alternative to active management.” The result is also an argument for active manager, API argues given that “the average fee for a $100-million balanced fund is below 0.5%.”

API’s numbers show that over the past one, two and four years, its balanced passive index generated a performance good enough for a fourth, third and third quartile ranking, which is presumably an argument for active management.

Over four years the five best performing balanced funds were: CC&L (19.0%); HughesLittle (15.8%); Barometer High Income Pool (15.7%); CI Signature Income & Growth Fund (13.2%) and Bissett Dividend Income Fund (13.2%.)

While CC&L and HughesLittle were the top performers last year, the balanced fund managed by Acuity, the Acuity Pooled Canadian balanced fund, was the worst performer: it was up by a mere 1.9%.
Now, I realize comparing the performance of Canadian balanced funds to the performance of large Canadian pension plans is not entirely appropriate because their portfolios are different but I bring up this point because in the end, stakeholders need to understand the opportunity cost of taking on illiquidity risk in private markets and  managing assets internally as opposed to going to top external managers.

A fairer comparison is with its peer group. And OMERS slightly outperformed most Canadian pension plans in 2012. An RBC Investor Services Ltd. survey of 200 Canadian pension plans with over $410-billion in assets under management showed investment returns averaged 9.4 per cent in 2012, a significant improvement over returns of 0.5 per cent in 2011 but slightly shy of 2010 returns of 10.4 per cent.

Nonetheless, the results are not stellar. If you look at the financial results fact sheet provided by OMERS, you'll see the gross returns by investment entity for 2011 and 2012 (click on image above) as well as the rate of return relative to benchmark over a one, five and ten year period (click on image below):


The added value over the benchmark portfolio was a mere 28, 52 and 51 basis points over a one, five and ten year period.  This is hardly what I call "shooting the lights out" in terms of delivering significant added value over their benchmark portfolio but at least OMERS publishes these results. What remains to be seen is whether they can execute on their new strategy and deliver better results in the years ahead.

As far as the plan's deficit, I agree with Patrick Crowley, OMERS' CFO, it's not something to worry about short-term. Moreover, OMERS is fully transparent and provides a fact sheet on the plan's funding status with details on a plan to return the plan to fully funded status.

OMERS is the first to report their results. They have yet to post their full annual report for 2012 on their website so I cannot look into these results in detail or provide readers with other information like compensation. 

In the weeks that follow, other large Canadian pension plans will also report their 2012 results. It will be interesting to see how their results stack up to their peer group including OMERS.

Below, Michael Nobrega, CEO of OMERS, talks with Bloomberg's Erik Schatzker and Margaret Brennan about the role of alternative investments in their pension-fund strategy. Nobrega also discussed a special review by CalPERS of fees investment managers paid to placement agents to win state business. They talked at The Economist's Buttonwood Conference at Pace University (March 2012).

And Gareth Neilson and Bill Tufts from Fair Pensions For All present to the City of London Finance Committee on OMERS pension funding shortfalls (November 5, 2012). They raise some excellent points on sharing the costs of the plan more fairly among all stakeholders but unfortunately they engage in classic scaremongering and misinformation so take this presentation with a grain of salt.


Friday, February 22, 2013

Pension Funds Improving Corporate Governance?

The Globe and Mail published a Reuters article, Pension funds look to strip Jamie Dimon of title:
Overseers of government worker pension funds pressed JPMorgan Chase & Co. to strip chief executive Jamie Dimon of his additional title of chairman after the London Whale fiasco, renewing a proxy battle the bank won only narrowly last year.

Pension funds, including that of the American Federation of State, County and Municipal Employees (AFSCME), said on Wednesday they filed a shareholder resolution that says the bank would be better run if the chairman and CEO jobs were held by different people.

Backers cited in a statement what they called “mounting investor concerns with the board’s oversight” following more than $6-billion (U.S.) of losses last year from bad derivatives trades linked to a London-based trader – known as the London Whale for his outsized bets.

The group also cited other problems such as the cease-and-desist orders the bank received from regulators last month that require it to improve its internal controls, which Mr. Dimon oversees.

“It is impossible to imagine how board oversight of the company’s affairs will be strengthened while CEO Jamie Dimon leads the very board that is charged with overseeing his own shortcomings,” said Denise L. Nappier, the Connecticut Treasurer who oversees the Connecticut Retirement Plans and Trust Funds, which are part of the group.

Other filers of the proposal include those overseeing the pension assets of New York City teachers, police and firefighters, according to their joint statement.

The issue of splitting the chairman and CEO jobs has become a staple argument of shareholder activists and reformers.

Proponents say having the roles filled by a single person concentrates too much corporate power and can lead to conflicts of interest. Many companies defend the practice, however, saying it can be more efficient and that other measures can assure the board’s independence and oversight.

AFSCME last year filed a similar resolution that won 40 per cent support from JPMorgan shareholders. Later filings showed backers of the resolution included mutual funds sponsored by American Funds, which before had voted with management on a similar resolution.

JPMorgan spokesman Mark Kornblau declined to comment.

Last year the bank argued the split was not necessary because other directors were independent. AFSCME filed, then withdrew, a similar proposal last year at Goldman Sachs Group Inc. after the bank agreed to appoint an independent lead director.

AFSCME last week said it has filed similar proposals this year calling for independent chairs to be named at companies including General Electric Co., Lazard LLC and Wal-Mart Stores Inc.

Another backer of the resolution at JPMorgan this year is Hermes Equity Ownership Services, an adviser owned by BT Pension Scheme, which operates pension funds for British Telecom employees.
You can read AFSCME's press release here. Does it make sense for pension funds to go after powerful bankers and strip them of their titles to improve corporate governance? You bet it does and many individual investors will cheer them on.

In the wake of the financial crisis, corporate governance will be a dominant theme. Just look at Citigroup which bowed to shareholder pressure, overhauling its pay:
Citigroup Inc (C.N) said on Thursday it has overhauled an executive pay plan that shareholders rejected last year as overly generous, revising it to tie bonus payments more closely to stock performance and profitability.

The company also said it will pay new Chief Executive Mike Corbat $11.5 million for his work in 2012, in line with remuneration for his peers at other major banks.

The new plan was crafted after board Chairman Michael O'Neill and other directors met with "nearly 20" shareholders representing more than 30 percent of Citigroup stock, Citi said in a filing.

"At first blush, the package appears to be responsive to a number of the issues we raised," said Michael Garland, an assistant comptroller overseeing corporate governance matters for the City of New York.

New York City's pension funds, which own about 7.4 million shares of the bank, met O'Neill in August to discuss senior executive pay, Garland said.

Citigroup's previous pay plan was rejected by shareholders in a non-binding vote at the company's annual meeting in April last year, in what was seen as a stinging rebuke to the bank's management and directors, and helped hasten departure of then-chief executive Vikram Pandit.

Compensation analysts had criticized the plan for giving directors too much discretion to set pay, and for setting the bar too low for bank executives to receive high payouts.

Under the previous profit-sharing plan, Citigroup would pay millions to executives if Citigroup earned more than $12 billion before taxes over two years, a figure the company easily topped in 2010 and 2011.

Under the new plan, 30 percent of the bonus for top executives will be paid in cash based on how much the company earns on assets and on total shareholder return compared with peers over three years through 2015. Another 40 percent will be a simple cash bonus and the final 30 percent will be deferred stock.

TICKING BOXES

Still, elements of the bank's proposed pay package could be better, said Paul Hodgson, a corporate governance analyst in Camden, Maine.

For example, the pay plan would ideally reward executives more for their performance. But too much of the stock bonuses are awarded mainly for the employee staying with the company, Hodgson said.

There were positives, including the fact that the bank needs to show stronger performance over the longer term than before, Hodgson said.

"They have done enough to check the boxes, basically," Hodgson said.

Charles Elson, director of a corporate governance center at the University of Delaware, said the new pay plan could be followed by other banks because it reduces the discretion of the board, a sore point for bank investors.

"At a lot of these financial institutions, people distrust the board, so moving away from discretion makes some sense," Elson said.

The 2012 pay for Corbat, who was named CEO in October, was based partly on the new pay plan.

Corbat's $11.5 million payment was based on his work as CEO and on his prior performance as head of the Europe, Middle East and Africa region, the company said. The board's compensation committee noted that Corbat had quickly moved as CEO to finalize the 2013 budget, including a restructuring plan to save $1.2 billion a year.

Of the payment, $1 million is base salary, $4.18 million is cash bonus, $3.14 million is deferred stock and $3.14 million is in new "performance share units" which deliver cash payments depending on profits and stock performance compared with peers.

Pandit, who was pushed out as CEO in October, received a symbolic $1 in 2010 and $128,741 in 2009, far less than rivals, after the company received more than $45 billion of government bailout money over three rescues during the financial crisis.

Pandit was paid $15 million in 2011.

Citigroup did not disclose pay for other top executives. It did, however, say that "performance share units" valued at $3.14 million had been awarded to Manuel Medina-Mora, the co-president, and that $1.95 million of the units had been awarded to CFO John Gerspach.

For 2012, JPMorgan Chase (JPM.N) Chief Executive Jamie Dimon received $11.5 million, and Bank of America's (BAC.N) Brian Moynihan was paid $12.1 million.
And it's not just pension funds that are pressing for better corporate governance. John Carney of CNBC reports, World's Biggest Fund Blasts Corporate Governance Rules:
Norway's gigantic $650 billion sovereign wealth fund has just published an important note on what it expects in terms of corporate governance from the companies it invests with.

The sheer size of the fund, the world's largest sovereign wealth fund, makes its "expectations" influential. Its equity portfolio is worth $380 billion. The fund is a minority shareholder in more than 7,000 companies world wide. It says it is among the 10 largest shareholders in 2,400 companies and among the five largest in 800 companies. So when Oslo-based Norges Bank Investment Management—the groups that manages the fund—speaks, you can be sure people are listening.

NBIM is interested in protecting minority shareholder rights and board accountability, of course. But what makes the note so interesting is that it questions the popular idea of formalizing good governance into regulatory or legislative codes. Or even of attempting to apply a voluntary code of good governance across all companies.

"Such a perspective has led the firm to question the basis for the near-universal consensus in support of features appearing in corporate governance codes, given that NBIM finds gaps in academic evidence for many of them," writes Gavin Grant, the fund's head of active ownership, in an introduction to the NBIM note for the Harvard Law School Forum on Corporate Governance and Financial Regulation.

In other words, NBIM recognizes that codes cannot substitute for judgment, in part because different companies face a diversity of challenges that can justify a wide variety of governance structures.

From the note (emphasis mine):
The original 1992 UK code of good governance (by informal tradition referred to as the "Cadbury Code"), on which many subsequent national and international codes have been based, was not intended to lay down the law on how companies should be governed. It was, explicitly by design, a statement of recommended good governance practices. It was then for boards to implement in ways which made sense to them and to their shareholders. Corporate governance would then be correctly positioned as a contract between a company and its investors.

In the intervening twenty years, these well-founded best-practice recommendations have been somewhat corrupted – first into principles and then into hard and fast rules. This has largely occurred for reasons of expediency and convenience. It is also an outcome of international portfolio diversification and a tradition of global standards and benchmarks in other important areas of investment: accounting, financial reporting, financial ratio analysis etc. A separate corporate-governance lexicon has been created which is now technical and perhaps largely impenetrable to the generalist investor.

It almost goes without saying that this corruption from best practices to principles to hard and fast rules describes exactly the direction of corporate governance in the United States for the last decade or so. From Sarbanes-Oxley to say-on-pay, we've increasingly mandated and federalized corporate governance rules. Indeed, many self-styled corporate governance experts appear to regard "progress" in this area as synonymous with homogenization.

Norway's dissent from this movement is a welcome development.
Indeed, Norway is way ahead of of its peers when it comes to improving corporate governance. Large global pension and sovereign wealth funds need to exercise their collective power to shape and improve corporate governance.

Below, the California State Teachers' Retirement System (CalSTRS) wants Disney to strip its CEO Bob Iger of his chairman status. Jack Ehnes, CalSTRS CEO, discussed this on CNBC's Closing Bell.

And as pension funds look to strip Jamie Dimon of his additional title of chairman and overhaul bankers' pay, a group of mothers in Spain are stripping down to save school bus. Now that's what I call taking matters into their own hands! Enjoy your weekend. :)

Thursday, February 21, 2013

Worst Trade of the Year?

Jeff Cox of CNBC reports, Worst Trade of the Year? Bet Against Bond Market:
While going long the stock market has been a great trade so far in 2013, betting that the bond market would suffer as a result could be the worst.

True, equities in a broad sense have outperformed their fixed income counterparts.

But the so-called Great Rotation trade that many market professionals had been looking for has failed to show any signs of materializing.

"Redistribution is not the same as rotation," said Kevin Ferry, president of Cronus Futures Management in Chicago and a trader not in the Great Rotation camp.

Ferry's point is not an arcane one - indeed, it goes to the heart of whether the 2013 market will be driven by an accelerated risk-on trade that finally will fulfill all those prophecies that the bond bull market is over, or if the safety play remains viable for investors' portfolios even if the stock market grows.

(Read More: Money Pouring Into Stocks 'Is Usually a Negative Sign')

The rotation play holds that investors will reverse four years of money flowing out of equities and into bonds.

So far, flows show that only half that trend has occurred.

In the first month and a half mutual funds that invest in stocks have taken in a robust $43.8 billion, a post-financial crisis high. If the rotation theme held, it would be likely to see a similar amount come out of fixed income mutual funds.

Instead, bond funds have taken in $37.6 billion - less than equities to be sure, but still a strong allocation and not indicative of a pronounced move out of bonds and into stocks.

So where has the equity side gotten all this money?

Money market funds - the dead pool that became so popular after the crisis - have lost $37 billion so far, helping explain the boon to stocks, and revealing an investor mentality in which the stock market is seen as a much better store of wealth than the zero-yielding alternative.

This has been pretty much the whole idea as the Federal Reserve has rolled through three rounds of bond buying known as quantitative easing designed to force yields down so much that investors will have no other choice but to seek out risk.

"It works until it doesn't," Ferry said. "That's what QE does - it turns the capital markets into an ATM machine. As long as there's not an exogenous event, you're OK."

(Read More: Central Banks Gone Wild: What Can Investors Do?)

If there has been a rotation, in fact, it probably is more from safer fixed-income instruments such as the benchmark 10-year Treasury note into higher-yielding bonds such as corporate junk.

Broadly, bonds as measured by the Barclays Composite Index have returned about 3 percent in 2013, but Treasurys have lost 3.5 percent. Corporate high-yield has returned 1.3 percent, while dividend growth is up nearly 6 percent.

Conversely, the Standard & Poor's 500 stock market index has gained 6.5 percent.

(Read More: Spending Cuts Loom as 'No. 1 Threat' to Market)

Looking purely at fund flows, exchange-traded products have seen about $1.2 billion come into bond funds, but double that for higher-yielding riskier offerings.

Ferry said the bond market actually has performed efficiently this year, with yields rising but in tandem, indicating that the yield curve remains constructive.

Still, Bank of America Merrill Lynch, one of the loudest proponents of the Great Rotation, insists that the trade is only in its early days even if appearances suggest otherwise.

"The Great Rotation theme is risk supportive, but even assuming volatility stays low and the macro remains in a trading range, the best outcome is for equities and other risk assets is to grind higher in coming months," Michael Hartnett, BofA's chief investment strategist, said in a note.

The firm is bullish on high yield, neutral on government bonds in emerging markets, and bearish on government, investment grade and similar traditional safe-haven bets.

Bond dealers have $47.6 billion in short positions on Treasurys, the highest level since before the crisis, according to RBC.

Meanwhile, a BofA sentiment indicator is now more bullish than 99 percent of its readings since 2002, Hartnett said, and the firm itself, despite espousing the Great Rotation theme, believes that bonds are not heading for a crash.

The bearish levels on Treasurys and bullishness on stocks are both approaching contrarian levels, meaning that the unraveling of both trades could be near.

So investors looking to position for the times ahead by betting heavily on stocks in anticipation of money rolling out of bonds may want to hold off.

"The disconnect between weak economic fundamentals, ebullient investor sentiment and elevated stock prices form an unhealthy and potentially toxic cocktail," said Doug Kass, head of Seabreeze Partners. " I am as bearish on stocks as I have been in some time."
This article was written on Tuesday, right before markets got rattled by Fed policy concerns. Stocks and other risk assets got hammered on fears that the Fed is about to reverse course on its very accommodating stance.

Interestingly, bond yields hardly budged on Wednesday. The 10-year Treasury bond is still yielding close to 2% and there was no panic in the bond market. This just tells me that traders used the Fed minutes as an excuse to take profits on stocks. There was also a lot of high-frequency trading nonsense going on as volume was higher than usual.

I've seen these one-day selloffs so many times that they don't phase me in the least. I can assure you that the top funds I track every quarter (see my Q4 activity comment) couldn't care less of the "Fed minutes" and they were busy scooping up stocks as they're still long the reflation trade.

Importantly, financial journalists are too fixated on whether the US great rotation is a fairy tale, and ignoring actions elsewhere like Japan's great rotation. Top hedge funds look at global monetary policy and they've made a killing shorting the yen and going long risk assets.

Another shortcoming of just looking at mutual fund flows is that it ignores pension fund flows. Earlier this month, I discussed how pension assets hit an all-time high.  I recently corrected this comment to use the findings of the Towers Watson Global Pension Assets Study 2013, the latest available survey. it clearly shows that at the end of 2012, allocations to equities increased.

I place a lot more weight on pension fund flows than mutual fund flows. And most pensions think the bond party is over and are now shifting assets into stocks and illiquid alternatives, taking on more illiquidity risk.

Still, I will concede that shorting bonds has thus far been the worst trade of the year. To understand why, you have to understand the profound structural forces at play behind the titanic battle over deflation. As I stated in that comment, I'm far from convinced that the bond bull market has ended and see this 'titanic battle over deflation' playing out for several more years, leading to more volatility in the stock market.

Below, Dennis Gartman, founder, editor and publisher of the Gartman Letter, tells CNBC why he thinks the psychology of the markets has changed, and changed dramatically. I tell you, this bull market gets no respect. ignore the noise and doomsday scenarios of "sequestration." Focus on what top funds are doing, not what some strategists and portfolio managers are saying on CNBC and elsewhere.

Wednesday, February 20, 2013

Canadian Bank Chief Sounds the Alarm?

Grant Robertson of the Globe and Mail reports, Retirement savings system is falling short, CIBC boss warns (h/t, Susan Eng, VP Advocacy at CARP):
The head of one of Canada’s largest banks is proposing a dramatic overhaul of the country’s pension regime, arguing that average Canadians need more certainty and simplicity from their savings than existing investment tools provide.

Canadian Imperial Bank of Commerce chief executive officer Gerry McCaughey said Canada should reform the Canada Pension Plan to allow people to make voluntary contributions that are beyond what they already pay through their salaries.

The move could give many Canadians something they do not have with RRSPs and other investment vehicles tied to the markets: a predictable payout when they retire.

Much as Canadians understand exactly how long it will take to pay off their mortgage when they buy a house, average earners should have a pension system that helps them forecast how much money they will have at retirement, and allows them to accelerate their contributions, Mr. McCaughey said in a speech to the National Summit on Pension Reform in Fredericton on Tuesday night.

“It would give Canadians the choice to put aside more – a little at a time – with the confidence of clearly knowing what benefits it will bring,” he said. “It would improve the future of Canadians who choose to opt in – through forced savings and no withdrawals – over the arc of 40 years.”

The country faces a looming pension crisis. Persistently low market returns and the erosion of defined-benefit pensions in corporations are leaving many people, particularly those in low to medium income brackets, with less certainty about their future financial security. One analysis suggests that Canadians now in their late 20s and early 30s could see a 30-per-cent drop in their standard of living when they retire.

A stronger, easier-to-understand pension system is better for the economy, Mr. McCaughey said, which is ultimately better for banks. While he still advocates the benefits of RRSPs and tax-free savings accounts, he said CPP is more reliable and clear on how much it will provide, which encourages saving. “This is not a solution that addresses every problem and meets every need,” he said. “But it’s a … starting point that gets to the heart of what a large number of Canadians need most – and that’s certainty of outcome.”

Pushing for a greater focus on the federally run CPP is remarkable coming from one of Canada’s top bankers, since the sector derives considerable revenues from investment products such as mutual funds in RRSPs.

But the suggestion comes at a time when Ottawa is concerned about falling savings rates. As Canadian companies scaled back their pension offerings over the past five years, the federal government has laid the groundwork for the creation of Pooled Registered Pension Plans, or PRPPs, which are essentially private funds operated by financial institutions. Banks and insurance companies and other financial institutions are expected to offer them once they gain provincial regulatory approval. In December, federal Finance Minister Jim Flaherty said he would work with the provinces in 2013 on ways to expand CPP for all Canadians.

Mr. McCaughey believes CPP is the best vehicle for boosting retirement savings, since it promises a certain payout on a specified date (age 65, or 60 if taken early at a reduced amount) and the contributions are committed over a long period – meaning they can’t be withdrawn on a whim. This allows the funds to compound. However, banks cannot operate funds that deny customers access to their money, leaving CPP as the best option, he said.

Savings rates are falling in Canada, but home ownership is among the highest in the world. Mr. McCaughey believes this shows Canadians understand the value of putting money into a home.

“Canadians go into a mortgage knowing that if they keep up their end of the bargain – if they make their payments – they are, on a specific date in the future, going to own that home free and clear. So, over the long term, housing has proven to be an effective vehicle for future savings,” Mr. McCaughey said. “Why does the home ownership system work so well? Because Canadians understand it. It’s date-certain and amount-certain. It’s predictable and transparent. There’s good governance. And the outcomes are clear.”

CIBC economists predict that Canadians now in their late 20s and early 30s can expect, on average, a 30 per cent drop in standard of living when they retire, based on current savings rates.

“We’re not talking about the normal reduction in income that individuals typically see in retirement,” he said. “We’re talking about a real and significant decline in living standards as measured by consumption power,” Mr. McCaughey said.

“Today, for many Canadians, there’s a bigger emphasis placed on investing – on rates of return – than on the critical need to actually set aside money. Individuals are more focused on how they’re investing their money rather than on how much they’re putting away, and for how long.”
This is a stunning endorsement for expanding the Canada Pension Plan (CPP). I commend Mr. McCaughey for coming out and sounding the alarm on our failing retirement system. He raises excellent points which tells me he absolutely understands the gravity of the looming retirement crisis we face in Canada.

I hope his peers follow his lead and also come out in favor of expanding CPP. Once they do, the federal government can drop this silly PRPP solution they've been banking on and get back to the table with provincial finance ministers to reform the CPP.

Of course, some experts think forced, not voluntary contributions, are the way to move forward. Bernard Dussault, Canada's former Chief Actuary notes the following:
Voluntary contributions to the CPP would not produce an additional layer of CPP defined defined benefits but rather just additional savings subject for each voluntary participant to investment risks (eg low or negative returns and/or capital losses) for the rest of their life.

Still, we desperately need to reform the CPP. Those of you who read my blog regularly know I'm worried about Canada's perfect storm. Through prudent bank lending standards and exports to China, we've been lucky to escape the worst of the US financial crisis. But that doesn't mean we have conquered cyclical downturns and I'm worried we're due for a whopper in the coming years led by the downturn in housing.

Imagine there is a severe contraction in housing and prices start plummeting.  Hopefully I'm wrong but this would create a significant negative wealth effect on Canadian households. The problem now is most young Canadians can't save enough because they're putting a huge portion of their disposable income to paying off their (overvalued) houses. They simply aren't diversifying their savings properly.

I raise this issue because this is exactly what happened in the United States and according to Brendan Greeley of Bloomberg Businessweek, U.S. Homeowners Are Repeating Their Mistakes:
If there’s one thing Americans should have learned from the recession, it’s the importance of diversifying risk. Middle-class households had too much of their net worth tied up in their homes and were too exposed to stocks through 401(k)s and other investments.

Despite the hit many Americans took, there’s little sign they’ve changed their dependence on homes as the mainstay of their wealth. Last year, Christian Weller, a professor at the University of Massachusetts, looked at Federal Reserve data for households run by those over 50. The number of families with what Weller calls “very high risk exposure”—a low wealth-to-income ratio, more than three-quarters of their assets in housing or stocks, and debt greater than a quarter of their assets—had almost doubled between 1989 and 2010, to 18 percent. That number didn’t decline during the deleveraging years from 2007 to 2010; its growth just slowed to a crawl.

The Fed will conduct a new wealth survey in 2013, but don’t look for a rational rebalancing. The same pressures that drove families to save less before the recession are still in place: low income growth, low interest rates, and high costs for health care, energy, and education. Families have been borrowing less since 2007, but the rate of the decline has slowed. As soon as banks start lending again, Weller says, people will put their money back into housing. “The trends look like they’re on autopilot,” he says. “They don’t suggest that people properly manage their risk.”
Indeed, people do not know how to properly manage their risk, which is another reason why we need to introduce forced savings into the equation and have that money managed by professional pension fund managers.

In my last comment on America's new pension poverty, I raised the key reasons why we need to expand large, well governed defined-benefit (DB) plans to provide secure retirement and combat old age poverty. In particular, cited the following reasons:
  • Unlike defined-contribution (DC) plans, DB plans guarantee a payment to retirees based on years of service and contributions. This means someone about to retire is not vulnerable to the whims of the market at the end of their career, jeopardizing their retirement dreams.
  • Large, well governed DB plans are able to pool resources and significantly lower costs and fees. Moreover, they are able to invest directly and indirectly in public and private markets using their own investment managers or through the best public, private equity and hedge funds in the world.
  • The long investment horizon of large pension plans is what gives them a significant advantage over mutual funds and other funds that face pressures to deliver returns on a much shorter investment horizon.
I also raised the following points on productivity:
Economists talk about productivity as the key determinant of the wealth of a nation but few talk about how having a good job with great benefits actually enhances productivity. I don't care if it's Microsoft, Google, Costco or Ford, companies that take care of their employees are the ones that thrive in an ultra competitive environment.

But because most companies cannot offer defined-benefit plans -- and indeed those that do offer them are cutting them to new employees -- I argue that the government should step in and create large, well-governed defined-benefit plans that covers all citizens. Let businesses worry about business, not pensions. This way workers can have portable pensions and are not at risk if a company goes under. It's logical and makes good economic sense for the long-term fiscal health of any nation.
I realize that some of you may disagree or dismiss my views as "Marxist, communist propaganda which tries to nationalize pensions." Nothing can be further from the truth. I'm more conservative and pro-business than Prime Minister Harper's staunchest allies but when it comes to setting out good economic policy for the long-run, I know what makes sense and what is pure rubbish. 

Once again, I applaud Mr. McCaughey for demonstrating true leadership and sounding the alarm on our failing retirement system. Hope all leaders from the six major Canadian banks come out to support expanding the CPP.

By the way, just so you know, CPPIB, the fund that invests on behalf of more than 18 million contributors and beneficiaries of the Canada Pension Plan reported gross investment returns of three per cent in its fiscal 2013 third quarter. CPPIB is also planning for the future:
The CPP Investment Board, with headquarters in Toronto and offices in London and Hong Kong, is a professional investment management organization that invests the funds not needed by the Canada Pension Plan to pay current benefits.

In the latest triennial review released in November 2010, the chief actuary of Canada reaffirmed that the CPP remains sustainable at the current contribution rate of 9.9 per cent throughout the 75-year period of his report. That includes the assumption that the fund will attain an annualized four per cent real rate of return.

The 10-year annualized nominal rate of return of the fund currently is 6.7 per cent, although the five-year rate is 3.1 per cent.

The latest chief actuary report also indicates that CPP contributions are expected to exceed annual benefits paid until 2021, providing an eight-year period before a portion of the investment income from the CPPIB will be needed to help pay pensions.
I've said it before and I'll say it again, Canadians are lucky to have some of the world's best public pension funds, true global trendsetters. We have everything it takes to significantly improve our retirement system. All it takes is political will and the backing of influential lobbies, like the banking and insurance lobbies.

Below, Global's Mike LeCouteur reports on the last meeting where provincial finance ministers gathered to plan a way to force Canadians to put away more for retirement. Let's see if the grinches who stole CPP's Christmas finally do what's right for Canada's retirement system.