Ted Ballantine | Pension360

Kolivakis On Canada Pension’s Big Brazil Bet

On Tuesday the Canada Pension Plan Investment Board (CPPIB), the entity that manages investments for the Canada Pension Plan, unveiled plans to invest $396 million in commercial real estate in Brazil.

The CPPIB now has nearly $2 billion committed to real estate investments in Brazil.

Leo Kolivakis, who runs the Pension Pulse blog, weighed in on CPPIB’s Brazil bet in a post this week:

Let me share my thoughts on this Brazilian real estate deal. From a timing perspective, this deal couldn’t come at a worse time. Why? Because the Brazilian economy remains in recession and things can get a lot worse for Latin American countries which experienced a boom/ bust from the Fed’s policies and China’s over-investment cycle. This is why some are calling it Latin America’s ‘made in the USA’ 2014 recession, and if you think it’s over, think again. John Maudin’s latest, A Scary Story for Emerging Markets, discusses how the end of QE and the surge in the mighty greenback can lead to a sea change in the global economy and another emerging markets crisis.
Mac Margolis, a Bloomberg View contributor in Rio de Janeiro, also wrote an excellent comment this week on why the oil bust has Brazil in deep water, going over the problems at Petroleo Brasileiro (PBR).

The re-election of President Dilma Rousseff didn’t exactly send a vote of confidence to markets as she now faces the challenge of delivering on campaign promises to expand social benefits for the poor while balancing a strained federal budget. President Rousseff says the Brazilian economy will recover and the country will avoid a credit downgrade but that remains to be seen.
Having said all this, CPPIB is looking at Brazil as a very long-term play, so they don’t care if things get worse in the short-run. In fact, the Fund will likely look to expand and buy more private assets in Brazil if things do get worse. And they aren’t the only Canadian pension fund with large investments in Brazil. The Caisse also bought the Brazilian boom and so have others, including Ontario Teachers which bet big on Eike Batista and got out before getting burned.

Are there risks to these private investments in Brazil? You bet. There is illiquidity risk, currency risk, political and regulatory risk but I trust CPPIB’s managers weighed all these risks and still decided to go ahead with big investment because they think over the long-run, they will make significant gains in these investments.

My biggest fear is how will emerging markets act as QE ends (for now) and I openly wonder if big investments in Brazil or other countries bound to oil and commodities are worth the risk now. Also, the correlation risk to Canadian markets is higher than we think. My only question to CPPIB’s top brass is why not just wait a little longer and pick these Brazilian assets up even cheaper?

But I already know what Mark Wiseman will tell me. CPPIB takes the long, long view and they are not looking at such deals for a quick buck. As far as “egos at CPPIB” that Mr. Doak mentions in the BNN interview, I can’t speak for everyone there, but I can tell you Mark Wiseman doesn’t have a huge ego. If you meet him, you’ll come away thinking he’s a very smart, humble and hard working guy who’s very careful about the deals he enters.

Canada Pension Plan Investment Board manages $226 billion in assets.

Read the entire Pension Pulse post here.

Japan Pension Unveils Portfolio Shifts, Takes On More Risk

Japan’s Government Pension Investment Fund has officially announced major changes to its portfolio. The pension fund had been reviewing its investments since the summer, but it wasn’t known when the process would end.

The shifts include doubling its equity allocations, cutting bonds by nearly 50 percent and a new target allocation for alternatives of 5 percent.

From Business Week:

Japan’s public retirement-savings manager will put half its holdings in local and foreign stocks and start investing in alternative assets as the world’s biggest pension fund seeks higher returns.

The 127.3 trillion yen ($1.1 trillion) Government Pension Investment Fund set allocation targets of 25 percent each for Japanese and overseas equities, up from 12 percent each, it said at a briefing today in Tokyo. GPIF will reduce domestic bonds to 35 percent of assets from 60 percent. The new figures don’t include an allocation to short-term assets, while the previous targets did. Analysts surveyed by Bloomberg this month had anticipated levels of 24 percent for local stocks, 15 percent for global shares and 40 percent for Japanese bonds, taking short-term holdings into account.

The new allocations were released hours after the Bank of Japan unexpectedly added to monetary easing, sending the Nikkei 225 Stock Average to a seven-year high. Reports that the fund’s announcement was coming today also buoyed shares. Investors have been awaiting the revised strategy since a government panel said last year GPIF was too reliant on domestic bonds, with the central bank stoking inflation and pension payouts mounting as the nation’s population ages.

GPIF increased its target for foreign bonds to 15 percent, up from 11 percent. The fund will put as much as 5 percent of holdings in alternative investments such as private equity, infrastructure and real estate, with those accounted for within the other asset classes rather than as a separate allocation.

The Government Pension Investment Fund is the largest public pension fund in the world. It manages $1.1 trillion in assets.

Photo by Ville Miettinen

Florida Fund Seeks Audit After Newspaper Reports On Officials Skirting DROP Payout Rules

Over the past few weeks, the Florida Times-Union has run a series of articles detailing how high-ranking public safety workers, and top pension officials, were able to rack up benefits by staying in the Jacksonville Police and Fire Pension Fund’s (JPFPF) DROP program for longer than rules allowed.

The articles have now gotten the attention of the JPFPF – the fund says it will hire an auditor to look into the allegations.

From the Florida Times-Union:

The head of Jacksonville Police and Fire Pension Fund said he will ask his board to hire an independent firm to review the fund’s practices and determine if the fund has been too lenient when it comes to senior members’ participation in the lucrative Deferred Retirement Option Program.

Pension executive director John Keane announced his decision in a four-page statement sent to City Council that takes issue with a Florida Times-Union investigation, “Too Much of a Good Thing.”

The Oct. 19 story exposed how, under strict interpretation of city code, at least three high-ranking police officers and firefighters with strong ties to Keane were able to skirt the rules and participate in the DROP program for too long, or even altogether, piling up excess pension benefits totaling $1.8 million.

The pension fund’s desire for an audit of its own comes as some city leaders are suggesting the fund be subjected to a forensic audit, which typically investigates whether there are grounds for criminal charges.

Details of the DROP program and the city code that employees may have breached:

The DROP allows police officers and firefighters to continue drawing a regular salary while at the same time having a pension placed into a special account for up to five years.

DROP calculations are based on math.

The number of years one works for either the police department of fire department determines the value of one’s first year of pension payments into DROP. Years of service also determine how long one may participate in DROP.

The code says once a member of the pension fund has worked 30 years, he or she is able to participate in the DROP for three years. Those falling into that category are entitled to 80 percent of the average salary they earned over the previous two years. Those with less than 30 years of service may participate for the full five years, but the percentage of their first year’s pension would be less. For instance, someone with 20 years would get a first-year pension that is 60 percent. That percent grows by two percentage points per work year. So someone with 29 years of service would get 78 percent.

The system is set up so one doesn’t get the best of both perks.

But some people did.

Bobby Deal, a retired police officer and long-time chairman of the pension fund’s board of trustees, and Richard Lundy, a retired firefighter and business partner of Keane and Deal, started their DROP participation after they hit the 30-year mark. And instead of participating for three years, they were allowed to remain in the DROP for the full five years.

Because the city does not currently require that a retiree cash out his or her DROP earnings upon retiring, the norm in states that offer DROP, including the Florida Retirement System, these DROP accounts are being re-invested in the pension fund and are guaranteed to grow 8.4 percent regardless of the true market value of the stock market.

Deal and Lundy now stand to make $1.3 million in questionable benefits on top of their regular pensions.

Read the previous Florida-Times Union investigations here.

Pension Funds Push Back Against Bank of America Governance Changes

Three of the country’s largest public pension funds are pushing back against Bank of America’s recent decision to appoint Brian Moynihan as CEO and chairman.

A shareholder resolution had previously mandated that the positions be separate.

Now, pension funds are telling Bank of America it has poked its “finger in the eye of investors.”

From the Wall Street Journal:

Three of the largest pension systems in the U.S. are pushing back on the bank’s move, announced earlier this month. The resistance from the California Public Employees’ Retirement System, the California State Teachers’ Retirement System and the adviser to New York City’s five pension funds may result in a variety of steps to try to improve governance, including a shareholder campaign to challenge the move in the spring, according to people familiar with the matter.

Bank of America set off these investors’ ire when its board changed the bank’s bylaws Oct. 1 to allow it to combine the chairman and CEO roles, then announced later that day that it had given the chairman’s job to Mr. Moynihan. The move essentially unraveled a binding 2009 shareholder resolution to separate the positions. A majority of shareholders, including the three pension systems, had voted for that change at the bank.

“They have flaunted the will of the shareholders,” said Anne Sheehan, corporate-governance director at the California State Teachers’ Retirement System, or Calstrs, the second-largest pension fund in the U.S. by assets. “It’s like the board poking their finger in the eye of investors,” said Michael Garland, director of corporate governance to New York City Comptroller Scott Stringer, who advises the five New York City pension funds.

Collectively, the three pension systems control 93 million Bank of America shares, or about 0.9% of shares outstanding, according to the most recent data available.

Bank of America’s board is within its rights to combine the positions, because the board of virtually any company incorporated in Delaware is allowed to alter corporate bylaws, even if it means undoing a previous shareholder change.

Warren Buffett, another large shareholder, said he supported the move. From the WSJ:

Some big shareholders supported the move, including Warren Buffett , whose Berkshire Hathaway Inc. made a $5 billion investment in the bank in 2011.

“I support the Board’s decision 100%,” Mr. Buffett said in an email Wednesday in response to questions from The Wall Street Journal. “ Brian Moynihan has done a superb job as CEO of Bank of America and he will make an excellent Chairman as well.”

A CalSTRS spokesman told the Wall Street Journal that it is talking with other shareholders about next steps. The pension funds could use their sway to vote out certain board members; they could also file another shareholder resolution, similar to the one in 2009, which would prohibit the CEO and chairman positions from being occupied by one person.

Principles For Better Pension Design

A long, insightful discussion and analysis of pension design was published in the Fall issue of the Rotman International Journal of Pension Management. During the course of the paper the three authors, Thomas van Galen, Theo Kocken, and Stefan Lundbergh, propose a set of principles to help navigate the dilemmas and trade-offs posed by both public and private pension systems.

The paper begins:

Designing a pension system is a complex business in which difficult tradeoffs must be made. On the one hand, we may want everyone to receive a retirement income that is linked to their own contribution; on the other, we want to protect people from poverty. How do we weight these two goals? The choice will depend on societal preferences and cultural values. We must also ask for whom we should design the pension system: what is ideal for a self-employed high-income earner may be far from adequate for someone living on a minimum wage, paying rent, and raising a family of five.

Addressing these dilemmas is a daunting task, especially with the recognition that pension systems all have their own historical background, and that each has evolved in its own particular context.

The authors propose a set of pension design principles, organized into three groups: behavioral principles, stability principles and risk-sharing principles.

The behavioral principles:

1. Keep it simple. Don’t make the pension solution any more complex than necessary. Complexity and lack of transparency make decision making more difficult, increasing the risk that people will make decision they will later regret. Simplicity, by contrast, helps manage people’s expectations and increases their trust, both vital qualities for a successful pension system.

2. Provide sensible choices. Employees should be given a standard package, on top of which a limited set of well- considered alternatives are offered, to protect them from making mistakes while allowing them individual freedom (Boon and Nijboer 2012). Creating a set of choices for a pension system is like drawing up a good restaurant menu: it offers people tools (the menu) for tailoring the solution (the meal) to their needs, but without expecting them to be financial experts (the chef) (Thaler and Benartzi 2004).

3. Under-promise, over-deliver. Research has shown that people experience twice as much pain from a loss as pleasure from a gain of equal size. Therefore, it is wise to avoid delivering outcomes below people’s expectations, which implies that a pension system should offer people a minimum level of pension income that, in practice, will likely be exceeded (Tversky and Kahneman 1992). Research shows that people value some kind of certainty very highly and are willing to pay substantial sums of money for it (Van Els et al. 2004), but too much certainty will make the pension design unaffordable.

The stability principles:

1. Ensure adaptability. Constantly changing external conditions require an adaptable pension system. Explicit individual ownership rights ensure flexibility, so that the system can adjust itself over time, and also make pensions more mobile to move to other systems.

2. Keep it objective. The health of a pension system should be measured based on objective market valuations. An objective diagnosis ensures that beneficiaries feel comfortable with how the pension fund deals with their property rights. If the valuations are calculated differently from market practice, participants may feel they are better off outside the system.

3. Prepare for extreme weather. The world is uncertain and unpredictable things happen; a pension system should be robust under extreme circumstances, built not on predictions but on consequences of possible outcomes. To assess the system’s robustness, draw up a set of “extreme weather” scenarios for risks outside and inside the pension system. The design of the pension system should target the ability to endure these extreme scenarios.

And the risk-sharing principles:

1. Avoid winner/loser outcomes. To avoid losing support, pension system design should prevent any one group of participants benefitting at the cost of another group. For example, if internal pricing in DB plans deviates from market pricing, it is likely to create winner/loser outcomes, eventually leading to pension system distrust.

2. Only diversifiable risks should be shared. A system founded on solidarity in bearing diversifiable risk creates value for all by reducing individual risk. For example, we have no idea how long we will live after we retire, but we can estimate the current average life expectancy of a homogenous group reasonably well, so it makes sense for individuals to pool their individual longevity risk with a large group.

3. Individuals must bear some risks. Risks that cannot be diversified or hedged in the market should be borne by the individual. Pooling non-diversifiable risks leads inevitably to transfers between groups in the collective pool and will eventually erode trust in the system. In reaching for higher long-term returns, younger people can absorb more market risk than older people; this calls not for risk sharing but for age differentiation in exposure to financial markets.

The authors go on to provide examples of these principles in action, using pension systems from the UK, Sweden and the Netherlands. The full seven page paper can be read here.

CalPERS: Think Tank “Needs A Lesson In Fact Checking” After Tax Claims

When Californians get their ballots, they will notice 140 different proposed tax increases. One think tank last week said they knew the reason behind the surge—high pension costs.

Mark Bucher, president of the California Policy Center, wrote a column for the Sacramento Bee earlier this week claiming the influx of potential tax increases stemmed from ballooning pension obligations.

Bucher wrote:

Tax-weary Californians looking to explain this paradox need look only to former Vernon (population 114) city administrator Bruce Malkenhorst for an answer.

Malkenhorst received a $552,000 pension in 2013, according to just-released 2013 CalPERS pension data on TransparentCalifornia.com.

[…]

Malkenhorst is part of a growing number of 99 California retirees who received at least half-million-dollar pension payouts in 2013, up from four in 2012. Such lucrative pensions mean that in 2014, California will spend approximately $45 billion on pensions, equaling total state and local welfare spending for the first time. And in the zero-sum game of government spending, an extra dollar spent on pensions means one less spent on welfare, infrastructure or safety – or returned to the taxpayer.

Though Malkenhorst and his ilk personify California’s pension profligacy, they do not drive it. That distinction goes to the 40,000 California retirees who took home pensions greater than $100,000 in 2013.

CalPERS has now responded to the California Policy Center with the following statement, titled “CPC Needs a Lesson in Fact Checking”:

The California Policy Center (CPC) used stale data from 2013 in its Sacramento Bee commentary “Big pensions drive proposed tax increases on CA ballots” and never bothered to check with CalPERS (or even media coverage) to learn that the pension data was no longer accurate. Bruce Malkenhorst, former City Manager of Vernon, no longer receives his half-million dollar pension. Earlier this year CalPERS slashed his benefit to approximately $10,000 a month in April from its peak of more than $45,000 a month, concluding he derived the benefit improperly from the salary set by his employer the City of Vernon. CalPERS is also seeking to recover overpaid assets from Malkenhorst.

While members earning more than $100,000 per year in pensions receive high publicity, the fact is they only represent 2.6 percent of CalPERS retiree payments. It would be helpful if the CPC and others would more carefully check the facts and report on the full picture instead of just painting all public employees with the brush of the likes of Malkenhorst.

Read the statement here and the original article from the California Policy Center here.

Judge Approves Stockton Bankruptcy Plan; Pensions To Be Protected

A bankruptcy judge on Thursday afternoon approved the bankruptcy plan of Stockton, California. As part of the plan, the pensions of city workers will remain intact.

Creditors, on the other hand, will not be so lucky. From the LA Times:

A federal bankruptcy judge approved the city of Stockton’s bankruptcy recovery plan, allowing the city to continue with planned pension payments to retired workers.

The case was being closely watched after the judge ruled this month that the city’s payments to the California Public Employees’ Retirement System could be cut in bankruptcy just like any other obligation.

If Judge Christopher M. Klein had rejected Stockton’s plan and forced the city to slash its payments to CalPERS, it could have opened the door for other cities struggling with escalating pension costs to follow suit.

Stockton officials had argued that they couldn’t afford to cut pensions or to create another retirement plan for city employees. They said employees would leave Stockton for other cities offering retirement benefits through CalPERS.

CalPERS had said that if Stockton left the state retirement system, the city would immediately owe it $1.6 billion — far more than the city’s current bill to the pension plan.

On Thursday, Klein said that workers had already taken hits in the bankruptcy. He said Stockton’s salaries and benefits for workers had been higher than those at other cities, but that workers had agreed after the bankruptcy filing to take big cuts, including eliminating the free medical care they received in retirement.

“It would be no simple task to go back and redo the pensions,” Klein said Thursday.

He added, “This plan, I’m persuaded, is the best that can be done.”

Klein said that rejecting the plan after two years in court and tens of millions of dollars in legal and other fees would have put the case back to “square one.”

The city’s plan slashes payments to other creditors, including Franklin Templeton, an investment firm that holds more than $36 million in bonds the city used to borrow money. Franklin had asked Klein to reject the city’s plan so that it could get more of its money back.

CalPERS Chief Executive Anne Stausboll said of the decision:

“The City has made a smart decision to protect pensions and find a reasonable path forward to a more fiscally sustainable future…We will continue to champion the integrity and soundness of public pensions – to protect the benefits that were promised to the active and retired public employees who participate in the CalPERS pension plan.”

Chart: Distribution of Assumed Rates of Return

The Los Angeles City Employee Retirement System (LACERS) announced this week it was lowering its assumed rate of return from 7.75 percent to 7.5 percent. For some context, here’s a graphic that charts the discount rates of 150 public pension funds as of 2013.

Two District of Columbia funds use among the lowest rates in the country: the Police and Fire fund and the Teachers’ fund both assume a 6.5 percent rate of return on investments.

On the other end of the spectrum are funds like the Houston Firefighters’ fund and the Connecticut Teachers’ system. Those funds assume an 8.5 percent rate of return.

Chart credit: The Center for Retirement Research

Ohio PERS Invests $75 Million In Shopping Centers

The Ohio Public Employees Retirement System (PERS) is giving $75 million to FCA Partners to invest in retail real estate – specifically, large shopping centers and grocery stores.

From IPE Real Estate:

The new allocation will be invested over the remainder of this year and the beginning of next year.

Capital will be invested in a mixture of grocery-anchored shopping centres and power shopping centres across the US, with a value-add approach.

As a separate-account structure, FCA will have investment discretion within agreed investment guidelines, giving the manager the authority to make final investment decisions without approval from Ohio PERS.

The manager will invest in both debt and equity investments.

Although the relationship between Ohio PERS and FCA Partners is a new one, the manager is a spin-off of Faison & Associates, in which the fund first invested in 1995.

Since inception, the pension fund has invested $932m with the manager.

The death of Henry Faison in 2012 saw the creation of FCA Partners; Ohio PERS has therefore transferred the separate account previously managed by Faison to FCA.

The pension fund is looking to place more capital with separate account managers in value-add retail, industrial and hotel property as part of its $1.26bn allocations to separate-account managers this year.

Ohio PERS manages $88.6 billion in assets, of which 10.3 percent is allocated towards real estate.

Report: 1 In 4 Australian Retirees Will Outlive Their Savings By 11 Years

A new report from Mercer indicates that 25 percent of Australians could outlive their retirement savings by over 10 years, and calls the situation a “very real economic and social dilemma”.

From Business Insider:

New research by financial services consultancy firm Mercer shows one in four Australian retirees will outlive their savings by 11 years.

It also found that as many as 10% of the population who live even longer may be forced to rely solely on the age pension for 15 years or more, with 54% of Australians expecting to have less money than they need for retirement – falling short by as much as $500,000.

The Financial System Inquiry interim report calls out the lack of effective longevity risk management as a major weakness of Australia’s retirement income system, with Mercer’s managing director David Anderson saying, “Australia is facing a very real economic and social dilemma due to a lack of protection against longevity risk up until now.”

Anderson says longevity risk is a huge threat to Australians’ quality of life and healthcare in retirement, which he says has ultimately put pressure on the public purse and our own personal finances.

Senior partner and senior actuary at Mercer, Dr David Knox, said:

“It’s time to leverage the scale of the superannuation industry to provide longevity risk pooling; the sharing of risk will lead to improved outcomes for everyone.

“Longevity risk is a problem in Australia that demands urgent action… The proverbial certainties in life are of course death and taxes, the uncertainties are when and how much.”

In what is almost certainly not a coincidence, Mercer recently rolled out its LifetimePlus plan, a longevity insurance product that “behaves like a lifetime annuity, creating a ‘pool of lives’ and paying out an income until death”.

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