Author: Leo Kolivakis

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Barbara Shecter of the National Post reports, Ontario Teachers’ Pension Plan owns 39% stake in terror-targeted Brussels Airport:

The terrorist attack in Brussels on Tuesday morning hit close to home for the Ontario Teachers’ Pension Plan.

The pension fund owns 39 per cent of the Brussels Airport, a stake acquired in 2011. Two bombs went off at the airport while another exploded at a busy metro station. The combined death toll reached at least 30, and more than 200 were injured.

“We are deeply saddened and shocked by the tragedy in Brussels and our thoughts are with all of those that have been affected,” said a statement posted on the Canadian pension fund’s website.

It added that Teachers’ is “in close contact with Brussels Airport and the Belgium Government,” and that the pension fund is “providing whatever support we can.”

Deborah Allan, a Teachers’ spokesperson, said there would be no further comment Tuesday.

Other shareholders in Brussels Airport include Macquarie European Infrastructure Funds and the Belgian State.

Teachers’ holds the airport stake in its infrastructure and natural resources portfolio, alongside stakes in Bristol Airport, Birmingham Airport, and Copenhagen Airports, the largest airport in Scandanavia.

The Canadian pension plan also has a stake in High Speed 1, the 109-kilometre high-speed railway connecting London to the Channel Tunnel.

Ontario Teachers’ has a large portfolio of infrastructure assets that includes many European airports. Most recently, along with AIMCo, OMERS, and Kuwait’s sovereign wealth fund, it bought London City Airport.

I questioned that deal, stating the premium they paid was outrageous but one senior Canadian pension fund manager who didn’t bid on this asset told me: “You can’t always look at infrastructure valuations as I’ve seen assets that look cheap and turn out to be terrible investments and others that look expensive and turn out to be great investments. It really all depends on their long-term strategic plan for this asset.”

This comment, however, isn’t about valuations or the Brusssels airport as an asset (I know it well and think it’s a great asset). It’s about another risk that comes along with infrastructure assets, namely, security risk associated with the scourge of terrorism.

If I was an owner of any any major infrastructure asset that terrorists can potentially strike, I would be sitting down with my infrastructure team to review security operations.

Admittedly, if you start thinking about airport security or security on a subway, bus or train, it can drive you mad because many of these are “soft” targets that terrorists can easily strike.

In the case of Brussels airport, we know the carnage happened outside the security perimeter where people were waiting in line to check in their bags.

Right now, there are many fingers being pointed at who is to blame for the Brussels attacks. Reuters reports one of the attackers in the Brussels suicide bombings was deported last year from Turkey, and Belgium subsequently ignored a warning that the man was a militant, Turkish President Tayyip Erdogan said on Wednesday.

The Haaretz reports that Belgian security services, as well as other Western intelligence agencies, had advance and precise intelligence warnings regarding the terrorist attacks in Belgium on Tuesday.

If this is the case, clearly security agencies need to accept their responsibility in this tragedy. Who else dropped the ball here? Some are pointing the finger at ICTS, a firm run by former Israeli intel operatives who run the security at Brussels airport:

ICTS was established in 1982 by former members of Shin Bet, Israel’s internal security agency and El Al airline security agents, and has a major presence around the world in airport security including operations in the Netherlands, Germany, Spain, Italy, Portugal, Japan and Russia. ICTS uses the security system employed in Israel, whereby passengers are profiled to assess the degree to which they pose a potential threat on the basis of a number of indicators, including age, name, origin and behavior during questioning.

Signs of the Times states this isn’t the first time that ICTS has come under scrutiny for possible security lapses. But when I read absurd nonsense like “it seems that the conditions are being created whereby the events of Nazi Germany may well repeat, only this time with Muslims in the position of the Jews,” I tune off and question the angle of this “investigative reporting” (only fools would state or believe such rubbish).

When it comes to airport security or any security, I would hire an Israeli firm run by former Shin Bet operatives in a second. Not that they can guarantee the security of passengers but these people are highly trained specialists who know what to look for when it comes to possible terrorist threats.

After Paris and Brussels, it’s easy to point fingers but the reality is security agencies across the world are stretched thin as governments cut back on their spending. This places more pressure on Ontario Teachers and others that own infrastructure assets to review their security measures to ensure the well-being of passengers as well as the security of all their infrastructure assets.

When thinking of infrastructure assets, experts often cite liquidity risk, currency risk, political and regulatory risks but rarely cite terrorism as a risk. Maybe they should start talking about this risk because terrorism isn’t going away, it’s only going to get worse.

 

Photo by Christian Junker via Flickr CC License

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Benefits Canada reports, AIMCo returns 9.1% in 2015:

Alberta Investment Management Corporation (AIMCo) has reported a 9.1% rate of return on its total assets under management for the year ending December 31, 2015.

The pension fund earned more than $1.5 billion of active value-add return above benchmark and overall investment income of $7.5 billion on total assets under management of $90.2 billion.

“I am very pleased with the terrific year of performance, especially against a backdrop of change and extreme volatility across the markets,” said Kevin Uebelein, chief executive officer. “AIMCo’s investment teams remained disciplined and focused on the long term, taking well-measured active risk positions, in-line with our investment strategies and our clients’ established needs.

“That steady hand approach, and the support of the entire organization, allowed us to identify, and act upon, value-generating opportunities across all major asset classes. This result is further evidence that the ‘Canadian Model’ of public asset management is one that very well serves the needs of the public.

“During these times of intense challenge for Alberta, it is especially gratifying to be able to deliver more than $1.5 billion of over-performance against our benchmark returns, which represents a best-ever performance figure for AIMCo.”

Detailed performance information will be available in AIMCo’s annual report to be released in June 2016.

Matt Scuffham of Reuters also reports, Canada’s AIMCo records 9.1 percent rate of return in 2015:

Canada’s Alberta Investment Management Corp (AIMCo) said it performed better in 2015 than in any year since its inception in 2008, with investments in real estate and infrastructure outperforming benchmarks.

AIMCo achieved an overall rate of return of 9.1 percent and a 10.1 percent rate after stripping out government and specialty fund clients for managing short and medium-term fixed income assets and for liquidity management.

AIMCo, which manages pension and government funds for the oil-rich province of Alberta, said overall investment income was C$7.5 billion ($5.75 billion) from total assets under management of C$90.2 billion. The performance exceeded its investment benchmark by over C$1.5 billion, it said.

AIMCo said investment teams in public equities, infrastructure, private equity and real estate all significantly outperformed their market benchmarks.

Like other Canadian pension funds, AIMCo has invested in real estate and infrastructure as an alternative to low-yielding government bonds.

“This result is further evidence that the ‘Canadian model’ of public asset management is one that very well serves the needs of the public,” said Chief Executive Officer Kevin Uebelein.

AIMCo put out a press release on its results which you can read here. In its press release, AIMCo emphasizes the 10.1% return for the Balanced Fund, which is more representative when comparing it to its large Canadian peers, and it states the following:

AIMCo’s strong results in 2015 were the outcome of contributions from across the organization. Investment teams in Public Equities, Infrastructure, Private Equity and Real Estate all significantly outperformed their market benchmarks, while Money Market & Fixed Income, Mortgages and Private Debt & Loan performed equally well, providing stable value-add through difficult market conditions.

I had a chance to discuss these results with Dénes Németh, Director, Corporate Communication at AIMCo. Unfortunately, Kevin Uebelein, AIMCo’s CEO, wasn’t available but I realized that it wouldn’t have been a fruitful discussion because the a detailed discussion of these results would require me to analyze the details from the Annual Report which only comes out in June.

I like the fact that AIMCo reports its calendar year and fiscal aggregate numbers. This makes it easier to compare its performance to its large Canadian peers.

But I find it unacceptable that AIMCo and a few other large Canadian pensions make their annual report public after releasing results. The Caisse and OMERS do this and it drives me crazy. At least the Caisse publishes a lot more detail on its performance when it releases it in February.

To be fair to these organizations, there are all sorts of reasons as to why they can’t make their annual reports available at the time of reporting their results. Leo de Bever, AIMCo’s former CEO, told me: “The fiscal release is constrained by provincial reporting issues: AIMCo ultimately consolidates in part with the provincial accounts, and we could not release before they do.”

So what do I think of AIMCo’s 2015 results? They are great. AIMCo handily beat the 5.4% average return of other large Canadian pension funds which defied market volatility last year and it even performed better than its peers like OMERS, HOOPP and the Caisse (AIMCo’s Balanced Fund returned 10.1% in 2015 vs the Caisse which returned 9.1%).

While I wasn’t able to get details of individual portfolios, Dénes Németh did tell me that AIMCo’s Balanced Fund gained 10.1% vs 8% for its benchmark in 2015 and over the last four years, it gained 11.8% vs 10.6% for its benchmark. This would explain the $1.5 billion in active value-add return above benchmark last year.

It’s also impressive that this performance was generated in Public Equities and Private Markets like Real Estate, Private Equity and Infrastructure. I commend both the Caisse and AIMCo for generating active value-add in Public Equities which is one reason why they both outperformed OMERS and HOOPP.

Of course, being an astute pension analyst, I asked Dénes two simple questions: “Does AIMCo hedge currency risk and what is the weighting of private market assets in its portfolio?”(see my coverage of HOOPP’s 2015 results to understand why I asked these questions).

Dénes replied:

“With respect to the questions below, I prefer not to respond as doing so would only provide insight toward one element of many that contribute to the successful outcomes achieved by our investment teams in 2015. My concern is that without the full story, which as I have explained will come in June, your readers may put more weight on these single factors than the overall effort that led to the strong results. I hope you will understand.”

Of course I understand and while it’s fair to point this out, it’s equally fair for me to ask these questions as a large part of AIMCo’s outperformance in 2015 is explained by these two factors.

In fact, I downloaded AIMCo’s 2014 Annual Report where I was able to get answers to all these questions and a lot more. If you want to get details on its investments and benchmarks governing every investment portfolio, take the time to read AIMCo’s 2014 Annual Report.

For example, here are the benchmarks governing each investment portfolio (click on image from page 33 of the 2014 Annual Report):

I’m not going to discuss the merits of each benchmark but for the most part, they’re excellent benchmarks that properly cover the risks of each portfolio (we can debate whether they should add a liquidity and leverage premium on the benchmark for PE and whether this benchmark has too much beta in it but benchmarks for private markets aren’t simple).

Now, to answer my question, roughly 25% of AIMCo’s assets were in Private Markets as of December 31st 2014 and I expect that figure stayed the same or marginally increased in 2015. Also, there is a note that states “For balanced funds, notional exposures and Client-directed currency derivatives are not included in asset class calculations.”

In fact, Leo de Bever shared this with me on AIMCo’s currency hedging policy:

“This has been a big debate in the pension industry. Some hedge, some don’t, some go 50-50 as a measure of ignorance. AIMCo tended to hedge fixed income because it was a US substitute for Canadian fixed income, but most listed equities were unhedged where FX markets were liquid to make that efficient.”

So, private market weights and currency gains had a material impact on overall performance in 2015. When you add to this outperformance in Public Equities which are unhedged, it was a great year for AIMCo.

Unfortunately,  I cannot share more specifics with you until AIMCO’s 2015 Annual Report is released in June. Just go to the website and you will find it here (AIMCO really needs to revamp that annoying flash website and make it cleaner and easier to find information and download PDF and HTML information).

As far as compensation, once again, I cannot provide you with details until the 2015 Annual Report is available but AIMCo pays its top brass in line with what other large Canadian pensions pay (click on image from page 69 of AIMCO’s 2014 Annual Report):

AIMCo’s CEO Kevin Uebelein just started working last year so I expect to see his compensation increase and Dale MacMaster assumed the role of CIO and is doing an outstanding job, so I expect his compensation to increase too.

Going forward, I also expect AIMCo is going to have a tough time with its Real Estate holdings in Alberta and this was expressed to me in a lunch meeting I had with Kevin Uebelein back in November (read some of those details here).

I also asked Dénes Németh about the London City Airport deal which AIMCo took part in with Ontario Teachers, OMERS and Kuwait’s sovereign wealth fund but he told me they are bound by the Consortium’s confidentiality clause.

It’s too bad because I questioned that deal, stating the premium they paid was outrageous, and would love if Kevin Uebelein, Michael Latimer or Ron Mock can share more on why this is such a great asset at that valuation and more importantly, what is their long-term strategic plan for this asset?

Of course, one senior Canadian pension fund manager who didn’t bid on this asset told me: “You can’t always look at infrastructure valuations as I’ve seen assets that look cheap and turn out to be terrible investments and others that look expensive and turn out to be great investments. It really all depends on their long-term strategic plan for this asset.” Ok, fair enough, let’s hope they know what they’re doing with this London airport.

 

Photo by thinkpanama via Flickr CC License

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Chris Bryant of Bloomberg reports, Draghi’s Pension Poison:

Mario Draghi’s latest batch of measures to boost the euro-area economy comes with a sting in the tail for companies and anyone hoping to retire comfortably one day.

Extending quantitative easing to include non-bank corporate bonds is poised to make life even tougher for company pension plans. Record-low interest rates had already depressed bond yields, making it harder for companies to finance retirement promises made to employees. The ECB’s move is likely to send company debt prices up and yields even lower, worsening their struggle (click on image).

It’s a huge problem. The The first stress test of European defined-benefit and hybrid pension plans in January found a combined 428 billion-euro ($484 billion) funding shortfall euros across 17 countries. To give but one example: Lufthansa’s 6.6 billion-euro pension-plan deficit is roughly the same as its market capitalization.

Rising prices boost the value of the assets pension plans use to fund retirement obligations — a good thing. But those gains have been swamped in recent years by problems on the liability side.

Accountancy rules require companies to assess projected pension liabilities using a discount rate based on the prevailing yield of investment-grade corporate bonds. The calculations determine how much companies must set aside now to fund future obligations.

Falling bond yields result in a lower discount rate, which in turn increases the costs of meeting those obligations. In short: pension deficits get bigger.

Paul Watters, credit analyst at Standard & Poor’s, estimates that a 1 percentage-point decline in the discount rate tends to increase pension obligations by about 16 percent at large companies with the most-exposed pension plans.

The ECB’s timing is unfortunate as its intervention followed a period of relative respite for pension plan managers last year, when discount rates rose and deficits therefore narrowed somewhat (click on image).

Total pension obligations for companies in Germany’s Dax had increased 24 percent to 372 billion euros in 2014 but declined by about 10 billion euros in 2015, according to Mercer, a consultancy. The funding ratio (of pension assets to obligations) improved from 61 percent to 65 percent last year.

This may all sound a bit dull, but it has important consequences for companies, investors, the economy, and of course, employees.

If companies divert capital to plug a hole in the pension fund, they have less cash to fund capital investments. A big pension deficit hanging over a company means employees are also less likely to be able to win pay increases. Widening pension deficits could therefore create a headwind to QE’s effectiveness.

Credit-rating companies pay attention to pension deficits, and bigger shortfalls might prompt them to raise a flag that could feed into higher borrowing costs — another drain on cash. Ballooning gaps also make equity investors nervous because dividend payments can come under pressure. These can counteract QE’s beneficial effect of cutting bond yields and boosting equities.

What can be done, besides closing defined benefit plans to new entrants? Companies could move liabilities to an insurer via a buyout, but this would cost it money, reducing reported profit.

Regulators could create a bit of breathing space for companies by allowing them to take less rigid approach to setting pension discount rates. Where permitted, corporate pension plans should also consider diversifying further into riskier assets like property and infrastructure — that would help in particular in Germany, where pension funds are often weighted heavily towards low-yielding bonds.

Yet until interest rates rise materially — which seems very unlikely — the fundamental problem isn’t going to go away.

It’s true that corporate pension plans would also be in serious trouble if the ECB had refused to act, and that created a deflationary spiral and pushed the continent back into recession.

Nevertheless, investors cheering Draghi’s latest injection of adrenaline into the region’s economy need to be alert to its side effects.

This is a great article which highlights the pros and cons of the ECB’s quantitative easing on Europe’s corporate defined-benefit plans.

But make no mistake, in order to avert his worst nightmare, Mario Draghi has chosen his pension poison, and it’s one that will decimate corporate and state defined-benefit plans. This is why I recently argued it’s checkmate for Europe’s pensions.

Of course, this is all part of a much bigger problem, the $78 trillion global pension disaster. That too isn’t going away and its implications will be with us for a very long time.

Interestingly, when I discuss solutions to the global pension crisis, I refer to common sense proposals like raising the retirement age, introducing better governance at pension plans, implementing a shared-risk model which means stakeholders share the risk of the plan.

That last one doesn’t sit well with public sector unions because they typically don’t want to share any risk of the plan but the reality is that in an ultra low rate or negative rate environment, stakeholders will need to prepare for lower returns ahead, especially if a long bout of deflation sets in. This will decimate pensions.

And herein lies the danger. Central banks might be the only game in town but thus far their policies have largely benefited elite hedge funds, private equity funds and big Wall Street banks. Their attempt to reflate economies via the wealth effect has fallen short and the reason is simple: When wealth is increasingly concentrated in fewer and fewer hands, all that liquidity benefits fewer and fewer people.

This is why I continuously cite six structural factors that virtually ensure global deflation:

1. The global jobs crisis
2. Aging demographics
3. The global pension crisis
4. Rising inequality
5. High and unsustainable debt
6. Technological shifts

There is another potential factor that worries me, one that hit close to home this morning as I watched reports of terrorists attacking the airport and a subway in Brussels. Terror in Brussels can easily spread throughout Europe and even North America and my fear is that governments throughout the world are underestimating the poison called ISIL and its ability to wreak havoc on our lives.

I’ve been to Brussels where my mother and stepfather lived for eight years (they are now living in London and their friends in Brussels are fine). It’s a beautiful, quaint city full of diplomats and I felt extremely safe there. Watching the horror unfold this morning reminded me that terrorists disrupt lives by ripping apart what we hold sacred, namely, living in peace and harmony while cherishing the diversity of our pluralistic societies.

My fear now is that another poison will take over Europe, one of extreme nationalism and intolerance which plagued the continent in the past. The same thing will happen in the United States, especially under a President Donald Trump who openly discusses increasing protectionism and curbing immigration.

Don’t get me wrong, the world is a dangerous place and there is a serious problem with radical Muslims who spread their poison by perverting and distorting their religion. But if we react to terrorism with policies that target groups or countries, we’re going to be playing right into the hands of terrorists and right-wing extremists who will use this as fuel to fight their twisted jihadist war or to bring back the dark side of nationalism. That is one poison Europe and the rest of the world can do without.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Matt Scuffham of Reuters reports, Canada pension funds hold back on U.K. deals ahead of Brexit vote:

Some of Canada’s top pension funds, among the world’s biggest investors in British real estate and infrastructure, are holding back on U.K. deals until after Britons vote on whether to leave the European Union, according to senior executives.

These funds, which together manage more than $700-billion in assets, fear valuations could drop if Britain chooses to leave the bloc and have particular concerns about the impact on London’s financial district, the executives said.

There is no precedent for an economy as big as Britain’s leaving a trade bloc, and the rival campaigns paint contrasting pictures of what quitting the EU might mean for its trade.

Pro-Europe campaigners say banks and other financial institutions could pull operations out of the City of London if they cannot access critical EU markets.

An executive at one of Canada’s biggest public pension funds, who spoke off the record due to the sensitivity of the issue, said the risks posed by the June 23 vote were part of the reason it passed on a recent deal for an office property in London’s financial district.

“London is the financial centre of Europe, but if that changes, the whole trajectory is different. That’s become a factor in our thinking,” he said.

The retreat by Canadian investors could be harmful to the British economy and raises questions about whether other international investors will also lose their appetite for U.K. assets.

Canadian institutions have been the second biggest international investors in U.K. real estate over the past three years, with direct investments peaking in 2015. They are also prominent infrastructure investors.

The Canada Pension Plan Investment Board (CPPIB), which manages money for the country’s main government pension fund, had $15.2-billion invested in Britain at the end of March 2015, almost 6 per cent of its assets at that time.

Fund executives say they will still pursue exceptional one-off opportunities, pointing to the recent purchase of London City Airport by a group including three Canadian funds. But they note a stringent criteria would be applied to take into account the so-called Brexit risk, which would affect pricing.

“We’d want to go through what the different potential scenarios are – how the situations might evolve from a political, regulatory and economic perspective,” an executive at one of Canada’s top three pension funds said.

London City Airport was bought by a consortium including the Ontario Teachers’ Pension Plan (OTPP), the Ontario Municipal Employees Retirement System (OMERS) and the Alberta Investment Management Corporation (AIMCo) for more than 2 billion pounds ($2.82-billion).

AIMCo Chief Executive Kevin Uebelein, speaking to Reuters after the deal was announced, said that Brexit concerns were taken into account when negotiating.

“The prospect of Brexit was not unknown to us as we crunched those numbers. You factor those things into your investments,” he said.

Jonathan Simmons, chief financial officer at OMERS, which owns the high-speed rail link between London and the Channel Tunnel in partnership with (OTPP), said last month his fund was looking at how it can offset the risk to its U.K. holdings.

“We’re focused on what’s going on right now around Brexit, and of course we are monitoring that and we’re thinking about how we hedge our positions,” Simmons told a media briefing.

Brexit is not the only factor weighing on the market for London real estate.

Real estate agents say Chinese, Russian and Middle Eastern investors are cooling on London’s luxury property market as a result of factors including the low price of oil, the Russian ruble’s collapse, slowing Chinese economic growth and higher taxes for foreign buyers.

London’s high end real estate bubble is already bursting for all sorts of reasons (Vancouver is next), and it’s not just that rich Chinese, Russian, and Middle Eastern investors are a lot poorer.

When you read that bond hedge funds are facing their worst ‘quarter in history’ or that the mighty Goldman Sachs is having a terrible quarter too, you have to ask yourself: who is going to bid up London and Manhattan real estate in this environment? 

There’s a reason why U.S. commercial real estate is getting hit and if you ask me, the weak CMBS market was a big factor in the Fed’s decision to stay put on Wednesday (of course, the Fed will point to “global risks” but there are domestic risks too).

Is Brexit a big concern for Canadian pension funds? Of course it is but I don’t think it’s the only concern. And it certainly didn’t deter Ontario Teachers’, AIMCo, OMERS and Kuwait’s sovereign wealth fund from snapping up London City Airport at a hefty premium (for the multiple they paid, they better have a great long-term strategic plan for this asset).

Moreover, while Canada’s large pensions are on the global prowl, they’re also focusing on domestic opportunities. Scott Deveau of Bloomberg reports, Canadian pension funds urge Trudeau to think big on infrastructure:

Canada’s largest pension funds have advice for Justin Trudeau’s government as it prepares to double its infrastructure investments over the next decade: follow the Australian model and think big.

The funds, which manage more than $760 billion in combined assets, say they need large projects like airports, toll roads and ports to justify their time and investment with so many global assets competing for their cash.

“What are we looking for? We’re looking for projects of scale,” said Mark Wiseman, chief executive officer of Canada Pension Plan Investment Board, the country’s largest pension fund with $283 billion in assets.

The Canadian government isn’t expected to provide extensive details of its infrastructure plan in the March 22 budget because it’s still developing a long-term strategy. Federal officials have said an extra $10 billion will be made available over the next two years while it crafts a broader strategy to deploy an additional $20 billion to each of three silos over the next decade: public transit, green infrastructure, and social infrastructure.

The country’s largest pension funds, including Canada Pension Plan, Caisse de Depot et Placement du Quebec, and Ontario Teachers’ Pension Plan, are encouraging the federal government to be ambitious for the longer-term strategy.

Canadian pension funds and money managers have become global leaders by investing in ports, toll roads, power plants and other infrastructure, deploying billions annually as they reduce risk in their portfolio through geographic diversification.

Home Grown

They’ve become so big, many have outgrown the opportunities at home, presenting a challenge for the Trudeau government as it seeks outside investment. The Canadian government estimates the infrastructure funding gap in the country is more than $150 billion, said Minister of Infrastructure and Communities Amarjeet Sohi.

Sohi is meeting various stakeholders, including mayors, premiers and pension funds, on how to bridge that gap.

“A key piece of engaging private investors is a significant long-term strategy,” he said in an e-mail interview last week. “We committed to doubling federal investment in infrastructure over the next decade, which will help ensure we have needed funding in place for critical infrastructure.”

Places like Canada are particularly attractive for infrastructure assets, with its strong rule of law, a progressive and predictable regulatory regime, and a talented managerial class, Wiseman said.

Mature Assets

“We’re very interested in investing in Canadian infrastructure under the right conditions,” he said “There’s no better place to invest than close to home.”

Canada Pension, like many other large global investors, would rather acquire mature infrastructure assets than finance new projects because they’re safer, Wiseman said. He encouraged the federal government to look to places like Australia or the U.K. as examples of how Ottawa could utilize the capital of these global funds to meet its own infrastructure needs.

In 2014, the Australian government established its Asset Recycling Initiative, in which the federal government grants 15 per cent of the sale price of privatized infrastructure assets to states and territories. The federal funds and proceeds from the sales are used to develop new projects.

The Australian government estimates the initiative could spark as much as A$32 billion (US$24 billion) in new infrastructure investment, and global investors have taken notice.

Last year, US$52 billion was invested in Australian companies from foreign buyers, including a record US$16.4 billion from Canadian investors, according to data compiled by Bloomberg. Canada Pension was part of a group that agreed to buy Asciano Ltd. in a deal announced Tuesday valuing the Australian port and rail operator at A$9.05 billion.
Quebec Model

Montreal-based Caisse, Canada’s second-largest pension fund, led a consortium last November to acquire Transgrid, a network of high-voltage power lines, from the State of New South Wales for US$7.4 billion.

The challenge for larger funds to invest in traditional public-private-partnerships is that the equity stake — and in turn the reward — is often too small for them to pursue, said Andrew Claerhout, head of the infrastructure group for Ontario Teachers’.

Projects like the Gordie Howe International Bridge in Windsor, Ontario may cost billions to build but only require an equity investment of $150 million or less because the private partners can load their investments up with debt with the government’s support, he said.

“If we were going to do that to deploy $150 million that means we wouldn’t be able to do a bunch of other things. So you have to think about returns on effort and on capital,” he said.

Ring Road

Canadian projects that might attract interest include a possible ring road around Toronto, he said. Another example would be the Metro Toronto Convention Centre, according to Michael Latimer, chief executive of the Ontario Municipal Employees Retirement System.

Michael Sabia, CEO of the Caisse, said he’d like to see the government follow his lead. Last year, the Caisse struck a deal to build and run infrastructure projects that Quebec is ill- equipped to fund itself.

The Caisse is working on two projects in Montreal, including a light-rail corridor on the new Champlain Bridge and a public transit system linking downtown to Trudeau International Airport and West Island. The combined value of those projects is estimated to be about $5 billion.

“We think that’s a creative way for the government to invest in infrastructure and in a way that makes it fiscally manageable,” Sabia told reporters earlier this month.

The federal government has outlined some broad strokes of its plan, including developing an Infrastructure Bank that would give out loans using its government credit rating.

Sohi said it’s too early to say whether he would eventually adopt a broader strategy, like the Australia model, to attract global pension and sovereign-wealth funds.

“We are in a consultation phase and are not ruling out any option,” he said.

My advice to our Minister of Infrastructure and Communities Amarjeet Sohi is to listen very carefully to Mark Wiseman, Michael Sabia, Michael Latimer and other leaders at Canada’s Top Ten pensions and adopt the Australian model for developing infrastructure and THINK BIG!!!

The problem in Canada is we think small and spend way too much time studying proposals which is fine when the economy is doing well, but now that the economic crisis is spreading (never mind what the media is reporting), the Trudeau Liberals better get a move on and start delivering on infrastructure.

Once again, take the time to listen to a presentation Michael Sabia, CEO of the Caisse, delivered back in November at the the 23rd Annual CCPPP National Conference on Public-Private Partnerships. You can view his entire presentation by clicking here. It’s a little long but it’s well worth listening to.

 

Photo credit: “Canada blank map” by Lokal_Profil image cut to remove USA by Paul Robinson – Vector map BlankMap-USA-states-Canada-provinces.svg.Modified by Lokal_Profil. Licensed under CC BY-SA 2.5 via Wikimedia Commons – http://commons.wikimedia.org/wiki/File:Canada_blank_map.svg#mediaviewer/File:Canada_blank_map.svg

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Katy Barnato of CNBC reports, Rich countries have a $78 trillion pension problem:

Dreams of lengthy cruises and beach life may be just that, with 20 of the world’s biggest countries facing a pension shortfall worth $78 trillion, Citi said in a report sent on Wednesday.

“Social security systems, national pension plans, private sector pensions, and individual retirement accounts are unfunded or underfunded across the globe,” pensions and insurance analysts at the bank said in the report.

“Government services, corporate profits, or retirement benefits themselves will have to be reduced to make any part of the system work. This poses an enormous challenge to employers, employees, and policymakers all over the world.”

The total value of unfunded or underfunded government pension liabilities for 20 countries belonging to the Organisation for Economic Co-operation and Development (OECD) — a group of largely wealthy countries — is $78 trillion, Citi said. (The countries studied include the U.K., France and Germany, plus several others in western and central Europe, the U.S., Japan, Canada, and Australia.)

The bank added that corporates also failed to consistently meet their pension obligations, with most U.S. and U.K. corporate pensions plans underfunded.

Countries with large public pension systems in Europe appear to have the greatest problem. Citi noted that Germany, France, Italy, the U.K., Portugal and Spain had estimated public sector pension liabilities that topped 300 percent of gross domestic product.

Improvements in health care mean retirees need to string out their income for longer. Meanwhile, the increase in the retirement-age population versus the working population is straining government pension schemes.

Several countries, including the U.K., France and Italy are gradually hiking retirement ages. Citi recommended that governments explicitly link the retirement age to expected longevity.

It also advised that government-funded pensions should serve merely as a “safety net,” rather than the prime pension provider, and that corporate pensions should be “opt out” rather than “opt in” to encourage greater enrollment.

No doubt, the world is facing a pension disaster. I’m with Citi until I read that last paragraph about government-funded pensions should serve merely as a “safety net” and that corporate pensions should be “opt out” rather than “opt in” to encourage greater enrollment.

Really? I think Citi needs to tone it down a bit and carefully examine what’s working and what’s not working around the world. For example, if you look at the 2015 global rankings of top pension systems, you will find Denmark and the Netherlands at the top spot.

I’ve long argued that countries need to go Dutch on pensions and bolster defined-benefit plans for their citizens. Moreover, I’m a big believer in large, well-governed public defined-benefit plans, much like we have in Canada. Our Top Ten pensions are scouring the globe for investment opportunities and they’re able to provide great investment results at a fraction of the cost of mutual funds or other “private sector providers” capitalizing on their size, liquidity and long investment horizon to lower fees by engaging in direct deals wherever they can.

Are Canada’s Top Ten perfect? Of course not, nobody is perfect. I’ve been very careful shining a light on their operations but also praising them for the direct and indirect benefits they provide our economy.

In short, I believe that large, well-governed public defined-benefit plans are a big part of the solution to the global pension crisis. So when Rob Carrick of the Globe and Mail asks, Just how good a deal is the Canada Pension Plan?, I agree with him and think it’s a great deal and every Canadian should be demanding enhanced CPP, ignoring the silly and flawed studies of right-wing think tanks questioning the costly CPP.

Of course the CPP is more costly than other large public DB plans, it manages the pensions of all Canadians, but that study from the Fraser Institute is completely flawed and biased. In fact, Keith Ambachtsheer, David Dupont, and Tom Scheibelhut of KPA Advisory put out a note correcting the Fraser’s Institute’s faulty analysis and conclusions and Jim Keohane, CEO of HOOPP, told me the study “double-counted” the costs of CPP.

The problem is that too many people turn pensions into a political debate between big government versus small government. But as I keep harping, good pension policy is good economic policy which is why I don’t have time for idiotic arguments which fail to see the long-term value of large, well-governed public defined-benefit plans.

Having said this, the world needs a reality check when it comes to state pensions.  In particular, in a recent comment of mine, Checkmate for Europe’s pensions, I highlighted the pension black hole threatening many European countries. It’s not just about raising the retirement age, there’s a lot more needed to completely overhaul many European public pensions that are living on borrowed time.

And the situation in the United States isn’t much better. Most Americans are ill-prepared for retirement and many underfunded U.S. public pensions are doomed, especially if deflation sets in. And if New Jersey’s COLA war spreads to other states, it will spell disaster for many state pension systems.

We need large well-governed public defined-benefit plans, but we also need to introduce risk-sharing at these plans, recognizing that markets aren’t always going to deliver the requisite return.

As far as the $78 trillion global pension disaster, I take this figure with a grain of salt. Politicians and corporations will use it to make the case for weakening defined-benefit plans, replacing them with defined-contribution plans, but that will only exacerbate pension poverty and global deflation.

Don’t get me wrong, the world has a huge pension problem. It also has a huge inequality problem fueled by an ongoing jobs and retirement crisis which will only get worse because of aging demographics. The question remains, how are we going to solve these problems?

 

Photo by  Horia Varlan via Flickr CC License

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Samantha Marcus of New Jersey Advanced Media reports, Public workers’ fight for pension adjustments hits N.J. Supreme Court:

Government workers’ fight for cost-of-living adjustments to their retirement benefits hits the state Supreme Court on Monday in a case that could pile billions of dollars onto New Jersey’s steep pension debt.

Berg v. Christie, or the COLA case as it’s known, again pits public workers against the administration, though this time for allegedly violating their contractual right to cost-of-living increases.

Restoring the increases could send the public pension system’s unfunded liabilities soaring and speed up the time frame for the funds to run dry. But if workers lose, they would see their lifetime pension checks eaten away by inflation.

Public workers will argue before the New Jersey Supreme Court on Monday morning that the state unlawfully froze their increases as part of a 2011 pension reform law that reduced workers’ benefits to save money. The state contends they are not a protected part of the benefits package.

The appellate court in 2014 ruled that retired workers were guaranteed COLAs by contract.

Retirees had lost at the trial court level, where a judge found that, based on a clause that gives lawmakers and the governor discretion over annual state spending, the state couldn’t be forced to pay cost-of-living increases. The three–person appellate panel disagreed, saying that clause was irrelevant, because “pensions are neither funded by appropriations on a pay-as-you-go basis… nor is their payment contingent on the making of a current appropriation.”

The state continued to pay out COLAs even as it skipped and underfunded pension payments.

The state’s high court has been asked to determine whether COLAs are part of workers’ nonforfeitable right to pension benefits that lawmakers granted in 1997.

The COLA suspension was part of a broader law requiring public employees and the state to pay more into the declining pension system. The overhaul was undertaken to reduce the state’s massive unfunded liability and stabilize the public pension system. Freezing cost-of-living adjustments was expected to save tens of billions of dollars over the next three decades.

Under that landmark law, COLAs could be reinstated as the seven individual pension plans become 80 percent funded. The adjustments were tied to the rate of inflation.

Public workers also sued when Gov. Chris Christie put less into the system that he’d promised under the 2011 law. Labor unions argued that violated their constitutionally protected contractual right to pension contributions.

In siding with Christie, the court cited the appropriations and debt limitations clauses in the state constitution, saying that the law could not create an enforceable contract that would bind the hands of future lawmakers and burden New Jerseyans with debt without their consent.

The U.S. Supreme Court last month declined to review the case.

Charles Ouslander, a plaintiff in the COLA case, said the current dispute is more routine and “not as complicated an issue.”

The fight over pension contributions involved bedrock constitutional issues, while Monday’s hearing is a matter of statutory interpretation, he said.

Still, a lot of money rides on it.

Moody’s Investors Service warned in January that the state portion of the pension system’s unfunded liability would increase from $40 billion to about $53 billion, and the system would fall from 51 percent funded to 44 percent funded, if the court forces the state to restore the adjustments.

“The heightened burden, combined with an increase in benefit costs, would hurt New Jersey’s pension fund cash flows and funded status and the state’s ability to reach structural budget balance,” the rating agency said.

If COLAs were reinstated, and for Christie to keep up with his new payment plan that increases the pension contribution annually by one-tenth of what’s recommended by actuaries, he would need to pay $2.3 billion next year. His pension contribution in the proposed budget for the fiscal year that begins in July is $1.86 billion.

Spokesmen for Christie and the Treasury Department did not respond to requests for comment.

Gov. Christie is too busy campaigning for Donald Trump these days and even skipped attending the funeral of a New Jersey state trooper who was killed in the line of duty last week.

So what are my thoughts on New Jersey’s COLA war? It’s a very big deal and there is a lot of money at stake here. And this issue isn’t exclusive to New Jersey. I foresee COLA wars breaking out all over the United States, hampering underfunded public pensions which are already doomed.

At issue is whether the cost-of-living (COLA) increases public unions are demanding are a constitutional contractual right. If the unions succeed in getting these inflation adjustments, it will immediately push New Jersey’s underfunded pension system deeper in the red, placing it among the worst funded U.S. state pensions like Illinois and Kentucky.

I’ve long argued that we need a lot more transparency at state pensions.  And when I say transparency, it’s not just in the way they report their performance, it’s also in the way they report their liabilities and what they plan on doing to tackle their pension deficit.

New Jersey’s pension wars have been raging for a long time. The state failed to top up its pension system for years, which is by far the biggest reason behind its underfunded status. If you add inflation protection to the mix, it will add billions to the underfunded status of the state’s pension system.

As far as investments, the New Jersey State Investment Council has been doing a decent job but nothing extraordinary. I looked at its 2015 Annual Report and noted the following (click on image):

The three and five year performance is very decent and it was the fifth consecutive fiscal year that the Pension fund outperformed its benchmark. So clearly it’s not investments that are contributing to the underfunded status of New Jersey’s state pension but the unions are right to point out the Pension Fund spent $701.4 million during the last fiscal year on fees, expenses and performances bonuses for alternative investments, including on its money-losing hedge funds (are the returns above net of fees???).

My point, however, is that no matter how well the the New Jersey State Investment Council performs, it’s not through investments that New Jersey’s pension system is going to regain its fully-funded status.

Why? Because as I keep harping, pension deficits are primarily determined by the level and direction of interest rates, not investment gains, especially when rates are at historic lows.

When rates are at historic lows and dropping, no matter how well your state pension fund managers perform, it’s a lost cause, especially if your state pension is already in deeply underfunded territory (remember, the duration of liabilities is a lot bigger than the duration of assets so a drop in rates disproportionately impacts liabilities).

Inflation protection is the other big determinant of pension liabilities. If you add inflation protection or COLAs on top of the burden of low and declining rates, it’s a huge weight on public pensions.

Moreover, it’s important to face the ugly truth: state pensions need to prepare for lower returns in a world where ultra low rates are here to stay as deflation sets in and the new negative normal takes hold.

Unfortunately, unlike Canada’s large public pensions which are going global investing directly in private equity, real estate and infrastructure, U.S. state pensions are taking increasingly more risk via private equity funds and hedge funds that are clobbering them on fees. And all those fees add up over the years, taking away from performance (but it enriches Wall Street and alternative asset managers).

The other problem that nobody is talking about is what Jim Keohane, HOOPP’s CEO, shared with me last week when I discussed super funded HOOPP’s 2015 results:

In terms of taking more risk, I noted that HOOPP is a relatively young plan and it can take a lot more risk than Ontario Teachers or OMERS which have a lower ratio of active to retired workers. Here Jim was unequivocal: “Just because you can take more risk, doesn’t mean you should.”

That got us talking about chronically underfunded U.S. public pensions taking on increasingly more risk in hedge funds and private equity funds. “That’s a recipe for disaster because when you’re starting off from an underfunded position, you should be even more cognizant of the risks you’re taking because your very path dependent and much more vulnerable to a shock.” (I’m paraphrasing here but that was his clear message).

What else does HOOPP, Ontario Teachers’ and other Ontario public pensions have that U.S. state pensions lack? Their plans have adopted the shared risk model that so many U.S. states desperately need to adopt.

Importantly, when HOOPP or Ontario Teachers reached underfunded status, they immediately went to their members to discuss cuts to their benefits. Typically, these cuts were to inflation protection, and they remained there for as long as needed until the fund reached fully funded or very close to fully funded status (not this arbitrary 80% funded status that so many U.S. public pensions are happy with).

In the U.S., you don’t have such shared risk plans at state pensions, which is why you see massive confrontations on public pensions and terrible solutions to the state pension crisis (like shifting out of defined-benefit into defined-contribution plans).

So who is going to win New Jersey’s COLA war? I don’t know. I feel for a lot of public sector employees getting screwed but the reality is New Jersey and other U.S. states are already screwed when it comes to their pension promise and unions and politicians will need to agree on very difficult cuts to shore up these public pensions. You can only kick the can down the road so far before the chicken comes home to roost.

One thing I do know, however, is that defined-contribution plans are not the solution to America’s ongoing retirement crisis. We can debate COLAs but there’s no debating that bolstering defined-benefit plans is the best way to bolster a country’s retirement system. You just need to get the governance right and introduce a shared-risk model at public pensions like New Brunswick did to tackle its pension deficit.

 

Photo by Bob Jagendorf from Manalapan, NJ, USA (NJ Governor Chris Christie) [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Jacqueline Nelson of the Globe and Mail reports, Going global: Pension funds on the prowl:

The calls rang in from all corners of the globe. Corporate giants and investment firms with assets to unload wondered whether Canada’s largest pension plans might want to take a look. And they did much more than that.

The country’s largest pension plans poured more than $60-billion (U.S.) into assets such as student housing, toll roads and public companies last year. They teamed up with other international heavyweight investors to increase exposure to infrastructure, real estate and private equity at a time when competition for real assets is stiff. And investment banks are paying close attention.

“Part of it is it’s a systematic strategic focus of the organization, and part of it is the market conditions right now are very favourable,” Mark Wiseman, chief executive officer of Canada Pension Plan Investment Board, said of the increasingly important role private-market assets play in the fund’s portfolio.

As commodity woes and concerns about global growth churn markets and put strain on some large competitors, Mr. Wiseman said the fund is even better positioned to make deals in the coming year.

“As we move into these volatile times … if we were farmers, this is planting season for CPPIB,” he said.

A decade ago, pension funds were on the fringes as a flood of mining and private-equity deals took centre stage, leading to a then-record $230-billion in mergers and acquisitions in 2006. That year, pension funds were responsible for just three of the top 20 deals, worth a combined $7.73-billion.

But many plans have swelled since then – the largest 10 plans now have nearly $1.2-trillion (Canadian) in assets under management. And in 2015, pension funds were a part of seven of the top 20 deals valued at $41.2-billion (U.S.) in total.

Years of swift growth has meant that pension funds are being treated differently on the world’s stage, and at home.

“When I think about when I started my own career, I think about the pillars of what we described as ‘industry’ at the time,” Michael Latimer, chief executive officer of Ontario Municipal Employees Retirement System, said in a recent panel discussion. “They were the banks, the trusts, the investment banks, the lifecos – but frankly, the pension community really wasn’t something you were familiar with.”

Now, many of those players have consolidated, and Mr. Latimer said it’s easier to see the role that major pension plans play as part of the financial community.

“The size of the pools of capital that we are today, the things we do, how we employ people, how we invest – it’s been quite a significant change,” he said.

Canadian investment banks have made adjustments to better serve these deal makers as they have grown and shifted focus internationally.

“The pension plans have really changed the game here,” said Paul Farrell, head of Canadian investment banking at CIBC World Markets. One example is real estate, where 20 years ago, properties were in private hands and bank-financed, but now pension plans own many of the best assets in the country, he said.

Mr. Farrell is currently eyeing opportunities to work with the pension funds on their “relationship investments” – minority equity interests taken in public companies with the goal to transform the businesses. When that transformation comes in the form of a major acquisition, banks can step up with backing from the capital markets.

Many investment bankers are calling for a more active M&A environment as strong and weak companies in the natural-resource sector merge. At the same time, some large pension funds have expressed interest in looking to the oil patch for deals. “And if the cheques are large,” Mr. Farrell said, there may need to be a combination of the capital markets and cornerstone pension investors. “That’s a pretty powerful duo,” Mr. Farrell said.

Lucky Seven Largest Pension Plan Deals in 2015*:

ANTARES

Pension Plan: Canada Pension Plan Investment Board

Total Deal Value: $12-billion, including a $3.85-billion equity stake

What they got: General Electric Co.’s private-equity lending business, which targets smaller companies in several industries. The pension plan had been watching for business opportunities in this space for several years, and seized on the chance to avoid having to build operations from scratch.

TRANSGRID (99-year lease)

Pension Plan: Caisse de dépôt et placement du Québec

Total Deal Value: $7.4-billion

What they got: Long-term control of about 13,000 km of the electricity transmission network of the state of New South Wales in Australia, along with investment partners. These high-voltage power lines reach economic and political capitals in the country and help diversify the pension plan’s assets by geography.

FORTUM DISTRIBUTION AB

Pension Plan: Ontario Municipal Employees Retirement System

Total Deal Value: $7-billion

What they got: A 50-per-cent stake in the second-largest electricity distribution business in Sweden, alongside some local pension plans.The solid regulatory environment and OMERS’ goal to increase its exposure to infrastructure were driving forces behind the deal, along with the relative scarcity of big, desirable electricity assets. The business has since been renamed Ellevio.

HUTCHISON 3G UK HOLDINGS (CI) LTD.

Pension Plans: Canada Pension Plan Investment Board and the Caisse de dépôt et placement du Québec

Deal Value: $4.8-billion

What they got: A slice of a major U.K. telecom business. Hong Kong billionaire Li Ka-shing’s firm Hutchison Whampoa Ltd. bought U.K. telco O2 for £9.25-billion to merge it with his existing telecom operator Three UK, but he needed some investment partners to get the deal done. Two Canadian funds stepped in, along with some other investors, to acquire one-third of the merged company. The deal was a chance to cozy up to a new investment partner with a global network.

INFORMATICA CORP.

Pension Plan: Canada Pension Plan Investment Board

Deal Value: $4.7-billion

What they got: To privatize a growing big data company alongside a partner. The deal saved Informatica from a fight with an activist investor. The California-based software developer helps other companies make their data more useful.

SKYWAY CONCESSION CO. LLC

Pension Plans: Canada Pension Plan Investment Board, Ontario Municipal Employees Retirement System and Ontario Teachers’ Pension Plan

Deal Value: $2.8-billion

What they got: The Chicago Skyway Toll Bridge System, split three ways. The pension plans jointly acquired a 88-year lease of the well-established system that connects downtown Chicago and its southeastern suburbs.

HERITAGE ROYALTY LP

Pension Plan: Ontario Teachers’ Pension Plan

Deal Value: $2.6-billion

What they got: A portfolio of land and oil and gas royalties in Western Canada, sold by Cenovus Energy Inc. for some badly needed cash. Teachers said its “opportunistic” deal had secured a steady stream of the company’s future revenues.

*All deal values in U.S. dollars.

There is no doubt about it, Canadian pension funds are increasingly looking around the world for big deals to capitalize on their competitive advantages: liquidity, scale and a very long investment horizon.

And some of Canada’s large pension behemoths — namely CPPIB and PSP Investments — have more of an advantage than others because they’re cash flow positive, meaning they’re still collecting more in contributions than they’re pay out in benefits (CPPIB calls this certainty of assets).

As Mark Wiseman states in the article above, these are the markets that CPPIB loves. Why? Because they’re volatile and there are many dislocations, providing fertile ground for a large, well capitalized Canadian pension fund with a long investment horizon to move in and make long-term strategic investments.

In fact, all of Canada’s Top Ten have gone global and they’ve opened up offices all around the world. Following CPPIB, the Caisse recently announced it will open its first Indian office in New Delhi to scout for investments in South Asia:

The Caisse also announced the appointment of Anita Marangoly George as managing director for South Asia. Based in New Delhi, George will head up the new CDPQ India unit to seek investment opportunities across all asset classes.

Canadian pension funds are expanding into new territories and investing directly in assets such as infrastructure and real estate as they seek alternatives to volatile global equity markets and low-yielding government bonds.

India is viewed as a prime investment opportunity, given its rapid economic growth and burgeoning middle class. The Canadian Pension Plan Investment Board, Canada’s biggest public pension fund, set up an office in Mumbai last year to scout for opportunities.

Caisse Chief Executive Officer Michael Sabia in a statement cited India’s “scope and quality of investment opportunities, the potential for strategic partnerships with leading Indian entrepreneurs, and the current government’s intention to pursue essential economic reforms.”

The Caisse also announced a commitment to invest $150 million in renewable energy in India.

Ontario Teachers’ Pension Plan recently invested $200 million in Indian online marketplace Snapdeal:

The latest fund-raising follows $500 million raised last August in a round led by Alibaba Group Holding, SoftBank Group Corp and Foxconn.

The e-commerce market in India is expected to grow to $220 billion in the value of goods sold by 2025, from an expected $11 billion this year, Bank of America Merrill Lynch said in a recent report.

You might be asking why are Canadian pension funds going global? Because they know the ugly truth: they need to prepare for lower returns in a world where ultra low rates are here to stay as deflation sets in and the new negative normal takes hold. As such, they need to find deals in countries (like India) where the demographics support long-term growth.

But investing in India, China, Brazil or anywhere in else in the world carries its own set of risks and these Canadian pension funds need to find the right partners to work with on these direct deals, much like Warren Buffett found Brazil’s 3G Capital to work on his private equity deals. And there aren’t many 3G Capitals in this world (there’s only one and it’s arguably one of the best cutthroat PE funds in the world).

And going global doesn’t always pan out great for Canadian funds. Ontario Teachers’ Pension Plan stepped on a German land mine when it bought a stake in Maple Financial Group, getting embroiled in a tax evasion/ fraud scheme that shut down its German affiliate (I’ve spoken to a few people who told me that this may look worse than it really is but it still looks bad).

I also recently questioned the nosebleed valuations that Teachers, AIMCo, OMERS and Kuwait Investment Authority (“the Consortium”) paid to buy London’s City Airport. One senior Canadian pension executive told me his fund didn’t bid on this asset but he added: “I’ve seen infrastructure deals that initially look great based on valuations and turn out to be duds and others that look outrageously expensive and turn out to be great investments. It all depends on their strategic plan for this asset.”

In its global expansion, PSP Investments recently bet big on U.S. private credit and debt at a time when the CLO business on Wall Street is showing a big slowdown and loan covenants remain categorically weak for a fourth straight year. Admittedly, this could present great opportunities for PSP but there’s no doubt the private debt market in the U.S. is very challenging and it could get a lot worse if the U.S. economy buckles.

What else? Canadian pension funds have been snapping up U.S. real estate but there are now big cracks in this market and that too will present big challenges and big opportunities to Canada’s Top Ten who are among the biggest and best real estate investors in the world.

Still, there’s no denying Canada’s large public pensions are increasingly carving out their global presence and hiring the right people to source direct deals across the world. They can do this because they have the right governance model that allows them to pay their senior pension fund managers big bucks to attract and retain talent and do deals that their U.S. counterparts can only do via private equity funds, paying huge fees in the process.

Lastly, Canada’s Top Ten aren’t just looking at global deals. They’re also looking at domestic deals, especially in infrastructure where the federal government is courting them to invest in new projects.

The best way I can describe Canada’s Top Ten is opportunistic long-term investors with very deep pockets looking to capitalize on large scalable investments at home and abroad.

 

Photo by  Horia Varlan via Flickr CC License

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Katie Allen of the Guardian reports, ECB cuts eurozone interest rate to zero to jump-start economy:

The European Central Bank has cut interest rates in the eurozone to zero, expanded its money printing programme and reduced a key deposit rate further into negative territory as it seeks to revive the region’s economy and fend off deflation.

Going further than economists had expected, the ECB cut the eurozone’s main “refinancing” rate from 0.05% to zero, prompting a sharp drop in the euro against the pound and the dollar.

The central bank also cut its two other interest rates as part of a package of measures to revive lending and economic activity in the eurozone. The deposit rate was cut as expected by 10 basis points to -0.4%, the ECB said in a statement.

The latest cut in the deposit rate means the ECB will be charging banks more to hold their money overnight, with the aim of encouraging them to lend it to businesses. The marginal lending rate, paid by banks to borrow from the ECB overnight, was cut from 0.3% to to 0.25%.

The ECB also expanded its quantitative easing programme to €80bn (£61bn) a month, up from €60bn. That was more than the €70bn economists had been expecting, according to the consensus in a Reuters poll of economists.

ECB chief, Mario Draghi, had already indicated the central bank would announce fresh stimulus at the conclusion of this week’s policy-setting meeting. Economists had widely expected the ECB to expand its quantitative easing programme – whereby it pumps money into the economy by buying up assets from financial institutions – and to cut the deposit rate.

The cut to the main refinancing rate and to the marginal lending rate caught markets off-guard and the euro weakened sharply after the decision was announced, fell about 1% against both the dollar and the pound.

The Frankfurt-based ECB had come under growing pressure to increase support for the eurozone’s flagging economy after the single currency bloc slipped back into negative inflation in February.

But the latest moves come amid growing scepticism on financial markets that central banks have enough ammunition left to bolster growth and stop falling prices becoming entrenched.

Commenting on the announcement, Carsten Brzeski, an economist at the bank ING, said: “The ECB just lifted at least parts of a white rabbit out of the hat … It will be interesting to see how Draghi will address recent criticism on the effects of the ECB’s monetary policy and whether he can give the markets the feeling that the ECB indeed is almighty and powerful and not impotent.”

As shown in the chart below, after initially dropping by 1%, the euro recovered and is up 1.95% at this writing. This is a huge intraday move for any currency (click on image)

So what’s going on? No doubt, a lot of short covering took place after the announcement but if you ask me, the euro is doing a yen and rising because the ECB once again disappointed markets just like the Bank of Japan did when it adopted negative rates on January 29th.

Importantly, nothing has changed and I would use any strength in the euro to short it (I still see it going to parity or below parity). Despite massive monetary stimulus from the ECB, the euro deflation crisis is still raging, and Mario Draghi’s worst nightmare hasn’t disappeared.

And the biggest nightmare of all in Europe? State pensions. There is a demographic and pensions crisis unfolding in Europe, exacerbated by the ongoing jobs crisis, and it’s a slow motion train wreck that will decimate public finances there.

Juliet Samuel of the Wall Street Journal reports, Europe Faces Pension Predicament:

Krystyna Trzcińska, 68 years old, has farmed a strip of land in this corner of eastern Poland for more than four decades. Retired now, she grows clover between neat rows of raspberry bushes to feed her rabbits. The rabbits she eats, the berries she sells.

The berries bring in the equivalent of about $1,300 a year. To survive, she and her husband depend on pensions provided by Poland’s government.

State-funded pensions are at the heart of Europe’s social-welfare model, insulating people from extreme poverty in old age. Most European countries have set aside almost nothing to pay these benefits, simply funding them each year out of tax revenue. Now, European countries face a demographic tsunami, in the form of a growing mismatch between low birthrates and high longevity, for which few are prepared.

Europe’s population of pensioners, already the largest in the world, continues to grow. Looking at Europeans 65 or older who aren’t working, there are 42 for every 100 workers, and this will rise to 65 per 100 by 2060, the European Union’s data agency says. By comparison, the U.S. has 24 nonworking people 65 or over per 100 workers, says the Bureau of Labor Statistics, which doesn’t have a projection for 2060.

While the problem has long been building, it is gaining urgency as European countries’ debt troubles, growing out of the 2008 crisis, push governments to reassess their priorities. Greece, the worst off, has had to reduce the generosity of its pension system repeatedly. Though its situation is unusually dire, Greece isn’t the only European government being forced to acknowledge it has made pension promises it can ill afford.

“Western European governments are close to bankruptcy because of the pension time bomb,” said Roy Stockell, head of asset management at Ernst & Young. “We have so many baby boomers moving into retirement [with] the expectation that the government will provide.”

Even the U.S., with a Social Security trust fund of $2.8 trillion, faces criticism for promising more than it can afford. That is because the fund—which is mostly in the form of IOUs from the Treasury—is projected to fall short of the sums needed to cover all benefits in a dozen years or so, and run out in 2035. Europe’s situation is much worse.

The demographic squeeze could be eased by the influx of more than a million migrants in the past year. If many of them eventually join the working population, the result could be increased tax revenue to keep the pension model afloat. Before migrants are even given the right to work, however, they require housing, food, education and medical treatment. Their arrival will have effects on public finances that officials have only started to assess (click on image).

The pension squeeze doesn’t follow the familiar battle lines of the eurozone crisis, which pits Europe’s more prosperous north against a higher-spending, deeply indebted south. Some of the governments facing the toughest demographic challenges, such as Austria and Slovenia, have been among those most critical of Greece.

Germans, meanwhile, “are promoting fiscal rules in Spain and other countries, but we are softening the pension rules” at home, said Christoph Müller, a German academic who advises the EU on pension statistics. He pointed to a recent change allowing some workers to collect benefits two years early, at 63. A German labor ministry spokesman called that “a very limited measure.”

Europe’s state pension plans are rife with special provisions. In Germany, employees of the government make no pension contributions. In the U.K., pensioners get an extra winter payment for heating. In France, manual laborers or those who work night shifts, such as bakers, can start their benefits early without penalty.

While a few countries—including Norway, the U.K. and the Netherlands—have considerable savings in public funds or employer-sponsored pension plans, many others have little. Governments’ annual costs for public pensions equal a tenth of gross domestic product, according to the EU data agency Eurostat. That GDP percentage should be stable in coming decades, Eurostat estimates, though its forecast depends on numerous economic assumptions.

Across Europe, the birthrate has fallen 40% since the 1960s to around 1.5 children per woman, according to the United Nations. In that time, life expectancies have risen to roughly 80 from 69.

In Poland, birthrates are even lower, and here the demographic disconnect is compounded by emigration. Taking advantage of the EU’s freedom of movement, many Polish youth of working age flock to the West, especially London, in search of higher pay. A paper published by the country’s central bank forecasts that by 2030, a quarter of Polish women and a fifth of Polish men will be 70 or older (click on image).

In 2012, the Polish government launched a series of changes in its main national pension plan to make it more affordable. One was a gradual rise in the age to receive benefits. It will reach 67 by 2040, marking an increase of 12 years for women and seven for men. The changes mean the main pension plan now is financially sustainable, said Jacek Rostowski, a former finance minister and architect of the overhaul.

The party that enacted the changes lost an election in October, however, and a central promise of the winning party is to undo them. Recently, Poland’s president introduced a bill to reverse some of the measures.

“You have to take care of people, of their dignity, not finances,” said Krzysztof Jurgiel, agriculture minister in the current Law & Justice Party government.

Ms. Trzcińska, the retired grower of berries and rabbits, doesn’t follow politics too closely. She switches channels when political debates such as the one over pensions appear on her TV screen. “They are all yelling at each other, I don’t understand it, and it’s unpleasant,” she said.

When she was young and living under communist rule, she recalls, her family worked the fields with horse-drawn plows and rarely left the village. She remembers winters so cold that a glass of hot tea placed on a window sill would freeze. For decades Ms. Trzcińska tilled a tiny farm of about 17 acres with her husband, Józef, retiring at 55, then the age when women could start collecting state pensions. They eventually gave most of their land to their son and two daughters.

For most of her working years, Ms. Trzcińska made no contributions to Poland’s special pension scheme for farmers. Modest though its payouts are—she receives the zloty equivalent of about $225 a month—barely a tenth of the plan’s benefits are covered by contributions from current farmers. Government budgets fill the gap.

Because her husband worked in a shop in addition to farming, he draws his benefit from the main national pension plan. After taxes, it equals about $200 a month. With their berry sales, the two have a combined posttax income equal to $6,400, about 60% of Poland’s median for two people.

“I’m not worried about myself,” Ms. Trzcińska said. “They already decided about my pension. But sometimes I see the debate and worry about what [my children’s] pensions will be.”

Her first daughter, 46-year-old Anna Mazurek, lives across the lane in Zaraszów. She teaches school—earning about $1,375 a month—cares for two children and spends many hours minding a shop she and her husband built. He too works at the shop, as well as growing wheat, barley and oats on their piece of the farm. “To live in the countryside, you have to have five jobs,” Ms. Mazurek said.

Once a year, the pension plan sends her an estimate of her benefits when she retires. The most recent was about $138 a month. A spokesman for the plan said it would provide at least $224 before taxes, a legal minimum the calculator doesn’t take into account.

An hour’s drive away in Lublin, a picturesque medieval town close to the Ukrainian border, her sister, Małgorazata Olechowska, works as an office manager for an EU-funded nonprofit for about $1,600 a month. She pays at least a third of her income in taxes, including 9.76% that is earmarked for retiree pensions. Her employer chips in an equal amount. The government pays all of that straight out to current pensioners, supplementing it with other tax revenue.

The system is “a mysterious machine,” Ms. Olechowska said. To her, it feels as if “there’s a huge black hole, and our money is going inside, and we get nothing from it.”

What both sisters do understand is that they will have to work long past the age at which their parents stopped, contribute more and likely retire with a less-generous pension.

It may be a more secure one, however, thanks to the 2012 overhaul that made the plan financially sounder. The changes mean that contributions from current workers and their employers now fund 84% of benefits provided by Poland’s national social security system, which includes not just pensions but also health-care and disability benefits.

Ms. Olechowska, 41, has considered investing in property to help fund her retirement but has taken no action. Her older sister, Ms. Mazurek, doubts she will be up to managing schoolchildren in her 60s but isn’t sure what to do about it. When the government raised the age for receiving a pension, she said: “I wasn’t angry, but I felt helpless.”

The EU has pressed European governments to be more upfront about their pension costs. They are required to publish forecasts of each year’s pension payouts. Only a few countries estimate the total debt burden of the pension promises they have made. In political discussion, most governments treat this as a kind of costless debt held off public balance sheets (click on image).

Starting in 2017, EU rules will require European governments to calculate the total amount they must pay current and future pensioners. Making this obligation more visible could spur them to deal with it, said Hans Hoogervorst, chairman of the International Accounting Standards Board and a former Dutch finance minister. “It will make clear that the current situation is unsustainable.”

That realization could trigger some tough decisions. Moritz Kramer, chief ratings officer for sovereigns at Standard & Poor’s, said European governments will have to admit at some point that current workers won’t receive as much from public pension plans.

Ernst & Young’s Mr. Stockell says he regularly asks a son in his 20s how much he is saving for his retirement. The answer is nothing. Mr. Stockell, who is 57, says even he hasn’t saved enough. “My expectation was that the company I worked for would provide,” he said.

Earlier this week, I discussed how U.S. public pensions are in big trouble. The article above discusses Europe’s pension black hole and highlights how pension poverty is alive and well in many European countries (with some notable exceptions like Denmark, Sweden and the Netherlands).

And now you have the ECB lowering rates to zero and buying a ton of European corporate paper. Good like with that strategy and good luck to European pensions trying to make their actuarial target rate of return in this new negative normal.

When I was interviewed by Gordon T. Long of the Financial Repression Authority on how financialization is causing inequality and limiting aggregate demand growth, I made reference to six major structural issues that will lead to global deflation:

• The global jobs crisis
• Aging demographics
• The global pension crisis
• Rising inequality
• Technological Advances
• High and unsustainable debt all over the world

Each of these six structural factors is impacting aggregate demand  and all we need now is another Big Bang out of China and an emerging markets crisis to reinforce global deflationary headwinds.

 

Photo by  Horia Varlan via Flickr CC License

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Yaldaz Sadakova of Benefits Canada reports, HOOPP’s 2015 return slides to 5% amid volatility:

Amid slow global growth, chronically low interest rates and declining commodity prices, the Healthcare of Ontario Pension Plan (HOOPP) saw its return for 2015 slide to 5.12%, down from 17.7% in 2014. Despite this decline, its funded status has strengthened.

The plan’s 10-year return was 9.32%, down from 10.27% in 2014 (still highest 10-year return among global pensions).

“We suspected 2015 [would] be a challenging year and that’s how it played out,” said Jim Keohane, HOOPP president and chief executive officer, speaking at a press conference in Toronto on March 3. It was a year of “very high volatility and low returns,” he added.

Keohane cited pressures such as slowing growth in China, structural problems in Europe, regulatory requirements for the financial firms serving the pension plan and sliding commodity prices.

Declining energy prices in particular inflicted a lot of pain on the Canadian economy, causing the country to slip into a technical recession in 2015.

As a result of the low interest rates, HOOPP has lowered its discount rate this year from 5.8% to 5.6%, Keohane said.

The pension fund’s investment income also dipped to $3.1 billion in 2015 from $9.1 billion in 2014.

Despite the lower investment income and returns, the multi-employer plan saw its net assets grow to $63.9 billion in 2015 from $60.8 billion in 2014.

Also, HOOPP’s funded position improved last year. It stood at 122%, compared to 115% in 2014. As a result, contribution levels for employers and members have remained unchanged. “We still have one of the lowest contribution rates [among] the major plans,” Keohane said.

HOOPP, which covers Ontario’s hospital and community-based healthcare sector, has about 470 participating employers and 295,000 members.

Matt Scuffham of Reuters also reports, Canada’s HOOPP boosted by strong private equity returns:

The Healthcare of Ontario Pension Plan, one of Canada’s largest public pension plans, said it achieved a return of 5.1 percent on its investments in 2015, with private equity investments the biggest contributor.

HOOPP said net assets grew to C$63.9 billion at the end of 2015 from C$60.8 billion a year earlier, and that its funded position was 122 percent at the end of 2015, up 7 percent from 115 percent in 2014.

“Even during a year of significant economic uncertainty, HOOPP remains fully funded, which means that we have sufficient resources to meet all of our current and future pension and benefit payments,” said HOOPP Chief Executive Jim Keohane.

Research by RBC Investor & Treasury Services last month showed Canadian pension funds achieved a return of 5.4 percent on their investments in 2015. The funds have pursued a strategy of directly investing in assets globally, including in private equity, infrastructure and real estate.

HOOPP’s private equity investments achieved a return of 17.7 percent in 2015.

Lastly, HOOPP put out a press release, HOOPP Strengthens Funded Ratio and Remains Fully Funded:

The Healthcare of Ontario Pension Plan (HOOPP) today announced its funded position was 122% at the end of 2015, up 7% from 115% in 2014. As a result of the stable funding position, contribution rates made by HOOPP members and their employers have remained at the same level since 2004.

The rate of return on investments was 5.12% for the year ended December 31, 2015, with net assets growing to a record $63.9 billion from $60.8 billion in 2014. Investment income for the year was $3.1 billion down from $9.1 billion in 2014, and HOOPP exceeded its portfolio benchmark by 1.17%, or $0.7 billion. The Plan’s 5-year return stands at 12.03%, the 10-year return stands at 9.32%, and the 20-year return at 9.46%.

“Even during a year of significant economic uncertainty, HOOPP remains fully funded which means that we have sufficient resources to meet all of our current and future pension and benefit payments,” said HOOPP President and CEO Jim Keohane. “Being fully funded means we are able to consistently deliver to our members and our liability driven investing approach has been critical to ensuring the long-term health and sustainability of the Plan.”

HOOPP’s liability driven investing (LDI) approach has served members well by providing stability through challenging markets. It is a holistic, long-term investment approach which considers the Plan’s assets in relation to pension obligations, in order to balance risk with returns.

For more information about HOOPP’s financial results please view the 2015 Annual Report, available on hoopp.com.

2015 Return Highlights

HOOPP’s liability driven investing approach utilizes two investment portfolios: a liability hedge portfolio that seeks to mitigate risks associated with our pension obligations, and a return seeking portfolio designed to earn incremental returns to help to keep contribution rates stable and affordable.

In 2015, the liability hedge portfolio provided approximately 62% of our investment income. Nominal bonds and real return bonds provided most of the income within this portfolio, generating returns of 8.9% and 2.2% respectively. The real estate portfolio was also a significant contributor during the year, with an 8.0% currency hedged return.

Within the return seeking portfolio, private equities were the largest contributor to investment income, returning 17.7% on a currency hedged basis, and other return seeking strategies also contributed to the income of the Fund. Public equities contributed 0.8%.

Rates of Return by Asset Class (Liability Hedge Portfolio)

Asset class 2015 Rate Of Return
Nominal bonds 8.9%
Real return bonds 2.2%
Real estate 8.0% (currency hedged)

Rates of Return by Asset Class (Return Seeking Portfolio)

Asset class 2015 Rate Of Return
Private equities 17.7% (currency hedged)
Public equities 0.8%

Other return seeking strategies also contributed to the income of the Fund.

On its website, HOOPP provides an excellent year in review section here. Take the time to skim through it all but I will provide you with a nice snapshot below (click on image):

As you can see, HOOPP has achieved super funded status, a term I reserve for any pension plan with over 120% assets to cover future liabilities. And it has done this using one of the lowest discount rates in the industry (5.6%) and at a lower cost than other large Canadian defined-benefit pensions and at a fraction of the cost of mutual funds.

What this means is that the contribution rates for members and employers will remain stable at least till the end of 2017 (see more details here). Above and beyond that, it also means HOOPP’s members will enjoy full inflation protection (ie., cost of living adjustment was bumped up from 75% to 100%).

Basically, HOOPP is a pensioner’s dream because the plan is super funded and 80 cents of each dollar paid in benefits comes from investment gains at a fraction of the cost of mutual funds which unlike HOOPP, offer no guaranteed (defined) pension payment for life. That’s the brutal truth on defined-contribution plans.

Now, let me go over HOOPP’s 2015 results in a little more detail. I will be referring to HOOPP’s 2015 year in review and to HOOPP’s 2015 Annual Report. Take the time to read HOOPP’s 2015 Annual Report as there is a lot of excellent information in this document.

I also had a chance to discuss HOOPP’s 2015 results with Jim Keohane, the president and CEO. Jim was kind enough to call me while on vacation and I thank him for taking the time to speak with me.

First, the 5.1% gain in 2015 was lower than that of the average Canadian pension fund which delivered 5.4% in 2015. It was also lower than OMERS’s 6.7% gain and a lot lower than the Caisse’s 9.1% gain in 2015.

So what accounted for HOOPP’s lower return in 2015? Jim Keohane cited three factors:

1. HOOPP dialed risk back last year in credit and public equities. “There was a lot of uncertainty and we didn’t feel like we were going to be properly compensated for taking risk in public markets.”
2. HOOPP hedges 100% of its currency risk. “This is done on a policy basis. Again, we don’t feel like we’re being paid for taking on currency risk so we fully hedge it. On a year like 2015, this cost us but over the long-run, we feel that there are too many unknown factors governing currencies so we prefer fully hedging that risk as our liabilities are in Canadian dollars.”
3. HOOPP has a lower weighting in private markets than other large Canadian DB pensions. “Real estate and private equity performed well last year, even after hedging out currency risk, but we don’t have a huge weighting in private markets like our larger peers.”

On this last point, take the time to view HOOPP’s asset mix and how they manage risk below (click on image):

You will notice that Private Equity represents only 5% of the total portfolio (most larger peers have between 10 and 15% allocation to PE) and Real Estate represents 12.5% of the total fund (those figures are a bit higher now). And you will also notice that unlike its larger Canadian peers, HOOPP has a huge allocation to Fixed Income (44%) and no allocation to Infrastructure whatsoever.

When I asked Jim Keohane about infrastructure, he told me flat out: “We aren’t against infrastructure assets but the pricing is too expensive right now” (no kidding!!). You will recall that Jim sounded the alarm on pensions taking on too much illiquidity risk three years ago on my blog.

On Real Estate, you can read details on page 21 of the Annual Report (click on image):

Interestingly, Jim told me that HOOPP is doing a few greenfield projects in Real Estate, including 1 York Street in Toronto where they will be moving into. “There is a huge gap between cost of a building relative to cost of construction right now.”

He also told me HOOPP has partnered with real estate funds in Canada, the U.S. and Europe where they have an equity stake in these funds (not paying 2 & 20). In the U.K., he mentioned that HOOPP is building industrial warehouses and Amazon will be one of its tenants (great tenant).

In Private Equity, there is not much in the Annual Report but the return was spectacular given that currency risk has full hedged (click on image):

But the most important driver of HOOPP’s overall return in 2015 was good old nominal bonds in the Liability Hedge Portfolio (click on image);

In fact, nominal bonds returned 9% for HOOPP in 2015, which is spectacular given that the Caisse only returned 3.8% last year in bonds, marginally beating its index by 10 basis points (3.8% vs 3.7%). This helped HOOPP’s managers beat their overall benchmark by 117 basis points in 2015 (click on image):

I asked Jim Keohane if they juiced their bond returns using leverage via derivatives and here is what he replied: “We made a significant tactical shift in bonds which enhanced the returns. We sold bonds into the rally in January and February and bought them back at much higher yields in October and November.”

Now, I’m not going to question him on that tactical call but when I see such a huge outperformance in a bond portfolio, there’s no question that there was significant leverage used to juice those returns. Not that this is a bad thing as they obviously got it right and this added some big returns to the overall portfolio.

In fact, as shown in the table below from page 60 of the 2015 Annual Report, HOOPP uses derivatives extensively for all sorts of value added activities (click on image):

One thing that strikes me as odd is why HOOPP doesn’t make tactical calls like this on the Canadian currency. In fact, I told Jim that negative rates are coming to Canada and in my humble opinion, shorting the loonie was one of the easiest calls to make in the last three years and I was very vocal about this on my blog when I stated it’s time to short Canada back in December 2013.

[Note: A lot of Canadian public pensions don’t have good currency teams, they don’t understand global macro trends and this is costing them big coin in terms of tactical currency moves. Some got lucky over the last couple of years as their policy is not to hedge or partially hedge currency risk, but most of them are completely clueless when it comes to currency risk and how to make money trading currencies.]

In its Annual Report, HOOPP states the following (click on image):

This helps explain the solid performance in bonds and mediocre one in Public Equities. Again, both HOOPP and OMERS delivered a lousy performance in Public Equities relative to the Caisse but it’s important to remember that the latter took risks in Public Equities that the former didn’t (more emerging markets and international exposure). And to be fair to the Caisse, it outperformed in all its public equities portfolios, including Canadian Equities (-3.9% vs -7.3% for the index).

So in Public Equities, it’s obvious the Caisse is doing something right even if I was very critical of the benchmark being used to gauge the performance of the “Global Quality Equities”.

I asked Jim Keohane what are his market thoughts. He told me he doesn’t “see another 2008 on the horizon.” They’re now neutral on U.S. and European markets and are overweight Canada. He said that both supply and demand factors explained the decline in oil but they’re overweight energy now and taking a “long-term view” as are other Canadian pensions betting on energy.

Jim also told me that he doesn’t understand why Canadian and especially U.S. banks move in unison with oil prices and that there is “no way Deutsche Bank is going under.”

But he also told me the risks he sees ahead are due to aging demographics in China, Japan, Europe and even in North America. “You can forget post-war growth rates over the next cycle, it’s just not going to happen.”

I agree with him on that and fear the worst as deflation sets in. I’m not as bullish as he is on energy and commodity names and would only trade these sectors given my long-term deflation outlook.

We also spoke about the new negative normal and interest rate sensitivity.  Jim told me that HOOPP “won’t be buying bonds with negative yields” and that despite rates being at historic lows, “the Plan’s liabilities are less sensitive to a decline in rates.”

Admittedly, that last point was a bit confusing for me as I told him that the duration of liabilities is a lot bigger than that of assets so in a low rate environment, you will see liabilities skyrocket when rates decline. But he told me that duration measures the “rate of change”, not the sensitivity of liabilities to moves in rates and that they stress-test their liabilities to make sure they’re on the right track (I need to get a better understanding of this).

In terms of taking more risk, I noted that HOOPP is a relatively young plan and it can take a lot more risk than Ontario Teachers or OMERS which have a lower ratio of active to retired workers. Here Jim was unequivocal: “Just because you can take more risk, doesn’t mean you should.”

That got us talking about chronically underfunded U.S. public pensions taking on increasingly more risk in hedge funds and private equity funds. “That’s a recipe for disaster because when you’re starting off from an underfunded position, you should be even more cognizant of the risks you’re taking because your very path dependent and much more vulnerable to a shock.” (I’m paraphrasing here but that was his clear message).

We also spoke about compensation. HOOPP is structured as a private trust, not a corporation, so it doesn’t have to publicly report compensation of its top brass. Jim told me that publishing compensation tends to inflate compensation and he told me that while HOOPP has competitive compensation, “the folks at CPPIB get compensated better at virtually every level.”

But he added: “People who come work for us come for the culture and the ability to do things they can’t do at larger shops. We’re a small team and portfolio managers here do a lot more trading across the spectrum than they’d be allowed to do at larger shops and they feel more engaged. Keeping the right culture is critical for us.”

Lastly, we talked about that silly Fraser Institute study on the costly CPP.  Here Jim was an ardent defender of CPPIB and DB plans. “That study double counted costs for CPPIB and the video they put up on their website about having more freedom with your money was just terrible and totally missed the point of why DB plans are better ar providing safe, secure retirement at a reasonable cost for Canadians.”

On that note, I thank Jim Keohane for taking some time while away on vacation to speak to me. I truly appreciate it. Any mistakes in this comment will be corrected and any additional information will be added in.

As always, I remind all of you that these comments take considerable time and effort so I would appreciate if you donate or subscribe to my blog on the right-hand side under my picture to support my efforts in bringing you the very best insights on pensions and investments.

More importantly, I am actively looking for work and would appreciate all the help I can get from Canada’s Top Ten pensions which I cover in detail on this blog. I’ve reached out to the leaders of these organizations and would appreciate their help in securing full-time employment doing what I love the most, analyzing pensions and investments.

 

Photo by www.SeniorLiving.Org via Flickr CC License

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Jacqueline Nelson of the Globe and Mail reports, OMERS posts 6.7-per-cent return, bolstered by infrastructure, real estate assets:

The pension plan for Ontario municipal employees earned a 6.7-per-cent return in 2015 as private market investments made gains.

The Ontario Municipal Employees Retirement System (OMERS) said Friday that its private equity, infrastructure and real estate investments performed especially well during 2015, cushioning the plan from volatility in the public markets.

Low interest rates and slower global growth contributed to a 0.7-per-cent return for public investments in 2015, down from 11 per cent a year earlier. Meanwhile, private investments showed solid performance with a 14.5-per-cent return in 2015, up from 9.1 per cent.

These results demonstrate “the importance of diversification, and investing in high-quality assets,” said Michael Latimer, chief executive of OMERS, in a statement. Net assets grew by $5-billion to more than $77-billion in 2015.

OMERS, which manages assets and administers pensions for 461,000 Ontario employees and retirees, continued to reduce its funding shortfall in 2015. The pension plan is now 91.5 per cent funded as a result of investment returns and member and employer contributions, compared with 90.8 per cent the year before. In 2010, OMERS said it planned to eliminate the deficit by 2025.

One year ago, OMERS said it would increase its exposure to infrastructure investments with stable cash flows in countries such as Canada and the U.S., as well as Australia. Over the course of last year the pension plan’s asset mix has tilted toward private investments, and infrastructure now makes up 16.4 per cent of the portfolio, up from 14.7 per cent a year before.

OMERS said its infrastructure holdings posted gains of 17.3 per cent, real estate earned 15.3 per cent and private equity investments earned 10 per cent in 2015.

Some of the pension plan’s largest deals of 2015 included infrastructure arm Borealis Infrastructure’s acquisition of Fortum Distribution AB, a large electricity distribution network in Sweden, along with a consortium. The deal was valued at about $7-billion (U.S.), according to data from Thomson Reuters.

OMERS also joined other pension funds on deals, including the $2.8-billion acquisition of toll road leading into downtown Chicago alongside Canada Pension Plan Investment Board and Ontario Teachers’ Pension Plan.

Mr. Latimer has also previously expressed plans to reduce the portfolio’s public market weighting to about 53 per cent. One year ago, it stood at 58 per cent, but this year public market investments such as stocks and bonds represented just 52 per cent of assets.

In 2015, OMERS received $3.8-billion (Canadian) in contributions from plan members and employers, and paid out $3.4-billion in benefits to the 141,000 people that receive an OMERS pension each month. About 18,000 people joined the plan as new members last year.

Yaldaz Sadakova and Jennifer Paterson of Benefits Canada also report, OMERS return drops to 6.7% in 2015:

As a result of slow global growth, low interest rates and market volatility, the Ontario Municipal Employees Retirement System (OMERS) saw its net investment return slide to 6.7% in 2015, down from 10% in 2014.

While the pension plan’s 2015 net return for public investments was 0.7%, down from 11% in 2014, it saw the net return for its private investments — which include private equity, infrastructure and real estate — grow to 14.5%, up from 9.1% in 2014.

Diversification is working for the fund, said Jonathan Simmons, chief financial officer at OMERS, during a presentation on Friday. “In a year where there were thin returns from fixed income … and poor returns from commodities, no one is surprised that our public investment returns were 0.7%, below the 11% return we enjoyed in the previous year,” he added.

“We had a solid return from our private equity group, held back a little bit by some of our exposure to a private equity asset we had in the Alberta oil and gas sector. But nonetheless, a respectable return for our private equity.”

Simmons added that it was an exceptional year for infrastructure – posting a return of 17.3% compared to 10.6% in 2014 – with strong gains across almost all assets in the portfolio, but most noticeably in its U.K. assets associated with the ports.

For real estate – which the results showed had a return of 15.3%, up from 8.7% in 2014 – Simmons said the pension fund experienced good returns in Canada, better in the U.S. and very strong returns out of its European portfolio.

The investor’s net assets grew to $77 billion in 2015, compared to $72 billion the previous year, “and we’re growing,” added Simmons.

“Where our exposures to our private investments in all of our asset classes have continued to grow, we are putting money to work.”

For example, in 2015, OMERS entered the Swedish market, buying Fortum Distribution AB and the Germany market through the purchase of Autobahn Tank & Rast Holding. It bought a UK consulting firm called Environmental Resources Management, and became the second largest landlord in Boston with three new office properties. It also expanded in Canada, with the redevelopment of Toronto’s Yorkdale mall just one example.

“We’re portfolio managers, not just aggregators,” said Simmons, “so while we have deployed $5.6 billion into the private markets, we’ve returned $5.5 billion to OMERS in terms of dividends, distributions and asset recycling.”

OMERS’ funded status climbed to 91.5% from 90.8% the year before as a result of investment returns as well as member and employer contributions.

“The good news is we exceeded our funding requirement,” said Simmons. “Our funding requirement for 2015 is 6.5%. That means we added $100 million of value above the funding requirement for the plan.”

In 2015, the pension fund received $3.8 billion in contributions from plan members and employers. It paid out $3.4 billion in benefits.

Approximately 18,000 new members joined OMERS in 2015 — an increase in active plan membership of 1% over the prior year. Almost 141,000 people receive pensions from OMERS every month.

OMERS put out a press release, OMERS Net Assets Exceed $77 Billion, Earns 6.7% Net Return in 2015:

In 2015, OMERS continued to make steady progress towards delivering secure and sustainable defined benefit pensions to the Plan’s members. Its funded status improved to 91.5% as a result of investment returns and member and employer contributions, compared with 90.8% the year before. OMERS earned a net investment return of 6.7% (after all expenses), exceeding its long-term funding requirement of 6.5%. Net assets grew to more than $77 billion in 2015, a $5 billion increase over 2014.

“Strong returns from private equity, infrastructure and real estate helped to offset challenges in public markets, demonstrating the importance of diversification, and investing in high-quality assets,” said Michael Latimer, OMERS President and Chief Executive Officer.

Public investments returned 0.7% (net) and private investments returned 14.5% (net). While private markets returns remained solid, financial markets are being challenged by slower global growth, continued low interest rates and increased volatility.

In 2015, OMERS received $3.8 billion in contributions from plan members and employers, and paid out $3.4 billion in benefits.

“We are pleased with the continued improvement of our funded ratio to 91.5% from 90.8%,” said Jonathan Simmons, OMERS Chief Financial Officer. “We remain very focused on the long-term health of the Plan, including a return to full funding and delivering even better value for OMERS members and employers.”

OMERS is an important part of Ontario’s retirement system and the broader economy. Approximately 18,000 new members joined the plan in 2015, leading to an increase in active plan membership of 1.0% over the prior year. Almost 141,000 people receive OMERS pensions every month.

“Our top priorities are serving our members, retirees and employers, and achieving our vision to be a leading model of defined benefit pension plan sustainability,” said Mr. Latimer.

About OMERS

Founded in 1962, OMERS is one of Canada’s largest defined benefit pension plans, with more than $77 billion in net assets as at December 31, 2015. It invests and administers pensions for 461,000 members from municipalities, school boards, emergency services and local agencies across Ontario. OMERS has employees in Toronto and other major cities across North America, the U.K., Europe and Australia — originating and managing a diversified portfolio of investments in public markets, private equity, infrastructure and real estate. For more information, please visit www.omers.com.

OMERS 2015 Annual Report will be made available later this month on its website here. For now, I highly recommend you read OMERS 2014 Annual Report for more details.

I will be referring to parts of the 2014 Annual Report and to the information above. One thing I like is OMERS’s long-term graph and explanation of its funded status below (click on image from page 6 of the 2014 Annual Report):

You’ll notice the Primary Plan’s funded ratio fell to a historic low in 2012 but has turned the corner and is improving. At 91.5% in 2015, OMERS has yet to reach fully funded status but it’s doing a lot better than it was four years ago and certainly a lot better than most U.S. public pensions which are chronically underfunded and pretty much doomed.

In terms of performance, 2015 was all about private markets. Unlike other large Canadian pensions, OMERS has a huge allocation to private markets (much bigger than everyone else) and those private investments really kicked in last year when public markets provided lackluster returns.

In particular, Infrastructure gained a whopping 17.3% last year, which is a testament to how OMERS Borealis is a global leader in infrastructure investments. But Real Estate and Private Equity also posted solid results, gaining 15.3% and 10% respectively in 2015.

And when almost half your assets are in private markets posting double digit returns, it helps explain why OMERS performed decently in 2015 even if its gains were not as strong as 2014 (click on image):

Now, the 2015 Annual report isn’t available but on page 12 of the 2014 Annual Report, we see the benchmarks OMERS uses to gauge its results (click on image):

Basically, OMERS uses absolute return benchmarks approved by the OMERS Administration Corporation at the start of each year.

While I understand absolute return benchmarks for private markets, I’m a little surprised that OMERS is using an absolute return benchmark for public markets which can get killed on any given year making it virtually impossible for OMERS to beat its overall benchmark on a year where capital markets are very weak (like in 2015).

And even in private markets, setting absolute return benchmarks can introduce all sorts of risk taking behavior which is not captured by these benchmarks. OMERS needs to do a much better job explaining all its benchmarks and how they relate to the risks being taken at individual portfolios.

The other thing that helped OMERS’s overall performance in 2015 was the decline in the Canadian dollar last year. Just like other Canadian pensions that defied volatile markets last year, OMERS benefited from direct investments in private markets and the decline in the loonie, which explains why its returns were marginally better than the 5.4% median return of other Canadian pension funds last year.

Still, OMERS didn’t perform as well as the Caisse which gained 9.1% in 2015 and part of the reason why is the Caisse’s Public Equities posted solid returns of 11.6% in 2015 vs its benchmark of 7.8% led by its Global Quality Equities and Emerging Markets portfolios (see my comment here).

Obviously OMERS Capital Markets dialed back risk in public equities and credit and I heard they invested a huge amount in Bridgewater’s All Weather fund which was down 7%  last year. I don’t know for sure but it’s obvious that OMERS didn’t take the same risks in public equities as the Caisse.

In terms of compensation, as you can see below from page 105 of the 2014 Annual Report, OMERS’s top brass is paid in line with the rest of Canada’s pension plutocrats (click on image):

One final note. I was very critical of OMERS, OTPP and AIMCo’s decision to acquire the London City Airport at a very hefty premium. Every expert I spoke with is scratching their head trying to justify such an outrageous multiple for an airport, even if its a prized asset.

Please note I contacted Michael Latimer and Jonathan Simmons to discuss OMERS’s 2015 results and ask them specific questions. If they come back to me, I’ll edit my comment to include their views.

 

Photo credit: “Canada blank map” by Lokal_Profil image cut to remove USA by Paul Robinson – Vector map BlankMap-USA-states-Canada-provinces.svg.Modified by Lokal_Profil. Licensed under CC BY-SA 2.5 via Wikimedia Commons – http://commons.wikimedia.org/wiki/File:Canada_blank_map.svg#mediaviewer/File:Canada_blank_map.svg