Author: Leo Kolivakis

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 pull back on infrastructure as prices climb:

Canada’s biggest pension funds say they are walking away from more and more global infrastructure deals, citing concerns that intense competition for assets has driven valuations too far.

The shift could help cool global prices for tunnels, airports, toll roads, energy networks and other infrastructure as Canadian pension plans are among the world’s biggest and most active buyers.

Pension funds’ investment in infrastructure has risen since the 2008 financial crisis, as plunging interest rates and bond yields drove these players to seek steady returns elsewhere. Global equity and commodity turmoil has done little to dampen that interest and intense competition for a limited number of assets has been reflected in recent valuations.

Some investors, particularly in private equity circles, complain that the Canadian funds – dubbed “maple revolutionaries” because of the strategy of direct equity investments they pioneered in the 1990s – have a tendency to overpay.

Senior executives at the leading Canadian funds defend the merits of past infrastructure deals, but say they are worried prices no longer reflect the illiquidity of the assets, which cannot be sold quickly like stocks or bonds.

“The market is overheated. We have stepped out of the bidding for a lot of assets over the last two or three years,” a senior executive at one of Canada’s biggest public pension funds, who declined to be named, told Reuters.

Among recent deals with no Canadian participation, British rail rolling-stock owner Eversholt Rail Group was sold for $3.8-billion (U.S.) to Hong Kong’s Cheung Kong Infrastructure Holdings (CKI).

Canadian funds still expect infrastructure to grow as a proportion of their overall investments because most plans have money rolling in and view infrastructure as a good match for long-term liabilities. But they say want to be more selective.

Canada’s biggest 10 public pension funds have more than trebled in size since 2003 to more than $1.1-trillion (Canadian) in assets. A third of that is now held in alternative assets such as infrastructure, real estate and private equity.

DUMB MONEY?

Four Canadian pension funds now rank among the world’s top 10 infrastructure investors, according to Boston Consulting Group. At the end of 2014 the four funds had $36.8-billion (U.S.) infrastructure assets under management, equivalent to 41 per cent of the total infrastructure assets held by the top 10.

One New York-based investment banker, speaking on condition of anonymity, said private equity firms that have lost an infrastructure auction to a Canadian pension fund often grumble they paid too much, referring to rival bids as “dumb money”.

For example, last year’s acquisition by Canada’s CPPIB and Hermes Infrastructure of a 30 per cent stake in Associated British Ports for about $2.4-billion valued the business at around 20 times earnings compared with multiples of 10 to 12 that investors say are typical for the sector.

But recent prices do not necessarily mean buyers are paying too much said Dougal Macdonald, the head of Morgan Stanley Canada, which has advised on a number of deals involving Canadian pension funds.

“In a low rate environment, target returns across virtually all asset classes have come down. It is simply a resetting of returns for the right assets,” he said.

Canadian pension funds typically look for nominal returns of 6 to 8 per cent from infrastructure, a few percentage points above what they would expect from fixed-income investments. Bankers note that private equity funds often seek returns of 20 per cent or higher, meaning pension funds can afford to pay more.

‘CLUB DEALS’ AND BIDDING WARS

Still, Canadian executives said their funds should avoid being drawn into bidding wars as part of competing consortia.

“You’ve got to try and avoid auctions because they can get crazy. If you’re just walking around with an open cheque book in these markets you’re going to pay too much,” said another executive with one of Canada’s three largest pension funds, who declined to be named because of the sensitivity of the issue.

The executive said Canada’s largest funds should co-operate more frequently. However, such “club deals” remained rare for the top three – the CPPIB, the Caisse de dépôt et placement du Québec and the Ontario Teachers’ Pension Plan.

In the past they often found themselves competing against each other as well as foreign rivals that include South Korea’s National Pension Service, Dutch pension fund APG, Australia’s Future Fund, private equity and some sovereign wealth funds.

Among recent deals, New South Wales Premier Mike Baird hailed a “stunning result” for the Australian province after a consortium including the Caisse agreed to pay $7.5-billion for an electricity network last year, significantly more than analysts expected.

The group had seen off competition from other investors including the CPPIB and a unit of another Canadian pension fund. The Caisse said at the time it was confident the acquisition met its investment objectives.

Canadian funds are also involved in a takeover battle for Australian port and rail giant Asciano AIO.AX, with Brookfield Asset Management BAMa.TO bidding against a consortium that includes the CPPIB.

Asciano’s shares are trading below both groups’ offers but at 34 times their earnings still look expensive compared with its nearest rival Aurizon, valued at 13 times its earnings.

“There’s a lot of money chasing assets,” an executive at an Ontario-based fund said. “The important thing is to maintain our discipline”.

None of this surprises me. Three years ago, I openly asked whether pensions are taking on too much illiquidity risk and whether their collective search for yield is inflating an infrastructure bubble.

In April of last year, Ontario Teachers’ CEO Ron Mock sounded the alarm on alternative investments stating: “There’s a lot of money crowded into the broadly defined alternatives space. We find it too expensive. It’s time for us to step back.”

I want you to all remember my rule of thumb, when everyone is doing the same thing, paying outrageous prices for liquid or illiquid investments, or investing in the hottest hedge funds or whatever hot new strategy or theme investment banks are peddling, it typically means lower returns ahead.

Call it the law of unintended consequences. When I was working at PSP back in 2005, I sent a Fortune article to the president and senior management which discussed why Tom Barrack, the king of real estate was cashing out. I specifically highlighted this quote, which remains my favorite investment quote of all-time: “There’s too much money chasing too few good deals, with too much debt and too few brains.”

That didn’t exactly win me any friends over in the Real Estate department where the then head of Real Estate at PSP, André Collin, was fuming but I couldn’t care less as my job wasn’t to coddle people, it was to warn them about risks lurking ahead (something Gordon Fyfe never fully appreciated and ended up regretting).

That same year, I flew over to London to attend some Barclays conference on commodities and came right back to Montreal to work on a board presentation arguing against commodities as an asset class (too many investment banking cheerleaders peddling BRICS and commodities at that conference) .

The investment bankers didn’t like me a lot as I made them do a lot of grunt work and finally decided against recommending commodities in PSP’s portfolio. Mihail Garchev who is still at PSP helped me look at the numbers and it just didn’t make sense. That decision alone saved PSP billions in losses.

Unfortunately, at the time, PSP was taking all sorts of stupid risks in its credit portfolio, including selling CDS and buying ABCP. In the summer of 2006, I looked at the issuance of CDOs and CDO-squared and cubed products, and warned PSP’s senior managers of the bursting of the U.S. housing bubble and how it will wreak havoc on credit markets, but nobody took my dire warnings seriously (to be fair, some were worried too and nobody had any idea how bad things would get).

In fact, I remember calling people at Goldman to discuss ways we can short ABX (an index of subprime debt) and this made them somewhat nervous: “Why would you want to do that? The U.S. housing market is great. ” (felt like saying “because I don’t trust you guys and I don’t want you to question me, just tell me if you can do it and how much it will cost us!”. But nothing came out of this because PSP’s management decided not to hedge our credit risk back then).

I wrote about that experience here and how it cost me my job here. Anyways, that’s all ancient history now but all this to say when everyone is doing the same thing, following the crowd, listening to their trusted investment bankers peddling them hot investment ideas, it typically doesn’t end well.

There are booms and busts in everything. That goes for public markets and private markets. You’ll have cycles and typically dumb money is on a feeding frenzy when you’re at the top of the cycle.

Now, as far as infrastructure, there’s no question it’s an important asset class. I know, I worked with Bruno Guilmette, PSP’s former head of infrastructure, on the board presentation to introduce that asset class at PSP back in 2005.

The best way to think of infrastructure is as an investment similar to real estate but with a much longer investment horizon, providing steady cash flows (yield) over a very, very long time. Typically infrastructure investments yield returns in between stocks and bonds over a very long period.

Why do pensions love infrastructure? Because pensions need to match assets with liabilities and with rates at record lows and likely staying ultra low for years, they need to find a relatively safe, secure and scalable substitute to long bonds which aren’t yielding enough to match their long dated liabilities which go out 75+ years (there’s a duration mismatch with long bonds and yields are too low).

And when you’re a big Canadian pension fund, you’re not going to invest in an infrastructure fund, you’re going to invest huge sums directly. Unlike private equity which is almost exclusively, if not exclusively, done via fund investments and co-investments, all of Canada’s Top Ten invest in infrastructure directly (same with real estate but there are also a lot of fund partnerships in that asset class).

The problem is when everyone is looking to find prize infrastructure assets, things get expensive because everyone is playing the bidding game. This is what the article above discusses. Note how many “senior executives” are complaining publicly to that reporter, off the record of course.

Still, there have been some interesting deals lately. For example, Borealis Infrastructure, an investment arm of OMERS and arguably one of the best infrastructure investors in the world, just bought a 24.15% stake in Spain’s largest operator of oil storage facilities and pipelines:

Borealis Infrastructure – part of the OMERS pension system – is acquiring a 9.15% stake in Compania Logistica de Hidrocarburos, or CLH, from Cepsa and a 15 stake from Global Infrastructure Partners.

Financial terms of the two deals were not immediately available.

CLH, Borealis Infrastructure’s first investment in Spain, expands the pension fund manager’s European infrastructure portfolio which already includes investments in the United Kingdom, Germany, Sweden, Finland and the Czech Republic.

CLH has 40 storage facilities and 4,000 kilometres of pipelines in Spain. The company also has 16 storage facilities and more than 2,000 km of pipelines in the United Kingdom.

Back in November, CPPIB, OMERS and Ontario Teachers’ bought a stake in a Chicago toll road:

Three Canadian pension funds have signed a deal to buy the company that operates the Chicago Skyway toll road for US$2.8 billion.

The Canada Pension Plan Investment Board, Ontario Municipal Employees Retirement System and Ontario Teachers’ Pension Plan will each hold a one-third stake in Skyway Concession Co. LLC, which runs the toll road under a concession agreement that lasts until 2104.

The Skyway runs 12.5 kilometres and connects the Dan Ryan Expressway to the Indiana Toll Road.

Skyway Concession, owned by Cintra Concesiones de Infraestructuras de Transporte S.A. and Macquarie Atlas Roads and Macquarie Infrastructure Partners, took over operations of the toll road in 2005 under a 99-year deal for US$1.83 billion.

The company is responsible for all operating and maintenance costs of the Skyway, but has the right to all toll and concession revenue.

The deal is subject to regulatory approvals and customary closing conditions.

As you can see, there of plenty of deals going on but things might be getting frothy and with risks of deflation and a global slowdown looming, I guess a lot of infrastructure investors are scrutinizing the multiples they pay on these investments a lot more closely.

And while many are cooling off on infrastructure, some are even selling assets. AIMCo just announced the sale of Autopista central toll road in Chile:

Alberta Investment Management Corporation (“AIMCo”) is pleased to announce the successful divestment of its 50% interest in Autopista Central de Chile, a Santiago-based toll road infrastructure asset, on behalf of certain of its clients, to Abertis Infraestructuras SA (“Abertis”) for € 948 million (approximately CAD 1.5 billion).

The sale of Autopista Central represents the culmination of a very successful private investment for AIMCo and a demonstration of its ability to manage this unique asset through the investment life cycle. This mutually beneficial transaction further provides a unique opportunity for Abertis to consolidate its interests under its Chilean Road Portfolio, furthering its current strategy.

Autopista Central is a 61-kilometer, six-lane highway in Santiago that went into operation in 2007. AIMCo acquired a 50% stake in Autopista Central de Chile in December 2010, on behalf of certain of its clients, joining a consortium of companies with 100% ownership of Autopista Central SA unit, a Santiago-based provider of toll roads operations services. The consortium, now solely-owned by Abertis, holds the concession until 2031.

“AIMCo has enjoyed working with the strong management team of Autopista Central and our partner Abertis over the last five years,” says Ben Hawkins, Senior Vice President, Infrastructure & Timberlands at AIMCo. “Autopista Central has one of the best management teams in the industry, and the acquisition will allow Abertis to achieve further synergies and benefits to its portfolio. We are happy to have been an owner of this important piece of infrastructure to Santiago, and remain committed to investing further in Chile given the right opportunities.”

AIMCo Chief Executive Officer, Kevin Uebelein, states further, “Today’s transaction realizes excellent gains for AIMCo’s clients. Our talented and capable team of Infrastructure investment professionals maximized the value of this asset through each stage of the investment lifecycle as evidenced by this outcome.”

I will leave you with something AIMCo’s former CEO Leo de Bever shared with me via email earlier today on this topic:

When I was at Ontario Teachers, we were one of the first Canadian funds to start investing in infrastructure. The market was inefficient, and we probably made more money than we should have because as others followed suit, prices started to rise.

With the rapid growth of pension and sovereign wealth funds, the money is piling into this asset class faster than the supply of good investments. Some of the new investors are seeking top line yield without factoring in risk. The biggest risk of infrastructure is political and contractual: whenever there is a dispute between a few investors and a lot of taxpayers or users, the investors are in danger of losing out. With publicly owned infrastructure, that cost is just quietly absorbed.

Reliability of contracts and concession provisions are key to attracting capital on good financial terms. With interest rates low, target returns of 6% to 8% may look like a king’s ransom, but pricing infrastructure as a risk free bond makes little sense, because it ignores efficiency of capital use and operating risks. The unit cost of capital on many publicly financed projects may be low, but in many cases they end up having to raise a lot more dollars. Some of the best projects I never financed ended up badly for that reason.

Most government owned social infrastructure has been underpriced for decades because of the political pressure to keep user rates low, resulting in a lot of deferred maintenance and no provision for capital replacement. It seems that we need bridges falling down and water pipes bursting before we make that connection.

There should be a growing opportunity for pension funds to fund new infrastructure, as governments look for more efficient ways to deal with these issues. I have been surprised that this is not happening faster.

The main reason seems to be that no one is held accountable for the social opportunity cost of deficient infrastructure caused by congestion, grid failure, and water pollution from poor sewage treatment capacity planning. I see this as one of the factors holding down future GDP growth potential.

Canada’s federal government is embarking on a big infrastructure build program. That could be great, and is long overdue, assuming it targets the right investments. We should think carefully about not just building more of what we already have. The future may need different facilities, reflecting, for example, what I see as a trend to more distributed production of energy, and more emphasis on decentralized ways to improve efficiency of water use and treatment.

Smart guy that Leo de Bever and you’ll recall the ‘godfather of infrastructure’ was warning investors of how expensive infrastructure was getting back in July 2010 when he stated the following:

“I did a fair bit of the early infrastructure stuff among Canadian pension funds,” he said. “And in the beginning you could get an honest 14 per cent return on equity because the market was very inefficient.” To do the same thing these days, with a number of players competing for deals, would take a whole pile of leverage, he suggested.

But ended with this comment:

“In most places, water and sewage are going to take an enormous amount of capital because everything is starting to leak,” he said. “Given that the fiscal positions of a lot of these governments is pretty weak, private capital has to come in at some point, and that’s when I think infrastructure will become attractive again.”

So while Canada’s big pensions are cooling on infrastructure, it doesn’t mean they’ve written this asset class off entirely. Quite the opposite, they still invest heavily in infrastructure but are scrutinizing deals a lot more carefully.

It’s also worth noting that some funds, like the Caisse, are taking on greenfield infrastructure projects in Quebec. While some are questioning whether it can make money on these projects, I’m very confident it will do just fine (the Caisse hired the right people to oversee these greenfield projects).

Photo by Kyle May 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.

Barbara Shecter of the National Post reports, Canada Pension Plan has no cost advantage over other large public pensions:

Proponents of expanding the Canada Pension Plan, or launching a similar large-scale retirement vehicle in Ontario, often tout the element of lower costs through economies of scale. But a new study from the Fraser Institute says the CPP has no clear cost advantage over other large public sector pensions.

The study by Philip Cross, a former chief economic analyst for Statistics Canada, compared the total costs of CPP and five large public sector pension plans in Ontario.

The author says his study is unique because it looked at a complete picture of both investment and administrative costs.

Economy of scale is often used as a rationale by those who favour CPP expansion, suggesting that the relative cost of plans declines as they grow and accumulate more assets. However, Cross says his study shows such claims “are simply not true.”

The study, to be released publicly on Tuesday, concludes that CPP, the largest plan scrutinized over the period from 2009 to 2014, was in fact the costliest as a percentage of assets.

“Specifically, the CPP with $269 billion in assets had the highest average cost-to-asset ratio at 1.07 per cent during that time,” the Fraser Institute, a research think-tank, said in a statement.

Cross contends that CPP’s reputation for being low cost is “coloured by incomplete comparisons that don’t account for all related costs.”

Furthering the notion that size does not correlate with cost, the study concluded that the Ontario Teachers’ Pension Plan — the second-largest fund, with $154 billion in assets — was only the fourth costliest, with an average cost ratio of 0.63 per cent.

The study looked at and dissected two cost categories: investment and administrative.

The smallest fund in the study, OPTrust — with just $17 billion in assets — was found to have the highest average investment costs as a percentage of assets. This was followed by CPP, with the second-highest investment costs.

Another of the smaller funds scrutinized, the Ontario Pension Board, had one of the lowest average investment costs.

Cross speculated that fund growth through asset accumulation might actually raise costs, since the complexity of implementing investment strategies calls for more — and costly — external expert counsel.

Debate over expansion of the Canada Pension Plan has raged in recent years, with some experts arguing Canadians aren’t saving enough for retirement and need a boost from the national public pension.

Ottawa and the provinces came close to agreeing to enhance CPP a couple of years ago, but fears about the strength of the economy derailed those efforts.

The government of Ontario responded with plans to launch its own provincial pension plan, the Ontario Retirement Pension Plan (ORPP), which could be rolled into an expanded national plan should that be embraced.

The Fraser Institute has weighed in on the CPP and ORPP before. A study published in July suggested that ramping up government-driven mandatory retirement savings programs could lead to less voluntary savings, resulting in no overall impact on how much Canadians have to fund their golden years.

Benefits Canada also reports, CPP more costly than other public sector pensions:

The Canada Pension Plan (CPP) is more costly than five public sector pension plans, according to a new report by the Fraser Institute.

The report compared the total costs, including investment and administrative of the CPP with five large public sector plans based in Ontario, including: the Ontario Teachers’ Pension Plan (OTPP), the Ontario Municipal Employees Retirement System (OMERS), the Healthcare of Ontario Pension Plan (HOOPP), the Ontario Pension Board (OPB), and the OPTrust.

It found that the CPP, which is the largest plan with $269 billion of assets, had the highest expense ratio at 1.07% of its assets on average for the whole period between 2009 and 2014. The OTPP, the next largest plan at $154 billion of assets, had the fourth highest average expense ratio (0.63%).

“In fact, there may be diseconomies of scale for larger public pension plans because of the complexity of implementing their investment strategies, which include contracting out for external experts – a practice that has become increasingly popular, with plans investing more in non-traditional assets such as real estate, infrastructure, and private equity,” said the report.

“These more aggressive investment strategies raise costs. Whether they are justified by higher rates of return will not be known for decades, and depend on whether the assumption that markets have mispriced these assets is borne out.”

The Fraser Institute put out this press release on comparing the costs of the Canada Pension Plan with public pension plans in Ontario. You can read the full report here.

Before I tear this study and its authors to pieces, let me first commend them for at least attempting to shed some light on costs at Ontario’s public pension plans. When it comes to public pensions, I’m all for more transparency on costs, fees, leverage, benchmarks, compensation, diversity, and anything else that Canadians deserve to know about.

In short, I believe that Joe and Jane Maple Leaf deserve to know a lot more about what is going on at Canada’s public pensions, as well as financial markets, which is why I started this blog back in June 2008, much to my personal demise (not that I had much of a choice!).

I have no problem taking on Canada’s Top Ten, shining a light on their activity, but when I read these studies on the CPP from the Fraser Institute, I can’t help but wonder who funds this nonsense and what is their ultimate political goal?

Just so you know, I have experience working as a senior investment analyst at two of the largest Canadian pension funds, the Caisse and PSP Investments, but I’ve also worked as a fixed income analyst at BCA Research, an economist at the National Bank, and as a senior economist at the Business Development Bank of Canada and then Industry Canada.

All this to say, I know the Fraser Institute all too well. It was recently ranked as the top think tank in Canada by the University of Pennsylvania, but it was always a right-wing think tank with an axe to grind against big government or anything else perceived to be big government (like Big CPP even though it’s a Crown corporation that operates at arms-length from the government).

One of the authors of this study, Philip Cross, has extensive experience at Statistics Canada, an organization which I respect, and then worked for the Macdonald-Laurier Institute. He is also a member of the Business Cycle Dating Committee at the CD Howe Institute.

But for all his credentials and experience, Cross has an axe to grind with the Canada Pension Plan and he has even written articles in — you guessed it, the National Post!! — arguing we should forget talk of a pension crisis, Canadians are very well protected in their retirement.

Really? That’s news to me because I’ve been arguing all along that we need real change to Canada’s Pension Plan and that now more than ever, our politicians need to stop dithering and enhance the CPP once and for all. And this despite the crisis in the Canadian economy which will more than likely usher in negative interest rates here just like in Japan and elsewhere.

This is all part of the new negative normal and a period of prolonged ultra low rates which are here to stay as long as the deflation supercycle keeps wreaking havoc on the global economy.  This too is why I want our political leaders to get on to enhancing the CPP as soon as possible and finally realize the brutal truth on defined-contribution plans: they aren’t working and will condemn millions of Canadians to pension poverty.

This is why unlike the Fraser Institute, I welcome Ontario’s “Wynning” pension strategy and think it’s a real shame our political leaders are once more squandering a golden opportunity to enhance the CPP once and for all.

Now that I got that out of the way, let me briefly go over some critical points of the Fraser Institute study comparing the costs of CPP with other Ontario public pension plans. You can click on the table below which summarizes the costs at various Ontario pensions relative to the CPP (click on image):

My first criticism of this study is it’s comparing apples to oranges. Apart from PSP Investments, which is growing fast and has a similar profile to CPPIB (but still a lot smaller), there’s is nothing like our national pension fund in Canada (the Caisse is huge but it manages money of mature Quebec pension plans which pay out more than they receive in contributions).

How can you compare CPPIB, a national pension fund which is growing fast, to smaller Ontario plans which cover only a small subset of the Canadian population? This is just silly and doesn’t take into account CPPIB’s mandate, challenges and advantages which are unique to it.

It’s one thing managing $20 billion, $50 billion or even $150 billion, but when you’re in charge of $270 billion and growing fast, you simply cannot take the same approach that others take and your costs will be relatively higher for all sorts of reasons.

CPPIB is a global powerhouse which is investing in public and private markets all over the world. It has over two dozen distinct investment programs (or “business units”) which are global in scope and competition is very intense among some of the world’s biggest investment institutions — many of which are trillion dollar behemoths.

In other words, because of its sheer size and liquidity advantages, CPPIB is engaging in investments activities that others are not doing either because they don’t need to or because they can’t (too small, too mature, etc). Sure, it’s doling out huge fees in private equity, an activity which it does exclusively through external investment partners (fund investments and co-investments with top private equity funds), but it’s also engaging direct investments in real estate and infrastructure (the latter is all direct investments).

CPPIB is also doing large deals which will better position itself for the future. For example, the acquisition of GE’s Antares Capital was the biggest deal of 2015 and one which will benefit the Fund over the very long run. But you need to pay the people running this financing arm and they don’t come cheap (still a lot cheaper than doling out huge fees to many private equity funds to do the same activity in the mid market space).

The Fraser Institute study talks about “diseconomies of scale of large public pensions because of the complexity of implementing their investment strategies” but it fails to explain the J-curve effect of private equity investments and how large transactions like the GE deal or other big deals might be expensive at first but over the long run, they will lower costs in significantly.

And just to be clear, when you’re the size of CPPIB, you’re not paying 2 & 20 to private equity funds or hedge funds. You’re paying significantly less than smaller pension funds which can’t use their size as leverage.

The second major criticism I have with the study is that CPPIB is very transparent in terms of all its costs. It is all broken down across operational, transactional and performance fees with driving factors. For example, look at page 53 and 54 of the Fiscal 2015 Annual Report which provides details on all costs and where it’s clearly stated:

As a cost-conscious organization, we take managing costs seriously. We have a long-standing practice of allocating operating expenses to the investment departments to provide a complete view of the costs associated with generating the investment returns and to encourage cost awareness across the organization. This cost transparency promotes constructive conversations between the departments receiving the cost allocations and the departments allocating the costs that are focused on value for spend and accountability for the expenditures.

If CPPIB has high transaction costs compared to other smaller plans in a given year it’s because their multiple businesses have pursued many investments over that period of time, not because it’s hiding anything from the public.

Also, it’s important to note performance fees are driven by high performance and they correlate to strong investment returns for the benefit of contributors and beneficiaries.

This brings me to my third major criticism of the study, the lack of understanding of CPPIB’s mandate. At the end of the study, the authors question CPPIB’s investment strategy, dismissing it as an “unproven experiment” and stating the following:

Of course, the rising expense of the CPP’s investment strategy after 2007 could be justified if the rate of return remains high. The problem is that we will not know for years, or even decades, if the rate of return stays elevated. This is especially true of the CPP’s purchase of illiquid assets such as infrastructure, land, and private equity. This strategy presumes first that these assets are mispriced because they are relatively unknown and infrequently traded, and second that the mispricing of assets is on the low and not the high side. In other words, there is a presumption of market failure in price discovery, which large pension funds can identify and profit from better than other investors such as hedge funds.

This view may be borne out by a higher return to CPP investments over the decades. Or it may be disproven if returns falter. It is important to remind people that this is an experiment in progress, not the execution of a proven strategy. It is worth remembering that The Economist observed recently that hedge funds once “sold themselves as clever and flexible enough to take advantage of opportunities that conventional fund managers neglected,” but this claim has been disproven over time(The Economist, 2015, August 1: 62).

It is also worth noting that high returns earned by the CPPIB’s assets will not benefit its members; the CPP remains largely a pay-as-you-go pension plan, with only 17% funded by CPPIB investments. Since members will not benefit from higher returns, why does management undertake investment strategies that involve more risk? Meanwhile, younger Canadians are already overpaying in terms of the ratio of their contributions to benefits, to compensate for the underfunding before the CPP was overhauled in 1997 (Canada, OSFI, 2013; Godbout, Trudel, and St-Cerny, 2014).

At a minimum, the CPPIB has not done a good job explaining publicly why its strategy justifies the additional expense and risk in its investments. Nor has it been shown that an active investment strategy has not distracted management from maximizing the efficiency of both the administrative and investment arms of the CPP, something it promised to do when it adopted this new strategy in 2006. This reference to improving efficiency seems to have been its last utterance on the subject, making it appear to be an empty slogan when maximum efficiency should be the foundation for the operations of the entire CPP, or indeed of any organization entrusted with the public’s money or supported by taxes (it is telling that the lower cost OPB refers to efficiency in its Annual Report, but the CPPIB does not). Developing intricate investment strategies and opening branches around the world may create a more interesting work environment for managers, but this does not guarantee the rate of return that results from higher efficiency and lower costs.

Wow, powerful accusations!! Unfortunately, none based on facts and it proves how utterly ignorant and biased the authors are when it comes to CPPIB, its activities and its mandate. In fact, right on CPPIB’s website, it clearly states: “CPPIB invests the assets of the CPP with a singular objective – to maximize returns without undue risk of loss. Our investment strategy is designed to capitalize on our comparative advantages.”

Unlike all those other public pensions in Ontario which the study alludes to, CPP is not a fully-funded plan and as such it can take risks in public and private markets that these other plans cannot or will not take. Its objective is clearly stated, “to maximize returns without undue risk of loss.” Period. This is their statutory fiduciary responsibility, a point which seems to have been lost by the authors of this study.

Importantly, the notion that higher returns do not benefit members is nonsense. The higher the return, the cheaper the cost of financing the CPP over the long run, which means lower pay-as-you go contributions for Canadians in the future.

And unlike what the authors state, CPPIB has been very clear explaining why its strategy justifies the expenses and risks it takes. Perhaps the authors of this study should take the time to read my public blog comments where I go over in detail CPPIB’s annual results like when it gained a record 18.3% in Fiscal 2015.

What else? Mark Wiseman, CPPIB’s CEO, has repeatedly told media outlets that he expects CPPIB to under-perform its reference (benchmark) portfolio, which is one of the toughest to beat, in periods when markets are roaring and outperform it during bear market cycles. It has delivered a solid 7.3% 10-year annualized rate of return which translates into multi-billions of net investment income over its passive reference (benchmark) portfolio, which is one reason why the Fund is actuarially on solid footing.

As far as shifting assets into private markets, this is the strategy that pretty much every large Canadian pension fund has been doing over the last decade but unlike large U.S. pensions, they’re investing directly whenever they can, significantly lowering the costs. Only in private equity do they do a lot of fund investments but also co-investment with their partners which brings the total fees down considerably.

Also, while shifting assets into private markets isn’t without risks, if you read Leo de Bever’s comments on why Norway’s giant pension fund should invest in unlisted real estate and infrastructure, you would gain a deeper appreciation for this long-term strategy.

Will the next ten years be a lot tougher than the last ten years for CPPIB and others to achieve their target rate of return? You bet they will but if I had a choice of having my retirement money in the CPP and other large well-governed Canadian DB plans or some crappy Canadian mutual fund charging me ridiculous fees or even a low-cost index fund which mimics public markets, there’s no question I’d choose CPP which is more diversified and a lot more secure.

All this to say that this Fraser study comparing the cost of CPP to other Ontario pensions isn’t very good as it’s full of false and grossly biased claims. I suggest Philip Cross and his co-author talk to a real pension experts like Leo de Bever, Jim Leech, Doug Pearce, John Crocker, Claude Lamoureux, Bob Bertram and Neil Petroff before they ever publish such a spurious study on the high costs of CPP.

But let me not be too hard on them, after all, I want to see more studies shining a light on public pensions. And their findings aren’t all terrible. They just need to be put in proper context and they need to be openly discussed by real pension experts who actually know what they’re talking about.

One thing the study demonstrates is why fully-funded HOOPP is one of the best pension plans in the world as it’s delivering stellar results at a fraction of the cost of other smaller and larger plans. But here too, you need to be careful as HOOPP’s approach cannot be replicated by everyone, especially much larger pensions like OTPP (which does everything HOOPP does and invests in external hedge funds and private equity funds) or CPPIB which is way too big to do everything internally.

If anything, this study makes OPTrust look somewhat bad as it has a very expensive cost structure relative to much bigger and smaller pensions but here too, you need to be very careful interpreting costs relative to results. If you look at OPTrust’s Annual Report 2014, the latest one available, you will see the Plan is fully funded and it achieved an investment return of 12%, net of external management fees, outperforming the Plan’s 6.2% composite benchmark portfolio.

Can OPTrust improve its cost structure by doing more internally? It probably can but the bottom line is it’s delivering great results net of all external management fees and it’s fully funded allowing it to increase its inflation protection to its members.

The bottom line is when most Canadian DB and DC plans are reeling because of the turmoil in global markets, all of the DB pensions discussed in this Fraser Institute study are doing just fine and the last thing we need is to spread more disinformation on why there are several reasons to oppose CPP expansion, including its cost structure.

I hope this comment lays all these criticisms to rest but I realize that public pensions, including the CPP and ORPP, are widely politicized and unfortunately, the real pension experts are not the ones being consulted to carry out such studies. Instead, we get academic or quasi-academic hacks publishing spurious studies that are not putting their findings in proper context.

If Philip Cross and Joel Emes or anyone else at the Fraser Institute wants to challenge my views, I’d me more than happy to give them an opportunity to reply to my comments (my email is LKolivakis@gmail.com). I’d be even happier if someone like Leo de Bever wrote a study comparing all of Canada’s large public pensions. When it comes to pensions, I like reading people who actually know what they’re talking about.

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

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

CPPIB has a message to all women in finance, it’s actively looking for you:

At CPPIB, our goal is to have an employee population that reflects the communities in which we operate. This is because we believe that diversity – of insights, backgrounds and experiences – leads to better decisions and business outcomes. Attracting, developing and retaining talented women is particularly important to our success as a high-performing global organization. By 2020, our goal is to have half of all of our new hires be women.

To help us achieve these goals, we have a variety of programs and resources ­ including coaching, mentoring, sponsorships, and internships ­ that help attract women early in their careers and then provide them with ongoing development and growth opportunities so they can enjoy the most challenging and fulfilling careers possible.

As part of our commitment to supporting the development of women, we recently established a partnership with Women in Capital Markets, the largest network of professional women in the Canadian financial sector and voice of advocacy for women in our industry. An element of this partnership is a new women’s internship program designed specifically for women in undergraduate programs who are curious about business and interested in exploring and being mentored in the world of finance and investments. This four month summer internship teaches technical skills used in the financial and investment industries, enables participants to engage in meaningful work and activities designed to develop business acumen, and provides opportunities to collaborate with colleagues, leaders and industry experts.

Our focus on gender diversity was recently underscored when our President and CEO, Mark Wiseman, was honoured with a “WCM” Leadership Award. This annual award recognizes members of the financial community who have demonstrated a commitment to advancing and supporting women working in capital markets.

In receiving this award, Mark commented that “we have made a commitment to advancing the role of women at our firm and in our industry…No organization can achieve the best business results when they restrict themselves to half the population in recruiting, developing and retaining talent. This Leadership Award truly recognizes the efforts of our entire organization to advance and support the careers of women in capital markets.”

Learn more about CPPIB career opportunities and our commitment to diversity by visiting our Careers page.

Diversity, or lack of diversity, is a hot topic these days, especially in Hollywood where Viola Davis had her say on the debate at the SAG Awards over the weekend. I’m not going to get into the whole Hollywood diversity debate except to say that my favorite movie of all-time remains The Shawshank Redemption (1994) featuring one of my favorite actors, the great Morgan Freeman.

When you are a great actor, you’ll be recognized by your peers. Period. Having said this, there undoubtedly is a lack of diversity in Hollywood and more importantly, lack of diverse, original ideas which explains the crappy movies that have been coming out in the last decade.

In fact, I had an email exchange with a friend of mine who is an entertainment lawyer bemoaning all this:

In my humble opinion, Hollywood has been in a recession for over a decade, and the main reason is deflation of original ideas, not piracy!

I was watching a classic comedy, Sideways (2004), with Paul Giamatti. When is the last time Hollywood came up with a script that compares to this???

Forget it, as long as Hollywood remains oblivious to people’s reality, I’m not going to shed a tear for these jerks!

To which my friend replied:

I didn’t want to shed any tears for them either, but I couldn’t help it when they announced that Star Wars VII had earned a billion dollars faster than any other movie in history and would shatter Avatar and Titanic worldwide box office records within a month. Disney is a money-printing machine.

However, only two companies account for nearly all of Hollywood’s profits this year (Disney and Universal), while others were suffering layoffs (Paramount, Weinstein Co., and Relativity).

I found his reply very interesting and think it explains why Disney’s shares (DIS) have done well over the last five years and it may be time to buy the recent dip. If you’re looking for a recession-proof industry, this is it, but make sure you’re investing in the right company, one that reflects real diversity and has original content.

Anyways, enough on Hollywood, let’s get back to the real world and CPPIB’s push for more gender diversity. I’ve been an outspoken critic of the lack of diversity in the workplace at Canada’s Top Ten so I welcome all these initiatives to introduce a more diverse workforce.

In my opinion, it’s simply indefensible for any public pension fund, government organization, Crown corporation or even large private sector employer like a federally regulated bank not to have a truly diverse workforce. 

So, in that regard, I applaud CPPIB’s push for more gender diversity. Mark Wiseman may be a creature of habit but he comes from a family with diverse interests and his partner of more than 22 years, Marcia Moffat, was a vice-president at the Royal Bank of Canada before joining Blackrock as head of the Canadian business (a little conflict of interest there but I’m sure it’s all kosher).

According to the Globe and Mail article,  they met on his first day at the University of Toronto. “I am, I think, the world’s greatest Jewish Christmas tree cutter,” Wiseman said. “My kids get all the holidays.”

The chair of the Board at CPPIB,  Dr. Heather Munroe-Blum, might have gotten in a bit of hot water over her own pension benefits, but there’s no denying she’s an extremely accomplished lady, receiving many accolades from the academic community including honorary degrees from various universities and the Order of Canada.

According to Wikipedia, Dr. Munroe-Blum trained as an epidemiologist and has led large-scale epidemiological investigations related to psychiatric disorders.  She is the author or co-author of over 60 scholarly publications, including four books. She has served on the board of directors of the Medical Research Council of Canada (now the Canadian Institutes of Health Research) as well as on international reviews of the German Academic Exchange Service (DAAD), the Swiss National Science Foundation, and the National Institute of Mental Health (USA).

My father and brother are psychiatrists at McGill and I think very highly of doctors, especially those on the front lines fighting mental illness in our society.

Was CPPIB’s focus on more gender diversity pushed from the top? I don’t know but knowing a bit about Heather Munroe-Blum (never met the lady), I can guarantee you she’s definitely no pushover and had something to do with it.

And again, while I applaud all these initiatives on introducing more diversity at the workplace, the sad reality is that a lot more needs to be done. When I look at CPPIB’s board of directors or it senior management team, I see a lot of white Anglo-Saxon Canadians, but I definitely don’t see a snapshot of Canada’s diverse population. 

I’m not going to sugarcoat it. Diversity initiatives are all great but when you dig a little deeper at CPPIB or the rest of Canada’s Top Ten, you’ll see how pathetically diverse they are at the board or senior management level. And while women are properly represented at the board level (by law, they have to be!), we have yet to have a woman nominated to the position of CEO of a major Canadian pension fund (hopefully that will change with Ontario’s new ORPP).

What else? I challenge all of Canada’s Top Ten to take a page from the Royal Bank of Canada and publish their own Diversity Blueprint and provide their own vision and priorities for diversity and inclusion and back it up with hard statistics that are readily available on their website.

For example, the Royal Bank publishes a Diversity and Inclusion Report as well as an Employment Equity Report and a diversity report card setting out initiatives and whether they were met.

Now, the Royal Bank isn’t exactly a paradigm of diversity, especially in upper management and a lot of this stuff is corporate marketing fluff, but it has done more than any other organization to promote diversity at all levels and unlike other organizations, it has a recruitment program specifically designed for people with disabilities.

On page 5 of its Diversity and Inclusion Report, the bank provides us with hard numbers (click on image):

You might be wondering why don’t all of Canada’s big banks, large public pension funds, Crown corporations and government organizations follow the Royal Bank and publish their own diversity reports reflecting objectives and a scoreboard (it would be nice if they published statistics on pay equity too).

The answer is pure laziness and nobody really wants to report on diversity at all levels of their organization because if they did, most Canadians would be appalled.

When I privately confront the leaders of Canada’s Top Ten pensions on diversity in the workplace, especially in regard to persons with disabilities, they either dismiss me or state some generic statement like “we take employment equity very seriously.”

Really? Where are the statistics in your annual report or on your website? Worse still, when applying to jobs at Canada’s Top Ten pensions, some of them don’t even ask you to self-identify your gender or whether you’re a visible minority, aboriginal or person with a disability.

My favorite is when I confront leaders and they assure me “they take diversity seriously” but always make sure they hire the “best and brightest” no matter their gender, sexual orientation, ethnicity or disability.

Of course, this is all nonsense as the unemployment rate for people with disabilities is running close to 75% and it’s not because they lack competence or skills for jobs (the unemployment rate for aboriginals is equally appalling). In most cases, they’re more skilled and a lot more competent than people with no disability but our society systematically discriminates against people with disabilities and so do our public and private organizations.

All this to say I welcome any initiative which focuses on diversity but there’s a lot more that needs to be done on this front at all of Canada’s Top Ten public pensions.

And just so you know, while CPPIB is publicly discussing gender diversity, others like the Caisse have made significant improvements in terms of diversity in the workplace under Michael Sabia’s watch. But you won’t hear of this push for diversity at the Caisse which is one of the few public pensions that asks candidates to self-identify when applying to positions.

Still, the Caisse also needs to hire more people with disabilities and allow them to access that bloody elevator at the main entrance on Jean-Paul Riopelle which is only reserved for big shots like Sabia.

Let me stop right there because this is a topic that makes my blood boil for a lot of personal reasons and the leaders at Canada’s Top Ten all know exactly what I’m talking about. While they quietly make off like bandits in what is essentially a rigged system, Canada’s best senior pension and investment analyst has been relegated to the blogosphere, in large part because he suffers from Multiple Sclerosis (and is doing just fine, knock on wood!).

Photo by Nick Wheeler 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.

Francesco Guerrera of Politico reports, European pension schemes ‘vulnerable to big market downturn’(h/t, Suzanne Bishopric):

Many work pension schemes are vulnerable to a major market and economic shock, the first Europe-wide stress tests of the sector found.

The tests, carried out by the European Insurance and Occupational Pensions Authority (EIOPA), found that dramatic falls in equity prices and other adverse economic occurrences would dramatically reduce the amount of money held by pension funds to pay for the retirement of current and past workers.

Pension funds suffer when markets fall because they invest in equities, bonds and other asset classes. Any reduction in interest rates is also detrimental because it reduces pension funds’ returns.

The results, released Tuesday, showed that “defined benefit” schemes — ones where the pension payout is based on the number of years worked and the level of salary attained — would find themselves with a deficit of more than €750 billion almost overnight under two different adverse scenarios.

That equates to a funding ratio — the amount of money available to pay for pensions — of between 59 percent and 61 percent of future liabilities. Such a low level would put pressure on pension funds to find other ways to fund the gap, such as reducing benefits or forcing the financial groups or companies that run the schemes to inject capital into the funds.

“While pension plan liabilities have a very long-term nature, it is important that supervisory regimes are prepared to deal with these stresses in a transparent way, be it through appropriate recovery periods, the role of pension protection schemes, increased sponsors’ contributions and/or benefit adjustment mechanisms,” said Gabriel Bernardino, chairman of EIOPA.

You can read the entire IORPs Stress Test  Report 2015 to get a better understanding of the serious challenges many European pensions face.

I strongly recommend you read the report as it discusses various investment, interest rate and longevity risk stress tests that impact defined-contribution (DC) plans and defined-benefit (DB) plans.

The key points worth noting are the following (click on image):

Basically, historic low rates, record stock market volatility and the increase in lifespans are driving the costs of defined-benefit pensions up which explains the inexorable global shift to DC pensions.

And I’ve got some bad news for you. That deflation tsunami I’ve been warning you about is going to decimate all pensions, especially ones taking increasingly more risk to achieve their target rate-of-return.

But as I’ve repeatedly argued, the solution isn’t to shift out of defined-benefit plans into defined-contribution plans. The brutal truth on DC plans is they will exacerbate pension poverty. The more we understand the benefits of well-governed DB plans, the better off we’ll be over the long run.

I just finished writing a comment on Ontario’s new pension plan going over these points. My former colleague, Brian Romanchuk, just wrote a comment on the difficulty of extending universal state pension which you all need to read. I sent that comment to Bernard Dussault, Canada’s former Chief Actuary, to get his thoughts and will follow-up with a comment of my own in the near future.

My views are firmly entrenched in what I believe a well-functioning social democracy requires to thrive: free healthcare as a fundamental right for all, free education for all especially the poor and working poor, and a universal pension plan which covers the retirement needs of a huge subset of the population no matter what happens in the bloody stock market!

In short, I believe the entire world needs to go Dutch on pensions and even improve on its retirement system. But while the Dutch and Danes got it right on pensions, most European countries are struggling with chronic deficits that threaten their pension system.

Nowhere is this more acute than in Greece, the epicenter of Europe’s deflation crisis. The Greek economy cannot escape a deep debt deflation crisis and its pension system has been teetering on collapse for a long time.

Not surprisingly, protests over Greek pension reforms are escalating, the country is a mess, and the FT reports Alexis Tsipras and Kyriakos Mitsotakis are clashing over Greek pensions:

Alexis Tsipras has fended off attacks from Kyriakos Mitsotakis, Greece’s newly elected opposition leader, by insisting that his Syriza government can rescue the country’s underfunded pension system without cutting benefits to retirees.

The prime minister and his rival went head-to-head on Tuesday night in a heated parliamentary debate, their first confrontation since Mr Mitsotakis, a pro-European reformer, was voted in to lead the centre-right New Democracy party this month.

“There will be no reductions in main pensions,” a defiant Mr Tsipras said. “One pension is a whole household’s income in the present [recessionary] circumstances.”

Syriza has resisted pressure from creditors — the EU and IMF — to impose hefty pension cuts by March. The move, postponed from last year, has become an urgent priority with bailout monitors due to return to Athens next week to assessing progress on the reforms agreed in return for a €86bn third international bailout.

Taking aim at Mr Mitsotakis, the son of a former conservative premier, Mr Tsipras asserted that state pension funds were poised to collapse because of “sustained looting” over decades by previous governments.

Mr Mitsotakis responded that the social security system was a victim of the Syriza government’s “incompetence” during a political roller-coaster last year that ended with Greece agreeing to a third bailout after defaulting on a sovereign debt repayment.

“It was accepted that the pension system was viable until 2060 — until Syriza came to power,” he said.

The debate came as thousands of farmers across Greece used tractors to block border crossings and main roads in protest at plans by the government to increase pension contributions and income tax for farmers. The farmers on Tuesday rejected Mr Tsipras’s call for dialogue, demanding immediate cancellation of the increases.

The premier argues that cuts to cover a projected €1.8bn pension deficit in this year’s budget can be avoided through a 1 per cent increase in contributions already agreed with employers and another 0.5 per cent raised from workers.

Syriza has dismissed criticism by creditors that increasing contributions will slow a return to economic growth by dissuading businesses from hiring and will also encourage small companies to employ workers without paying social insurance.

Mr Mitsotakis, who launched an overhaul of the civil service while serving as administrative reform minister in 2013 and 2014, said there were resources available to fund social security without resorting to increased contributions “if the public sector undergoes a restructuring”.

Lawyers, engineers and doctors have staged protests against large projected increases in contributions to a pension fund for self-employed professionals running an annual deficit exceeding €500m

New Democracy has proposed the fragmented social security system be streamlined into three funds covering employees, self-employed professionals and farmers with a basic pension guaranteed at the age of 67 after at least 20 years of employment.

“As a new political leader, I have recognised the mistakes of the past and I am committed not to repeat them,” Mr Mitsotakis said.

Greek journalists have now joined the strike against the pension reforms. The country is a mess and I foresee another Greek crisis in the not too distant future.

And Kyriakos Mitsotakis is right, it’s high time Greeks wake up and stop the charade of public sector profligacy run amok. The Greek public sector is unsustainable and so are Greek pensions (I disagree with Mitsotakis’s assertion that they were ever sustainable).

But what is going on in Greece can easily happen in Italy, Spain and even France. The entire eurozone system is built on unsustainable promises and unlike Canada, you’d be hard pressed to find websites on many large European pensions plans to understand how they invest and what governance models they use to manage pensions (with a few exceptions).

In fact, in Greece, there is no accountability, no transparency, no governance whatsoever on pensions and pretty much anything the government is involved with. It makes me sick and until Mitsotakis wins the next elections by knocking some sense into stubbornly foolish Greeks who think they can have their cake and eat it too, the situation will only get worse.

Let me leave it there. Greek pensions are teetering on collapse but this comment demonstrates that Europe’s pensions aren’t that much better and there’s a very real risk that a prolonged deflation crisis will negatively impact them for years to come.

Photo credit: “Flag-map of Greece” by en.wiki: Aivazovskycommons: Aivazovskybased on a map by User:Morwen – Own work. Licensed under Public Domain via Wikimedia Commons – https://commons.wikimedia.org/wiki/File:Flag-map_of_Greece.svg#/media/File:Flag-map_of_Greece.svg

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, Ontario pushes ahead with new government pension plan:

Ontario, Canada’s most populous province, said on Tuesday it will push ahead with the launch of a new government pension plan rather than counting on an expansion of the country’s existing federal plan.The Ontario Retirement Pension Plan (ORPP) is set to be introduced in 2017 and is designed to benefit the two-thirds of workers in Ontario who do not have an employer pension plan, provincial officials said.

“Our government is unwavering in its focus on ensuring a financially secure retirement for every worker in our province through the Ontario Retirement Pension Plan,” province Premier Kathleen Wynne said.

Ontario has taken a two-track pension strategy since 2013, preparing to introduce the ORPP while also waiting for a possible expansion of the Canada Pension Plan (CPP), the federal plan that covers most working Canadians.

However, Ontario Finance Minister Charles Sousa said it had so far proven too difficult to get the necessary agreement required among Canada’s provinces to expand the CPP.

“We advocated strongly for a CPP enhancement, as did the federal government, but the consensus was not to be had,” Sousa told reporters.

Like other governments around the world, Canada faces a challenge to provide for its aging population. By 2024, more than 20 percent of Canadians are expected to be age 65 or older, the traditional retirement age, according to federal government data.

“Changes in the nature of work are compounding the problem. The working world is no longer dominated by single job careers and guaranteed workplace retirement plans,” Wynne told reporters.

Under the new Ontario plan, by 2020 every eligible worker in Ontario will be part of either the ORPP or a comparable workplace pension plan. The lowest-income earners will not be required to contribute.

The plan, which will start paying benefits in 2022, is designed to pay out up to 15 percent of individuals’ earnings over their career if they contribute to it for over 40 years.

It particularly targets younger workers at smaller companies who may be well paid but are not offered a pension as part of their benefits because it is too expensive for their employer to provide one. Wynne said it will only have a limited benefit for older workers.

Ashley Csanady of the National Post also reports, Ontario pension plan going full steam ahead toward 2017 launch — just don’t ask the cost to run it:

Deductions from the Ontario Retirement Pension Plan will start coming off paycheques in less than a year, but the province still can’t say how much it will cost to run.

Premier Kathleen Wynne was joined by two ministers Tuesday to announce more details of the pension plan, including the fact spouses or a designated beneficiary can reap its benefits after a contributors dies. And like the Canada Pension Plan, those benefits will be indexed to increases in wages and the cost of living.

An independent actuary will be able to approve 0.2 per cent contribution increases if the fund runs low on cash and anyone earning less than $3,500 a year will be exempt from enrolling.

Those tidbits and some technical details prompted Wynne and Associate Finance Minister Mitzie Hunter to proclaim the design of the ORPP is “now complete.”

That design, however, excludes one key point: how much the administration of the plan will cost. CPP, for example, costs about 1.2 per cent each year to run, and many private sector pension plans costs between two and three per cent, though it can be higher.

Hunter said the ORPP is “going to mirror the CPP as closely as possible” but couldn’t yet pin an exact number on its costs. She said large, public-service pension plans in Ontario are very successful and are helping to determine how the ORPP will be administered.

“We expect that it will be very much in the similar range as CPP and those very large plans,” she said.

Pension expert Ian Lee, an assistant professor at Carleton University’s Sprott School of Business, is one of many prominent economists to ring alarm bells about the ORPP. Like Kevin Milligan at the University of British Columbia and Jack Mintz at the Calgary School of Public Policy he questions the very assumption that a mandatory savings scheme is necessary. He also doubts the ORPP can be run as efficiently as the much larger CPP, as the government hopes.

“I do not think it’s possible (to) bring the cost anywhere near that of the Canada Pension Plan, simply because it won’t have the economies of scale,” Lee said, simply because there won’t be enough people — even with six million expected enrolees — for the ORPP to match its federal counterparts efficiencies.

A Conference Board of Canada report released in December found the ORPP would, over the long run, benefit the Ontario economy, and that for many workers it would prove a more cost-effective form of savings than private investment. The report found someone earning $60,000 a year and contributing to the ORPP for 40 years would, on average, see $188,000 more in pension benefits by retirement age than someone who invested privately.

“I have a great deal of respect for the Conference Board of Canada but until we see those numbers (from the province) I don’t think they can make such a statement,” Lee said.

The ORPP will start a phased roll out in 2017 and the province expects six million Ontarians to be enrolled by 2020. Benefits are expected to start flowing in 2022. Anyone without a comparable workplace and their employer will be required to contribute 3.8 per cent of their income for the first $90,000 earned annually. Someone making $45,000 would pay about $16 a week into the plan to be matched by his employer for a total of $1,710 a year, which after 40 years would make him eligible for $6.410 in annual benefits.

Business groups and the provincial Progressive Conservatives maintain the ORPP will amount to a “payroll tax” that will hurt employment.

I began this comment with articles from the Globe and Mail and the National Post so you can get a feel of how politicized the debate on Ontario’s new pension plan (ORPP) has become.

Where do I stand on this debate? My title pretty much says it all and let me tell you that Canadian newspapers are doing a lousy job explaining the advantages of this new pension plan as well as that of enhancing the CPP for all Canadians.

First, some of the pension experts quoted in the National Post article are completely clueless. In particular, when Ian Lee states “I do not think it’s possible (to) bring the cost anywhere near that of the Canada Pension Plan, simply because it won’t have the economies of scale,” he simply doesn’t know what he’s talking about.

Yes, the CPPIB is huge and can use its size to negotiate fees and costs down, but the ORPP is going to be a young plan which is just getting started. As such, it has the luxury to take a different approach from CPPIB and emulate Canada’s top pension plan, the Healthcare of Ontario Pension Plan (HOOPP) which does everything internally and has the lowest administrative costs of any large public or private defined-benefit pension plan.

As the ORPP gets much bigger and needs to start investing in external managers, it can then start taking the approach Ontario Teachers’ Pension Plan or CPPIB takes, but this debate on administrative costs is just plain silly until we get more details of who will be hired to run the pension plan and what approach they will take.

For me, it all boils down to governance. Ontario has some of the best pension talent in the world, and if they place the right board of directors in there and pay pension fund managers properly, they will have no problem attracting competent people who can manage assets internally and keep costs low.

In fact, the ORPP is in a great spot to use the same governance model that has helped Ontario Teachers, CPPIB  and most of Canada’s top ten pensions to succeed and it can go a step further and improve on the existing governance to get better alignment of interests over the long run.

Second, the reason why Ontario is going it alone on the ORPP is because Canadian politicians are petrified to expand the CPP once and for all, especially now that the economy is going through a crisis. In my opinion, this is the stupidest, most shortsighted decision that our politicians are making and they’re squandering a golden opportunity to enhance the CPP once and for all.

Importantly, and I can’t overemphasize this, good pension policy makes for good economic policy. Bolstering a country’s retirement system to provide more defined-benefits will end up bolstering economic activity over the long run, lower social welfare costs of pension poverty, and reduce the debt by increasing sales and other taxes. These are all advantages of well governed DB plans.

There is a more important political and philosophical argument to be made here. When Democratic candidate Bernie Sanders talks about “healthcare being a fundamental right,” Canadians from all political parties understand exactly what he’s talking about.

A well functioning social democracy should provide three basic pillars: free healthcare, free education and retirement benefits people can count on till they die no matter what happens in the volatile stock market dominated by big hedge funds, big banks and high-frequency traders.

Right now in Canada, we have the first two pillars but are lacking any initiative on tackling that third pillar. The debate has become so politicized to the point of absurdity. It’s high time Canadians realize the brutal truth on defined-contribution plans and accept the fact that the current path isn’t working and will only condemn more people to pension poverty.

As I’ve stated before, there shouldn’t be four or more views on defined-benefit plans, there should only be one view, we need to bolster public DB plans for all Canadians. And I emphasize public because apart from a few exceptions (HOOPP, CN, Air Canada and a few others), most private DB plans are crumbling and failing to deliver on their pension promise.

I think it’s high time we create a few more large public defined-benefit plans in Canada and get rid of private DB plans altogether. We can staff these new plans with existing talent pool across public and private DB plans and bolster the retirement security of all Canadians. 

I realize my views aren’t going to sit well with right-wing nuts who constantly fret over “big government” or small business groups that oppose “payroll taxes” (even if pension contributions aren’t taxes!). But I’ve thought long and hard about pensions, have worked at two of Canada’s largest public pension funds, and have dedicated eight years of my life writing a blog on pensions and investments to educate many clueless Canadians on what goes on in markets and at big pensions and why a sound pension policy is so important.

I’ll share something else with you. My brutally honest comments on pensions haven’t won me many friends at Canada’s top ten. Sure, a few subscribe to my blog, but nobody is hiring me even though they know I have MS and I’m the best damn senior pension analyst who produces more in a week than most of their senior analysts do in a year (I’m not saying this to sound arrogant, it’s the brutal truth!).

What else? Despite having progressive multiple sclerosis (and doing well) and defending the rights of the poor and disabled on my blog, I’m actually a fiscal conservative at heart, believe in free markets, competition and responsible and accountable governments that spend wisely. My views on expanding the CPP have nothing to do with my politics even if I can make a solid economic case for it over the very long run.

In fact, a friend of mine, a die hard Conservative, had this to share with me in a recent email exchange where I told him rising inequality is very deflationary (we were talking about 5 books billionaires don’t want you to read):

There is no doubt that it is. Extreme inequality also breeds civil unrest and, as much as the extremely wealthy think they are untouchable, it is difficult to stop a lynch mob.

The “win at all costs” mentality is really shortsighted.

Same concept goes for the debate between DC and DB pensions. In the long term, DC pensions transfer retirement risk to the government because if people do not save enough, social systems will need to step in and make up the difference.

Now, if my friend who is a die hard Conservative (who like me, thinks Harper bungled our economy up!) gets it, I’m shocked that many Liberal and NDP politicians still don’t get it.

As such, I applaud Premiere Kathleen Wynne and her team for going it alone and introducing a new pension plan that will bolster the retirement security of all Ontarians. The rest of Canada’s leaders should stop dragging their feet on enhancing the CPP and follow Ontario’s lead and introduce real change to Canada’s pension plan (thus far, Justin Trudeau’s Liberals have failed to impress me with their asinine, populist pension gaffes).

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.

Anna Kitanaka and Shigeki Nozawa of Bloomberg report, Japan’s GPIF Debates 3% Stock Cap in Push for In-House Investing (h/t: Pension360):

The world’s biggest pension fund signaled a willingness to cap direct holdings at 3 percent of a company’s stock as it seeks freedom to invest in equities itself rather than hiring asset managers.

Japan’s $1.2 trillion Government Pension Investment Fund currently tells external fund managers to hold less than 5 percent of a company, Hiromichi Mizuno, chief investment officer for the fund, said at a health ministry pension panel on Tuesday. Should GPIF begin direct investments in stocks, a 3 percent limit on holdings of each company should be considered, Mizuno said, without explaining why.

The fund has undergone unprecedented changes since 2013, paring its bond allocation to make way for more equities and a foray into alternative investments. GPIF’s overseers at Japan’s health ministry now want to improve the fund’s governance by creating a board of directors, and are debating whether laws should be changed to allow the fund to invest in stocks directly.

“I’m frequently meeting the CIOs of global pension funds, and when I tell them that most of our investments are outsourced and that only some passive domestic bond investments are in-house, they look amazed, and I’m sick of seeing it,” Mizuno said. “From a global standpoint, GPIF’s investment is behind the curve.”

The government panel is likely to meet about three more times to discuss changes to the law determining what GPIF assets can buy directly. The fund’s own staff managed 867.3 billion yen ($7.4 billion) of active domestic bond investments and 31.4 trillion yen in passive Japanese debt holdings at the end of March.

Debate, Law

When the panel met earlier this month, the health ministry proposed establishing a 10-person committee as it moves closer to completing the long-awaited governance revamp. If the panel agree GPIF should begin in-house stock investments, the health ministry will draft a bill along with the governance proposal and submit it to the Diet, which runs through mid-June.

By investing directly in equities, GPIF would gain access to more market information and reduce the fees it pays external managers, according to Mizuno. Under the current law, the fund is also unable to invest in derivatives to hedge investments, and this should also be reviewed, he said.

GPIF’s average annual payout in fees to domestic stock managers over the past three years was about 6 billion yen, it said.

Hiromichi Mizuno is obviously a bright guy who is responsible for a mammoth, political and arcane global pension giant that desperately needs to revamp its governance, investment policy and the way it invests in public and private markets.

I recently covered why Japan’s pension whale got harpooned in Q3 2015 as global stocks sold off and how it’s looking to diversify into infrastructure. Mizuno has his work cut out for him and I suggest he takes a trip to Toronto to meet up with Ontario Teachers’ new CIO, Bjarne Graven Larsen, to discuss his investment strategy and the approach he wants to take.

And I don’t blame Mizuno for being sick of outsourcing investments and think it makes absolutely no sense whatsoever to pay fees for things that can easily be done in-house at a fraction of the cost. Canada’s large pension funds figured this out a long time ago and now they manage a huge portion of their assets in-house (some more than others).

What other advice do I have for Mr. Mizuno? Beware of hedge funds and private equity funds looking for a nice handout from GPIF so they can gather ever more assets and charge you huge fees. If you decide to invest in hedge funds or private equity funds, make sure you get the right alignment of interests and use your giant size to squeeze them hard on fees.

Trust me, they will bend over backwards for you but before you invest in external managers, make sure you think very carefully of what you want to outsource and what you want to bring in-house.

But I have to tell you,  I got very nervous when I read a Bloomberg article from last October, World’s Biggest Pension Fund Is Moving Into Junk and Emerging Bonds. Apart from the terrible timing, GPIF is going to be doling out huge fees to these external active and passive bond investors, many of which will underperform in this environment, and those fees can be used to hire people to manage these investments in-house (at a fraction of the cost).

The problem for GPIF is it’s too big, too slow and too political. External managers around the world are all salivating at the prospect of milking it dry. It desperately needs to reform its governance which it’s finally slowly doing.

Another problem for Mr. Mizuno is my Outlook 2016 on the global deflation tsunami. I suggest he and everyone else paying huge fees to external managers read it very carefully. I don’t envy any CIO at a large pension or sovereign wealth fund in this environment but if Mr. Mizuno is looking for help, I can provide him with four or five names of people in Canada with great experience that can help him structure his investment approach so he can better weather the storm ahead (just contact me at LKolivakis@gmail.com).

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.

Barbara Shecter of the National Post reports, Ontario Teachers’ Pension Plan finds new chief investment officer in Denmark:

The Ontario Teachers’ Pension Plan has appointed a new chief investment officer to replace longtime CIO Neil Petroff, who retired in June.

Bjarne Graven Larsen, who will also serve as executive vice-president, takes the role Feb. 1, and will report to chief executive Ron Mock.

Graven Larsen is a former CIO and executive board member of Denmark’s largest pension plan, ATP, which is the fourth largest pension in Europe.

Most recently, however, he was chief financial officer of Novo A/S in Copenhagen, and before that he led the successful turnaround of Denmark’s sixth largest bank, FIH Erhvervsbank A/S, which was acquired by an ATP-led Danish consortium.

“With his investment expertise, global experience, forward thinking on risk management, and importantly, hands-on work within a total return framework, Bjarne is uniquely positioned to be our Chief Investment Officer,” Mock said in a statement Monday.

“He has the experience and vision to lead our world-class investment team into our next generation of global growth.”

Graven Larsen will lead Teachers’ senior investment leadership team, which was recently restructured “to reflect the evolving global pension investment environment,” the pension plan said.

Divisions include infrastructure and natural resources, public equities, capital markets, portfolio construction, emerging markets, Asia-Pacific, real estate and investment operations.

Graven Larsen, who is also former managing director of Denmark’s largest mortgage bank and a former monetary policy director at Denmark’s central bank, said he has “admired the innovative work and success of Ontario Teachers’ for many years.”

Jennifer Paterson of Benefits Canada also reports, Ontario Teachers’ appoints new CIO:

The Ontario Teachers’ Pension Plan has appointed Bjarne Graven Larsen as executive vice president and chief investment officer (CIO), effective February 1, 2016.

Graven Larsen is the former CIO and executive board member of ATP, Denmark’s largest pension plan and the fourth largest in Europe. He was most recently the chief financial officer at Novo A/S in Copenhagen. Between these two engagements he led the successful turnaround of Denmark’s sixth largest bank, FIH Erhvervsbank A/S, which was acquired by an ATP-led Danish consortium.

Graven Larsen will head up Ontario Teachers’ senior investment leadership team, which was recently restructured to reflect the evolving global pension investment environment.

“With his investment expertise, global experience, forward thinking on risk management, and importantly, hands-on work within a total return framework, Bjarne is uniquely positioned to be our chief investment officer,” said CEO Ron Mock. “He has the experience and vision to lead our world-class investment team into our next generation of global growth.”

“I have admired the innovative work and success of Ontario Teachers’ for many years,” said Graven Larsen. “I consider this position to be a career opportunity of a lifetime and I look forward to learning from the outstanding team here and sharing my experiences with them as we work together to deliver members’ pensions.”

Lastly, Reuters also reports, Ontario Teachers appoints Danish investment veteran as CIO:

The Ontario Teachers’ Pension Plan (Teachers’), one of Canada’s biggest investors, has appointed veteran Danish investment professional Bjarne Graven Larsen as its new chief investment officer (CIO) and executive vice president.

Graven Larsen, 52, is a former CIO and executive board member of ATP, Denmark’s biggest pension plan and the fourth largest in Europe. He was most recently chief financial officer at holding company Novo A/S, majority shareholder in Danish insulin maker Novo Nordisk.

Teachers’, which is Canada’s third biggest public pension fund, said on Monday that Graven Larsen would report to its Chief Executive Ron Mock and be based in Toronto. He will take up the position on Feb. 1.

“With his investment expertise, global experience, forward thinking on risk management and, importantly, hands-on work within a total return framework, Bjarne is uniquely positioned to be our chief investment officer,” Mock said in a statement.

Teachers’ and peers like the Canada Pension Plan Investment Board and Caisse de dépôt et placement du Québec have been among the world’s most active dealmakers in recent years, with major bets on real estate, natural resources and infrastructure.

Teachers’ managed net assets worth 154.5 billion Canadian dollars ($109 billion) at the end of 2014.

Graven Larsen will succeed Neil Petroff, who retired in June.

Ontario Teachers’ put out a press release here which basically states a lot of what is stated above.

Bjarne Graven Larsen is a huge recruit for Ontario Teachers. He has unbelievable experience as a former CIO of ATP and as a monetary policy director at Denmark’s central bank.

He also has big shoes to fill as Neil Petroff who retired last year was unquestionably a great CIO. And before Neil Petroff, there was Bob Bertram, another great CIO who built Teachers’ investment divisions along with Claude Lamoureux.

In my last conversation with Ron Mock before Christmas, he told me they were on the verge of hiring a CIO. And they hired a veteran who was a CIO at ATP, arguably one of the best pension plans in the world (on par with OTPP and HOOPP, if not better, and highly regarded by everyone including Jim Keohane, CEO of HOOPP, who told me he reformed HOOPP’s asset-liability approach based on the one ATP is using).

This is a critical position and Ron Mock took his time recruiting someone who really knows his stuff. And I’m sure a lot of people within and outside Teachers’ wanted this position which not only has big perks like huge compensation, but is also responsible for overseeing private and public investments as well as hedge funds and the risk that is allocated between them.

The fact that Ron Mock, who has tremendous investment experience under his belt, hired someone with this experience tells me he wanted a veteran who is able to navigate what increasingly looks like a very difficult investment landscape. Ron also wanted someone who will command the same respect Neil Petroff had and someone who offers fresh eyes and views to the way Teachers’ invests across public and private markets.

Graven Larsen will now be responsible for a great investment team which includes Jane Rowe, John Sullivan, Michael Wissell, Wayne Kozun, Ken Manget, and Lee Sienna, just to name a few.

There is no doubt in my mind that Graven Larsen will be another great CIO for Ontario Teachers’ during what will be a very difficult period marked by global deflation and lower returns.

When I met Kevin Uebelein, AIMCo’s chief executive officer, here in Montreal in late November, he asked me my thoughts on separating the CEO and CIO function at public pension funds. He appointed Dale MacMaster as the chief investment officer responsible for private and public investments.

I told him flat out: “I don’t care if it’s Ron Mock, Mark Wiseman, Leo de Bever, Gordon Fyfe or you, I do not think any CEO of a major Canadian pension fund can successfully carry both CEO and CIO hats. And if you’re going to hire a CIO, make sure he or she is responsible for both private and public markets.”

Michael Sabia at the Caisse who has the least investment experience hired Roland Lescure as CIO but the latter is only in charge of public markets. Neil Petroff once told me on the phone that to be an effective CIO, you need to allocate risk across public and private markets and he was absolutely right.

I know people have different views on this matter. Gordon Fyfe once told me he likes being CEO and CIO but as I explained to him during our breakfast right before I was wrongfully dismissed from PSP in October 2006, “it’s stupid and leaves you exposed to all sorts of risks you have no idea of” (boy, that was an understatement).

Let me be crystal clear. I can’t take any CEO of any major public pension fund seriously if they don’t appoint an experienced CIO to oversee and allocate risk across public and private markets. I think it’s highly irresponsible not to do so.

Again, Ron Mock has more direct investment experience than all other CEOs at Canada’s Top Ten (apart from Jim Keohane who is equally investment savvy) and he still chose to find an exceptionally talented CIO to help him manage investment risks. That speaks volumes to Ron’s judgment and lack of investment ego.

I’m sure Gordon Fyfe is reading this and saying “everything worked well at PSP without a dedicated CIO” in charge of public and private markets. He is wrong, he was always wrong on this front. Period.

But let me not be too critical of Gordon, after all, I hear PSP is a total mess now after the departure of Bruno Guilmette, the head of Infrastructure and Jim Pittman, a senior VP of Private Equity. Neil Cunningham is still there as the head of Real Estate and Daniel Garant is CIO (of what exactly? public markets??) but the senior managers Gordon put in place have been forced out or are leaving on their own.

My sources tell me the culture at PSP is going from bad to terrible with a lot of infighting between and within investment teams and no real direction on where they’re heading. You can criticize Gordon Fyfe on many fronts, and God knows I have done so on my blog, but at least he kept cohesion in his senior ranks and kept a balance between anglophones and francophones (even if it was a boys club full of egos).

I don’t know what exactly André Bourbonnais is trying to accomplish but I suggest he takes me up on my lunch invitation and I will give it to him straight (have nothing to lose!). He needs to do a hell of a lot more to improve the culture at PSP and this means getting rid of some cockroaches at that place who are nothing more than backstabbing egomaniacs. I can say the same thing to Michael Sabia over at the Caisse. He too needs to shake things up in the senior ranks (and I’m not referring to Roland Lescure).

When I hear stories at all of Canada’s Top Ten on some power-hungry weasels backstabbing people, it makes my blood boil, especially since it’s typically these idiots that are responsible for poor performance and god awful culture at these big shops.

As far as Ontario Teachers’, I’m sure it has its share of backstabbing egomaniacs but that shit won’t fly with a guy like Ron Mock at the helm. And I doubt it will with a veteran outsider from Denmark like Bjarne Graven Larsen who is serious and focused on risk-adjusted returns.

The first article above states Teachers’ senior investment leadership team was recently restructured “to reflect the evolving global pension investment environment.” I have no details if this means some people were let go for poor performance or other reasons but knowing Ron, you better be focused on your job and be a team player or you’re out. It’s that simple.

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

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

Barry Critchley of the National Post reports, Pension solvency dipped slightly in 2015, Mercer report shows:

The poor equity market performance, the continued decline in long-term bond yields and new mortality tables that reflect increased life expectancy, have all combined to cause a slight decline in the funded status of the country’s pension plans in 2015. The only good news: the funded status of the 611 plans covered in the Mercer study was improved by the positive impact of the decline in the Canadian dollar on foreign asset returns.

That’s the two key conclusions contained in a report by Mercer, a pension consulting company that was released Tuesday. At the end of 2015, Mercer said that the “median solvency ratio of the pension plans” of its clients stood at 85 per cent, down from 88 per cent one year earlier.

A similar result applied when an alternative measure, The Mercer Pension Health Index, which represents the solvency ratio of a hypothetical plan, was used. That measure finished the year at 93 per cent down from 95 per cent at the end of 2014. In parts of 2014 and 2015 the same measure – that shows the ratio of assets to liabilities for a model pension plan – posted a solvency ratio of more than 100 per cent.

According to its analysis, a typical balanced pension portfolio would have returned 2.9 per cent during the fourth quarter and 5.3 per cent for 2015.

“There was considerable variability in the financial performance of pension plans in 2015,” said Manuel Monteiro, leader of Mercer’s Financial Strategy Group. “Pension plans with significant Canadian equity holdings and those that hedge their foreign currency exposure experienced larger than average declines in their solvency ratio.”

In its report, Mercer said that with “weak economic conditions continuing to persist and central bankers discussing the possibility of negative interest rates, plan sponsors are coming to the conclusion that they cannot count on higher interest rates to erase their lingering pension deficits.”

Mercer noted one possible solution: pension plans need to better understand the risks that they face, and establish a robust risk management strategy to manage them.

The report noted that at least four provincial governments have recognized the challenging economic conditions and are moving towards lessening the funding burden for defined benefit pension plan sponsors. Mercer said that Quebec is making the most significant changes “by moving away from a solvency-based funding target starting in 2016,” while Alberta and British Columbia have also introduced helpful changes in the past few years.

As for Ontario, Mercer said that it has recently announced plans to develop a set of reforms that would “focus on plan sustainability, affordability and benefit security while balancing the interests of pension stakeholders.”

I agree with the findings of Mercer’s report. First and foremost, plan sponsors cannot count on higher interest rates to erase lingering pension deficits. This is especially true now that the global deflation tsunami is upon us and negative rates are right around the corner in Canada and possibly the U.S. if things get really bad.

Importantly, deflation will decimate all pensions because it will drive rates around the world to negative territory and bring asset values to new lows, including those of  illiquid alternative assets where pensions have increased their exposure to take on more risk in order to achieve their objective.

But when it comes to pension deficits, it’s rates that matter most because the duration of liabilities is a lot bigger than the duration of assets so a decline in rates disproportionately hurts pensions a lot more than a decline in asset values.

Second, the Mercer report notes the following:

“There was considerable variability in the financial performance of pension plans in 2015,” said Manuel Monteiro, leader of Mercer’s Financial Strategy Group. “Pension plans with significant Canadian equity holdings and those that hedge their foreign currency exposure experienced larger than average declines in their solvency ratio.”

In terms of Canadian equity exposure, the typical Canadian DB plans aren’t big enough to be as globally diversified as Canada’s Top Ten across public and private markets, which explains why they underperform them over a very long period.

As far as currency risk, when I covered CPPIB’s record results in FY 2015, I noted that the value of its investments got a $7.8-billion boost during that fiscal year from a decline in the Canadian dollar against certain currencies, including the U.S. dollar and U.K. pound. I also noted that even though PSP had solid results in FY 2015, it partially hedges (50% hedged) its foreign currency exposure, which is one reason why it didn’t perform as well as CPPIB (they have the same fiscal year period and PSP is now reviewing its currency hedging policy).

I remember a conversation I had with Jim Keohane, CEO of HOOPP, on currency risk and hedging policy where he told me “from a strict asset-liability standpoint, it’s better not to hedge F/X risk.”

If you ask me, currency hedging is extremely important in a deflationary world, but you need to hire smart people who know how to make money in currencies and who can guide you on future trends in currencies (I have never heard of a star currency trader at Canada’s Top Ten! There were one year wonders but nobody who can consistently make money trading currencies).

It’s worth noting that I told my readers about Canada’s perfect storm back in January 2013 and continued to warn everyone to short the loonie in December of that year because I saw oil prices going much lower. Given my Outlook 2016, I see no reason to change my views on Canada, oil or the loonie (I see it going to 66 cents US and settling around 66-68 cents).

It’s also worth noting that if global deflation risks rise, investors will seek refuge in good old U.S. bonds, which will propel the mighty greenback even higher. King Dollar is already off to a great start in 2016 but this is a double-edged sword because as the USD rises, corporate profits decline and so do import prices, reinforcing deflationary headwinds in the US. and around the world.

This brings me to another topic the Mercer report discusses, namely, the importance of risk management. Pensions have long-dated liabilities and a much longer investment horizon than mutual funds, hedge funds and private equity funds. So when you see Canada’s big pensions betting on energy, they’re not looking to make a quick buck.

But there are structural factors at work here that present a different set of risks to pensions altogether. In a deflationary world, risk management is crucial and I’m not just talking about VaR and quantitative analysis, you also need to have great thinkers who are able to qualitatively assess important structural and cyclical factors that are shaping the investment landscape in the short-run and long-run (again, read my Outlook 2016 for more insights).

Lastly, a small comment on “Quebec moving away from a solvency-based funding target starting in 2016.” I’m very uncomfortable with this and think it’s another way to mask Quebec’s serious debt crisis. When it comes to solvency-based funding, I prefer if we all stop the charade and go Dutch on pensions. It will be tough and it will hurt, but I prefer living in reality than clinging to a rate-of-return fantasy or moving away from a solvency-based funding target.

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

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

Leah Schnurr and Randall Palmer of Reuters report, Ministers eye no action on Canada Pension Plan premium:

Canada’s federal and provincial financial ministers are considering not raising premiums for the Canada Pension Plan (CPP), federal Liberal Finance Minister Bill Morneau said on Monday, despite a Liberal campaign promise to enhance the plan.

The ministers will be considering a range of options over the coming year “from doing nothing because of the economy to more significant changes,” Morneau told reporters after meeting with his provincial counterparts.

The Liberals, elected in October, campaigned on expanding the CPP, but the Canadian Federation of Independent Business warned that a premium increase would boost unemployment, because it does not take profit into account.

The CPP is comparable to the U.S. Social Security program.

The minister said the province of Ontario, which has talked about starting an Ontario pension plan because people are not saving enough, would continue with its process. But he said the Canadian government’s clear hope is that there can be something done nationally.

The seniors’ lobby group CARP Canada criticized the ministers for failing to act on CPP.

CARP members … have given a clear political mandate in two major elections on what they want – specifically a CPP increase. What part of that declaration was unclear to the finance ministers?” asked CARP Executive Vice President Susan Eng in a release.

Bank of Canada Governor Stephen Poloz also briefed the ministers and presented a view of cautious optimism about the country’s economic road ahead, Morneau said.

Andy Blatchford of the Canadian Press also reports, Canada’s finance ministers agree to revisit pension reform talks in the new year:

A federal-provincial gathering of finance ministers reached rare consensus Monday on the polarizing subject of Canada Pension Plan reform — they agreed to keep debating it.

Federal Finance Minister Bill Morneau emerged from two days of discussions with his provincial and territorial counterparts to explain that the group will reconvene midway through 2016 to continue their talks about CPP enhancement.

“Our goal is that in a year from now, we’ll have more to talk to Canadians about, but we did not get to conclusion to what exactly we would be proposing,” Morneau told a news conference in Ottawa.

“We did not commit to any end game, nor in fact was that our objective today. Our objective today was to begin a process to review the potential to move forward.”

Morneau aims to eventually get some consensus on enhancing the Canada Pension Plan, a goal outlined in the new Liberal government’s election platform. The party has not released specifics on what changes could be made to the plan.

Changing the CPP would require support from seven of the 10 provinces representing two-thirds of the country’s population as well as a green light from Ottawa.

But it’s unclear how much support the Liberals will attract when it comes to CPP enhancement, even though the provinces agreed Monday to continue discussing the subject in the new year.

Ontario supports CPP expansion, while other big provinces like Quebec and British Columbia remain unconvinced. Quebec already has a public pension plan and B.C. has concerns about the fragile economy.

Saskatchewan, meanwhile, opposes beefing up the CPP.

“We’re happy with respect to the fact there’s no immediate changes to CPP — we’ve been advocating that,” Saskatchewan Finance Minister Kevin Doherty said Monday after the meetings.

Doherty has voiced his concerns about the negative impacts from the plunge in oil prices on his province’s bottom line.

The economic realities of the country in 12 months will dictate how the provinces proceed with the CPP, he added.

“We’ve agreed on a path forward with respect to coming back a year from now to talk about potential options — including not doing anything,” said Doherty, who noted fellow oil producers in Alberta and Newfoundland and Labrador are also facing intense fiscal pressure.

Quebec Finance Minister Carlos Leitao said, at the other end of the spectrum, the group will also look at the possibility of doubling the size public pensions — like Ontario plans to do. Leitao said he’s wary of going that far, especially since Quebec recently increased its payroll premiums just to maintain the current benefits.

“Whatever happens we have to be very mindful of a potential fiscal shock,” he said. “We want to avoid that.”

Ontario Finance Minister Charles Sousa said he was encouraged the provinces are willing to discuss enhancing the CPP, particularly since he felt some had been “reluctant” and were “pushing back” on the issue.

In the meantime, Sousa will proceed with his province’s own program, the Ontario Retirement Pension Plan, which essentially mirrors the CPP for anyone who doesn’t already have a workplace pension. He said it’s necessary for retirement security.

“We’re going down both tracks because the timing is essential,” said Sousa, who added the province has “off ramps” if changes are made to the CPP.

And lastly, Thomas Walkom of the Toronto Star wrote a stinging comment, Trudeau government wimps out on Canada Pension Plan reform:

Since coming to power, Prime Minister Justin Trudeau’s new Liberal government has taken strikingly bold positions.

It has promised a radically different relationship with Canada’s first nations. It has thumbed its nose at balanced-budget orthodoxy.

It has vowed to fight climate change without nettling the provinces and pledged to fight the Islamic State without engaging in combat.

It has defied both the polls and its critics to welcome thousands of Syrian refugees.

But when it comes to their campaign promise to beef up the Canada Pension Plan, the Trudeau Liberals have wimped out.

They are not doing anything. They are not even bothering to make empty promises about doing anything.

After hosting a federal-provincial meeting this week that dealt with the CPP, all Finance Minister Bill Morneau could provide was a promise to study the issue further and meet again.

It was hardly an example of the federal leadership that Trudeau had promised during the election campaign.

Introduced in 1965, the Canada Pension Plan is a forced savings scheme that serves as the backbone of the country’s retirement system.

Technically, employers and employees split the costs of the CPP. But in the long run, workers bear most of the burden — in the form of wages that are lower than they otherwise would have been.

What these workers get in return is a guaranteed annual retirement pension tied to the rate of inflation.

It’s not a big pension. In 2015, the maximum annual payout was only $12,780. But the idea behind the CPP was that this — combined with workplace pensions and private savings — would provide for a comfortable retirement.

Since then, workplace pension plans have become a rarity as employers strive to cut costs. Moreover, individuals aren’t saving enough on their own.

All of this has put more pressure on Canada’s federal and provincial governments to boost the CPP.

At any given time, most governments think the CPP should be enriched. Even Stephen Harper’s Conservatives were, at one point, committed to increasing CPP premiums and benefits.

Governments reckon, correctly, that if people aren’t required to save enough during their working years, they are more likely to become a burden on public finances when retired.

But small-business employers hate having to pay any kind of payroll tax. Back in 2010, that was enough to turn the Conservative federal government away from reform.

As well, provincial governments get nervous about raising payroll taxes — particularly during the run-up to elections.

At one point, both Quebec and Alberta were opposed to CPP reform — which was enough to kill the idea (amendments require the agreement of Ottawa and seven provinces representing two-thirds of Canada’s population).

By 2013, enough provinces were on side to get something done. But the Harper Conservatives remained opposed.

That’s when Ontario Premier Kathleen Wynne announced plans to set up a supplementary provincial pension scheme in her province. She said she’d scrap those plans if a new government in Ottawa could be convinced to expand the CPP proper.

Her federal Liberal cousins promised to be such a government.

Last June, they issued a statement under the name of then seniors critic John McCallum arguing that the CPP “simply isn’t enough,” and that the Liberals would increase benefits gradually to improve it.

“Clearly, the time is right,” said McCallum, now immigration minister. “All that is missing is federal leadership.”

Alas, that federal leadership is still missing.

Currently, only Saskatchewan and British Columbia seem adamantly opposed to boosting CPP premiums and benefits. If Ottawa wanted to do something, enough other provinces are on side to satisfy the requirements of law.

As well, Morneau could easily mollify those worried about increasing payroll taxes during hard times.

As it is, the law requires a minimum three-year waiting period before implementing any legislated reforms to the CPP. This waiting period could be longer.

In a book called The Real Retirement that Morneau co-authored in 2013, the millionaire finance minister writes that there is no retirement crisis in Canada, that the elderly may work past 65 if their pensions are skimpy and that most seniors can live perfectly well on 50 per cent of their pre-retirement income.

This may explain his laissez faire approach to the CPP. But it isn’t exactly what his party and leader campaigned on.

So here we are, another Christmas goes by and our finance ministers are dithering, “debating” and worse, backtracking on enhancing the CPP (it was three years ago when we debated going slow on enhancing CPP!).

Let me enlighten our Canadian politicians. Canada is screwed, period. I’ve been warning of Canada’s perfect storm since January 2013 and have been short Canada for a long time. Things aren’t going to get better, they’re going to get a whole lot worse. There is no end to the deflation supercycle and I foresee negative interest rates and other unconventional measures in the not too distant future.

But the country’s dire economic situation shouldn’t be a factor against enhancing the CPP now. In fact, quite the opposite, I believe the coming economic crisis is one more reason to start the process and get on with it because as I keep harping in this blog, enhancing the CPP is smart economic policy over the very long run.

I just finished blasting the Trudeau Liberals for the biggest pension gaffe of 2015. Their asinine policy of rolling back the TFSA limit is a dumb populist move to make them look as if they’re going after the rich and helping the poor (in reality, this policy does the opposite).

I want you to all to once again read what a friend of mine sent me over the weekend on negative rates coming to Canada after he read the unintended consequences of negative interest rates in Switzerland:

“I found this article fascinating. Central Banks around the world have been experimenting with the economies of the G20 countries since the crisis. They are doing shit that they have never done before and it is clear that the world has become their Petri dish.

All of this comes from one fundamental issue – a demographic bubble of baby boomers going through the system. The world (including Canada) is completely unprepared for this new economic reality.

When push comes to shove, it is this demographic bubble that will drive the Canadian economy over the next 40 years and, unfortunately, I do not see Canadian policy preparing for this at all.

For example, the country should have increased immigration in 1990s but it did not because the unions stopped it. Instead, they invited high net worth individual to move to Canada (i.e. we want your money without you stealing our jobs). The unintended consequence of this policy was that these “high net worth individuals” came in droves, most of them Chinese and Middle Eastern, and pushed real estate prices skyward in two of our major cities to the point where no one in their 20s can buy a home.

So expect more of the same, Justin is not a visionary. He is simply a populist Prime Minister (no different than Greek PM Tsipras). He got voted in because everybody hated the other guy. He is now implementing tax policy that completely ignores reality but will secure his populist promises (tax the rich – give to the poor). When the next election comes, he will be faced with an opponent who will try to one-up him and the race to bottom will continue.

My reaction to Justin’s tax policy. At a 53% marginal rate, I have a whole bunch of tax advisors looking at what to do to minimize it. I am sure that they will find a loophole than hasn’t been plugged yet. If they don’t, I will just adapt and perhaps leave Canada when I retire with my future tax dollars in hand.”

On bolstering the CPP, my friend sent me this:

“It’s not about left wing or right wing politics. Enhancing the CPP is just a smart move. You’re right, companies are unloading retirement risk on to the state and unless something is done, this demographic nightmare I’m talking about will explode in Canada and we’ll see a huge rise in social welfare costs.”

I suggest our politicians read all about the benefits of defined-benefit plans (they should know all about retiring in EU style) and think long and hard about my friend’s comments on Canada’s demographic time bomb and how we’re ill-prepared for it.

Then I suggest our politicians get to work and introduce real change to Canada’s pension plan. Don’t wait till the economy gets better, if you do you’ll never enhance the CPP. Start thinking long-term and start making decisions which will benefit the country over the very long run. If you do, I promise you Canada will be on much more solid footing the next time we get hit by a global economic and financial crisis.
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