Tuesday, May 31, 2016

Memo To Mark Machin?

Andrew Willis of the Globe and Mail wrote a tongue-in-cheek comment, Memo to Mark Machin: Here's Your To-Do List at CPPIB:
After 11 years at Canada Pension Plan Investment Board, CEO Mark Wiseman is handing the reins to the fund’s head of Asian investments, Mark Machin, effective June 13. The changing of the guard at the $279-billion fund comes as federal and provincial finance ministers prepare to gather in Vancouver later in June for talks aimed at enhancing CPP coverage. Against that backdrop, here’s the note Mr. Wiseman should leave for his successor:

To: Mark #2

From: Mark #1

Subject: CPPIB handover

Welcome to the top of the mountain! Well, the top of the heap in Canada. We both know I’m heading to the Mount Everest of funds at BlackRock, where they measure assets in trillions, not mere billions.

You’re probably arrived with a fancy 100-day plan for shaping CPPIB in your own image. I’ve got two pieces of advice that I humbly suggest will determine your success at CPPIB and, frankly, my legacy.

First: Get our house in order. CPPIB costs are too high. You know how that weighs on long-term performance. This needs to be a priority, because those holier-than-thou types at the Fraser Institute are all over us.

Second: Make CPPIB a true national resource. The good news on this front is you’ve got a unique opportunity, because the new guy in Ottawa is a pension fund geek who believes that bigger is better when it comes to money management. The bad news: Finance Minister Bill Morneau can be a bulldozer and he knows our business cold.

Oh, and as an aside, Beaudoin at Bombardier is going to ring you every morning to beg for a billion bucks. Just forward the call to Sabia at the Caisse.

On costs, you know I spent huge amounts of energy trying to streamline the fund. I didn’t do enough. You saw that Fraser Institute study: As a percentage of assets, CPPIB expenses are far higher than any of the big Ontario pension funds. Our costs are close to twice those of my old shop, Ontario Teachers, and our 10-year performance trails Teachers. Badly.

Running the CPPIB when we’re growing explosively is tons of fun. In less than two decades, we’ve gone from zero to 1,266 employees in seven countries. We’re running 25 distinct investment strategies. And we’re hanging with all the cool kids: We paid out $1.3-billion last year to external managers, and we have 219 global partners.

But the Fraser Institute is making things awkward by saying: “Developing intricate investment strategies and opening branches around the world may create a more interesting work environment for managers, but this does not guarantee the rate of return that results from higher efficiency and lower costs.”

You need to figure out if lower expenses come from moving assets to internal teams, or fewer, smarter strategies, or slashing fees paid to those legions of external managers. But CPPIB must act. Chairperson Heather Munroe-Blum defended CPPIB’s expenses in the 2016 annual report by explaining that the fund is investing for the future. But she also said the board and management “are committed to realizing efficiencies in CPPIB’s operations to help ensure expenses are appropriate.”

And wait till those Fraser Institute purists chew through that 2016 annual report and realize CPPIB board members voted themselves an 86-per-cent raise over the next two years.

Once you’ve got a handle on CPPIB expenses, you can dream big. The Finance Minister wants to beef up CPP benefits, and as long as they can find someone else to shoulder the cost, every provincial premier wants to deliver a bigger pension payment to aging voters who forgot to open RRSPs.

Recall that back in 2012, when he was still an obscure benefits consultant, Morneau wrote a white paper for the Ontario government that recommended smashing together over 100 smaller public-sector pension plans to create one monster $50-billion fund. He argued that approach could potentially improve investment returns, while saving $100-million annually by cutting costs.

In the pension fund world, that Ontario report was hugely controversial, in part because it proposed saving money by cutting reams of white-collar jobs. Morneau knew that he’d be attacked for that recommendation, and he wasn’t fussed. The politicians didn’t follow through back in 2012, but timing is everything in politics.

Morneau also had a politically sensible approach to consolidating fund managers. When he was working for Ontario, he recommend creating a pooled fund framework, similar to the Caisse in Quebec, and successful provincial funds in Alberta (AIMCo) and British Columbia (bcIMC). Different employers and unions contribute assets and one central manager invests all the money.

CPPIB could be that national pooled fund, drawing additional capital to pay for enhanced CPP benefits, plus adding assets from small funds that want access to global expertise. If Morneau sets this goal, he’s got the smarts and stamina to get there. Be warned: he’s shown that he’s willing to jettison those who stand in his way.

So here’s my advice: CPPIB needs to get more credible on expenses. Then you need to be a central player in the debate on how to provide Canadians with a better retirement. Do both and you make me look like a moron for going to BlackRock.
Although this comment was written tongue-in-cheek and was meant to be humorous, it propagates the exact same myths other lazy and clueless journalists from rival newspapers propagate.

Here's what I think happened. Andrew Coyne and Andrew Willis met up at some pub in Toronto recently to exchange notes over a few beers:
To: Andrew #2

From: Andrew #1

Subject: CPPIB's Bloated State

Hey, did you read my hatched job on CPPIB's bloated state? Some blogger in Montreal with a funny sounding Greek name ripped it apart but most clueless Canadians don't read his blog. I think you should follow up and keep spreading myths on the costly CPP using that sham report from the grossly biased Fraser Institute which loves to question whether Canadians are getting a good bang for their CPP buck.

Never mind if that report was deeply flawed and discredited by real pension experts at CEM Benchmarking, the Fraser Institute sounds so Canadian, so reputable that the enlightened readers of the National Post and Globe and Mail will lap it up and keep asking for more.

Nothing gets regular hard working Canadians going more than reading about how much money Canada's pension plutocrats are raking in even if they are delivering long term results. Never mind CPPIB's fiscal year 2016 results which were actually much better than the headline number suggests as it gained 3% and recorded a record year with $11.2 billion of net dollar value-added compared to the Reference Portfolio of public market indexes which experienced a -1.0% decline. According to me, that Reference Portfolio is a fraud and active management is a fraud too, so better off just indexing everything and pray to God we never have another 2008 ever again!

Oh, throw in something about CPPIB's Board jacking up their compensation. We all know they aren't accountable to anyone (except the federal and provincial governments).

What else? Compare the long-term results of CPPIB with those of Ontario Teachers and highlight how "badly" they performed on a relative basis even if you're comparing apples to oranges. Also, make no mention that since implementing active management strategies, CPPIB has generated cumulative value-added over the past 10 years which totals $17.1 billion, after all CPPIB costs and more importantly, CPPIB’s 10-year annualized net nominal rate of return of 6.8%, or 5.1% on a real rate of return basis, was comfortably above the Chief Actuary’s 4.0% real rate of return target over that period.

Also, throw a bone to Bill Morneau, he's working hard trying to fix our pension system by finally doing the right thing and enhancing the CPP once and for all since RRSPs, TFSAs and defined-contribution plans are a total and utter failure (Actually, scratch that, we don't want to piss off banks, insurance companies and mutual funds making an honest living milking Canadians dry on fees as they deliver mediocre returns based on schizoid public markets).

So here's my advice: keep harping on the CPPIB and some day you'll be a moron like me and make regular appearances on national television sounding really smart even though I haven't the faintest idea of what I'm talking about!!
I can go on and on but it's a nice day and I have a lunch to enjoy with someone who appreciates my blog and actually subscribes to it.

That reminds me. My memo to Mark Machin and the rest of the leaders of Canada's Top Ten: Your subscriptions are due and while I appreciate your financial support (at least from some of you), I think I'm worth a hell of a lot more. I feel like the Rodney Dangerfield of pensions; either that or I'm the biggest pension moron of all.

Below, once again, Leo de Bever, the former head of the Alberta Investment Management Corporation, discusses why it makes sense to appoint Mark Machin as the new head of CPPIB. Listen very carefully to Leo's comments as I think this is one of his best interviews ever (watch it here if it doesn't load below).

Monday, May 30, 2016

The Ultimate Diversifier?

Joe Davis of Vanguard wrote a very interesting comment, By this measure, bonds have never been more valuable:
Global bond yields hover near all-time lows. In the United States, a 10-year Treasury note yields less than 2%. In Europe and Japan, the bond markets have tumbled through the looking glass into a world of negative interest rates. About 40% of European government bonds yield less than 0%. In Japan, the figure is 70%.

The prospect of low to negative returns on government bonds has raised doubts about their value. Why hold an asset that yields almost nothing (or less than nothing)? Why take on any price volatility if you can stash cash in a safe?

The doubts are understandable. Return is the most salient feature of any asset class, and it’s hard to get happy about 0%. In an asset allocation framework, however, return has different dimensions. And by one critical measure in mean-variance optimization, which weighs both return and risk, high-quality government bonds have never been more valuable.

Portfolio specs

Building a multi-asset-class portfolio appropriate to a given goal and risk preference depends, primarily, on the following three characteristics of each asset:
  • its expected return
  • the expected volatility of those returns
  • the correlation of the asset’s return with those of other assets (i.e., its covariance)
The low yields of U.S. Treasury bonds imply that their expected returns are exceedingly modest. We expect the volatility of government bonds to remain consistent with recent trends. But government bonds’ correlation with stocks suggests that their diversification power has never been stronger. And under some simple assumptions, this higher diversification value offsets the lower expected returns on government bonds. Period.

The chart below displays the correlation between monthly percentage changes in the price of the S&P 500 Index and changes in the yield of the 10-year U.S. Treasury note. The blue line displays correlations over rolling five-year periods. The data come courtesy of Nobel laureate Robert Shiller (click on image below).

Since 1871—yes, almost back to the American Civil War—the correlation between changes in stock prices and changes in bond yields has averaged 0%. Over the past five years, the correlation has averaged –0.6%, the lowest in U.S. history.

In portfolio construction, assets with a strongly negative correlation to other portfolio assets are the Holy Grail. They rally when other assets retreat. This relationship was especially visible at the start of 2016. The U.S. dollar is the world’s reserve currency, making U.S. Treasuries the destination of choice in a flight to quality. And when global stock prices tumbled earlier this year, intermediate-term Treasury bonds rallied.


Data: Shiller, correlation between monthly percentage changes in S&P 500 and inverse monthly difference in 10-year yields.

What explains the unusually negative correlations? The correlation between stocks and bonds changes through time. It has tended to rise in periods of higher-than-expected inflation, as in the stagflationary late 1970s and early 1980s, when both stocks and bonds retreated. Stock-bond correlations in the United States have tended to fall in periods of slow growth and deflationary fears, the environment that has prevailed over the past few years. Our outlook suggests that such conditions are likely to persist in the years ahead.

A reassessment

My colleague Fran Kinniry has called high-quality bonds the Rodney Dangerfield of investments. Like the late comedian, they get no respect. And as yields have crept lower, their status has declined. But that drop in status is undeserved. Successful portfolio construction is not just about return. It’s also about diversification. And at the moment, the data indicate that no asset boasts more potent diversification power—and more potential to protect a portfolio in a stock market downturn—than U.S. Treasury bonds.

Notes:

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
I've been meaning to write a comment on the ultimate diversifier for a long time. Why do I call US governments bonds the ultimate diversfier? Because even though some strategist claim deflation is dead, I see it very much alive everywhere outside the United States and that is a very bullish for US government bonds.

How should people think about bonds? A few very brief points:
  • Bond yields move inversely with bond prices. As fears of inflation pick up, yields on US government notes (10, 20, 30 year government bonds) will rise and their price will fall.
  • The longer term bond prices swing much more than shorter term ones because there is a lot more uncertainty the further out you go into the term structure. The Fed's decision on rates impacts short term bonds, inflation expectations are what matter most for long term bonds.
  • If you believe the global recovery is gaining steam and that inflation expectations are picking up everywhere, then you should be hedging inflation risk by buying Treasury Inflation Protection Securities (TIP).  
  • Conversely, if you believe that deflation headwinds are picking up all over the world, you should be buying nominal US government notes (TLT) to hedge against deflation and deleveraging, not to mention a possible market crash
  • If you want more bang for your bond buck in a deflationary world, you can buy zero coupon bonds like the PIMCO 25+ Year Zero Coupon US Trs ETF (ZROZ) or the Vanguard Extended Duration Treasury ETF (EDV) but you need to understand what zero coupon bonds are, the difference between them and regular bonds and the risks associated with these investments
  • If you think everything is just fine and we're in a period of low inflation and modest growth, then you can take more risk and follow high rollers flocking to the 'HYG Hotel' in record numbers. High yield bonds (HYG or JNK) are basically a call on the economy; when it does well, they do well and offer a very nice yield too. They act a lot like high dividend stocks (DVY or VYM) and are very sensitive to changes on interest rates or fears of a market jolt (in a Risk Off environment, they get clobbered hard, just like stocks).
Now that I got those brief points out of the way, I want to come back to bonds as the ultimate diversifier in a deflationary world.  On Friday, I discussed hedge funds' day of reckoning and went over structural factors that are impacting the performance of most hedge funds.

One thing I keep noting is all these billions chasing alpha, investing in hedge funds and private equity funds, are inadvertently ensuring that future returns will be mediocre or modest at best.

Importantly, if you calculate the aggregate net IRR after all fees of hedge funds and private equity funds as assets under management mushroomed, you'll see the performance has declined quite drastically.

Of course, some funds are doing much better than others but even elite funds can't magically create returns in a world where ultra low rates or negative rates are here to stay (unless they crank up the risk and expose themselves to blow-up risk).

This is why most Canadian pensions are investing in real estate and infrastructure to capture steady returns over a very long period but in doing so, they're driving the valuations of these assets up and taking on ever more illiquidity risk.

This is why when Ontario Teachers' CEO Ron Mock went over their 2015 results, he specifically noted  that "privates kicked in last year but a few years back, it was bonds that kicked in." Ron emphasized a total portfolio approach and he understands the important role of bonds in a pension portfolio.

It's all about maximizing your risk-adjusted rate-of-return. Bonds protect against downside risk like no other asset class when it hits the fan. And this is why Ron Mock and HOOPP's CEO Jim Keohane keep emphasizing the importance of path dependency for pensions which are trying to reach fully funded status like their plans have achieved.

If you are a chronically underfunded pension plan taking ever more risk in hedge funds and private equity funds, stocks and corporate bonds, you can make money but if you suffer another drawdown like in 2008, you're basically toast (just like an individual who loses 50% in a stock and has to make 100% to get back to to even).

Again, go back to read my comment on building on CPPIB's success where I discuss the total portfolio approach and recommend books like like William Bernstein's The Four Pillars of Investing and The Intelligent Asset Allocator. Smart portfolio construction, diversification and rebalancing are the key to long term investment success.

Lastly, it is Memorial Day, US markets are closed and I wasn't going to write anything but I wanted to bring your attention to an article by CNBC's Gina Gusovsky,
LinkedIn and other tech companies investing in military veterans:
The unemployment rate for veterans who served on active duty since September 2001 hovers at around 5.8 percent, which is higher than the national average of 5 percent. And even when employed, about half of veterans leave their first jobs after the military within a year of transitioning home and 65 percent within two years, according to a survey on job retention among veterans.

These statistics are encouraging veterans and advocates to focus on a smoother transition from military to civilian life. Medal of Honor recipient and retired Army Captain Florent Groberg has partnered with LinkedIn to encourage more hiring managers to pay attention to the skills that veterans have to offer.

"Our veterans program is about how many vets we can empower to find employment," Groberg said.

Currently, the technology sector is a big part of this mission, both in the networking platform and ultimate work placement.

Groberg told CNBC that the program will assist around 100,000 veterans this year with free premium subscriptions to LinkedIn.

"What I learned after many failures is that networking is the solution."

Promoting veteran candidates within the technology industry specifically was the focus of a recent hearing on Capitol Hill, which included representatives from Microsoft, Amazon and Uber testifying about their respective companies' opportunities for veterans.

Ohio Congressman Brad Wenstrup, Republican and Chairman of the Subcommittee on Economic Opportunity, Committee on Veterans' Affairs, said that he was highlighting the tech industry specifically because the "flexibility these jobs offer, as well as the skills needed to be successful in these careers, make veterans an obvious fit for these positions and trades."

Bernard Bergan, technical account manager at Microsoft and a veteran himself, told the committee that "it is past time for industry, government and nonprofit leaders to give back to our veterans."

Microsoft's goal is to train and find IT careers for 5,000 service members over the next five years, Bergan said.

Amazon pledged to hire 25,000 veterans in the next five years, and Uber said the company had already fulfilled its goal of employing 50,000 veterans.

The need for veteran candidates extends far beyond the tech sector, though, and that is something that America's largest nonprofit health-care system, Ascension, acknowledged as well.

Ascension CEO Anthony Tersigni told CNBC that the company currently has 2,000 employees who are veterans. "Right now in many parts of the country the veterans are most vulnerable," Tersigni said. "We understand that veterans have different needs than some of our other patients, and we want to have a better understanding of them and so we want to engage those veteran organizations and the veterans themselves."

Groberg said that regardless of the industry or sector, finding better employment opportunities for veterans and retaining them in these jobs will only occur by helping veterans build a professional identity, a professional network and professional skills in a civilian career.

Florent Groberg has already met with companies, including IBM, Google, HP and JPMorgan Chase, to help them better understand how to best serve veterans in their time of transition.

"I go in there, and I talk to them about what we can bring to corporate America as service members, because the skills that allowed us to be successful in the military are transferable to corporate America," Groberg said.

The survey on job retention among veterans, conducted by Syracuse University's Institute for Veterans and Military Families and VetAdvisor, found that respondents employed in their preferred career field reported longer average job tenure.

"I think we can be successful in any sector if given the right opportunities and the right mentors."
My grandfather after whom I was named left Crete when he was 17 to go work in the United States. He fought with the US Army in World War I and then returned to Crete to settle down and have a family. After he died, my grandmother in Crete continued receiving a decent  pension from the US Army which covered her basic needs. I remember her telling me how proud he was of his service, how thankful she was for that pension and how good the United States was to her and my grandfather.

Taking care of US veterans, many of whom are disabled and/ or suffer from mental illness, should be priority number one for any US government and Corporate America. Period. It's nice to hail soldiers as heroes when they go off to fight for their country but it's more important to treat them like heroes when they come back by creating employment programs that specifically target them.

When it comes to diversity in the workplace, I'm a stickler for concrete action and solid programs which target women, visible and ethnic minorities, the disabled, veterans and any group which has a much harder time finding suitable employment in this cutthroat world focused on "profits at all cost," ignoring the human and social responsibilities companies have to protect the rights of disadvantaged groups.

If you are a CEO of a bank or major corporation, a public pension fund or some huge hedge fund and private equity fund, always ask yourself: "Are we doing enough to diversify our workforce?". I guarantee you the answer is "no" and that there is a lot more work ahead (a good starting point is to look at what the Royal Bank is doing in terms of diversity and inclusion but even it can do a lot more at all levels of its organization...others are much, much worse).

Below, CNBC's Dina Gusovsky reports on how the jobless rate for military veterans and their struggles in return to civilian jobs have created a critical mission.

Last year, Blackstone CEO Steve Schwarzman talked to CNNMoney's Cristina Alesci about how hiring veterans has been good for the firm and veterans alike. Listen to his comments.

Third, ABC's Bob Woodruff reports on the remarkable story of the unbreakable bond between Navy SEALs and their combat interpreter Nguyen Hoang Minh. I love this story, it epitomizes the best in humanity and gives me hope that there are still many decent people out there doing the right thing.

Lastly, Sebastian Junger has seen war up close, and he knows the impact that battlefield trauma has on soldiers. But he suggests there's another major cause of pain for veterans when they come home: the experience of leaving the tribal closeness of the military and returning to an alienating and bitterly divided modern society. Watch his powerful Ted Talk below, it is truly excellent. 




Friday, May 27, 2016

Hedge Funds' Day of Reckoning?

Scott Deveau and Devin Banerjee of Bloomberg report, Hedge Funds May Lose 25% of Assets, Blackstone’s James Says:
The $2.9 trillion hedge-fund industry may lose about a quarter of its assets in the next year as performance slumps, said Tony James, Blackstone Group LP’s billionaire president.

“It’s kind of a day of reckoning that we face here,” James said Wednesday in an interview with Bloomberg TV Canada’s Pamela Ritchie at a conference in Toronto. “There will be a shrinkage in the industry and it will be painful. That’s going to be pretty painful for an awful lot of places.”

The hedge-fund industry is having its worst start to a year in performance and investor withdrawals since global markets reeled after the financial crisis. Third Point, the hedge-fund firm founded by Dan Loeb, last month said the industry is in the first stage of a “washout” after “catastrophic” results this year.

Hedge funds have lost 1.8 percent this year, according to Hedge Fund Research’s global index, the poorest performance since 2008. The industry had net outflows of $16.6 billion in the past two quarters, the most since 2009, according to HFR. In 2015, 979 funds closed, more than any year since 2009, according to the research firm.

Performance Concern

Blackstone is the largest allocator to hedge funds globally, and the New York-based firm also provides startup money to managers and buys equity stakes in hedge-fund firms. Results in its hedge-fund business are better than the industry average, James said, though performance generally remains a cause for concern.

“We’re definitely worried about what’s going to happen in the hedge-fund world right now,” he said, speaking at the Canadian Venture Capital and Private Equity Association’s annual conference.

Hedge-fund managers have been stymied by central bank stimulus worldwide, declining trading volumes and markets marked by wide swings in prices. Carlyle Group LP’s David Rubenstein said this month he was surprised that “so many macro people got it wrong.” Carlyle owns three hedge-fund firms and last week said Mitch Petrick, the head of the unit that houses the firms, stepped down.

James said hedge funds may be expected to under-perform the stock market during a bull run because they’re hedged to reduce volatility. Blackstone’s fund of hedge funds has about one-fifth of the volatility of the stock market and about 65 percent of the upside, he said.

“For a while that’s a good trade for them,” James said of investors in hedge funds. “But the longer that bull market goes, they fall further behind. Pretty soon, they don’t like that trade anymore.”

‘Unbelievable’ Compensation

James also called out hedge-fund managers for the fees they charge, which are typically 2 percent of assets annually and 20 percent of investment profits -- a structure he said “is hard to justify these days.” Billionaire Warren Buffett last month described such fees as “a compensation scheme that is unbelievable,” and Bill Gross of Janus Capital Group Inc. said on Twitter: “Hedge fund fees exposed for what they are: a giant ripoff.”

Tudor Investment Corp., one of the oldest and most expensive hedge funds, is trimming fees, according to a letter sent to clients this week. The $11.6 billion firm, run by billionaire Paul Tudor Jones, will reduce fees for a share class that contains most of its biggest fund’s money to 2.25 percent of assets and 25 percent of profits starting July 1. That’s down from 2.75 percent and 27 percent.

“We’re talking about three years of under-performance, the fact that investors pulled $1 billion of capital and already a 2-and-20 fee structure which is under duress,” Ilana Weinstein, the chief executive officer of IDW Group, which recruits investment professionals for hedge funds, said of Tudor. “Investors aren’t really excited about a slight discount for crappy performance.”

“There’s going to be a real weeding out of hedge funds,” she said Wednesday on Bloomberg TV.

Crowded Business

Blackstone in 2014 embarked on a new strategy to bring some traders in-house. The move has been enabled by a talent drain coming out of banks and other institutions, James said, where proprietary trading has been hampered by regulation after the financial crisis.

“We take these really remarkable talent and we can pick just a couple dozen out of thousands out there and put them in business,” he said. “They’re actually working for themselves yet we’re the ones who give them capital, tell them what they can and can’t do.”

His comments contrast with those made earlier this month by billionaire trader Steve Cohen, who said he’s “blown away by the lack of talent” in the industry.

Cohen, who spoke at the Milken Institute Global Conference in Beverly Hills, California, said the business has “gotten crowded” with too many managers following similar strategies. Hedge funds seem to think that by hiring skilled people, they can “magically” generate returns, he said.

Blackstone had $68.5 billion dedicated to hedge funds as of March 31, and the business produced $244 million in economic income, which includes realized and unrealized gains and losses, in the past year, down 35 percent from the previous 12 months. The alternative asset manager, run by James and CEO Steve Schwarzman, oversaw $344 billion in real estate, private equity holdings, credit assets and hedge funds at the end of the first quarter.

Peter Grauer, chairman of Bloomberg LP, the parent of Bloomberg News, is a non-executive director at Blackstone.
When Tony James talks about a solution to America's retirement crisis, peddling a "revolutionary retirement plan" which he conceived with Teresa Ghilarducci of the New School of Social Research, I tune off because it's another sham of a plan which will benefit Wall Street and do nothing to address America's looming retirement crisis.

But when he talks hedge funds, private equity and real estate, I do listen carefully as he knows what he's talking about. Blackstone is an alternatives powerhouse and one of the largest allocators to hedge funds globally with $68.5 billion dedicated to hedge funds as at March 31, 2016.

The other global juggernaut when it comes to hedge funds is Man Group, one of the world’s largest independent alternative investment managers and a leader in liquid, high-alpha investment strategies with $78.6 billion assets under management (as at 31 March 2016).

Interestingly, while shares of Blackstone (BX) have recovered a bit from their lows, Man Group's shares hit an 18-month low recently as worries grew about a slump in AHL funds:
Citigroup downgraded Man from “buy” to “sell” on concerns about AHL, the trend-chasing funds that make up about a quarter of its assets under management and are estimated to provide more than half of the group’s earnings.

AHL Diversified is down nearly 14 per cent since mid-February and is about 15 per cent below the high water mark that it reached in March 2015, below which Man does not earn performance fees.

“Without AHL, performance fee generation looks challenged — there is little help elsewhere,” said Citi.

It forecast Man’s 2016 profit to slump 43 per cent, based on a 70 per cent reduction in performance fee revenue.
Not surprisingly, nearly four in ten Man Group investors voted against remuneration:
Shareholders at the hedge fund Man Group have hit out at the firm’s executive pay for the second year running, in the latest in a growing list of City rebellions about remuneration this year.

Around 37pc of the investors who participated cast their vote against Man Group’s remuneration report, which gave chief executive Manny Roman nearly $5.4m in pay and perks, up from $5.1m.

Mr Roman was awarded 83.3pc of his maximum bonus, which was not tied to profits but was based on targets such as integrating newly-acquired parts of the business, cutting costs and rejigging the firm’s reporting framework.

Ten percent of shareholders also voted against the reappointment of Phillip Colebatch, the non-executive director in charge of setting remuneration.

The board said it takes shareholder views into account when setting pay policies “in the light of the changing market place and Man Group's evolving strategy and development”.

“We will continue our efforts to engage with our shareholders and take account of their views in the coming year,” they said.

The protest vote comes a year after shareholders spoke up against Man’s pay policy. The firm’s first ever binding vote on future pay was passed and the board adopted the new targets, despite a 43pc vote against it in May 2015.

Man Group gave its chief executive Manny Roman a 10pc pay rise for the coming year, saying that he had not seen his $1m salary increase since he joined five years ago.
You will recall Mr. Roman was mentioned in my comment on the list of highest-paid pension fund CEOs where their compensation was outstripping his. Man Group's board rectified this "gross injustice" but the problem is Man Group isn't delivering the results that Canada's large pensions are delivering even if they have captive clients.

So when people ask me why is Mark Wiseman leaving CPPIB to go work at Blackrock,  I tell them because he's very good at what he does, led a team that has delivered great long and short-term results, and he seized the opportunity to go work at the world's largest asset manager.

Sure, he will be compensated well at Blackrock and make a lot more money than he did at CPPIB but only if he delivers on the bottom line. Blackrock isn't a charity, it's a private company focused on profits and Mark Wiseman knows he has to deliver or else he's out.

Anyways, back to hedge funds. Steve Cohen laments that he's "blown away by the lack of talent" but the problem may not be the lack of talent, but the lack of opportunities for emerging hedge fund managers who want to start their own shop.

There are important structural changes going on in the hedge fund industry that you all need to bear in mind:
  • The bifurcation of the industry continues unabated: This has been going on for years. The bulk of the money is going to large, well-known hedge funds which are tracked and recommended by pretty much every consultant. The big shops have big teams to take care of compliance, making it easier for them to address regulatory issues and garner huge assets from pensions and sovereign wealth funds. It shouldn't surprise anyone that Ray Dalio's Bridgewater Associates just passed the $100 billion mark in hedge fund assets, that he took home $1.4 billion last year or that Bridgewater will receive a $52 million economic assistance package from Connecticut to create jobs and expand its current locations in Westport, Wilton and Norwalk (unbelievable!). 
  • Crowding matters a lot more now: As the industry grows, more and more hedge fund managers are betraying their glory days with group think, engaging in the same strategies and trades and this crowding often leads to disastrous outcomes. Crowded trades are a direct consequence of too much money chasing limited opportunities which is why returns are suffering. This is why Goldman Sachs thinks hedge funds lost their magic and insurers are redeeming from them. Interestingly, according to bond manager Jeffrey Gundlach, Jim Chanos, founder of Kynikos Associates, is the best hedge fund manager because he’s permanently bearish and avoids the group think that led others in his industry to lose money last year (no doubt, Chanos is one of the great ones).
  •  Fees are going to come down hard: I don't care if you're Paul Tudor Jones, Ray Dalio, Jim Simons, Ken Griffin, or Steve Cohen, in a deflationary world -- and make no mistake, deflation isn't dead -- fees matter a lot more which is why 2 & 20 is dead and never coming back. Institutional investors are onto the hedge fund scam and are totally fed up of paying outrageous fees so they can enrich hedge fund billionaires that receive payouts fit for a king no matter how well they perform. And we're surprised that hedge funds are under attack or that people are openly discussing divorcing your hedge fund manager and asking why they still exist?
  • Deflation will roil hedge funds: This is especially true for the large shops which have become nothing more than glorified asset gatherers charging alpha fees for leveraged beta. They're going to be unable to cope with deflation, negative rates, huge volatility in public markets, and their returns are going to suffer considerably in the years ahead.
  • Big investors are starting to shun hedge funds: For all these reasons, large sophisticated investors are giving up on hedge funds and even private equity funds, preferring to invest huge assets directly in infrastructure, an asset class that offers stable returns over a long period, better matching their long dated liabilities. Why pay a few hedge fund hot shots 2 & 20 or even 1 & 15 when you can directly invest huge sums in infrastructure and have a better chance of delivering on your actuarial return target without the negative press that goes with hedge funds?
Cambridge Associates recently asked, Is the Hedge Fund Heyday Behind Us?, to which I can unequivocally reply: "You better believe it is!". Susana Rust of Pensions & Investments Europe reports, Fees make most hedge fund portfolios 'bad investments':
The vast majority of institutional investors’ hedge fund portfolios underperform simple investable benchmarks, with fees responsible for making most hedge fund portfolios “bad investments”, according to a study.

The study, carried out by Canadian research company CEM Benchmarking, was commissioned by 27 large institutional investors from Denmark, the Netherlands, Sweden and the UK, among others.

The study found that most hedge fund portfolios “look surprisingly like simple stock/bond portfolios”, according to Alexander Beath, senior research analyst and lead author of the study.

“Worse,” he added, “what little alpha is generated goes to the hedge fund managers and then some.”

According to CEM Benchmarking, the study found that institutional investors’ hedge fund portfolios have over 15 years outperformed simple stock/bond portfolios by 0.97% before fees but that “fees have made most hedge fund portfolios bad investments with net alpha of -1.88”.

The company analysed the realised hedge fund portfolio returns of more than 300 large global investors.

Half of these have invested with hedge funds for five years or more, with analysis of these return histories showing that, “for most funds, the performance can be replicated at much lower cost by simple equity/debt blends”.

The average correlation to simple stock/bond portfolios was 84% and more than 90% for more than half of funds, according to CEM Benchmarking.

“These results would not be disappointing except for the fact 70% of funds underperformed the simple benchmarks,” it said, “and the average fund underperformed by -1.88%.”

Thirty percent of the surveyed institutional investors had hedge fund portfolio returns that beat the benchmark, and they had the following features in common, according to CEM Benchmarking:
  • Funds with long histories investing in hedge funds tend to outperform those with short histories
  • Funds with lower correlation to equity/debt blends tend to outperform those with high correlations
  • Funds with low cost implementation tend to outperform those with high cost implementation
CEM Benchmarking said most institutional investors benchmarked their hedge fund portfolios against speciality hedge fund indices or cash-based benchmarks, and that both styles were “flawed”.

Speciality hedge fund indices suffer from survival biases, it said, while cash-based benchmarks show no correlation to hedge fund returns.

Neither of these types of indices is investable or representative of a low-cost viable alternative, it noted.
These findings hardly surprise me as most hedge funds stink and are charging alpha fees for leveraged beta. There are excellent funds but it's becoming increasingly more difficult to find them and even more difficult to get the right alignment of interests when you do find them.

Finally, I want all you hedge funds and institutions allocating to hedge funds to read a comment from Ben Carlson of the A Wealth of Common Sense blog, How Should Alternatives Be Benchmarked? as well as one from my friends over at Phocion Investments, Managers Distinguish Themselves by Implementing Sound Risk Practices. If you're a hedge fund looking to beef up your risk practices and improve your performance or if you're an institution that needs customized operational due diligence on your hedge fund investments, I recommend you contact them here. They are nice, smart guys with years of experience working at large pension funds who will help you.

Let me end by plugging my blog too. I work very hard on a blog that offers me very little in terms of remuneration but a lot in terms of talking and meeting interesting people. I will ask many of you who regularly read this blog to please kindly subscribe or donate via PayPal at the top right-hand side and show your appreciation for the hard work that goes into these daily comments.

I thank all my supporters and wish my American readers a great Memorial Day weekend.

Below, Bloomberg's Scott Deveau discusses why Blackstone's Tony James isn't particularly gun-ho on Canada or Canadian real estate (stay away from Canadian real estate!) and why hedge fund assets will shrink markedly over the next year.

Second, CNBC reports that Wall Street's "billionaires club" is only growing even after some of the biggest hedge funds struggled in 2015.

Third, CNBC's Kate Kelly reports that Tudor Investment Corp is cutting its hedge fund fees. Tudor can cut those fees a lot more and there will be many more hedge funds following suit in the years ahead. Kelly also takes a look at this year's ranking of the world's largest hedge funds.

Lastly, to all you glorified hedge fund asset gatherers charging alpha fees for leveraged beta, Tom Lee of Fundstrat Global Advisors has some good news for you, he thinks the recent rally in high yield is bullish for stocks. Hope he's right but in case he's wrong, you'd better hedge to limit downside risk!





Thursday, May 26, 2016

R.I.P. Deflation?

Amey Stone of Barron's reports, Deflation Is Dead, Buy TIPS over Treasuries:
BlackRock’s global chief investment strategist Richard Turnhill is worrying a lot more about inflation lately. His weekly commentary is titled, “Why deflation is dead,” and argues investors should own Treasury Inflation-Protected Securities (TIPS) as a hedge and also because they are likely to do better than Treasuries.

Higher energy prices is a big reason why he thinks more inflation is coming. But he has a lot of additional reasons, too. He explains:
Our analysis suggests rising U.S. inflation pressures will persist, as factory-gate price increases are passed on to consumers. It is not just the rebound in energy prices pushing inflation higher. An appreciating U.S. dollar is abating as a headwind. Prices of more stable service-based components of the CPI are also rising. Wages, too, are moderately increasing, as are survey-based consumer inflation expectations.
TIPS price in inflation of just 1.4% over the next 10 years. An exchange-traded fund that tracks the TIPS market, iShares TIPS Bond ETF (TIP), is up 4% year-to-date. It fell in the past week, however, as investors judged that if the Fed raises rates this summer, it would lower the risk of inflation and might even cause deflation.

Turnhill’s view is very different. He concludes:
The odds of the Fed increasing rates this summer have increased, although we see only one to two rate increases this year amid slow U.S. growth. We are cautious on duration, but rising inflation means owning TIPS in lieu of nominal Treasuries can be an important hedge for fixed income portfolios.
ValueWalk also reports, A Chart Showing Why Deflation Is Dead:
U.S. deflation is no longer an imminent risk. Global Chief Investment Strategist Richard Turnill’s chart of the week helps illustrate why.

U.S. deflation is no longer an imminent risk. This week’s chart helps illustrate why (click on image).


U.S. inflation has been picking up, following a prolonged period of subdued price rises, as evident in the chart above. The U.S. Consumer Price Index (CPI) in April posted its largest increase since February 2013. The inflation upturn is even more pronounced in forward-looking prices-paid surveys, such as the Institute for Supply Management’s Price Index, our analysis suggests. A greater number of purchasing manager survey respondents reported paying more for products and services in March and April, as the chart above shows.

We see the inflation upturn continuing over the near term. Energy supply-demand fundamentals are turning from a headwind into a tailwind for inflation. Oil supply has tightened, and demand is picking up, primarily out of China and India. This suggests current prices look increasingly sustainable, unless we get a significant reopening of idled shale-oil production. It points to energy’s downward pressures on inflation beginning to subside, in line with the view expressed in hawkish Federal Reserve (Fed) meeting minutes released last week.

Our analysis suggests rising U.S. inflation pressures will persist, as factory-gate price increases are passed on to consumers. It is not just the rebound in energy prices pushing inflation higher. An appreciating U.S. dollar is abating as a headwind. Prices of more stable service-based components of the CPI are also rising. Wages, too, are moderately increasing, as are survey-based consumer inflation expectations.

Bottom line: The odds of the Fed increasing rates this summer have increased, although we see only one to two rate increases this year amid slow U.S. growth. We are cautious on duration, but rising inflation means owning Treasury Inflation Protected Securities (TIPS) in lieu of nominal Treasuries can be an important hedge for fixed income portfolios. Read more market insights in my weekly commentary.
So is Richard Turnhill right? Is deflation dead? Have policymakers succeeded in resurrecting global inflation? Is deflation the dog which has not barked? Has the deflation tsunami receded into oblivion?

Of course not, deflation is very much alive everywhere outside the United States and the Fed and other central bankers are desperately worried that if it becomes entrenched, the global economy is going to fall into a long deflationary slump.

I know, everyone is getting excited as US crude breaks above $50 for first time in seven months and some are even worried the Fed could be blindsided by 1970s style stagflation. Some geopolitical analysts are even claiming that China thinks the US will default via inflation.

I'm afraid to rain on the inflation parade but the global reality is deflationary headwinds are picking up steam. Paul Hannon of the Wall Street Journal reports, Eurozone Slides Back Into Deflation:
The eurozone slipped back into deflation in April despite a stabilization in energy prices, underlining the difficulties the European Central Bank faces as it struggles to boost consumer prices.

The European Union’s statistics agency on Wednesday confirmed a preliminary estimate that showed consumer prices were 0.2% below their year-earlier levels in April, making it the second month this year in which the eurozone was in deflation.

The decline in consumer prices won’t have come as a surprise to the ECB, which had expected such an outcome during the first half of this year. But the reasons for the slide back into deflation have caused some fresh anxiety among policy makers.

“I am more worried about deflation,” ECB governing council member Ignazio Visco said in an interview with German business daily Handelsblatt published Tuesday. “With this come bankruptcies and very negative effects on the real economy. I believe we still face a concrete deflation risk.”

For much of the three years during which inflation has remained stubbornly below the central bank’s target of just under 2%, falling energy prices have been the main culprit. But energy prices have rebounded after sharp falls in the first two months of the year, and indeed rose slightly during April.

Instead, the main driver of the decline in consumer prices during April was a sharp drop in the rate at which prices for services rose, to 0.9% from 1.4% in March. Some of that likely reflects the timing of Easter, which this year pushed up prices of package holidays and other services in March.

But it may also be a sign of what central bankers call “second-round effects,” when businesses outside the energy sector start cutting their prices to reflect lower costs or falling inflation expectations among consumers. The core rate of inflation—excluding items such as food and energy, the prices of which are set mainly in world markets—fell to 0.7% from 1% in March, hitting its lowest level in a year.

“It will clearly be a very long, hard slog to get eurozone consumer-price inflation back up to the ECB’s target rate,” said Howard Archer, an economist at IHS Global Insight.

The ECB has launched a series of stimulus packages since mid-2014, all in an effort to achieve its inflation target. The most recent, announced in March, included cuts to all its main interest rates, a series of ultracheap loans for banks and an acceleration of its bond purchases to €80 billion ($91 billion) a month.

But the bank’s efforts have been frustrated by lower energy prices that partly reflect weaker growth in a number of large developing economies, as well as the modest pace of the eurozone’s recovery from its debt crisis, now in its fourth year.

“The stabilization in global energy prices since early 2016 raises the bar for additional easing at the next release of the ECB’s macroeconomic projections on June 2, but another rate cut is not out of the question,” said Bill Adams, an economist at PNC Financial Services.

One obstacle to the announcement of new measures is the U.K.’s referendum on whether to remain in the EU or leave, which will be held in June. Either outcome could have significant implications for the eurozone economy.

In an interview with The Wall Street Journal published Wednesday, ECB council member Vitas Vasiliauskas said he favors waiting until autumn before considering any additional policy moves.

“If there will be a need, we will of course do additional measures,” Mr. Vasiliauskas, who also heads Lithuania’s central bank. But “if there will be no need, we will do nothing.”
The Financial Times also reports, Spain PPI deflation worst since financial crisis:
Producer prices in Spain continued to deflate in April, with the biggest drop in almost seven years.

The PPI index fell 6.1 per cent year-on-year in April, the 22nd consecutive month of decline. They had fallen 5.6 per cent in March, but April marks the sharpest pace of contraction since July 2009, in the depths of the financial crisis.


Month on month, prices fell 0.1 per cent, after rising 0.6 per cent in March.

Consumer and producer prices around the world have generally been deflating for the past 18 months, with low oil prices a big driver. However over the long term, deflation erodes corporate profits, leading to layoffs and tighter investment, curbing economic growth.
In Asia, things are going from bad to worse. The Hindu Business Line reports that slowing or declining producer prices are haunting the two major Asian economies, China and India, signalling that the deflation contagion has spread to the developing world as well.

In Japan, Prime Minister Shinzo Abe has decided to postpone a consumption tax increase that was planned for next April, judging it to threaten efforts to pull the world's third-largest economy out of deflation:
Abe conceded earlier in the month that raising the consumption tax to 8% had a bigger-than-expected impact on consumer spending. He has argued repeatedly in parliament that Japan would be worse off after an increase that failed to generate higher revenue. Abe cited the threat to his campaign against deflation as grounds for postponing the rise to 10% the first time.

Japan's economy shrank an inflation-adjusted 0.3% in the fourth quarter of 2015 compared with the previous three months, revised figures show. The initial GDP reading for the first quarter of 2016 showed an annualized 1.7% expansion, but that meager growth was partly the result of an additional day in February due to a leap year. Consumer prices are sinking. And the impact of the Kyushu temblors on consumer and business activity will linger.

The rising yen is threatening corporate Japan's earnings and the stock market's performance. As for the global economy, growth prospects in China and other emerging markets are dimming amid unstable crude oil prices. Nobel laureate Paul Krugman, Joseph Stiglitz and other prominent economists have counseled Abe not to impose a higher tax burden on consumers under such conditions.
In Australia Bloomberg reports, Gloomy Aussie Rates Traders Win as Inflation Forces RBA Rethink:
Australian policy makers and economists are finally seeing the domestic economy through the dismal lens interest-rate traders have been using for the past year.

Swaps have been indicating for that long that the Reserve Bank of Australia would cut its benchmark rate at least once if not twice over 12 months, even as most economists saw the central bank sitting at a record-low 2 percent. Traders were proved right May 3 when Governor Glenn Stevens cut the policy rate to 1.75 percent. Now, markets and the majority of economists agree that a move to 1.5 percent is likely with JPMorgan Chase & Co., Commonwealth Bank of Australia and Morgan Stanley more bearish still.

Inflation was “a bit too low” Stevens said Tuesday, adding that and the central bank’s framework of targeting annual consumer-price gains of 2 percent to 3 percent had been a successful tool in deciding policy rates, though it wasn’t rigid. Swaps markets predict the low-point for the Australian benchmark will be about 1.4 percent in April next year, said Jarrod Kerr, a senior rates strategist at Commonwealth Bank, which is calling for a reduction to 1.25 percent by the end of 2016.

“The linkages between international and domestic inflation are a lot stronger these days and global inflation expectations are a lot lower,” Kerr said. “The fact that the RBA capitulated on its forecasts suggests to us that they are willing to do more to get inflation higher. The risk is more toward 1 percent than that they just do another cut and call it quits.”
In Canada, the inflation rate rose to an annual rate of 1.7 per cent in April as higher prices for food and shelter contributed to a higher cost of living but the Bank of Canada announced that it is maintaining its target for the overnight rate at 1/2 per cent, saying Alberta's wildfires will hurt the economy.

In her comment looking at why the Bank of Canada stood pat on rates, Sherry Cooper, Chief Economist of the Dominion Lending Centres, notes massive capital outflows from China are sustaining housing markets around the world, especially in Canada and the United States:
The media continue to put the spotlight on the Vancouver and Toronto housing booms and the role played by foreigners to drive up prices. Affordability issues are of great concern and questions continue to arise regarding the sustainability of the housing bubble.

I am currently researching the viability of continued housing demand by the Chinese given the government’s 2015 introduction of capital controls, which limits capital withdrawal to the equivalent of $50,000 (U.S. currency) per person. I will detail my findings in another report, but suffice it to  say China’s capital outflow has surged in recent months, notwithstanding these controls. There are a number of ways to circumvent the rules and the penalties are tiny. The Chinese government is simply not enforcing the controls and the continued devaluation of the Chinese yuan continues to trigger massive outflows (see Chart below). Much of that money is moving to housing in Toronto and Vancouver, as well as to Australia, New Zealand and the United States. The Chinese are now the number-one foreign purchaser of U.S. residential real estate, surpassing Canadian inflows this year. This is stimulating the housing markets especially in New York, Los Angeles, San Francisco and Seattle. Chicago, Miami and Las Vegas are also seeing significant investment.


The Canadian government and regulatory response to this foreign inflow of money is evolving. The media have recently highlighted the potential for money laundering and the lax enforcement of of anti-money laundering initiatives in the real estate sector. But it appears that most of the Chinese purchase of Canadian housing is not for money laundering purposes, meaning garnered through illegal activity or to support terrorism.

More on this to come.
There is a lot of money laundering going on in Canada and elsewhere but Sherry Cooper is right, it's not the main driver of capital outflows out of China. Chinese are worried about their future and their currency depreciating, impacting their purchasing power.

And if Soros is right and a crash and deflation ravages China, there will be a lot less money available to propel housing markets in developed economies much higher and this will hit many bubble markets extremely hard.

If you ask me, it's the global deflationary wildfires that really worry Bank of Canada Governor Stephen Poloz and other central bankers around the world. 

But BlackRock’s global chief investment strategist Richard Turnhill says deflation is dead and he's not alone. I hear a lot of strategists claiming that there will be an inflationary pickup in the near term and some think it will possibly last years.

I think they are all wrong, confusing cyclical swings due to currency moves, and if you look at the US bond market, it's yawning too at all these foolish forecasts of a pickup in inflation. I know, oil just crossed the "psychologically important $50 mark," the "US housing market is on fire," everyone is getting ready for "the Fed to raise rates" at least once, but I remain highly skeptical as I see no clear evidence of a global recovery (quite the contrary) and still think the dumbest thing the Fed can do is raise rates (it will heighten global deflation).

The main reason why US inflation picked up in recent months was because of the weaker US dollar. That is it, nothing more fundamental. Outside the US, deflationary pressures are picking up and this will force central banks to do more stimulus to get their economies out of their deflation rut. This is bullish for the US dollar which is why I see it rallying in the second half of the year.

And as I stated in my comment looking at top funds' activity for Q1 2016:
The rising USD should provide relief in terms of deflationary pressures in Asia (except China which pegs the yuan to the USD) and Europe but it also means lower commodity and gold prices. It also means lower import prices for the US which will lower inflation expectations there, effectively importing deflation into that country.
My best advice remains to focus on the big picture which is DEFLATION. This is why I remain bullish bonds (TLT) and to a lesser extent high dividend sectors. The problem with the latter which are made up of utilities, REITS, telecoms and staples is that they ran up too much and have become very crowded. Also, any potential rise in rates will hurt these sectors as they are very interest rate sensitive.

In terms of risk trades, I still trade biotech shares (IBB and XBI) which got slaughtered this year and are coming back strong even if concerns over Valeant (VRX) continue to weigh on the sector.

So, when people ask me my Long/ Short macro trade for the second half of the year it's to go long biotechs (IBB and XBI) and short Metals & Mining (XME), Energy (XLE), and Emerging Markets (EEM).

Of course, if things get really bad, all sectors are going to get slammed hard, especially high beta biotechs, and the only thing that will save your portfolio are good old government bonds (TLT).
That is US nominal Treasury bonds, not TIPS! But if you believe in fairy tales on inflation and global economic growth, by all means, buy the garbage that Wall Street is feeding you about deflation being dead. I'm not buying it and neither is the US bond market.

Below, Chris Verrone, Strategas Research Partners, takes a look at crude oil charts and what stands out in the energy sector. He thinks investors should fade the oil rally and I agree, there may be a little more upside but there's plenty of downside and energy, metal and mining stocks are already diverging from oil prices.

Second,  with the Chinese yuan sliding, Rich Ross of Evercore ISI and Max Wolff of Manhattan Venture Partners discuss the Chinese currency’s importance to global markets with Brian Sullivan. They also discussed whether the market could be poised for a breakout (watch third clip).

Lastly, Gary Schilling, President of A. Gary Shilling & Co and author of The Age of Deleveraging, gave a very interesting presentation on how to make money in a world of deflation.

Deflation is looming and will enhance Shilling's investment strategies. They focus on first, owning Treasury bonds which are also the world's safe haven. Second, owning the US dollar which is also a refuge in troubled times and benefits from almost every other currency devaluing against it. Finally, shorting oil and other commodities that suffer from excess global supply and deficient demand.




Wednesday, May 25, 2016

Chicago's Pension Patch Job?

Hal Dardick of the Chicago Tribune reports, Mayor floats plan to fix city's smallest pension fund:
Mayor Rahm Emanuel on Monday floated a new idea to fix the city's smallest government worker pension system, one that he hopes will become a model to address far greater financial woes in the largest retirement fund.

Under the plan, both taxpayers and newly hired city laborers would pay more toward pension costs, and in return, workers could retire two years earlier.

But the Emanuel administration declined to say precisely how much money such an approach could save, and the mayor does not plan to press state lawmakers for approval during the final scheduled week of spring session.

City officials hope the plan would pass muster with the Illinois Supreme Court, which in March struck down an earlier Emanuel plan aimed at addressing the money shortfalls in pension funds covering laborers and municipal employees.

What "we want is a concrete and sustainable funding path that's not going to get caught up in any legal process, and if there should be some sort of lawsuit on any of this, this is extremely strong, and should not put us in a position of two years of uncertainty like we were" on the previous plan, said Michael Rendina, senior adviser to the mayor.

The Emanuel administration provided an outline of the plan Monday. Starting next year, newly hired employees would pay 11.5 percent of their wages toward retirement, compared with 8.5 percent today. Employees hired from 2011 to 2016 also could opt to pay more into the pension fund, city officials said. In exchange, workers who make the higher pension payments could retire at 65 instead of 67. The plan would not affect people hired by the city before 2011 or laborers who have already retired.

The city would gradually increase how much it puts into the laborers' pension fund, with the aim of reaching 90 percent funding by 2057. To come up with part of the money, Emanuel would spend all of the proceeds from a $1.40-a-month tax hike on emergency services slapped onto all city phone bills in 2014. That boosted city revenue by about $40 million a year.

The administration, however, did not provide a schedule of how payments would increase the next 40 years. City Hall officials also said they don't yet have figures on how much money they expect to save under the proposal. The laborers' fund is about $1.2 billion short of what's needed to pay retiree benefits. It's at risk of going broke in about 11 years.

Joe Healy, business manager for Laborers Local 1092, said the two unions representing city laborers have agreed to the deal, figuring that the extra employee contributions represent an equal trade for retiring two years earlier. But Healy also cautioned that the Laborers' Annuity and Benefit Fund is still reviewing the numbers on the value of the trade-off.

Emanuel went back to the drawing board after the state's high court rejected his 2014 plan to restore financial health to both the laborers' fund and the Municipal Employees' Annuity and Benefit Fund. Justices ruled that reduced cost-of-living increases violated a clause in the Illinois Constitution that states retiree benefits "shall not be diminished or impaired."

But the court left unanswered the question of whether the city could require employees to pay more toward their retirement and also suggested the city could give employees the option of keeping their own plan or switching to a new one, provided they were offered something of value — "consideration" in legal contract parlance. With the mayor's new plan, the earlier retirement is the consideration, Rendina said.

Ralph Martire, the executive director of the Center for Tax and Budget Accountability who was critical of the legal soundness of the Emanuel's earlier plan, said the outline of the latest one likely would fall within the boundaries of the constitution. The city can "create any kind of new" pension plan it wants for employees yet to be hired, and it can provide options to current employees — provided one of the choices is keeping their current plan.

"I don't see how there's a constitutional complication to it," said Martire, who added one caution: If future benefits fall below those provided by Social Security — which city workers don't receive — the city could ultimately run afoul of federal law and have to pay more into the funds.

The $1.2 billion laborers' shortfall is significantly smaller than the ones faced by city pension funds for municipal workers, police officers and firefighters. The municipal workers' fund alone is nearly $10 billion short and at risk of going broke within eight years.

Still, the mayor hopes that the new laborers' bill serves as a model for talks with the municipal workers' fund, and city officials have started talking to leaders of some of the dozens of unions that represent those city employees. "If we reach agreement with them, we'll have to come up with alternate funding source for that," said Alexandra Holt, the city's budget director.

Emanuel's latest pension plan comes as he's under pressure for solutions. After the Supreme Court ruling in March, Wall Street agencies that evaluate city creditworthiness warned the city that it could further downgrade the city's already low debt ratings if it did not come up with a plan. At the time, Emanuel financial aides told the analysts that the city would come up with a plan within weeks.

Given unresolved problems with all four city pension funds, it's uncertain whether proposing a plan for the smallest of the funds will soothe the angst felt on Wall Street over the city's financial problems. Emanuel last week won City Council approval to borrow up to $600 million, and a lowered credit rating could increase interest costs.
Karen Pierog of Reuters also reports, Chicago, unions reach deal to rescue city pension fund:
Chicago would increase its annual contribution to its laborers' retirement system, as would newer workers, in order to save the fund from insolvency, under an agreement in principle announced on Monday by Mayor Rahm Emanuel and unions.

While the city hailed the deal for the smallest of its four pension systems, a solution has yet to emerge for its largest fund, covering more than 50,000 active and retired municipal workers.

The city will dedicate $40 million a year from a 2014 increase in its 911 telephone surcharge to the laborers' fund, under the agreement. Workers hired after Jan. 1, 2017, would have to contribute 11.5 percent of their salaries, while those hired after Jan. 1, 2011, would choose between contributing 11.5 percent and retiring at age 65 or contributing 8.5 percent and retiring at 67.

Chicago needs the Illinois legislature to approve later this year a five-year phase-in of the higher contributions by the city to the laborers' system to attain a 90 percent funding level by 2057. The fund, which had $1.36 billion in assets at the end of 2014, covers nearly 3,000 active workers and 2,700 retirees.

In March, the Illinois Supreme Court tossed out a 2014 state law aimed at making the laborers' fund and the municipal pension system solvent by requiring higher contributions from the city and affected workers and reducing benefits.

Emanuel has said that ruling put Chicago into a straitjacket by reaffirming iron-clad protection in the Illinois Constitution against reducing public sector worker pension benefits.

Chicago Budget Director Alex Holt said the deal for the laborers' fund does not reduce benefits but gives newer workers choices as to when they can retire.

"Choice is one of the areas that the Illinois Supreme Court indicated should pass constitutional muster," she told reporters in a conference call.

The impact of the high court's ruling, along with new accounting changes, more than doubled the unfunded liability for the municipal fund to $18.6 billion at the end of 2015 from $7.13 billion at the end of 2014, according to an actuarial report by Segal Consulting released last week. It predicted the system will run out of money within the next 10 years in the absence of increased funding.

"We feel that the solution we laid out for laborers offers a good framework for discussions with the (municipal) fund," said Chicago Chief Financial Officer Carole Brown.
Those new accounting changes really sting. Elizabeth Campbell of Bloomberg reports, Chicago’s Pension-Fund Woes Just Became $11.5 Billion Bigger:
Chicago’s pension-fund shortfall just got $11.5 billion bigger.

Thanks to the defeat of the city’s retirement-fund overhaul by the Illinois Supreme Court and new accounting rules, Chicago’s so-called net pension liability to its Municipal Employees’ Annuity and Benefit Fund soared to $18.6 billion by the end of 2015 from $7.1 billion a year earlier, according to its annual report. The fund serves some 70,000 workers and retirees.

The new figure, a result of actuaries’ revised estimates for the value in today’s dollars of benefits due as long as decades from now, doesn’t change how much Chicago needs to contribute each year to make sure the promised checks arrive. But it highlights the long-term pressure on the city from shortchanging its retirement funds year after year -- decisions that are now adding hundreds of millions of dollars to its annual bills and have left it with a lower credit rating than any big U.S. city but once-bankrupt Detroit.

“The longer they wait to get this fixed, the more expensive it’s going to get for the city’s taxpayers,” Richard Ciccarone, the Chicago-based president of Merritt Research Services LLC, which analyzes municipal finances.


The estimate presented Thursday to the board of the municipal fund, one of Chicago’s four pensions, will add to what had been an unfunded retirement liability for the city estimated at $20 billion.

A key driver was the court ruling striking down Mayor Rahm Emanuel’s plan that cut benefits and boosted city and employee contributions. Without it in place, the fund is now set to run out of money within 10 years.

That triggered another change. New accounting rules, adopted to keep governments from using overly optimistic investment-return forecasts to mask the scale of their liabilities, require them to use more modest assumptions once pension plans go broke. As a result, the reported liabilities jump.

The Chicago fund is notable because very few governments have been affected by the change, according to Ciccarone. “The investment returns are not going to fix the problems themselves,” he said.

City officials from Emanuel to Chief Financial Officer Carole Brown have said the city is working on a solution to shore up the retirement system. Chicago has already passed a record property-tax increase that will bolster the police and fire funds.

Under the traditional way of estimating the municipal fund’s obligations, which is how annual contributions are set, the shortfall rose to $9.9 billion as of Dec. 31, based on market value of its assets, according to the actuaries report. That’s up from $7.1 billion a year earlier.

The pension is only 32 percent funded -- meaning it has 32 cents for every dollar it owes -- compared to 42 percent last year, according to the actuaries. And it has to sell 12 percent to 15 percent of its assets every year to pay out benefits.

City officials are having “very good discussions” with the unions about the issue, according to Emanuel, who has made clear that he disagrees with the court’s ruling to throw out his plan.

“We’re working through the issue to get to what I call a responsible way to fund their pensions within the confines, the straitjacket that the court has determined,” Emanuel told reporters at City Hall on Wednesday.

A proposal is pending in the state legislature to bolster funding for the benefit fund. The plan would ensure it’s 90 percent funded by the end of fiscal year 2055. Jim Mohler, executive director of the fund, told board members on Thursday that it’s a “fluid situation.”
I've already covered Chicago's pension nightmare in detail. If you ever want to get a glimpse of America's future pension crisis, have a look at what's going on in Chicago because it's coming to a city near you. I guarantee you will see a series of never-ending crazy hikes in property taxes to pay for chronically underfunded public pensions.

When Greece was going through its crisis last year, my uncle from Crete would call me and blurt "it's worse than Chicago here!", referring to the old Al Capone days when Chicago was the Wild West. Little did he know that in many ways, Chicago is much worse than Greece because Greeks had no choice but to swallow their bitter medicine (and they're still swallowing it).

In Chicago, powerful public unions are going head to head with a powerful and unpopular mayor who got rebuffed by Illinois's Supreme Court when he tried cutting pension benefits. Now, they are tinkering around the edges, increasing the contribution rate for new employees of the city's smallest pension, which is not going to make a significant impact on what is truly ailing Chicago and Illinois's public pensions.

All these measures are like putting a band-aid over a metastasized tumor. Creditors know exactly what I'm talking about which is why I'll be shocked if they ease up on the city's credit rating.

Importantly, when a public pension is 42% or 32% funded, it's effectively broke and nothing they do can fix the problem unless they increase contributions and cut benefits for everyone, top up these pensions and introduce real governance and a risk-sharing model.

When people ask me what's the number one problem with Chicago's public pensions, I tell them straight out: "Governance, Governance and Governance". This city has a long history of corrupt public union leaders and equally corrupt politicians who kept masking the pension crisis for as long as possible. And Chicago isn't alone; there are plenty of other American cities in dire straits when it comes to public finances and public pensions.

But nobody dares discuss these problems in an open and honest way. Unions point the finger at politicians and politicians point the finger at unions and US taxpayers end up footing the public pension bill.

This is why when I read stupid articles in Canadian newspapers questioning the compensation and performance at Canada's large public pensions, I ignore them because these foolish journalists haven't done their research to understand why what we have here is infinitely better than what they have in the United States and elsewhere.

Why are we paying Canadian public pension fund managers big bucks? Because we got the governance right, paying public pension managers properly to bring assets internally, diversifying across public and private assets all around the world and only paying external funds when it can't be replicated internally. This lowers the costs and improves the performance of our public pensions which is why none of Canada's Top Ten pensions are chronically underfunded (a few are even over-funded and super-funded).

What else? Canada's best public pensions -- Ontario Teachers, HOOPP and even smaller ones like CAAT and OPTrust -- have implemented a risk-sharing model that ensures pension beneficiaries and governments share the risk of the plan so as not to impose any additional tax burden on Canadian taxpayers if these plans ever become underfunded. This level of governance and risk-sharing simply doesn't exist at any US public pension which is why many of them are chronically underfunded or on the verge of becoming chronically underfunded.

Below, FBN's Jeff Flock breaks down Chicago's growing pension shortfall. Like I said, get ready for never-ending property tax hikes if you live in cities like Chicago, it's only going to get worse