Monday, September 18, 2017

US Pension Storms From Nowhere?

Over the weekend, John Mauldin wrote a comment, Pension Storm Warning (added emphasis is mine):
This time is different are the four most dangerous words any economist or money manager can utter. We learn new things and invent new technologies. Players come and go. But in the big picture, this time is usually not fundamentally different, because fallible humans are still in charge. (Ken Rogoff and Carmen Reinhart wrote an important book called This Time Is Different on the 260-odd times that governments have defaulted on their debts; and on each occasion, up until the moment of collapse, investors kept telling themselves “This time is different.” It never was.)

Nevertheless, I uttered those four words in last week’s letter. I stand by them, too. In the next 20 years, we’re going to see changes that humanity has never seen before, and in some cases never even imagined, and we’re going to have to change. I truly believe this. We have unleashed economic and technological forces we can observe but not entirely control.

I will defend this bold claim at greater length in my forthcoming book, The Age of Transformation.

Today we will zero in on one of those forces, which last week I called “the bubble in government promises,” which I think is arguably the biggest bubble in human history. Elected officials at all levels have promised workers they will receive pension benefits without taking the hard steps necessary to deliver on those promises. This situation will end badly and hurt many people. Unfortunately, massive snafus like this rarely hurt the politicians who made those overly optimistic promises, often years ago.

Earlier this year I called the pension mess “The Crisis We Can’t Muddle Through.” Reflecting since then, I think I was too optimistic. Simply waiting for the floodwaters to drop down to muddle-through depth won’t be enough. We face an entire new ocean, deeper and wider than we can ever cross unaided.

Storms from Nowhere?

This year marks the first time on record that two Category 4 hurricanes have struck the US mainland in the same year. Worse, Harvey and Irma landed directly on some of our most valuable and vulnerable coastal areas. So now, in addition to all the problems that existed a month ago, the US economy has to absorb cleanup and rebuilding costs for large parts of Texas and Florida, as well as our Puerto Rico and US Virgin Islands territories.

Now then, people who live in coastal areas know full well that hurricanes happen – they know the risk, just not which hurricane season might launch a devastating storm in their direction. In a note to me about Harvey, fellow Rice University graduate Gary Haubold (1980) noted just how flawed the city’s assumptions actually were regarding what constitutes adequate preparedness. He cited this excerpt from a recent Los Angeles Times article:
The storm was unprecedented, but the city has been deceiving itself for decades about its vulnerability to flooding, said Robert Bea, a member of the National Academy of Engineering and UC Berkeley emeritus civil engineering professor who has studied hurricane risks along the Gulf Coast.

The city’s flood system is supposed to protect the public from a 100-year storm, but Bea calls that “a 100-year lie” because it is based on a rainfall total of 13 inches in 24 hours.

“That has happened more than eight times in the last 27 years,” Bea said. “It is wrong on two counts. It isn’t accurate about the past risk and it doesn’t reflect what will happen in the next 100 years.” (Source)
Anybody who lives in Houston can tell you that 13 inches in 24 hours is not all that unusual. But how do Robert Bea’s points apply to today’s topic, public pensions? Both pension plan shortfalls and hurricanes are known risks for which state and local governments must prepare. And in both instances, too much optimism and too little preparation ultimately have devastating results.

Admittedly, public pension liabilities don’t come out of nowhere the way hurricanes seem to – we know exactly where they will strike. In many cases, we know approximately when they’ll strike, too. Yet we still let our elected officials make impossible-to-fulfill promises on our behalf. The rest of us are not so different from those who built beach homes and didn’t buy hurricane or storm surge insurance. We just face a different kind of storm.

Worse, we let our government officials use predictions about future returns that are every bit as unrealistic as calling a 13-inch rain in Houston a 100-year event. And while some of us have called pension officials out, they just keep telling lies – and probably will until we reach the breaking point.

Puerto Rico is a good example. The Commonwealth was already in deep debt before Irma blew in – $123 billion worth of it. There’s simply no way the island can repay such a massive debt. Creditors can fight in the courts, but in the end you can’t squeeze money out of plantains or pineapples. Not enough money, anyway. Now add Irma damages, and the creditors have even less hope of recovering their principal, let alone interest.

Puerto Rico is presently in a new form of bankruptcy that Congress authorized last year. Court proceedings will probably drag on for years, but the final outcome isn’t in doubt. Creditors will get some scraps – at best perhaps $0.30 on the dollar, my sources say – and then move on. We’re going to find out how strong those credit insurance guarantees really are.

“That’s just Puerto Rico,” you may say if you’re a US citizen in one of the 50 states. Be very careful. Your state is probably not so much better off. In 10 years, your state may well be in the same place where Puerto Rico is now. I’d say the odds are better than even.

Are your elected leaders doing anything about this huge issue, or even talking about it? Probably not.

As it stands now, states can’t declare bankruptcy in federal courts. Letting them do so would raises thorny constitutional issues. So maybe we’ll have to call it something else, but it’s going to end the same way. Your state’s public-sector retirees will not get what they were promised, and they won’t take the outcome kindly.

Blood from Turnips

Public sector bankruptcy, up to and including state-level bankruptcy, is fundamentally different from corporate bankruptcy in ways that many people haven’t considered. The pension crisis will likely expose those differences as deadly to creditors and retirees.

Say a corporation goes bankrupt. A court will take all its assets and decide how to divvy them up. The assets are easy to identify: buildings, land, intellectual property, cash, etc. The parties may argue over their value, but everyone knows what the assets are. They won’t walk away.

Not so in a public bankruptcy. The primary asset of a city, county, or state is future tax revenue from households and businesses within its boundaries. The taxpayers can walk away. Even without moving, they can bypass sales taxes by shopping elsewhere. If property taxes are too high, they can sell and move. When they take a loss on the sale, the new owner will have established a property value that yields the city far less revenue than it used to receive.

Cities and states don’t have the ability to shed their pension liabilities. They are stuck with them, even as population and property values change.

We may soon see an example of this in Houston. Here in Texas, our property taxes are very high because we have no income tax. Your tax is a percentage of your home’s taxable value. So people argue to appraisal boards that their homes are falling apart and not worth anything like the appraised value. (Then they argue the opposite when it’s time to sell the home.)

About 200 entities in Harris County can charge taxes. That includes governments from Houston to Baytown to Hedwig Village, plus 20 independent school districts.

There’s a hospital district, port authority, several college districts, the flood control district, a multitude of utility districts, and the Harris County Department of Education. Some homes may fall within 10 or more jurisdictions.

What about those thousands of flooded homes in and around Houston; how much are they worth? Right now, I’d say their value is zero in many cases. Maybe they will have some value if it’s possible to rebuild, but at the very least they ought to receive a sharp discount from the tax collector this year.

Considering how many destroyed or unlivable properties there are all over South Texas, I suspect cities and counties will lose billions in revenue even as their expenses rise. That’s a small version of what I expect as city and state pension systems all over the US finally face reality.

Here in Dallas I pay about 2.7% in property taxes. When I bought my home over four years ago, I checked our local pension and was told we were 100% funded. I even mentioned in my letter that I was rather surprised. Turns out they lied. Now, realistic assessments suggest they will have to double the municipal tax rate (yes, I said double) to be able to fund fire and police pension funds. Not a terribly popular thing to do. At some point, look for taxpayers to desert the most-indebted cities and states. Then what? I don’t know. Every solution I can imagine is ugly.

Promises from Air

Most public pension plans are not fully funded. Earlier this year in “Disappearing Pensions” I shared this chart from my good friend Danielle DiMartino Booth (click on image):


Total unfunded liabilities in state and local pensions have roughly quintupled in the last decade. You read that right – not doubled, tripled or quadrupled: quintupled. That’s nice when it happens on a slot machine, not so nice when it’s money you owe.

You will also notice in the chart that much of that change happened in 2008. Why was that? That’s when the Fed took interest rates down to nearly zero, meaning it suddenly took more cash to fund future payments. Also, some strapped localities conserved cash by promising public workers more generous pension benefits in lieu of pay raises.

According to a 2014 Pew study, only 15 states follow policies that have funded at least 100% of their pension needs. And that estimate is based on the aggressive assumptions of pension funds that they will get their predicted rate of returns (the “discount rate”).

Kentucky, for instance, has unfunded pension liabilities of $40 billion or more. This month the state budget director notified local governments that pension costs could jump 50-60% next year. That’s due to a proposed reduction in the system’s assumed rate of return from 7.5% to 6.25% – a step in the right direction but not nearly enough.

Think about this as an investor. Do you know a way to guarantee yourself even 6.25% average annual returns for the next 10–20 years? Of course you don’t. Yes, some strategies have a good shot at doing it, but there’s no guarantee.

And if you believe Jeremy Grantham’s seven-year forecasts (I do: His 2009 growth forecast was spot on), then those pension funds have very little hope of getting their average 7% predicted rate of return, at least for the next seven years.


Now, here is the truth about pension liabilities. Let’s assume you have $1 billion in funding today. If you assume a 7% compound return – about the average for most pension funds – then that means in 30 years that $1 billion will have grown to $8 billion (approximately). Now, what if it’s a 4% return? Using the Rule of 72, the $1 billion grows to around $3.5 billion, or less than half the future assets in 30 years if you assume 7%.

Remember that every dollar that is not funded today means that somewhere between four dollars and eight dollars will not be there in 30 years when somebody who is on a pension is expecting to get it. Worse, without proper funding, as the fund starts going negative, the funding ratio actually gets worse, sending it into a death spiral. The only way to bring it out of the spiral is with huge cuts to other needed services or with massive tax cuts to pension benefits.

The State of Kentucky’s unusually frank report regarding the state’s public pension liability sums up that state’s plight in one chart (click on image):


The news for Kentucky retirees is quite dire, especially considering what returns on investments are realistically likely to be. But there’s a make or break point somewhere. What if pension plans must either hit that 6% average annual return for 2018–2028 or declare bankruptcy and lose it all?

That’s a much greater problem, and it’s a rough equivalent of what state pension trustees have to do. Failing to generate the target returns doesn’t reduce the liability. It just means taxpayers must make up the difference.

But wait, it gets worse. The graph we showed earlier stated that unfunded pension liabilities for state and local governments was $2 trillion. But that assumes an average 7% compound return. What if we assume 4% compound returns? Now the admitted unfunded pension liability is $4 trillion. But what if we have a recession and the stock market goes down by the past average of more than 40%? Now you have an unfunded liability in the range of $7–8 trillion.


We throw the words a trillion dollars around, not realizing how much that actually is. Combined state and local revenues for the US total around $2.6 trillion. Following the next recession (whenever that is), the unfunded pension liabilities for state and local governments will be roughly three times the revenue they are collecting today, and that’s before a recession reduces their revenues. Can you see the taxpayer stuck between a rock and a hard place? Two immovable objects meeting? The math just doesn’t work.

Pension trustees don’t face personal liability. They’re literally playing with someone else’s money. Some try very hard to be realistic and cautious. Others don’t. But even the most diligent can’t control when the next recession comes, or when the stock market will crash, leaving a gaping hole in their assets while liabilities keep right on rising.

I have had meetings with trustees of various government pensions. Many of them want to assume a more realistic discount rate, but the politicians in their state literally refuse to allow them to assume a reasonable discount rate, because owning up to reality would require them to increase their current pension funding dramatically. So they kick the can down the road.

Intentionally or not, state and local officials all over the US made pension promises that future officials can’t possibly keep. Many will be out of office when the bill comes due, protected from liability by sovereign immunity.

We are starting to see cities filing for bankruptcy. That small ripple will be a tsunami within 7–10 years.

But wait, it gets still worse. (Do you see a trend here?) Many state and local governments have actually 100% funded their pension plans. Some states and local governments have even overfunded them – assuming they get their projected returns. What that really means is that the unfunded liabilities are more concentrated, and they show up in unlikely places. You think Texas is doing well? Look at some of our cities and weep. Look, too, at other seemingly semi-prosperous cities all over the country. Do you think the suburbs of Dallas will want to see their taxes increased to help out the city? If you do, I may have a bridge to sell you – unless you would rather have oceanfront properties in Arizona.

This issue is going to set neighbor against neighbor and retirees against taxpayers. It will become one of the most heated battles of my lifetime. It will make the Trump-Clinton campaigns look like a school kids’ tiddlywinks smackdown.

I was heavily involved in politics at both the national and local levels in the 80s and 90s and much of the 2000s. Trust me, local politics is far nastier and more vicious. And there is nothing more local than police and firefighters and teachers seeing their pensions cut because the money isn’t there. Tax increases of up to 100% are going to become commonplace. But even these new revenues won’t be enough… because we will be acting with too little, too late.

This is the core problem. Our political system gives some people incentives to make unrealistic promises while also absolving them of liability for doing so. It also places the costs of those must-break promises on innocent parties, i.e. the retirees who did their jobs and rightly expect the compensation they were told they would receive.

So at its heart the pension crisis is really not a financial problem. It’s a moral and ethical problem of making and breaking promises that profoundly impact people’s lives. Our culture puts a high value on integrity: doing what you said you would do.

We take a job because the compensation package includes x, y and z. Then someone says no, we can’t give you z, so quit and go elsewhere.

The pension problem is going to get worse as more and more retirees get stuck with broken promises, and as taxpayers get handed higher and higher bills. These are irreconcilable demands in many cases. It’s not possible to keep contradictory promises.

What’s the endgame? I think much of the US will end up like Puerto Rico. But the hardship map will be more random than you can possibly imagine. Some sort of authority – whether bankruptcy courts or something else – will have to seize pension assets and figure out who gets hurt and how much. Some courts in some states will require taxes to go up. But courts don’t have taxing authority, so they can only require cities to pay, but with what money and from whom?

In many states we literally don’t have the laws and courts in place with authority to deal with this. And just try passing a law that allows for states or cities to file bankruptcy in order to get out of their pension obligations.

The struggle will get ugly, and innocent people on both sides will be hurt. We hear stories about retired police chiefs and teachers with lifetime six-digit pensions and so on. Those aberrations (if you look at the national salary picture) are a problem, but the more distressing cases are the firefighters, teachers, police officers, or humble civil servants who served the public for decades, never making much money but looking forward to a somewhat comfortable retirement. How do you tell these people that they can’t have a livable pension? We will see many human tragedies.

On the other side will be homeowners and small business owners, already struggling in a changing economy and then being told their taxes will double. This may actually happen in Dallas; and if it does, we won’t be alone for long.

The website Pension Tsunami posts scores of articles, written all across America, about pension problems. We find out today that in places like New York and Chicago and Cook County, pension funds have more retirees collecting than workers paying into the fund. There are more retired cops in New York and Chicago than there are working cops. And the numbers of retirees just keep growing. On an individual basis, it is smart for the Chicago police officer to retire as early possible, locking in benefits, go on to another job that offers more retirement benefits, and round out a career by working at least three years at a private job that qualifies the officer for Social Security. Many police and fire pensions are based on the last three years of income; so in the last three years before they retire, these diligent public servants work enormous amounts of overtime, increasing their annual pay and thus their final pension payouts.

As I’ve said, this is the crisis we can’t muddle through. While the federal government (and I realize this is economic heresy) can print money if it has to, state and local governments can’t print. They actually have to tax to pay their bills. It’s the law. It’s also an arrangement with real potential to cause political and social upheaval that Americans have not seen in decades. The storm is only beginning. Think Hurricane Harvey on steroids, but all over America. Of all the intractable economic problems I see in the future (and I have a vivid imagination), this is the most daunting.
Hello! Welcome to Pension Pulse Brother Mauldin! Where have you been since June 2008 when I started providing daily coverage on pensions and investments, forewarning the world about a global pension crisis in the making? At least you did mention the great work Jack Dean has done on his site, Pension Tsunami, chronicling America's pension disaster.

I met John Mauldin over six years ago (or longer) right here in Montreal when he was in town for a conference and visiting his friend Martin Barnes of BCA Research.

We met at the bar at Sofitel hotel on Sherbrooke right across BCA's office. John came down to meet me wearing his jogging pants and a sleeveless very old T-shirt with a Ronald Reagan imprint "One for the Gipper". He was getting ready to work out so we chatted for a bit.

Back then, he was into hedge funds, providing alpha solutions to his clients. He's an interesting character, a red-blooded Republican Texan who loves markets, is a prolific author and covers a lot of market and economic topics.

He also has a wide following and many subscribers. People tell me I should pursue the Mauldin model to get properly compensated for the work I put into this blog but I have a philosophical problem charging people when I want to educate them first and foremost about pensions AND markets.

Thankfully, I have some very big and important institutional subscribers who value and support my efforts but it's not enough. At one point, I have to make a decision, keep writing on pensions and investments, or just focus all my attention on analyzing markets and trading stocks which is by far my biggest passion of all (I can do both but it's a lot of work).

Anyway, I'm glad John Mauldin has brought America's looming pension crisis to the attention of his million plus readers. Zero Hedge also reprinted this comment on its site and I think it's crucially important we have an open and honest debate on this issue now even if I feel it's already too late.

I have been covering America's public and private pension crisis for a long time. It's a disaster and John is right, it's only going to get worse and a lot of innocent public-sector workers and retirees and private-sector businesses are going to get hurt in the process.

But it's even worse than even John can imagine. With global deflation headed to the US, when the pension storm cometh, it will wreak havoc on public and private pensions for a decade or longer. At that point, it won't just be companies breaking the pension promise, everyone will be at risk.

Importantly, if my worst fears materialize, this isn't going to be like the 2008 crisis where you follow Warren Buffett who bought preferred shares of Goldman Sachs and Bank of America at the bottom, and everything comes roaring back to new highs in subsequent years.

When the next crisis hits, it will be Chinese water torture for years, a bear market even worse than 1973-74, one that will potentially drag on a lot longer than we can imagine.

This will be the death knell for many chronically underfunded US public and private pensions for two reasons:
  1. First, and most importantly, rates will plunge to new secular lows and remain ultra-low for years. Because the duration of pension liabilities is much bigger than the duration of assets, any decline in rates will disproportionately hurt pensions, especially chronically underfunded pensions.
  2. Second, a prolonged bear market will strike public and private assets too. Not only are pensions going to see pension deficits soar as rates plunge to new secular lows, they will see their assets shrink, a perfect double-whammy storm for pensions. 
No doubt, some pensions will be hit much harder than others, but all pensions will be hit.

This brings me to another point, how will policymakers address this crisis when it really hits them hard and they can't ignore it because pension costs overwhelm public budgets?

Well, Kentucky's public pensions may be finished but I am truly disheartened by the moronic, knee-jerk response. Tom Loftus of courier-journal reports, Kentucky pension crisis: Are 401(k) plans the solution?. I note the following passage:
Keith Brainard, research director for the National Association of State Retirement Administrators, said risk doesn't disappear under a 401(k) plan.

"These proposals shift that risk from the state and its public employers and taxpayers and put it all on the workers. In fact, there’s going to be more risk because they are no longer in a group that can manage the risk much better," he said.

Whether the moves actually will save the state money is a question being hotly debated.

Jason Bailey, executive director of the Kentucky Center for Economic Policy, of Berea, said, “Moving employees into 401(k)-type plans is actually more expensive … and harms retirees while making it much more difficult to attract and retain a skilled workforce.”
I will keep hammering the point that moving public sector employees to a 401(k) plan shifts retirement risk entirely onto employees, leaves them exposed to the vagaries of public markets, and ultimately many of them will succumb to pension poverty just like private sector employees with DC plans. Moreover, the long-term effects to the state of Kentucky are not good, they will raise social welfare costs and cut economic growth as more people retire with little to no savings.

Another point I need to make to the John Mauldins of this world, the pension crisis is deflationary. Period. I don't care if it's DB or DC pensions, a retirement crisis putting millions at risk for pension poverty will exacerbate rising inequality and necessarily impact aggregate demand and government revenues (collect less sales taxes).

Don't get me wrong, the US has a whole host of problems with their large public DB plans, and chief among them is lack of proper governance. Sure, states aren't topping them up, pensions still use rosy investment assumptions to discount future liabilities, but the biggest problem is government interference and their inability to attract and retain qualified investment staff to manage public and private assets internally.

Following my comment on CalPERS looking to outsource its private equity program to BlackRock, a former CalPERS' employee sent me this:
It's not as simple as compensation alone. You still need people to sign up. Lack of independence and bureaucracy in investment decision-making, reputation for being extremely slow in decision-making, the fact that there's one office in Sacramento and that will not be changing, the fact that Sacramento is a real stretch for anyone with a family living elsewhere, and don't forget the silly reporting on your personal life and myopic focus on expenses and gifts like coffee mugs and umbrellas. And flying economy on long-haul flights to do multi-billion dollar deals while paying thousands for free conferences. There are a lot of factors at play on why it's difficult for them to attract and retain people. Plus in certain areas like fixed income cronyism runs rampant.

All these factors deter highly sophisticated people from making the career risk. And the really good people that join end up staying for a limited time once they get the idea. So you're left with people who join to get a fat pension down the road. The sick thing about that level of high job security is it breeds mediocrity and also creates a false sense of loyalty. Loyalty is only good if a highly competitive culture can be maintained.
Whether or not you agree, there are a lot of statements there that are likely true. And CalPERS is one of the better large public pensions, imagine what is going on elsewhere.

On top of these issues, some fully-funded US pensions are getting hit with brutal changes to accounting rules. I recently discussed how this new math hit Minnesota's pensions but as other states adopt similar rules to discount future liabilities, get ready, they will get ht hard too.

This is why on top of good governance which separates public pensions from the government, I believe we need to introduce some form of risk-sharing in public pensions so when the plans do experience a deficit, contribution rates increase or benefits are cut until the plan regains fully-funded status again.

In my recent conversation with Jim Leech on pensions and Canada's Infrastructure Bank, the former President and CEO of Ontario Teachers' shared this with me on how OTPP regained its fully-funded status:
Basically, there are two levers Ontario Teachers' Pension Plan uses when the plan goes into deficit to restore fully-funded status:
  • It partially or fully removes cost-of-living adjustments (conditional inflation protection) and
  • It raises the contribution rate from the base of 9% to an agreed upon rate (a special levy)
After the plan ran into deficits after the 2008 crisis, the contribution rate was increased to 13% and since it is a jointly sponsored plan, both teachers and the government needed to contribute this rate.

However, unlike 1997 where benefits were increased, now that the plan is fully-funded,  the new agreement is simply to restore full inflation protection and reduce the contribution rate back to the base case of 9% (can never go lower).

The key here is there are no increases in benefits, it's simply restoring full inflation protection and reducing the contribution rate going forward to the base rate of 9%.
Lastly, a dire warning to John Mauldin and residents of Dallas. All roads lead to Dallas. The great state of Texas will survive and rebuild after Hurricane Harvey but get ready for major increases in property taxes when the pension storm cometh and deflation hits the US.

And there will be no escape (to where? Illinois, New Jersey or Kentucky?!?). The pension storm will strike us when we least expect it and it will wreak havoc on the US and global economy for a very long time.

On that cheery Monday note, let me leave you with some more cheerful clips. First, the New York Times published a nice article over the weekend, False Peace for Markets?, profiling a young 38-year old trader, Christopher Cole who runs Artemis Capital, and is betting big that volatility won't stay at historic lows for long. Watch him below discussing the long road to volatility.

I've already covered the silence of the VIX in great detail and it's worth noting Mr. Cole could come out of this a hero or a big zero depending on when markets break down. Like I said in my last comment, it's not markets but Hugh Hendry that was wrong. Cole could be right, and I myself am cautious and defensive right now, but markets can stay irrational longer than you can stay solvent.

Second, OECD Economic and Development Review Committee Chairman William White discusses concerns he has about the economy. He speaks on "Bloomberg Markets: Middle East" and states he sees more dangers in the economy than in 2007. I'm afraid he's absolutely right, we have an insolvency problem that only governments, not central banks, can address properly (see Reuters article, BIS: Global debt may be understated by $13 trillion).

Lastly, Hoisington Investment Management's Lacy Hunt and CNBC's Rick Santelli discuss monetary tightening in an extremely over-leveraged economy. Excellent discussion, listen to his insights on why long bond yields are headed much lower (and pension deficits much higher).

All I know is while the timing of the next financial and economic crisis is a matter of debate, there is no debate the US and global pension crisis has already arrived. When it really hits us, you'll witness "fire and fury" unlike anything you've ever seen before.


Friday, September 15, 2017

Are Markets or Hugh Hendry Wrong?

Zero Hedge posted a comment yesterday that caught my attention, "Markets Are Wrong": Hugh Hendry Shuts Down His Hedge Fund; Here Is His Farewell Letter:
In the beginning, Hugh Hendry was the consummate contrarian bear, which helped him make a killing a decade ago when everyone else was blowing up. Unfortunately for him, he did not realize just how far the central planners were willing to take their monetary experiment, so after the market troughed in 2009, he kept his bearish perspective, which cost him dearly in terms of missed gains and lost capital under management, until one day in November 2013, he capitulated and turned bullish, infamously saying "I cannot look at myself in the mirror; everything I have believed in I have had to reject. This environment only makes sense through the prism of trends."

Since then, the reborn Hendry who would never again fight central banks, gingerly made his way, earning his single digit P&L...(click on image)


.... even as many of his formerly loyal LPs deserted the former bear. It culminates with July and August, when Hendry posted some of his worst monthly returns on record which ultimately sealed his fate, and as he writes in a letter sent to investors today, Hendry decided to shut down his Eclectica hedge funds after 15 years, following a 9.8% YTD loss and massive redemptions, which left the fund which as recently as a few years ago managed billions with just $30.6 million as of August 31. As he best puts it "It wasn’t supposed to be like this."

The final P&L (click on image):


So what is Hendry's parting message to his investors and fans? Surprisingly, perhaps, he disavows the original Hugh Hendry, and goes out long (if not quite so strong). Below we repost his full final letter in its entirety, and wish Hendry good luck in his next endeavour.

CF Eclectica Absolute Macro Fund

Manager Commentary, September 2017

What if I was to tell you I wasn’t bearish on anything? Is that something you would be interested in?

It wasn’t supposed to be like this and it is especially frustrating as nothing much has gone wrong with the economy over the summer. If anything we feel more convinced that our thesis of a healing global economy is understated: for the first time in an age all parts of the world are enjoying synchronised economic momentum and I can’t see it ending for some time. It’s just that our substantial risk book became strongly correlated over the short term to the maelstrom of President Trump and the daily news bombs emanating from the Korean Peninsula; that and the increasing regulatory burden which makes it almost impossible to manage small pools of capital today. Like I said, it wasn’t supposed to be like this…

But let me bow out by sharing my team’s views. For the implications of a sustained bout of economic growth are good for you. It’s good because it should continue to underwrite a continuation in the positive performance of global equities. I would stay long. It’s also good because I can’t see interest rates rising abruptly to interrupt the upward path of equities. And commodities have already acknowledged the upturn in the fortunes of the global economy and are likely to trend higher still. That’s a lot of good news.

But it is bad news for me because funds like mine are required to demonstrate negative correlation with risk assets (when they go up like this I go down…), avoid large drawdowns and post consistent high risk adjusted returns.

Oh, and I forgot, macro fund clients don’t like us investing in the stock market for the understandable fear that we concentrate their already considerable risk undertaking. That proved to be an almighty puzzle for a fund like mine that has been proclaiming the stock market as a “safe-ish” bet ever since 2013.

Let me explain the “markets are wrong and we boom now” argument. To begin with, and for the sake of clarity, I think we have to carefully go back and deconstruct the volatile engagement between capital markets and central banks for the last ten years for an understanding of where we stand today.

The first die was cast by the central bankers in early 2009: having stared into the abyss of a deflationary spiral in 2008 the Fed and the BoE announced a radical new policy of bond purchases named Quantitative Easing. The bond market hated the idea as it was expected to cause a severe inflation problem.

Thankfully Bernanke, a student of the great depression knew better.

Markets primed themselves for inflation yet even with a ripping stock market in 2009/10 they were disappointed. QE rescued the financial system but the liquidity created was distributed to the very rich who have a very low monetary velocity and so the expected inflation fillip never materialised as the liquidity injection came to be stored rather than multiplied by the banking system.

Several years later, in 2013, the Fed suggested a reduction in the pace of its QE program. They wanted to tighten credit conditions gradually. However, capital markets beat them to it and the ensuing “taper tantrum” tightened monetary policy on their behalf. Within four months the market had taken 10 year treasuries from a yield of 1.6% to 2.9%, a move of far greater impact, and much more rapid, than anything the Fed had contemplated doing.

Markets initially thought the US could cope with this higher level of rates, but with a slowing economy, an unfortunately-timed oil price crash, and persistent ghosts in the machine (like the substantial Yuan devaluation fear which never materialised) they were proven wrong. Back then, with a 7.6% national unemployment rate and tepid wage inflation, this tightening always looked a little premature to us and so it proved with the rate of price inflation inevitably sliding lower to present levels.

And so last year, following many years of berating the Fed for its easy monetary policy regime, investors collectively threw in the towel. This rejection of the basic tenets of the business cycle by those who direct the huge pools of real money is proving particularly onerous to attack as it seems that the basic macro fund model is broken: there are just not enough “coins in them pirates’ chests” to challenge the navy of this flawed real money doctrine. Managers, and I must count myself in this camp, feel compromised by our poor absolute returns since 2012 and we find ourselves unable to put up much resistance to this FAKE NEWS.

Why should you fight it? Well let’s look at the last few times American unemployment dipped below 4.5% like today. I would largely ignore 2000 and 2006 when monetary policy was tightened and the economy buckled under the duress of the dramatic reversal in what had been credit fuelled misallocations of capital in the TMT and property sectors. No, for me 1965 is far more illuminating. Then, like today, there was no epic bubble or set of circumstances whose reversal could cause a slump; people forget but recessions don’t come out of thin air. No, in 1965, economic growth got choked by a tight labour market; a market as ominously tight as today’s.

In the middle of 1964, CPI core inflation was running at 1.7% and indeed dropped to just 1.2% in 1965; unemployment was 4.5%, the same as today. And yet by the end of 1966 inflation had essentially got out of control and didn’t dip below 2% again until 1995, almost 30 years later (click on image).


It seems to me that wage or cost push inflation is far more difficult to prevent and contain than asset price inflation. It tends to bear comparison with how Hemmingway described going broke: slow at first and then devastatingly quick. It may prove especially potent right now as the labour market is tight and there are no catalysts to generate a self-correcting US recession with both central bankers and markets now united in their desire for loose policy.

Look at the graph below, the unemployment rate (red) is at lows, job openings (blue) have increased beyond the hiring rate (teal) and are now approaching the unemployment rate for the first time since the Job Openings and Labor Turnover Survey data began. Ultimately robust GDP growth plus this labour tightness will lead to wage hikes and conceivably a self-sustaining inflationary cycle.


This is all the more ominous as the Fed has been reluctant to unwind its balance sheet. The largesse of this program fell to those already wealthy (“the global creditor”) and who had a low propensity to spend: financial markets boomed, less so the real economy. However the legacy of QE plus wage gains would turn this equation on its head. It would distribute incremental dollars to those with a much higher propensity to spend. The boost to monetary velocity from widespread wage increases would start to look much more like the helicopter money that Chairman Bernanke promised back in 2002 and subsequent central bankers dared not distribute.

The macro shock would not necessarily be the subsequent inflation but, that by waiting to respond until later, higher policy rates might fail in the first instance to induce a recession setting off a loop begetting higher and higher rates. Let me explain: companies will continue to employ staff, and with wages increasing, it is likely that sales will hold up and, depending on whether they achieve productivity gains or not, corporate profitability might also remain firm. So companies will commit to pay staff more whilst raising prices to meet higher wage and interest payment demands where possible. Like I said, wage or cost push inflation is a very different beast to contain.

I have to say that should this scenario unfold then capital markets will be as culpable as the Fed. This year, bond investors have aggressively flattened the US yield curve. The clear message is that 1.25% overnight rates threaten to pull the US economy into recession. I disagree. I think they are undermining the ability of the Federal Reserve to respond proactively; the Fed is simply not going to hike rates under such conditions having learnt the hard way back in 1999 and 2005. But what if such flatness has more to do with the commercial investment pressure brought on by QE rather than a genuine recession threat? Could it be that the bond market’s cautionary recessionary indicator is stuck flashing RED whilst the US economy goes from strength to strength? I fear so.

Clearly of course no one knows. However if an inflationary path like 1966 is gestating then I fear there is very little chance that anything timely will be done about it. Rate hikes will continue to be sparse, we only have one quarter point hike predicted between now and the end of 2019, which if fulfilled will be highly unlikely to spark a severe recession. Most likely the US economy will continue to grow and the labour market will tighten making a larger adjustment to rates in the future inevitable.

And so QE could conceivably end up doing what it was always supposed to do in the first place: find its way through the financial system to increase, not decrease, interest rates. This scenario would diminish greatly if bond curves steepened a lot now and gave the Fed the credibility to hike. Sadly I just don’t see this happening. They will steepen of course but I fear only after the virus of cost push inflation is released into the global hothouse.

This potentially leaves us in a strange environment. In the absence of any recognisable asset bubble set to burst, and the Fed grounded, the US economy is unlikely to slip into recession. China continues to rip. And now the European continent is recovering. Risk assets should continue to trend positively. And with the bond market, wrongly in my opinion, infatuated with the likelihood of an approaching US recession, the Treasury market is unlikely to move much. This is simply not a good time to offer a risk diversifying portfolio.

However, perhaps being long fixed income volatility isn’t such a bad idea. It has not been persistently lower than this for almost three decades. And unlike equity volatility it does not tend to trade in lengthy and definable regimes; it is never a great idea to go long equity volatility just because it happens to be low. The same cannot be said of its fixed income counterpart.

The collapse in volatility since 2012 seems to resonate with the drawn out process of QE in the US and its slow spread across the world. However that era is clearly now abating as this year’s synchronised global growth gradually shifts the debate from looseness to gradual global tightening. And yet fixed income volatility resides on the floor…

Looking at the one year implied volatility on 10 year swaps, the cost of entry seems reasonable even compared to the narrow trading range we have seen this year. That is unless you expect volatility to crash and the trading range to contract even further. With only one Fed hike priced in until the end of 2019 any further contractions are likely to be driven by outright recession. In that case volatility will rise across all asset classes. On the other hand, if our thesis is right, and the market and Fed are too complacent on inflationary pressures, then it is likely that we see more hikes from the Fed alongside yield curves steepening from their currently very low levels. Fixed income volatility will surge. When the status quo priced in is this boring, fixed income volatility really has only one direction it can go (click on image).


With inflation still weak and government bond prices unlikely to crack just yet it is too early to seek a short fixed income trade in disguise. In the past, correlations have, just like in the stock market, typically been negative between the price (SPX or Treasury) and the implied volatility (VIX or swaption vol.). Now however the correlation is mildly positive. So being long fixed income volatility is not necessarily the same as being short fixed income. My contention is simply that fixed income volatility has over shot to the downside, that such moments are fleeting and that you are not necessarily dependant on a correction in treasury prices (click on image).

Sadly I will be unable to participate with such trades during the next upheaval in global markets with the Fund but I hope that this commentary has at least roused you into contemplating scenarios that are presently deemed less plausible.

It remains only that I thank you for the great honour of having been responsible for managing your capital and to wish you all great financial fortune.

Hugh Hendry and team
Before I get to Hugh to explain in detail why HE is wrong, not the market, I almost fell off my chair laughing this morning when I saw Brian Romanchuk's (publisher of the Bond Economics blog) tweet this in reply to the Zero Hedge post I tweeted to my followers (click on image):


Brian is right, if you're charging 2 & 20, you better come up with something better than that!

Now, Hugh Hendry, no relation to the great econometrician at Oxford, David Hendry, always struck me as a bit of an arrogant, smug, quirky chap who admittedly was posting ok (not great) numbers and loved to hear himself speak about how he's right and the market is wrong.

I used to allocate to top hedge funds in the directional portfolio made up of L/S Equity, Global Macros, CTAs, Short Sellers and a few Funds of Hedge Funds. I did this a while ago (2002-2003) working under Mario Therrien's group at the Caisse.

I didn't stay long but I learned about constructing a portfolio of hedge funds, doing good due diligence, following up, adding and redeeming from managers and learned a lot from my discussions with all these managers.

The first thing I'm going to tell you, the market is never wrong, people who claim so are wrong. This doesn't just apply to Hugh, it applies to everyone from Steve Cohen, to George Soros, to Ray Dalio, to Ken Griffin, to Leo Kolivakis!!

Yes, I came out a couple of months ago with my top three macro conviction trades:
  1. Load up on US long bonds (TLT) as I see a US slowdown on the horizon, deflation headed to America, and the yield on the 10-year Treasury note plunging well below 1%.
  2. Start nibbling on the US dollar (UUP) and get ready for a major reversal of the downtrend as I still see deflation wreaking havoc in China, Europe and Japan and their economies are getting ready to roll over. This means their currencies will necessarily need to bear the brunt of this coming slowdown.
  3. Short oil (OIL), energy (XLE), metal and mining (XME), emerging markets shares (EEM) and short commodity indexes and currencies like the Canadian dollar (FXC).
I even shifted all my money out of biotech (XBI) into US long bonds two months ago, and even though bonds went up, the appreciation of the loonie took away all those gains and left me in the red (the Bank of Canada flirting with disaster only exacerbated the loonie's insane appreciation).

Still, I made money in the first half of the year trading small biotechs. And to my horror, one of them, Mirati Therapeutics (MRTX) which at one time I owned 5000 shares of at around $5, just popped HUGE this morning, up a whopping 150% at this writing on Friday morning (click on image):


I had bought it because one of the top biotech funds I track closely every quarter, Broadfin, took a big stake in it early in the year, as did Boxer Capital, a well-known activist investor.

Another small biotech stock that popped huge this week was Aldeyra Therapeutics (ALDX). The top institutional holder of that stock is Perceptive Advisors, one of the best biotech funds out there (they really impress me with their picks).

Honestly, I was kicking myself this week, asking myself WHY in God's name did I stop trading biotechs, why didn't I keep Warren Buffett's quote in mind: "The stock market is a device for transferring money from the impatient to the patient."

Then, I remembered, I had a terrible summer on the health front, was eventually diagnosed with Graves' disease which caused my hyperthyroidism, and this on top of dealing with Multiple Sclerosis  for twenty years. My thyroid completely screwed me up, was a lot weaker than normal, was ready to collapse after a few steps.

Luckily, it is treatable and I responded well to the medication (Tapazole) which I've been taking for a month. I'm still not 100 percent but I feel a lot better and my endocrinologist thinks I've had it for years and because of my MS diagnosis, I never got it checked out properly (always wrongly assumed symptoms were related to MS).

[Note: As an aside, to save on healthcare costs, the Quebec government doesn't include thyroid tests as part of a standard GP workup any longer because most people have a normal thyroid, but learn all you can about thyroid disease, especially if you're an older woman or are exhibiting unexplained weight gain or weight loss or many other symptoms, including depression or irritability.]

Now that I'm feeling better, I'm asking myself whether I should jump back in and start trading individual biotech names, take huge concentration risk, and roll the dice once more.

But I keep thinking about my macro concerns, and I ask myself whether it's worth the stress of living through huge 80%++ drawdowns that I lived through in the past, triple averaging down on Catalyst Pharmaceuticals (CPRX) before I got out of that name with a decent profit.

Traders will tell you, cut your losses quickly, never average down, and most of the time they are right. For example, look at the five-year chart of Mirati Therapeutics (MRTX) and you'll see those that bought at close to $50 a share and didn't average down, aren't rejoicing today's big pop (click on image):


Anyway, there is clearly A LOT of liquidity in this market which keeps driving risk assets higher and higher, but let me get back to Hugh Hendry's comment above.

Just like Ken Griffin, Hugh thinks there is too much complacency in the market and it's not discounting inflation risks properly. He even agrees with Alan Greenspan and others, that there's a bubble in bonds. Well, the Maestro is wrong on bonds, and so are Hugh and many others worried about the inflation boogeyman.

Go back to read my recent comment on deflation headed to the US, where once again, I highlighted the seven structural factors that lead me to believe we are headed for a prolonged period of debt deflation:
  1. The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
  2. Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
  3. The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
  4. Excessive private and public debt: Rising government and consumer debt levels are constraining public finances and consumer spending.
  5. Rising inequality: Hedge fund gurus cannot appreciate this because they live in an alternate universe, but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
  6. Globalization: Capital is free to move around the world in search of better opportunities but labor isn't. Offshoring manufacturing and service sector jobs to countries with lower wages increases corporate profits but exacerbates inequality.
  7. Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create.
These are the seven structural factors I keep referring to when I warn investors to temper their growth forecasts and to prepare for global deflation.

Hugh can cry foul all he wants about FAKE NEWS and central banks tampering with markets but the reality is he and many other hedge fund gurus have been on the wrong side of the baffling mystery of inflation deflation.

Worse still, he married into this position and failed to manage his downside risk. Period. You can be right but if you forget that markets can stay irrational longer than you can stay solvent, you're dead!

I'm going to share another story with you. Back in June 2003, Mario Therrien and I went to some hedge fund conference in Geneva. I didn't like the conference but afterward, we hooked up with two global macro managers we wanted to meet, Ravinder "Ravi" Mehra and Jesus Saa Requejo who were there for their annual medical checkup.

At the time, Ravi and Jesus were running Vega Asset Management, a large global macro fund that was growing by leaps and bounds. You can read all about them here and here.

One of my concerns was the fund was a marketing machine but I liked their risk management and thought they were worth an allocation. Right after Geneva, Mario and I flew to Madrid to visit their offices (I love that city and was saddened to learn about the terrorist attacks this summer).

But I remember at the dinner with Ravi and Jesus in Geneva, something irked me about their short US Treasuries view. Jesus was convinced rates couldn't go lower and even told me "deflation is impossible in the US where helicopter drops can occur".

At the time, we were wondering whether to allocate $50 million to them but I recommended cutting it in half. While I liked them and their fund, the marketing of the fund and their short Treasuries view bugged me. They made money the subsequent years, grew to $12+ billion in assets under management, but the fund eventually got hit and then had to close to new investors to claw its way back in 2007 after devastating losses.

I lost touch with Ravi and Jesus but the point I'm making is nobody is infallible, the market is always right until it breaks down, and if you don't have deep pockets to ride it out when it's going against you, you will die (all you young bucks should read When Genius Failed, one of my favorite books on this subject).

Below, Andrew Ross Sorkin sits down with billionaire Ray Dalio of Bridgewater Associates, the world’s largest hedge fund, to discuss tax reform, leadership and the wealth gap.

Earlier this week, I said it's time we look beyond Bridgewater's culture and principles, sharing my skepticism on "radical transparency".

But there's no denying Ray Dalio is a macro god one of the few who has been able to weather the macro storm that has hit many other macro gods. He's also built a great company and even though I have profound disagreements with some of his Principles and what I feel is radically transparent marketing nonsense, I have tremendous respect for the man and the shop he has built over decades.

I'll end by sharing one final story with you, one I've shared a few times before.

Back in late 2003 or early 2004, after I had moved over to PSP, I took a trip with Gordon Fyfe who was just getting the lay of the land as PSP's new CEO back then. We went to meet peers and funds. I had invested in Bridgewater in 2003 while at the Caisse, so we went there and got meet Ray Dalio and his senior team (only reason Ray was present was Gordon was there and PSP was a great potential client).

During the meeting, after Ray gave us his talk about how great Bridgewater's All Weather portfolio is, I started pressing him hard on the US housing market going into bubble territory, and the very real threat of deflation down the road.

We had a good exchange but I obviously got under his skin because at one point, he looked annoyed and blurted: "What's your track record?". The look on the sales guys next to him was a look of horror.

I left that meeting with my testicles stuffed in my mouth and Gordon Fyfe kept teasing all the way to the airport and for the remainder of that trip: "What's your track record?"

But the truth is I really enjoyed that and many other exchanges I had with top hedge fund managers and wasn't paid money to coddle anyone, including Ray and Gordon.

Ray is right, markets are very tough to call, taking contrarian and concentrated bets is how to make big money but when you're wrong, it can kill you, which is why All Weather takes an agnostic approach to the market environment.

Hugh Hendry discovered this the hard way. You can listen to his recent Macrovoices  podcast below but keep in mind my macro comments above.

One last thing, I highly recommend all my institutional readers subscribe to  the great market research at Cornerstone Macro. Francois Trahan and Michael Kantrowitz posted a replay of their conference call which is an absolute must watch as they explain why big downward economic revisions are coming in the US, and now is the time to be defensive.

I think they're right but I'm going back to looking at the biotech melt-up I didn't participate in (ARGH!). Hope you enjoyed reading this comment, and please remember to donate and/or subscribe to this blog via PayPal under my picture on the right-hand side (view web version on you cell).

I thank all of you who support my blog, it's greatly appreciated, but please keep me in mind for full-time employment and/ or contract work. As my health improves, I think I'm ready to get back into the daily grind but I will need your support, at least initially until I get back in the swing of things.


Thursday, September 14, 2017

ATP and OTPP Strike Airport Deal?

Jacqueline Nelson of the Globe and Mail reports, Teachers’ European airport gets new pension investor:
Ontario Teachers' Pension Plan is getting a new partner in its investment in a growing European airport that is in the midst of an expansion.

Part of Denmark's Copenhagen Airports is trading hands as an infrastructure division of Macquarie sells a 27.7-per-cent stake to the country's state pension plan known as ATP Group, for 9.77 billion Danish Krone ($1.9-billion). Combined with the 30-per-cent stake Teachers owns, this will give pension funds control over 57.7 per cent of the flight hub. The Danish government will continue to own a nearly 40-per-cent stake.

The deal showcases the value of relationships among the world's top private market investors. Macquarie had been looking sell off its holding in the airport for several months and was required to first offer the stake to Teachers, because of a privilege called pre-emptive rights. Teachers, which also owns portions of a variety of other airports around Europe, did not want to enlarge its already sizable investment. But the Toronto-based pension fund was able to act as a matchmaker between ATP and Macquarie to secure a like-minded partner that is well-known and respected in its home Danish market. This could be an advantage as the airport continues an extensive capital investment and renovation plan amid rigorous regulatory oversight.

In infrastructure investing, being aligned with a partner that has similar aspirations, expectations and growth targets for the asset is desirable. Copenhagen is currently seeking to boost its status as a European hub airport, with the aim to increase the number of flights as well as domestic and international passengers moving through the terminal each year. It plans to boost capacity to 40 million passengers annually from 29 million, and at the same time lower some fees.

"The airport in Copenhagen is key infrastructure in Denmark and we are proud to be one of its stewards going forward," Christian Hyldahl, CEO of ATP Group, said in a statement. "We are keen to work together with all stakeholders to further develop the airport and contribute to its long-term continuation as a critical transportation hub in northern Europe to the benefit of both Danish society as well as the members in ATP."

Deals for infrastructure around the world are increasingly competitive and the utility assets where cash-flow streams are contracted and regulated are among the most appealing to investors. For pension funds looking for a proxy to fixed-income investments in a low-interest-rate environment, these holdings have a lot of appeal. Airports are a little different because they are high profile, relatively scarce and offer the potential for growth not only by increased global travel but also through the development of retail offerings and other services such as parking and on-site hotels.

Teachers and Macquarie have a long history working together on airport deals. Teachers' bought into Copenhagen's airport in 2011 when it agreed to trade stakes with a division of Macquarie. Teachers gave over its 11-per-cent holding in Sydney, Australia's airport and paid nearly $800-million (Australian) ($780-million) in exchange for stakes in Brussels and Copenhagen airports.

Since then, Teachers has had an active airport investment strategy, building up a dedicated aviation subsidiary called Ontario Airports Investments Ltd. to oversee its portfolio, as well as source other acquisition opportunities. It now owns parts of London City, Bristol and Birmingham airports, as well as Brussels and Copenhagen.
Reuters also reports, Danish pension fund to buy stake in Copenhagen Airports in $1.6 billion deal:
Danish pension fund ATP has agreed to buy a 27.7 percent stake in Copenhagen Airports (CPH) from Australia’s Macquarie for about 9.8 billion Danish crowns ($1.57 billion).

The transaction depends on approval by the Danish and European Union authorities and is expected to be completed in the fourth quarter, the parties said in a joint statement.

ATP estimated the offer price would be about 5,700 crowns per share, but said this could fluctuate depending on the date of completion.

Shares in the airport company rose as much as 12.3 percent after the announcement to 5,750 crowns per share. It closed at 5,620 crowns on Thursday.

Macquarie has invested more than 10 billion crowns during its 12 years of ownership in the company which owns Kastrup airport, the main international airport serving Copenhagen.

The Danish state owns 39.2 percent of the firm and Denmark’s Finance Minister Kristian Jensen said on Twitter he was “very satisfied” that the future ownership was clarified and was looking forward to working with the new shareholders.

Canadian pension fund Ontario Teachers’ Pension Plan (OTTP) holds a 30 percent stake in the airport company.
4-traders also reports, ATP, Macquarie and Ontario Teachers' Pension Plan Announce Copenhagen Airports Transaction:
Ontario Teachers' Pension Plan issued the following news release:

Arbejdsmarkedets Tillcgspension ("ATP"), Macquarie Infrastructure and Real Assets (MIRA) and Ontario Teachers' Pension Plan ("Ontario Teachers'") are pleased to announce the signing of a transaction that will change the ultimate shareholding of Copenhagen Airports A/S ("CPH"). By announcement of 23 May 2017, Macquarie Infrastructure and Real Assets (Europe) Limited on behalf of Macquarie European Infrastructure Fund III ("MEIF3") informed CPH that it would undertake a strategic review of MEIF3's investment in CPH. Following this announcement, MEIF3 offered for sale its securities in Kastrup Airport Parents ApS ("KAP"), a holding company which indirectly holds a 57.7 percent ownership in CPH, to Ontario Teachers'. Today Ontario Teachers' has exercised its preemptive right to acquire MEIF3's stake in KAP.

Ontario Teachers' has partnered with Danish pension plan ATP which will provide the financing to fully fund the transaction which is valued at approximately DKK 9.8 billion (EUR1.3 billion) (such amount subject to change depending on the completion date of the transaction). Completion of the transaction is expected to occur during Q4 2017. As a result of the transaction, ATP will become a direct shareholder in KAP and, together with Ontario Teachers', the two will hold an indirect ownership of 57.7 percent of CPH.

"ATP is now becoming a significant investor in Copenhagen Airports. The airport in Copenhagen is key infrastructure in Denmark and we are proud to be one of its stewards going forward. We are keen to work together with all stakeholders to further develop the airport and contribute to its long-term continuation as a critical transportation hub in northern Europe to the benefit of both the Danish society as well as the members in ATP." said Christian Hyldahl, Chief Executive Officer, ATP Group.

"Macquarie is proud of the investments and focus that have contributed to making Copenhagen Airport one of the largest and best connected airports in Northern Europe. In the period of our 12 year ownership Copenhagen Airport invested over DKK 10 billion and it now has both state of the art and low cost terminals, the largest international route network in the Nordics and excellent transport links across Denmark and Southern Sweden. The airport is powerfully positioned, with the support of its new shareholder in ATP, to continue to grow and provide choice, competition and convenience as well as make a significant economic contribution to the Danish economy" said Martin Stanley, Global Head of MIRA.

"Having strong, long-term investment partners is crucial as we support Copenhagen Airports in delivering the best possible experience for its customers," said Andrew Claerhout, Senior Managing Director, Infrastructure and Natural Resources at Ontario Teachers'. "During our more than six years as a partner with Macquarie, Copenhagen Airports has received numerous industry awards for its quality and efficiency. We look forward to continuing and growing on this track record of success in what will be our second partnership with ATP, with whom we are strongly aligned in our focus on long-term value creation."

Completion of the acquisition is subject to approval by the EU Commission pursuant to the EU Merger Regulation (EUMR). Ontario Teachers' and ATP expect that completion of the transaction will result in joint control of the 57.7 percent indirect shareholding in CPH and ultimately the issuance of a mandatory tender offer for the remaining shares in CPH. The tender offer is also conditional on completion taking place and will be fully financed by ATP.

The tender offer price (per share of CPH) will be based on the price paid for MEIF3's securities in KAP in relation to the transaction, adjusted for third party debt financing, certain liabilities and cash in KAP and in its subsidiaries that hold the shares in CPH (all together, the Tender Price). The transaction value and the adjustments, as well as the Tender Price, are subject to change depending on the date of completion.

Ontario Teachers' and ATP estimate that the transaction value of approximately DKK 9.8 billion will imply a Tender Price in their tender offer of approximately DKK 5,700 per share in CPH based on an illustrative completion date of mid November 2017, however, such Tender Price shall be determined based on the transaction value and adjustments established on the actual completion date and be subject to approval of the Danish Financial Supervisory Authority of the tender offer document and the price offered. MEIF3 is not involved with, and assumes no responsibility or liability for, the mandatory tender offer and for determining the Tender Price.

External factors described herein are outside the control of Ontario Teachers', ATP or MEIF3 and thus there is no certainty that the transaction will complete or that a subsequent tender offer will be issued.

Ownership and Performance at Copenhagen Airports

* MIRA has been involved in Copenhagen Airports A/S for the past 12 years, having initially acquired a stake in 2005. MEIF3 invested in Copenhagen Airports A/S in 2008.

* Ontario Teachers' Pension Plan acquired its current stake in CPH in 2011.

* MEIF3 is a ten year closed-ended infrastructure fund whose investors include pension funds and institutional investors. MEIF3 is approaching fund life maturity.

* Since 2005, passenger volumes have increased by approximately 45 percent, and the airport now serves 77 airlines with direct connections to 165 destinations.

* Employee numbers have increased by approximately 41 percent, providing greater employment opportunities in Denmark.

* In 2016, Copenhagen Airport was ranked best airport in Northern Europe, featured in the top five for overall passenger satisfaction out of 27 other European Airports with more than 15 million passengers a year, and for the tenth time in 12 years was named Europe's most efficient airport.

About ATP

ATP is a mandatory savings scheme with more than five million member and approximately DKK 750 billion (EUR 100 billion) under management. ATP has longstanding experience in direct investments both domestically and internationally, including infrastructure, timberlands and real estate.

ATP Lifelong Pension is guaranteed and lifelong and is disbursed to nearly all pensioners. For 50 per cent of all old-age pensioners, ATP Lifelong Pension is their only source of pension income other than their state-funded old-age pension. Besides ATP Lifelong Pension, ATP administers key welfare benefits and schemes on behalf of the Danish state, the local authorities in Denmark and the social partners. ATP is the largest administration provider in the Nordic countries, managing two thirds of welfare benefits disbursed in Denmark.

About MIRA

MIRA is part of Macquarie Asset Management Group, the asset management arm of Macquarie Group (Macquarie), a diversified financial group providing clients with asset management, banking, advisory and risk and capital solutions across debt, equity and commodities. Founded in 1969, Macquarie employs 13,597 people in 27 countries. As at 31 March 2017, Macquarie had assets under management of EUR345 billion.

MIRA pioneered infrastructure as a new asset class for institutional investors. For more than 20 years it has been investing in and managing the assets that people use every day - extending beyond Infrastructure to Real Estate, Agriculture and Energy. MIRA's dedicated operational and financial experts work where MIRA's funds invest and the portfolio companies operate. They are part of a global team which helps clients to see across the regions and deep into local markets. As at 31 March 2017, MIRA has assets under management of more than EUR110.4 billion invested in 134 portfolio businesses, ~300 properties and 4.5 million hectares of farmland.

About Ontario Teachers'

The Ontario Teachers' Pension Plan (Ontario Teachers') is Canada's largest single-profession pension plan, with C$180.5 billion in net assets at 30 June 2017. It holds a diverse global portfolio of assets, approximately 80 percent of which is managed in-house, and has earned an annualized gross rate of return of 10.1 percent since the Plan's founding in 1990. Ontario Teachers' is an independent organization headquartered in Toronto. Its Asia-Pacific region office is located in Hong Kong and its Europe, Middle East & Africa region office is in London. The defined-benefit plan, which is fully funded, invests and administers the pensions of the province of Ontario's 318,000 active and retired teachers. For more information, visit otpp.com and follow us on Twitter @OtppInfo.
How did Ontario Teachers' strike a deal with Denmark's ATP for this particular airport deal? I suspect this man had something to do with this deal (click on image):

Ontario Teachers' new CIO, Bjarne Graven Larsen, was  the former CIO and executive board member of Denmark's ATP, so it's fair to assume he knew who to contact quickly to facilitate this transaction.

ATP is one of the best pension plans in Europe and the world. The last time I covered ATP was in a comment explaining how it's bucking the hedge fund trend. Lars Rohde, the former CEO of ATP,  became the governor of the country’s national bank in 2013.

One thing ATP and Ontario Teacher's Pension Plan (OTPP) have in common is matching assets with liabilities. OTPP's Infrastructure chief, Andrew Claerhout, is taking a new approach, but the name of the game remains the same, namely, how to best match assets with liabilities with the least amount of volatility over the long run.

Again, what are pension plans all about? Matching assets with liabilities. Pension liabilities are long-dated, going out 75+ years, and require long duration assets to be matched properly. But most assets are short duration and the ones that are long like a 30-year long bond, don't offer the actuarially required yield to ensure pensions will remain solvent over a long period.

In the last two decades, Canada's large pensions have been moving aggressively into private markets like private equity, real estate, infrastructure and natural resources which include farmland and timberland.

Real estate and infrastructure offer great cash flows and they are long duration assets, offering yields in between stocks and bonds, perfect for fully-funded or close to fully-funded pensions looking to reduce public market risk and match their long-dated liabilities.

I believe over the next ten or twenty years, infrastructure will take over real estate as the most important asset class for Canada's large pensions.

Why infrastructure? Apart from being able to match long-dated liabilities, infrastructure offers these large pensions scalability, meaning they can put a huge chunk of change to work relatively quickly. Also, unlike private equity, they invest in infrastructure directly, paying no fees to outside managers.

Why bother trying to invest $20, $50 or $100 million tickets to some hedge funds or private equity funds when you can write a $300, $500 or even a billion or more dollar ticket to own a stake in some coveted infrastructure asset which is already operational (brownfield), has well-known revenue streams, and very realistic growth projections?

Fewer headaches, more secure and less volatile cash flows (yield) and you can put a lot of money to work relatively quickly.

Are there risks to infrastructure? You bet, illiquidity, regulatory and currency risks are among them. The strong Canadian dollar has already impacted Ontario Teachers' mid-year results and will impact its second half results too.

But if you ask me, now is the time to pounce on foreign assets, using the CTA momentum-chasing artificially high loonie to pounce on foreign assets. This isn't the case here, but now is the time for Canada's large pensions to crank it up, diversifying in private and public markets outside Canada.

By the way, Ontario Teachers' isn't the only large Canadian pension that loves airports or airport related investments. Earlier this month, Reuters reported that Canadian pension fund Caisse de depot et Placement du Quebec (CDPQ) and private equity fund Ardian entered into exclusive talks to acquire a significant stake in airport ground support firm Alvest:
Canada’s second-biggest public pension fund and the French private equity investor are set to acquire the stake from French Sagard Private Equity Partners. The terms of the deal were not disclosed.

Alvest designs, manufactures and distributes technical products for the aviation industry and has more than 1,800 employees. It operates 10 factories in the United States, Canada, France and China.
And in May, Barbara Shecter of the National Post reported, Pension funds circle around airports amid speculation about a Canadian sale:
Canadian pension funds still love airports, judging by the latest deal of the Public Sector Pension Investment Board.

On Tuesday, PSP Investments said it purchased a 40 per cent interest in Aerostar Airport Holdings LLC, operator of the Luis Munoz Marin International Airport in San Juan, Puerto Rico.

The balance of Aerostar is held by Grupo Aeroportuario del Sureste S.A.B. de C.V. (ASUR), which already owned 50 per cent and picked up an additional 10 per cent stake.

The seller was funds managed by Oaktree Capital Management L.P., and the combined new purchases by PSP and ASUR were valued at US$430 million.

“This acquisition is an excellent fit with PSP Investments’ long-term investment philosophy and leverages the capabilities of AviAlliance, our airport platform,” said Patrick Charbonneau, managing director of infrastructure investments at PSP.

AviAlliance holds interests in the airports of Athens, Budapest, Düsseldorf and Hamburg. With the latest investment in Aerostar, airports will represent more than 15 per cent of PSP Investments’ infrastructure portfolio, a spokesperson for the pension investment manager said.

The latest deal comes amid speculation that the Canadian government is mulling the sale airports, or stakes in them, to private interests to raise funds. Toronto’s Pearson International Airport has been valued at $5 billion, according to media reports.

Canada Pension Plan Investment Board chief executive Mark Machin told the Financial Post earlier this year that CPPIB would look at any Canadian airport put on the block.

“We know airports, we like airports, we’d be interested if something happened,” he said during an interview in March.

A group of Canadian pension investment managers including the Ontario Teachers’ Pension Plan, OMERS, and Alberta Investment Management Corp. (AIMCo) joined a consortium last year to purchase London City Airport.

Teachers’ had already acquired a 39 per cent stake in Brussels Airport, and a 30 per cent of Denmark’s Copenhagen airport in 2011.
In short, Canada's large pensions know airports, love airports, and they almost all have some platform made up of outside experts to manage these assets properly.

I can also tell you while Greece is still a mess, the Athens airport is booming, doing extremely well, and PSP was smart to have purchased a stake in it years ago.

All in all, this is a great deal for ATP and OTPP, two of the very best pension plans in the world looking to match assets and liabilities very closely.

Below, inside Copenhagen Airport located just outside Copenhagen in Denmark (actually located in Kastrup a town located in the Tårnby municipality and a small piece in Dragør). This footage was taken early morning in the international departures area of the airport past security control where only passengers have access.

There is no doubt this is one of the most important airports in Northern Europe, one that will provide ATP and OTPP stable cash flows for a very long time. 

Update: Someone sent me an email after reading this comment:
"Regarding the Copenhagen airport transaction - OTPP really just swapped Macquarie for ATP as a partner. This wasn't really a buy or sell from OTPP's perspective but they now get a new partner which should have better alignment."
I agree and I'm sorry if it didn't come out properly in this post (my bad).