Author: Leo Kolivakis

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

Watching that awkward moment at the end of Miss Universe 2015 on Sunday evening got me thinking about the biggest pension gaffe of the year. Earlier this month, Adam Mayers of the Toronto Star reported, $10,000 TFSA limit gone to help fund tax cut:

Friday’s Throne Speech didn’t mention Tax Free Savings Accounts (TFSAs), but federal Finance Minister Bill Morneau didn’t leave us in suspense for long.

On Monday afternoon, as part of measures to help pay for a middle-class tax cut, Morneau — cheerfully and in a brisk boardroom manner — said the $10,000 annual limit introduced by Conservative Finance Minister Joe Oliver is gone.

The good news is that the $10,000 amount stands for this year and goes into your lifetime total. But as of Jan. 1, it’s back to the future for this popular savings vehicle, dubbed the Totally Fantastic Savings Account by Wealthy Barber David Chilton. It reverts to $5,500 a year.

The Liberals argued during the election that the higher limit only benefits the rich, but I doubt the rich care one way or another about TFSAs. When you have millions to save, the $41,000 in room we all have after seven years isn’t meaningful. The rich have plenty of other ways to take care of themselves.

“It comes down to how you define ‘wealthy’ — which nobody does when making such statements,” says Dan Hallett, a financial planner and vice president of Oakville’s HighView Financial Group.

“And that’s a critical point. Certainly, those who maximize the TFSA contribution limits are more affluent than those that don’t — on average. But that doesn’t mean a higher limit only benefits the wealthy.”

For middle-income Canadians, older Canadians heading into retirement and those already there, the higher limit — and any portion of it they could use — would have been helpful. Savings rates are at record lows, so encouragement to save would seem to be a good thing.

Morneau says the promised middle-class tax cut will average $330 a year for single earners and $540 per couple. He has to pay for that, and imposing a higher tax on those making over $200,000 won’t do the job alone. Rolling back the TFSA is a way to narrow the gap.

Here, the new government is out of touch with the people who elected it. An Angus Reid poll in the middle of the election campaign found that 67 per cent of Canadians opposed rolling back the TFSA limit. By party, NDP supporters liked the increase more than Liberals — 63 per cent vs. 62 per cent — with Conservative supporters highest at 78 per cent.

A study by the Canadian Association for Retired People (CARP) this spring found the same thing. Two-thirds of CARP members supported the extra saving room.

The TFSA has been of particular benefit to older Canadians. It has only been around for seven years and so is a new way to shelter a little more money in retirement. Those 55 and older hold almost half of all TFSA accounts, according to the CRA.

Strict rules force you to convert your RRSP into a Registered Retirement Income Fund (RRIF) when you turn 71. That’s because the government wants the taxes foregone when you put the money into your RRSP and got a refund.

But some older Canadians don’t need all that money to live, on so they use a TFSA to let it grow tax-free.

So here’s where we are:

• The $10,000 TFSA limit introduced this spring stands for the year. If you don’t contribute the full amount, it becomes part of your lifetime limit.
• As of Jan.1, the limit reverts to $5,500 per year, which will be indexed, which the $10,000 wasn’t.
• Morneau said indexing will allow the TFSA to retain its real value. It is set to rise in $500 increments whenever inflation erodes the value by $250.

At a 2 per cent rate of inflation, that bump should come every three years or so, since the $5,500 is worth $110 less each year. The only increase so far was in 2013. It’s unclear when the next one will be.

In the end, the new government had to make choices about how to fund its ambitious agenda. A higher TFSA, cast as a perk for the rich, was an easy choice. But what the middle class is getting in a tax cut isn’t as large as what it’s losing in a higher TFSA limit.

But some people think the TFSA rollback while historic isn’t a big deal. Jennifer Robson, an Assistant Professor at Carleton University, wrote a comment for MacLean’s, The Liberal changes to TFSA contributions were actually historic:

The new government wanted to make its first policy move in the House substantive and symbolic, but it also managed to make it historic. On Monday, the government gave notice that it will introduce a motion (a Ways and Means motion, to be precise) to cut the second federal income tax rate (applied to taxable income between $45,283 and $90,563) and create a new tax bracket applied to taxable incomes of $200,000 or more.

It’s true that this is the first time since 2001 that the basic architecture of federal tax rates has been renovated in a big way. It’s also true that if your taxable income is $45,000 or less, then this tax cut isn’t for you. Finally, yes, it’s true that a person with a taxable income of $120,000 stands to save more ($783) on their federal tax bill than a person with a taxable income of $80,000 ($582).

No, no, that’s not the historic part in my view. Look, 2001 wasn’t that long ago and I’ve written loads before about tax credits and public programs that benefit the better-off.

I’m talking about Clause 9 of the government’s motion that scales back the annual contribution room available to adults who open a Tax-Free Savings Account (TFSA) from the current $10,000 limit introduced for 2015 to the $5,500 annual limit that had done just fine before an election loomed on the horizon. Don’t forget, unused contribution room rolls over each year and there is still no lifetime cap on contributions. This means that between exemptions for home equity, lifetime capital gains rules and the TFSA, it won’t be long before most households in Canada are able to shelter virtually all of their assets from income taxation.

Back before the election, federal officials were at pains to explain that the increase in the TFSA room was well, really, really necessary, because, you see, over a quarter-million low-income Canadians (making less than $20,000 a year) had managed to max out their TFSA room under the $5,500 limit. ”Don’t you understand that these low-income people are just trying to put away some savings? Why do you hate people who are just… frugal?” With the national household savings rate stumbling along at about four per cent these days, shouldn’t we reward those who were saving roughly half of their modest annual incomes?

Well, no, and here’s why: From what I can see, the phenomenon that was offered as”‘the problem” to be fixed is likely temporary.

Looking at data from the 2012 Survey of Financial Security (Statistics Canada) when the TFSA was four years old (offering $20,000 of accumulated room for every adult in Canada) is instructive here:

– Singles and families aged 65 and older are far more likely to own a TFSA than their working-age counterparts (38-47 per cent versus 25-34 per cent respectively).

– Median TFSA balances amongst all working-age singles (under age 65) were just $5,000 (or 25 per cent of that limit) but median balances for singles aged 65+ were $15,000 (75 per cent of the limit). That’s the median, meaning that half of single seniors had TFSA balances between 76 per cent and 100 per cent of their allowable limit.

– Among couples and families, the age-related gap in median TFSA balances persists: $10,000 at the median for working-age households and $20,000 for those aged 65 or older.

– Within the working age population, there are also important age-related differences. Median TFSA values for couples or families aged 35-44 suggest median deposits of about $1,000 per year. But closer to retirement (age 55-64), household TFSA balances suggest median deposits of a little more than $3,500 per year, still well below the old $5,500 limit.

Those older households are, in the vast majority of cases, unlikely to be saving “new” money. Instead, they may well be shifting assets from one source—maybe perhaps proceeds from the sale of a family house that is now too large for their needs; or maybe this is coming from taxable RRIF income that is being recycled into a different and non-taxable registered savings account. Recall that the TFSA doesn’t offer a deduction for (most) deposits, doesn’t create new tax liability on withdrawals and is exempt for the purpose of working out the key income-tested senior’s benefit, the Guaranteed Income Supplement (GIS). Seniors with $20,000 in total personal income have too much income to receive the GIS now, but they may worry about exhausting their savings and needing the GIS later on. In these cases, shifting assets into a TFSA just makes good financial sense.

But that’s not what the TFSA was supposed to be for.

When it was introduced in 2008, the late Jim Flaherty cheerfully called the TFSA “an RRSP for everything else in your life.” His budget communications documents that year offered examples of people saving for all kinds of short- and medium-term uses like vacations and “rainy days.” The literature dating back to at least a 1987 study by the Economic Council of Canada (of which, Liberals, please give thought to reviving that creature to complement the work of a beefed-up Parliamentary Budget Officer) saw tax-prepaid savings as a way to stimulate more saving and investment by giving households choices when RRSP incentives fail. The literature doesn’t seem to have anticipated asset-shifting uses among the already-retired.

Unless the TFSA undergoes more dramatic changes like a lifetime limit, future generations of seniors are unlikely to worry much about annual caps limiting their ability to shift assets around to gain the best tax and benefit treatment. A person aged 55 today will have nearly $100,000 in TFSA room by age 65. And while today’s seniors with low income but some savings may feel cheated by an accident of policy timing, there are many other ways to address some of their concerns—flexibility on RRIF withdrawals for example.

But I still haven’t given you the punchline, have I?

The TFSA is just one among five separate tax-preferred and registered savings instruments in Canada. The first was the RRSP, introduced in 1957. When Kenneth Carter recommended scaling back RRSP limits in his 1966 report on Canadian tax reform, he was summarily ignored. Instead, we have, through relentless incremental policy choices, grown a tax and transfer system that is schizophrenic in its treatment of savings—rewarding people who already have money for saving it but often penalizing small savers. In the last 58 years, there have been exactly zero reductions to annual contribution room to any of these instruments—that is, until now.

By scaling back annual TFSA limits, the new government can keep the flexibility that tax pre-paid accounts offer without encouraging as much asset-shifting among the already comfortable. Promoting economic growth is the stated motive behind this renovation to the income tax brackets. If the government is serious about making that growth inclusive, then removing regressive incentives is a good start at breaking a 58-year trend. But it’s just a start.

Jennifer Robson raises good points in her article but I think the Liberals’ policy to rollback TFSA contributions is the dumbest most populist gaffe the Trudeau government could have done and I explicitly warned against this when I discussed real change to Canada’s pension plan:

 There are other problems with the Liberals’ retirement policy. I disagree with their stance on limiting the amount in tax-free savings accounts (TFSAs) because while most Canadians aren’t saving enough, TFSAs help a lot of professionals and others with no pensions who do manage to save for retirement (of course, TFSAs are no substitute to enhancing the CPP!).

The point I’m trying to make here is that rolling back TFSA limits hurts a lot of hard working people who aren’t rich, they’re just trying to save as much money as possible for retirement because unlike the government bureaucrats that design these policies, they have no defined-benefit pension plan to rely on during their golden years.

And it’s not just hard working people with no pension getting hurt with this asinine TFSA rollback. Neil Mohindra, a public policy consultant based in Toronto wrote a comment for the National Post earlier this month, TFSA rollbacks will hurt the needy:

The debate over maintaining or rolling back the TFSA limit of $10,000 has centred on whether middle class Canadians or only the rich benefit from the higher limit. But a rollback will disproportionately affect middle and lower income Canadians with limited work histories in this country, including new immigrants and Canadians who have spent time as caregivers.

Take the following fictitious example. Jonathan, a welder by trade, immigrated to Canada in his mid-forties with $175,000 in savings. During the three years he needed to qualify for this profession in Canada, he supported himself with minimum wage jobs. Every year he places $10,000 of his savings into his TFSA, to obtain a reasonable standard of living in retirement.

In Jonathan’s case, retirement income and savings in Canada will be limited. His CPP income will be lower because of fewer qualifying years and he will have limited RRSP space and no accumulated TFSA space on arrival in Canada. He will qualify for Old Age Security because of a social security agreement between Canada and his home country that will allow Jonathan to meet the minimum eligibility criteria. Despite earning a good living as a welder, Jonathan could be at risk of having inadequate income in retirement.

Many face Jonathan’s predicament. In the five years ending 2014-2015, 1.3 million immigrants arrived in Canada, 23 per cent of them over age 40 with limited work histories in Canada. While not all immigrants have savings, many will have real assets like houses or pensions that can be converted to savings and brought to Canada. Maintaining the TFSA limit at $10,000 instead of rolling it back to $5,500 allows these new Canadians to convert more savings into tax sheltered investments, reducing any disadvantage they may have relative to other Canadians.

Returning emigrants, people who work in boom-bust industries, and anyone whose working life is disrupted by a physical or mental disability could also be at risk of inadequate retirement income. A very significant group of Canadians at risk are caregivers. Take Mary, a recently widowed 67-year-old who worked full time for five years before quitting to raise children and care for a disabled sister. She worked part-time later in life. She has a modest inheritance from her sister’s estate of $50,000, and a payout from her husband’s life insurance policy of $250,000. Accumulated TFSA space will allow her to earn investment income on these amounts, and she will make modest periodic withdrawals to supplement her retirement income.

Mary, what Statistics Canada would describe as a “sandwiched caregiver,” may be representative of a significant number of Canadians. A Statistics Canada article, based on 2012 data, noted 28 per cent of caregivers, or 2.2 million individuals were sandwiched between raising children and caregiving. The article also indicated that in 2012, 8.1 million individuals, or 28 per cent of Canadians aged 15 years and older, provided some care to a family member or friend with a long-term health condition, disability or aging needs.

In Mary’s case, it is not the annual TFSA limit that is important but the accumulated limit. In her scenario, Mary would not have anywhere near the accumulated space that she needs, since TFSAs were only introduced in 2009. It will actually take 27 years before individuals will have the accumulated space they need for this scenario even at $10,000 per year.

A Broadbent Institute report criticized higher TFSA limit for not necessarily incenting Canadians to save more, rather to shift taxable assets into TFSA accounts. Jonathan and Mary provide counter examples. Maintaining the higher TFSA limit can play a role in helping low and middle income Canadians with limited work history in Canada successfully meet retirement goals.

Nevertheless, it’s not all bad news. As provincial and territorial finance ministers gathered with their new federal counterpart in Ottawa on Sunday night to begin confronting the hard economic truths facing Canada, the good news is there seems to be enough provincial support to boost the CPP.

I can’t overemphasize how crucial it will be to bolster Canada’s retirement policy now more than ever. I’ve been warning of Canada’s perfect storm since January 2013 and think our country will experience a serious crisis in the next few years which will bring about negative interest rates and other unconventional monetary policy responses.

Importantly, this isn’t the time to rollback the TFSA contribution limit or to implement other populist policies “against the rich,” but it’s the time for the bureaucrats in Ottawa to finally get their heads out of their asses and closely examine all pension policies very carefully. Keep what works well and bolster what needs to be bolstered. 

And it’s not just the rollback in TFSA limit that irks me. The age limit on converting RRSPs to RRIFs should be pushed back for seniors who continue to work in their seventies (there’s a reason why they’re working so why should they get penalized?). Also, Ottawa needs to significantly improve the registered disability savings plan (RDSP) which Jim Flaherty started to help Canadians with disabilities and parents with disabled kids to save money for their needs (the program is excellent but there should be an option to have the money managed by CPPIB).

What else? Dominic Clermont, formerly of the Caisse and now back from working at Barra in London sent me this interesting comparison to pt things in perespective:

In the UK, taxpayers can invest in an ISA which is equivalent to our TFSA. The yearly contribution limit for the fiscal year 2015-2016 is £15,240 which at current exchange rate is about $31,600 – much higher than the $10,000 which the Liberals found too high.

Interest rates are so low (you can find savings accounts paying 0.75% interest…), it doesn’t make much sense to tax small investors on such small interest. The first £1,000 of interest income is now non-taxable – that is more than $2,000/year of tax free interest income outside of the ISA (TSFA).

The maximum contribution to a pension scheme (employer or private – equivalent to our RRSP) is also much higher in the IK: £40,000 per year or about $83,000.

In Canada and particularly in Quebec, taxing the rich is always popular. The are such a minority that their vote is less important. The ultra-rich can afford to pay for the best fiscalist anyway. The regular rich can move elsewhere.

Also, a friend of mine shared this with 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.”

I’m sure a lot of people sick and tired with dumb policies which supposedly favor the poor share my friend’s views. Interestingly, we share conservative economic views and he completely agrees with me that bolstering the CPP is smart pension and economic policy:

“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 hope someone in Ottawa will share this comment with the Privy Council and other offices in Ottawa. Unfortunately, the Conservatives made plenty of pension gaffes (and other gaffes) but raising the contribution limit on the TFSA wasn’t one of them.

Photo by Roland O’Daniel 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.

Paul Taylor of Reuters reports, As pension reform crunch nears, Greek coalition looks fragile:

Greek Prime Minister Alexis Tsipras’ governing majority is looking fragile as crunch time approaches for a pension reform that will test his resolve to impose painful measures to satisfy Athens’ international creditors.

The coalition of Tsipras’ leftist Syriza party and the right-wing nationalist Independent Greeks has a majority of just three seats in parliament, and pro-European opposition parties that voted for Greece’s latest bailout are publicly refusing him any help on the toxic pension issue.

The overhaul, which must deliver savings worth 1 percent of gross domestic product or 1.8 billion euros next year, is the most sensitive of a raft of reforms demanded by the euro zone and the International Monetary Fund in return for up to 85 billion euros in aid in the country’s third bailout since 2010.

Trade unions have staged two 24-hour general strikes against further pension cuts and Tsipras has promised there will be no across-the-board reduction in benefits for retirees.

Tsipras says most of the savings will be achieved by ending early retirement under a law enacted last month, leaving about 600 million euros more to be saved.

“Hell, there must be ways to find those 600 million euros. It’s not 6 billion, it’s 600 million,” he said in a television interview this week after critics said he would struggle to avoid a new round of unpopular pension cuts.

Instead the government is proposing to increase social security contributions, mostly by employers – a move the lenders warn would deter job creation and set back economic recovery, setting the stage for tough negotiations next month.

WARS OF WORDS

As the deadline approaches, Tsipras launched an attack on the IMF this week, saying it was making unconstructive demands on both sides and should make up its mind whether it wanted to stay in the Greek program.

That in turn triggered another war of words with Germany, the biggest European creditor, which insists the global lender must stay in the program to enforce tough discipline and to reassure German lawmakers.

Sources in Syriza say some deputies are unhappy at the prospect of a reform that will entail merging the country’s multiple underfunded pension funds and reducing state subsidies to the system and is bound to lead to lower benefits for many.

No one knows how many, if any, of the grumblers may refuse to back the law.

Aides say Tsipras will negotiate hard with the lenders but ultimately will face down any opposition in his own party and push the pension reform through parliament so that Greece can start negotiations with the euro zone on debt relief in March.

Tsipras dismissed talk of a wider coalition in the state TV interview, saying his 153 seats in parliament were more solid than the 225-seat majority which had initially supported a 2011-12 interim government of technocrat Lucas Papademos, which crumbled within six months.

Political sources say the prime minister has put out feelers to a small opposition party, the Union of the Centre, which has hinted its nine lawmakers might let the legislation pass.

Despite their tough public stance, other opposition parties could well abstain or absent themselves in sufficient numbers to ensure passage of the pension bill, the sources said.

“No one has an interest in having another election now,” said a senior political source, noting that the conservative New Democracy is in disarray ahead of a leadership election next week, and the center-left PASOK party is wary of taking any new responsibility for unpopular austerity measures.

The source said that while his “central scenario” was that Tsipras would ram the pension reform through, there was a risk that the prime minister would decide to play for time, delaying any reform until pressure mounted and the threat of another destabilizing Greek crisis began to affect financial markets.

A source on the lenders’ side said creditors could also play things long to increase reform leverage over Greece and push back debt relief talks until after sensitive regional elections in Germany and a general election in Slovakia in March.

While Tsipras remains Greece’s dominant politician, with no challenger in sight, Athens is awash with rumors of an “ecumenical government” combining technocrats with consensual politicians if he loses his majority.

The Greek pension system is effectively bankrupt and getting worse as the country keeps sinking into a debt deflation hellhole. It desperately needs to be reformed but with so many Greeks relying on grandpa and grandma’s pension which has already been cut to the bone, I’m not surprised there’s such massive opposition to reforming pensions.

Unfortunately, Greeks don’t have much of a choice. Either they reform pensions, which means merging them, introducing real governance which shields them from political interference, and risk-sharing so that they’re sustainable over the long-run or else those pensions are going to disappear altogether.

Of course, this is Greece and nothing in Greece ever gets done without drama. I’ve given up hope on Greece and Greeks. It’s quite shocking how they fail to grasp reality and this is reflected in the clowns they keep voting into power. I think Alexis Tsipras is finally taking the right stance but it’s a day late and a dollar short. The titanic is sinking and I expect another “Greek crisis” in the near future which will only exacerbate Europe’s deflation crisis (keep shorting the euro on any strength!).

Worse still, there’s no end of the deflation supercycle and this is bad news for all pensions, not just the ones in Greece. In fact, Greek pension bombs are exploding everywhere including Illinois where the unfunded pension liability has risen to $111 billion:

Illinois added another $6.4 billion to its already large unfunded pension liability in fiscal 2015, pushing the total to $111 billion, according to a state legislative report on Thursday.

The bad news on the pension front comes as a budget stalemate between Republican Governor Bruce Rauner and Democrats who control the legislature continues nearly halfway through the fiscal year that began on July 1.

Analysts at the legislature’s Commission on Government Forecasting and Accountability said changes in some actuarial assumptions at two of the five Illinois public employee retirement systems, along with insufficient state contributions, were the main reasons for the higher unfunded liability when fiscal 2015 ended on June 30.

Illinois has the worst-funded pensions among the 50 states and its funded ratio fell to 41.9 percent at the end of fiscal 2015 from 42.9 percent in fiscal 2014, the report said. Those percentages are well below the 80 percent level that is considered healthy.

Moody’s Investors Service and Fitch Ratings in October pushed Illinois’ credit ratings into the low investment grade triple-B level, citing the state’s pension funding problems, the budget impasse, and a growing structural deficit.

A cash crunch resulting from the budget stalemate forced Illinois’ comptroller to delay a $560 million November pension payment. However, stronger revenue this month made a $560 million December payment possible.

The legislative commission’s report projected that the state’s pension contribution will rise to $7.908 billion in fiscal 2017, which begins on July 1, from nearly $7.535 this fiscal year. The report also projected the unfunded liability will grow to $114.8 billion at the end of fiscal 2016 and will keep growing until it tops out at $132.16 billion in fiscal 2029.

Teachers’ Retirement System, the biggest of the five state retirement systems, said on Thursday that Illinois’ $3.986 billion fiscal 2017 contribution falls far short of the $6.07 billion that would be required using actuarial standards.

And it’s not just Illinois. The unfunded liability at Kentucky’s troubled public pension fund for teachers surged by more than $10 billion last fiscal year under new accounting rules intended to provide a more realistic picture of the worst funded public pension plans:

Kentucky Teachers Retirement System’s (KTRS) unfunded liability jumped to $24.43 billion in the fiscal year ended June 30, 2015, using new accounting rules known as GASB 67, compared to $14.01 billion in the prior year, a meeting of board members was told on Wednesday.

Under the rules Kentucky had to use a discount rate of 4.88 percent to calculate the net present value of its liabilities, compared to the 7.5 percent it would have used normally, said Beau Barnes, an executive and general counsel for the fund.

The unfunded liability of $14.01 billion in the 2014 fiscal year was calculated using the higher discount rate. Using the lower rate it would have been $21.59 billion.

News of the situation at the fund comes just days after Reuters reported that two of Kentucky’s pension funds for state employees would start exiting illiquid private equity investments as their funding status worsened.

Lawmakers have consistently failed to make required payments into the teachers’ fund, which is supposed to provide retirement security to over 122,000 state teachers.

“We are in a crisis,” Gary Harbin, KTRS executive secretary, was quoted as saying in the Lexington Herald Leader newspaper. “It’s a crisis for the teachers in the classroom today.”

An unfunded liability of more than $24 billion in the teachers’ fund alone is a staggering burden on a state with an annual budget of around $10 billion.

The sharp increase in the unfunded liability led to a decline in the system’s funded ratio to 42.5 percent from 45.6 percent, meaning the fund only has 42.5 cents for every dollar of pension benefits it owes to members.

The appropriate discount rate to use when calculating public pension fund liabilities is hotly contested. Most funds use a rate of 7 percent to 8 percent. Some economists say that is far too high and should be closer to prevailing long-term interest rates.

Using the 7.5 percent discount rate the system’s funded ratio increased to 55.3 percent from 53.6 percent in the prior year, Barnes said, and the unfunded liability actually fell slightly to $13.90 billion.

It’s about time U.S. public pensions start using more realistic assumptions to discount their future liabilities. When people tell me the Greek pension fiasco can never happen elsewhere, I tell them to open their eyes as it’s already happening all around the world, including in the United States where the trillion dollar state funding gap is set to explode higher as rates keep sinking.

Mark my words, a prolonged period of debt deflation will be brutal and unrelenting, especially for underfunded pension plans. Why do you think central banks are busy trying to save the world, introducing all sorts of unconventional monetary policy measures including negative interest rates?

These measures will punish pensions and force them to take increasingly more risk, but this exactly what central banks want to awaken “animal spirits” and stoke inflation expectations higher.

Will they succeed? I have my doubts and fear that the Fed is set to make a huge policy blunder if it raises rates next week. What really worries me is rising inequality and how deflationary this is for the U.S. and global economy.

In fact, Nobel-Prize winning economist Joseph Stiglitz wrote another great comment for Project Syndicate, When Inequality Kills, which discusses how rising inequality is literally very unhealthy for the U.S. economy and contributing to higher rates of drug abuse, alcoholism, and suicide.

But rising inequality is also adding to deflationary headwinds and this too spells big trouble for the United States of pension poverty. Unfortunately, America’s pension justice is going the way of its justice system, penalizing the most vulnerable and rewarding the most affluent, some of whom have the gall to propose a solution to the retirement crisis which primarily benefits them. And all of this is happening under the watchful eye of Congress which ensures the quiet screwing of America.

George Carlin was right: “it’s called the American dream because you have to be asleep to believe it.” This holiday season, try to read Joe Stiglitz’s latest book on inequality, The Great Divide, and make sure you read the chapter on the “Myth of America’s Golden Age” twice. Then read Thomas Piketty’s The Economics of Inequality, Tony Atkinson’s Inequality: What Can Be Done?, and Bob Reich’s Saving Capitalism: For the Many, Not the Few.

After reading these books, if you’re still convinced America, and by extension the world, doesn’t have a massive inequality problem which will threaten future growth and all but ensure a long period of secular stagnation that Larry Summers is warning of, then hats off to you! My bet remains on global deflation and I see the Greek pension disease spreading all over the world in the not too distant future, wreaking more havoc on our already frail pension systems. 

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, Canada’s top 10 pension funds tripled in size since 2003:

Canada’s biggest 10 public pension funds now manage assets worth more than $1.1-trillion, having tripled in size since 2003, according to a study published by the Boston Consulting Group on Thursday.

The funds have expanded rapidly in recent years, pursuing a strategy of directly investing in assets globally with an emphasis on real estate and infrastructure projects such as bridges, tunnels and roads. Some pension experts say this approach has helped them mitigate the impact of volatility in global equity markets and challenging economic conditions.

About one-third of the top 10 funds’ investments are in alternative asset classes such as infrastructure, private equity and real estate, according to the study, which was commissioned by the top 10 funds.

“The top 10 have shown impressive growth in investment capabilities and scale to manage the realities of a post-financial crisis world,” said Craig Hapelt, partner and managing director at BCG.

“Their investments also have a broader positive impact on Canada’s prosperity,” he added.

By directly investing, the Canadian funds are able to manage assets themselves, a move the funds say results in lower costs. They have also built up sufficient scale over the past two decades to acquire capital-intensive assets such as infrastructure.

At the end of 2014, the top 10 funds now manage assets worth the equivalent of over 45 per cent of Canada’s gross domestic product (GDP), the research showed.

However, the funds face increasing economic headwinds including falling energy prices. Separate research by RBC in November revealed they had suffered a second consecutive quarterly fall in the value of their assets for the first time since the 2007-09 financial crisis.

The 10 largest funds include the Canadian Pension Plan Investment Board (CPPIB), the Caisse de dépôt et placement du Québec (Caisse) and the Ontario Teachers’ Pension Plan Board, the three biggest Canadian funds which are also in the top 20 public pension funds globally. Seven of the funds are among the top 30 infrastructure investors in the world.

Recent investments by Canadian pension funds include the $2.8-billion acquisition of the operator of the Chicago Skyway toll road by CPPIB, Ontario Teachers and the Ontario Municipal Employees Retirement System and the $7.5-billion purchase of an Australian electricity network by a consortium including the Caisse.

The Ontario Teachers’ Pension Plan posted a press release on its website, Among the most successful in the world, the total value of Canada’s ten largest public pension funds has tripled since 2003:

According to  a new study conducted by The Boston Consulting Group (BCG), Canada’s ten largest public pension funds (Top Ten) continue to drive impressive investment returns and remain key players on the global stage during a period of challenging economic conditions both domestically and in major markets globally. The funds now manage over $1.1 trillion in assets, which is the equivalent of over 45 per cent of Canada’s GDP. An infographic highlighting key results and investments is available here.

“The Top Ten have shown impressive growth in investment capabilities and scale to manage the realities of a post-financial crisis world,” said Craig Hapelt, a Toronto-based partner at BCG. “Not only do the funds represent an important aspect of Canada’s retirement income landscape, but their investments also have a broader positive impact on Canada’s prosperity.”

The study indicates that three pension investment funds[1] are listed among the top 20 public pension funds globally. Additionally, the Top Ten remain prominent global players in the alternative asset management industry, with seven funds[2] named among the top 30 global infrastructure investors and five[3] listed as part of the top 30 global real estate investors.

Top Ten funds important to Canada’s prosperity

The Top Ten are a significant component of Canada’s retirement income system, helping to provide financial security in retirement to over 18 million Canadians. Their total assets under management tripled between 2003 and the end of 2014 and 80 per cent of this increase in value was driven by investment returns.

As investors behind several Canadian landmark assets and flagship companies, the Top Ten have invested approximately $600 billion across various asset classes in Canada and directly employ almost 11,000 professionals. In addition to monetary contributions, the Top Ten are responsible for creating talent clusters in multiple Canadian cities – attracting Canadian talent currently working abroad or providing home-based talent with opportunities to gain global experience.

Investment strategy promotes portfolio diversification to maximize long-term returns

While each fund’s strategy is designed to meet its unique mandate, the Top Ten similarly focus on creating well-diversified portfolios that align with the funds’ relatively long-term payout profiles. Enabled by their scale, approximately one third (32 per cent) of the Top Ten’s investments are in alternative asset classes such as infrastructure, private equity, and real estate in Canada and abroad. This figure contrasts to a less than 11 per cent allocation in alternative asset classes by most other Canadian pension plans.

Some of these investments include Canada’s TMX Group, Ontario’s Yorkdale Mall, and BC’s TimberWest Forest Corporation and Brentwood Town Centre. Globally, the Top Ten have invested in such assets as ING Life Korea; Globalvia, a portfolio of infrastructure assets in Europe and Latam; Port of Brisbane, one of Australia’s fastest growing container ports; Open Grid Europe, a gas transmission network operator responsible for approximately 70 per cent of Germany’s total national shipping volume; and, Camelot Group, the UK’s national lottery operator.

About Measuring Impact of Canadian Pension Funds Report

This is the second time that BCG has been commissioned to conduct this survey on behalf of the Top Ten. The study focused on the ten largest public sector pension funds (ranked here by size of net pension assets under management): The Canada Pension Plan Investment Board ($265 billion), The Caisse de dépôt et placement du Québec ($192 billion), The Ontario Teachers’ Pension Plan Board ($154 billion), PSP Investments ($112 billion),The British Columbia Investment Management Corporation ($104 billion), The Ontario Municipal Employees Retirement System ($73 billion), The Healthcare of Ontario Pension Plan ($61 billion), The Alberta Investment Management Corp. ($50 billion), The Ontario Pension Board ($22 billion) and The OPSEU Pension Trust ($18 billion).

About The Boston Consulting Group

The Boston Consulting Group (BCG) is a global management consulting firm and the world’s leading advisor on business strategy. We partner with clients from the private, public, and not-for-profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 82 offices in 46 countries. For more information, please visit bcg.com.

You can download Boston Consulting Group’s second study on Canada’s top ten pensions here. I covered the first study going over the benefits of the top ten pensions in June 2013.

This study is a continuation of the first one and it demonstrates how impressive Canada’s biggest pensions are not just domestically but internationally, investing across public and private markets all around the world.

To be sure, the BCG study is a bit of public relations piece commissioned by Canada’s Top Ten so let me carefully scrutinize it by going over some important points which are worth bearing in mind:

• The growth of Canada’s Top Ten since 2003 (after the tech bubble crashed) has been explosive and while a lot of this growth was fueled by strong gains in global stocks and corporate bonds, the bulk of the value added over public benchmarks came from private market investments like real estate, infrastructure and private equity (except for HOOPP which does invest in private markets but has delivered stellar returns primarily by investing like a multi-strategy hedge fund across public markets doing everything internally).
• The key point in the press release Ontario Teachers’ put out was this: 80 per cent of this increase in value was driven by investment returns. This seems quite high to me (thought it was more like 70 percent) but the point is that it’s investment gains, not contributions which explain the explosive growth of Canada’s Top Ten. This and many other benefits of DB plans are critically important to remember when we look at bolstering our retirement system by building on the success of our large DB plans.
• What else? Canada’s Top Ten have roughly 30% of their assets in alternative asset classes like infrastructure, real estate and private equity in Canada and abroad. This figure contrasts to a less than 11% allocation in alternative asset classes by most other Canadian pension plans which explains why Canada’s Top Ten are outperforming their domestic and international peers. It’s not only the large allocation to alternative asset classes which explains this outperformance, it’s the approach they use. Canada’s Top Ten invest directly in real estate, infrastructure and private equity, saving a ton on fees.
• The main reason behind the success of Canada’s Top Ten is their governance model which ensures no government interference and introduces a compensation scheme that pays senior pension fund managers at Canada’s Top Ten extremely well so they can attract talent to bring public and private assets in-house.
• However, as I recently stated, the media loves overtouting the Canadian pension model and in doing so it often presents biased views of what the Top Ten are doing, especially in terms of direct private equity deals. Still, there’s no denying the success of Canada’s Top Ten which is why many public and private pensions are trying to emulate their approach.
• The main drawback of this BCG study is that it doesn’t delve deeply into the diverse approaches Canada’s Top Ten use to add value over their benchmarks. For example, I recently covered PSP Investment’s global expansion discussing how the fund is going into leveraged finance. The report also doesn’t discuss the benchmarks Canada’s Top Ten use to gauge their performance in public and private markets, nor does it discuss how a few in the Top Ten are highly levered relative to their peers which could explain part of their long-term outperformance (it’s not the only factor but it’s a big factor).
• In other words, this BCG is more of a public relations study; it isn’t a rigorous, comprehensive performance audit on Canada’s Top Ten. To be fair, BCG and McKinsey are large consultants which are typically used by Canada’s Top Ten for big studies but they’re there to deliver a product which is shaped by the senior managers at these shops. The consultants’ focus is on repeat business which is why they present findings in a favorable manner. They’re not hired to rock the boat (that’s my job!).
•  Although I welcome this new BCG study, I wish the Government of Canada would commission a new study on the governance at Canada’s Top Ten which closely examines the various approaches they use to deliver their results, the benchmarks they use to gauge their performance in public and private markets and whether their benchmarks appropriately reflect all the risks they’re taking to deliver these results and whether these risks justify the very generous compensation being doled out to their senior managers.
• What else? We need to improve the communication at Canada’s Top Ten and perhaps even legislate that board meetings will be made public on a dedicated YouTube channel just like CalPERS, CalSTRS and other large U.S. public pensions do. More transparency is needed on investments, benchmarks and how its tied to compensation.

I know, I’m dreaming but when we want to shine a light on Canada’s Top Ten, we’re better off looking at the good, the bad and the ugly, not just the good.

Having said this, I’m a huge supporter of Canada’s Top Ten and would like to build on their success to improve our retirement system and propel Canada to the top spot in the global ranking of top pensions. There are plenty of pension fund heroes in Canada who quietly do extraordinary work, delivering solid long-term results and even though I’m on their ass constantly to improve their governance and hire a more diversified workforce, if we’re ever going to introduce real change to Canada’s Pension Plan, we have to build on the success of our large DB pensions.

There’s another reason why I’m a big believer in our large DB pensions. The next ten years will be nothing like the last ten years. We need to prepare for lower returns, especially here in Canada where negative interest rates could be right around the corner. In this environment, you’re better off having your pension money invested in Canada’s Top Ten than in some crappy mutual fund which rakes you on fees and is vulnerable to the whims and fancies of public markets.

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.

Chris Newlands and Madison Marriage of the Financial Times report, BT pulls pension mandate from Hermes:

Telecoms group BT has pulled an £8.4bn investment mandate from Hermes, the asset manager it owns, in an attempt to reduce the costs of running its £40bn pension scheme.

BT’s decision will mean that total assets run by Hermes, the fund company BT created in 1983 to manage its pension scheme, will slide almost 30 per cent to £21.7bn.

The shift comes as BT struggles to plug the funding gap of its pension scheme. There is growing pressure on pension funds to reduce their costs of investment.

BT’s pension deficit increased from £5.8bn to £7bn in the 12 months to the end of 2014 and is the highest of any FTSE 100 company, according to consultancy LCP.

BT said in a statement: “We have made the decision to move the mandate . . . as this best meets the needs of the scheme and will be more cost effective going forward.”

The telecoms company will run the £8.4bn inflation-linked government bond mandate passively using a strategy that tracks the benchmark, rather than the more expensive active management strategy used by Hermes to beat the market.

John Ralfe, an independent pension consultant, said: “Index-linked gilts are by definition entirely inert. Therefore the idea that you pay anybody for managing them — even a passive manager — doesn’t make any sense.

“BT shareholders paying two people to sit around actively managing a gilt portfolio [is] just money down the drain.”

Mr Ralfe said it did not make sense to pay for active management of an inflation-linked gilt strategy as these tended to be buy-and-hold investments that did not require much trading.

He believed active management was too costly, and passive investments tended to outperform active equivalents on average.

Hermes’ main actively managed gilts strategy underperformed its benchmark by 47 basis points in 2014 and has underperformed since it was launched, according to the company’s annual report. Hermes said some accounts with that strategy — including BT’s scheme — performed better.

BT said in a statement: “Hermes has delivered strong performance for this mandate and across the portfolios they manage for us.”

Although the bond mandate made up almost 30 per cent of assets at Hermes, it accounted for just 3 per cent of revenues, according to the company’s chief executive Saker Nusseibeh.

He said: “When I joined the company in 2009, 92 per cent of revenues came from BT but that is now less than half. Fifty seven per cent of our revenues come from third parties. This loss absolutely does not affect our other mandates with BT.”

Mr Nusseibeh added that Hermes, which made a statutory loss of £8.1m last year but is forecast to make a £9.2m profit this year, had “entered into discussions” with Paul Oliver and Paul Syms, who were managing the bond mandate at Hermes on behalf of BT, about their future at the company.

The BT pension fund is likely to shift other active mandates into cheaper, passive alternatives, according to Mr Ralfe.

Around half of the scheme’s £40bn of assets are allocated to external fund companies, including active investment managers Ashmore, M&G and Wellington, as well as BlackRock, the world’s largest provider of passive funds.

Mr Ralfe said: “Over the years, [the scheme’s board] has moved some assets into passive. That may well continue. There’s a hell of a lot of money to be saved [in passive].”

Marion Dakers of the Telegraph also reports, BT pension fund pulls £8.4bn from its own investment manager:

Hermes, the investment manager set up by the BT pension fund, is losing 30pc of its assets after the telecoms giant decided to take part of its portfolio in-house.

Hermes said that the decision by its owner would affect its £8.4bn government bond mandate, which will be switched from active management to a cheaper, passive strategy that simply tracks the benchmark.

Saker Nusseibeh, chief executive of Hermes, said the BT Pension Scheme’s decision was expected and should not affect the rest of the firm’s mandates with the telecoms group. “We knew that our client was unusual in having an actively-managed gilt business. The performance of it had been stunning… but I wasn’t particularly surprised.

“The effect on our financials will be de minimis,” he added, noting that the mandate represented just 3pc of Hermes’ revenues.

Hermes will continue to manage between 30pc and 40pc of BT’s pension assets in future, BT said.

BT founded Hermes in 1983 and is still the group’s largest client, with a mandate to help fund retirement obligations for 320,000 workers. The telecoms firm, which uses several investment managers to run its pension holdings, said in early 2015 that it would inject £2bn into its pension funds over the next two years and reduce its costs in a bid to scale back its £7bn deficit.

Meanwhile, Hermes has recently diversified and increased revenues from third parties from 18pc in 2011 to more than 50pc this year. Its assets under management rose 9pc to £27.5bn last year, although the firm’s statutory losses widened to £8.1m.

The investment manager has also ventured into private equity and infrastructure deals, such as a joint venture with the Canada Pension Plan to acquire Associated British Ports, and has launched several new funds.

In early August, I covered CPPIB’s big stake in British ports, a deal which included Hermes. As far as BT Pension’s decision to bring its gilts strategy internally, it’s a no-brainer and it should have been done a long time ago.

In a deflationary world, all public and private pension plans need to reduce costs everywhere and the number one place they’re going to be looking at is external managers. This typically means bringing anything you can internally to be managed at a fraction of the cost.

In my last comment where I examined how the media is overtouting the Canadian pension model, I was careful to state that while there’s some fluff and inaccurate information on what Canada’s large public pensions are doing in terms of direct private equity deals, there’s no question that they’re increasingly managing more and more internally to lower costs significantly.

In fact, keeping fees at a minimum is the first lesson of how to invest like a Canadian. The best pension plan in the world, fully-funded HOOPP, knows this all too well which is why its does everything internally. Ontario Teachers is also a fully-funded world class pension plan but it’s bigger than HOOPP and needs to allocate to external hedge funds and private equity funds. However, Teachers uses its size to negotiate fees down and it too goes direct in some asset classes (just not as much as they lead you to believe in private equity).

The key thing is to bring costs down and bring a lot of mandates in-house, especially anything which deals with indexing bonds or stocks.  If you’re looking for alpha and want to allocate to private equity funds and hedge funds, make sure you negotiate hard on fees and have proper alignment of interests which at a minimum includes a  hurdle rate and a high-water mark in place in case your premier hedge funds get clobbered with their big bets gone awry.

And what if inflation comes roaring back and all these elite funds betting on reflation turn out to be right? Well, I wouldn’t bet on it and neither are Canada’s highly leveraged pension plans. More importantly, whether or not we get inflation or deflation doesn’t change the fact that pensions need to reduce costs and lower external management fees (much more so in a deflationary environment).

But there are some pretty smart economists who do think inflation is right around the corner, I just don’t agree with them. One of them is Martin Feldstein, Harvard University economics professor, who shared his thoughts on Federal Reserve policy, the U.S. economy and markets earlier today on CNBC.

According to professor Feldstein, with core inflation now running at close to 2%, it’s only a matter of time before U.S. inflation pressures pick up and he thinks the Fed will have to increase rates significantly (Fed funds rate at 4%) to tame the growing threat of inflation. The bond market obviously disagrees with his analysis and so do I but pensions with huge deficits would welcome such a scenario.

Photo by TaxCredits.net

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

Chris Taylor of Fortune reports, These Canadians Own Your Town:

Conspiracy theorists have no shortage of ideas about who runs the world, which secret cabal is meeting in private to count cash and pull strings: the Bilderberg Conference, maybe, or the Trilateral Commission, or even Yale’s Skull and Bones society.

But in investing, the answer isn’t so sinister, nor is it even a secret. In fact, on this chilly autumn day, you can find a cadre of financial lever pullers walking the halls of downtown Toronto’s Ritz-Carlton Hotel, clutching their morning cups of coffee and slipping discreetly into meeting rooms: the world’s top pension-fund managers. Collectively the investors who gathered for the International Pensions Conference—among them, fund managers from the U.S., U.K., Canada, the Netherlands, and Japan—are stewards of $2.5 trillion, a very significant chunk of the world’s assets.

Circulating through this crowd is Ron Mock, head of the Ontario Teachers’ Pension Plan. The avuncular, unassuming 62-year-old “host CEO,” his name tag reads—is moderating panels and introducing guest speakers; he also has the distinction of offering opening and closing remarks. Mock has a modest mien befitting a lifelong usher at Toronto’s Maple Leaf Gardens arena. But among fellow pension managers, Mock might as well be strutting around like Mick Jagger. After all, he sits at the helm of a pension plan whose track record and revolutionary approach to investing have set benchmarks for just about anyone who manages a major endowment or pension fund.

Mock’s Ontario Teachers’ Pension Plan, widely known as “Teachers,” manages a hefty $154 billion Canadian ($116 billion) in assets. It represents the collective savings of 129,000 retired Ontario teachers and 182,000 currently active ones. It’s one of the most successful plans as well, with double-digit average annual returns since 1990, including an 11.8% return in 2014 (about four percentage points better than Canada’s TSX index). Over the past 10 years, according to Toronto-based pension-fund analysis firm CEM Benchmarking, Teachers has placed among the top two performers in the world—out of 273 funds managing a total of $8.5 trillion.

So what the hell is going on north of the 49th parallel? These unassuming investors have a secret sauce that has been so successful, for so long, that pension experts have dubbed it “the Canadian model.” Canadian-model investing means minimizing passive stocks-and-bonds portfolios and buying sizable direct stakes—in companies, in infrastructure, in property. It also means running a pension fund as an independent business: no handing management reins to political cronies, no farming out research to expensive outside advisers. It means bringing in top pros and paying them handsomely, the better to keep them on board. And in Teachers’ case, it means higher-than-average returns paired with lower-than-average risk.

Of course, none of this is any guarantee of success. And although you presumably don’t have $100 billion or more to manage, chances are that you and the Teachers team are grappling with some of the same challenges: the financial strain that comes with growing longevity, as retirement assets stretch to cover 25 or 30 years of living expenses; the difficulty of investing for a long time horizon in an investing climate that emphasizes short-term results; and the fact that, after a six-year global bull market, too many assets are just too expensive. Indeed, Mock and his team are earnestly scouring this pension conference for new strategic ideas. “Market valuations are high, and there’s a lot of capital chasing every opportunity,” laments Jane Rowe, one of Teachers’ top managers.

Still, the Teachers crew has every reason to believe that sticking to the method will pay off. “If you execute the Canadian model correctly—and there is 20 years of data on this—
it is worth an extra 2% every year,” says Keith Ambachtsheer, founding director of Canada’s International Centre for Pension Management. “Compound that every year, and then look at your returns.”

Pension experts credit Teachers with originating this approach a quarter century ago, in 1990—before then the fund was little more than a collection of dusty provincial bonds. Since then Teachers has become the pacesetter for the industry, as more public-pension plans say, to paraphrase When Harry Met Sally, “I’ll have what they’re having.” “The Koreans are doing it, the Singaporeans are doing it, the Dutch are doing it,” says Larry Schloss, president of alternative-asset managers Angelo, Gordon & Co. and former chief investment officer of New York City’s pension plans. “All the largest sovereign funds are trying to do it. The Canadians have figured it out—and they have the returns to prove it.”

Ron Mock didn’t invent the model—he joined Teachers in 2001 and took the helm on Jan. 1, 2014—but he’s well aware of its influence. “Back in 2000 there were only a handful of players on the planet like us,” says Mock, an electrical engineer by training who used to be in charge of safety at nuclear plants (no Homer Simpson jokes, please). “Now there might be 150 of them. People watched where we went and what we did, and suddenly our approach became very popular.”

That popularity is forcing Mock and his colleagues to up their game. While Teachers used to be virtually alone among pension funds in scouring the world for innovative private deals, now it has serious competition. Trying to figure out those critical next steps: 1,100 Teachers employees, many of them housed in a nondescript office building in Toronto’s North End.

Mock is “very smart, he’s very savvy, and he hires investment people who fit that mold,” says Chris Ailman, chief investment officer for Calstrs, the $181 billion fund managing the pensions of California teachers. “His real challenge is that he inherited a dynasty that has been successful for decades, like the New York Yankees. What do you do next?”

To get a sense of how far-reaching Teachers’ strategy is, consider the myriad ways it might overlap with your daily life.

The next time you eat at an Applebee’s or a Taco Bell, for instance, you may well be interacting with Teachers, via its investment in the $1.7 billion San Francisco–based franchisor Flynn Restaurant Group. If you go to a laundromat (Alliance Laundry Systems) or take your pet to an animal hospital (PetVet Care Centers) or buy a bag of kettle-cooked potato chips (Shearer’s Snacks) or keep stuff in storage (Portable On-Demand Storage) or park your car in a pay lot (Imperial Parking) or go to the dentist (Heartland Dental Care) or buy a suit (Hugo Boss) or go the gym (24-Hour Fitness) or wear outdoor gear (Helly Hansen), you’re crossing paths with Teachers’ investments.

And that’s just within the U.S. If you’ve ever traveled through airports in Copenhagen or Brussels, or Birmingham or Bristol in England, or taken the high-speed train connecting London with the Channel Tunnel, you’ve been sending a few bucks to Ontario Teachers. If you shop in any large Canadian mall, you’re probably setting foot in part of a Teachers-owned real estate portfolio. Oh, and the Ritz-Carlton where I recently sat with Mock, Teachers co-owns that particular one, along with Ritz-Carlton itself, through Teachers’ $28 billion Cadillac Fairview real estate operations.

Of course, lots of portfolio managers can claim similar breadth. Many mutual funds, in both actively managed and index forms, have hundreds or even thousands of stock holdings. But few can claim the operational influence that Teachers has on the companies it invests in.

In a conversation in a Toronto boardroom, two of Teachers’ heaviest investment hitters walk Fortune through the fund’s process. The two are very, well, Canadian. Mike Wissell heads Teachers’ public equities investing, when he’s not taking his kids to hockey practices or cheering Blue Jays games at the SkyDome. Jane Rowe, who runs the fund’s private equity arm, has a boast-worthy track record—Teachers’ private equity holdings have averaged annual returns of 19.7% since 1991 and are now valued at $21 billion Canadian—but she’s more likely to reminisce about Newfoundland and getaways to her cottage in Ontario’s Muskoka region.

Still, as pleasant as they seem, Wissell and Rowe send a clear message that Teachers’ money is not to be messed with. If the fund buys a stake in your private firm, they explain, it would like to help call the shots. No 5% or 10% slice, thanks; more likely it will shell out for 30%, 40%, 50%, or more. Oh, and Teachers will want a board seat. Did they mention that? “It’s not unusual for us to have absolute control,” says Rowe. “That is very rare in the pension-plan world.”

If Teachers takes a stake in your company, and it doesn’t like what it sees, big changes may come and management heads may roll. When Teachers pushed McGraw-Hill to split up its business—well, it split up its business, in 2011. Teachers supported hedge fund rabble-rouser Bill Ackman in his battle with CP Rail, leading to the departure of CEO Fred Green in favor of E. Hunter Harrison in 2012. The fund also objected to what it saw as excessive compensation of top management at Sprint Nextel, contributing to the replacement of CEO Dan Hesse by Marcelo Claure.

“It is the most proactive pension fund in Canada,” says John Coffee, a law professor and corporate-governance expert at Columbia University. “It is activist—but hardly the most aggressive.” Indeed, there’s a marked difference in style between Teachers and many American activists: While the latter often take their campaigns public, making themselves part of the narrative, Teachers does its talking behind closed doors, says Ambachtsheer, the pension expert.

Teachers’ managers insist they don’t seek control for its own sake but in order to grow their business. And their successes show their impact. When the fund bought out vitamin giant GNC in 2007, it helped GNC expand into new markets and prepped the company for its IPO before selling out in 2012—having made five times its original investment. When it bought Alliance Laundry from Bain Capital in 2005, Teachers replaced the CEO and made key acquisitions—and has since scored a return of eight times its money. And when Teachers sold its 80% stake in Maple Leaf Sports and Entertainment, owner of hockey’s Toronto Maple Leafs, it got a princely $1.32 billion. Teachers had originally bought half the company, in 1994, for just $44 million—building it into a powerhouse with additions like basketball’s Toronto Raptors.

Of course, assuming big stakes also means assuming sizable risks. “You won’t meet anyone here who doesn’t have some tragic investment story,” admits Wissell. One stands out in company lore: its very first private-capital investment, White Rose Crafts and Nursery Sales, bought in 1991 for $15.75 million. Teachers foresaw grand things for the home-and-garden chain; it didn’t foresee the hit the company would take from surging competitors like Walmart Canada and Costco Wholesale. Within a year, White Rose had folded. Laments Mock: “Bankruptcy right out of the gate.”

Mock knows something about bouncing back from embarrassing adversity. After his stint at Ontario’s nuclear plants, he earned an MBA and started working for the investment dealer now known as BMO Nesbitt Burns. Eventually he became head of a hedge fund, Phoenix Research and Trading. In 2000 the fund tanked, wiping out $125 million in assets. Regulators found that a rogue trader was at fault for having amassed unapproved bond positions. Since Mock was head of the firm, though, the buck stopped with him. He was reprimanded by the Ontario Securities Commission for lack of oversight and was barred for years from becoming a public-company director or officer.

Given that car crash, it is perhaps surprising that Mock was hired the year after by Teachers. Commissioned to steer its alternative assets, he rewarded the trust he’d been given by launching initiatives like Ole, a music-rights-management company that now owns the lucrative catalogues of artists like Rush and Timbaland. He was given the keys to the fund entirely in 2014, when he became the plan’s president and CEO, with former head Jim Leech praising Mock’s appointment as “outstanding.”

“I learned a lot from that experience,” Mock says of the Phoenix flameout. “People will be people. But you have to have a governance structure in place to prevent those things from happening. As the adage goes, trust—but verify.”

In the U.S., trust in public-pension programs is in short supply, and understandably so. Teachers is a fully funded plan, with enough cash on hand to meet 104% of its payment obligations. In comparison, the funding ratio for state and local pension plans in the U.S. is a worrisome 74%, according to Boston College’s Center for Retirement Research.

Much of the U.S. shortfall reflects shortsighted decisions by governments to underfund their pensions, often in unfounded hope that sky-high investment returns would make up the difference. But critics say U.S. funds’ performance also suffers from meddling in investment decisions by political appointees, from restrictions on the kinds of investment strategies they can pursue—and, often, from exorbitant fees charged by advisers.

When Teachers started stacking wins, other plans started following its lead, with the Canada Pension Plan ($264.6 billion Canadian), the Ontario Municipal Employees Retirement System ($72 billion Canadian), and the Caisse de Dépôt et Placement du Québec ($225.9 billion Canadian) adopting similar philosophies. The Canadian model crossed the border as well. The Teacher Retirement System of Texas ($132.8 billion), Calstrs ($191.4 billion), and the Florida State Board of Administration ($170 billion) have all been singled out for their maple-flavored approach.

But U.S. managers say they’d like to go even further in Teachers’ direction. Hampered by traditional U.S. pension-fund rules, they feel as though they’re in a fistfight with one hand tied behind their backs. Among the problems, they say, is relatively modest manager compensation. “The Canadian model pays their in-house team much closer to market compensation than their American counterparts,” says Schloss, the former New York City official. “When I was CIO for NYC pension funds, I made $224,000. Meanwhile, a first-year associate at J.P. Morgan right out of business school made $300,000.” In contrast, Mock made a cool $3.62 million Canadian in 2014, followed closely by executive vice president of investments Neil Petroff, who earned $3.56 million Canadian, according to Teachers’ annual report.

While some U.S. pensions stand out for Canadian-style independence, the model has proved a challenging transplant. “I fear that it will take a crisis, like the Titanic hitting the iceberg, before we do anything about it,” says Calstrs’s Ailman. “Until then we all just keep banging our head against the wall trying to make our current system work.”

While publicly run American funds look on longingly, other funds have no such limitations—and that’s where Teachers’ managers are finding the stiffest competition. Mammoth university endowments like those of Harvard and Yale, and sovereign government funds from Abu Dhabi to Norway are all open to alternative assets and private ventures—and much more active in those spaces than they were when Teachers got started. And all of them share Teachers’ ability to write $500 million checks.

That’s where Teachers hopes its 20-year headstart comes in handy. It already has tentacles all over the world, with outposts in Hong Kong and London expanding to enable more boots on the ground. In its hunt for cash flow, the fund is increasingly deploying those boots in infrastructure deals. Toll roads, airport services, high-speed trains? Count Teachers in. As Mock quips, “If you’re selling an airport, I can get 15 people on a plane tomorrow.”

The sector is decidedly unsexy, but it now makes up $12.6 billion of its portfolio. Infrastructure hits a sweet spot for managers who need to pay for teacher pensions 50, 60, or 70 years out. Like the utility or railroad properties in Monopoly, they may not be marquee venues—but they are consistent, underrated revenue streams. Not long after Fortune met with Teachers’ leaders, the fund announced a deal to buy a one-third stake in the Chicago Skyway, a toll road that accommodates some 17 million passenger cars a year. For $512 million upfront, Teachers will get a share of tens of millions annually in toll income through the year 2104. The rationale is right out of Teachers’ basic playbook: It’s a “critical asset” that “will provide inflation-protected returns to match our liabilities,” says Andrew Claerhout, Teachers’ senior vice president of infrastructure.

The Skyway deal stands out for another reason: It’s one of the few big buys Teachers has made recently. After years of rising prices, in assets from North American real estate to the Dow Jones industrial average, today’s valuations make the fund’s managers nervous. While Teachers declined to comment on which asset classes look intriguing, every interviewee brought up the flood of global capital chasing limited opportunities. You get the sense they are waiting for the fever to break and for prices to come back down to earth.

In the meantime they are doing bottom-up research, unwilling to overpay. “Our bosses always tell us we don’t have to do anything,” says Wissell. “It’s okay to wait for the softballs.” Finding softballs is hard work: That’s why Jane Rowe just got back from Greenland, and Wissell from Brazil, as they scoured the globe for revenue streams. But no matter how far Teachers’ managers travel, you can’t take the Canada out of them. “We are very proud of the Canadian model,” says Wissell. “But we don’t scream it to the highest rafters. It’s just not our way.”

This is a good article on Ontario Teachers’ Pension Plan but it’s a bit of a puff piece and I’m going to take it down a notch in my comment.

First, the best large pension plan in Canada and the world over the last ten years is the Healthcare of Ontario Pension Plan (HOOPP), not Ontario Teachers’.  The latter comes in a close second but let’s call a spade a spade here and stop spreading the myth that “Ontario Teachers is the best”. It’s an excellent plan, a world leader but there are plenty of other great global pensions.

This is especially true now that you have intense competition from CPPIB, PSP Investments, the Caisse, bcIMC, and a pack of other large global pensions and sovereign wealth funds. Yes, Teachers was first mover but that doesn’t mean much in the world we live in but articles like this help in terms of PR and getting the recognition when Teachers approaches partners on prospective deals.

Second, like everyone else, Ontario Teachers has made plenty of mistakes along the way in all asset classes. In other words, its senior managers are mavericks in a lot of areas but they suffered many pitfalls along the way. They’re just better at covering up their huge mistakes, learning from them and moving on.

I mention this because Ron Mock has had his share of harsh hedge fund lessons before and during his time at Teachers. The thing with Ron, however, is he owns his mistakes, learns from them and moves on. Also, he’s always thinking about the next 18 months ahead and thinking hard about his strategy to meet Teachers’ obligations in an increasingly competitive world.

What else do I know about Ron Mock? Unlike others, he doesn’t get swept away by performance figures and he’s always asking tough questions on hedge funds, private equity, real estate and infrastructure. He’s also not the type of guy who toots his own horn or basks in glory. The motto “complacency kills” is deeply embedded in Ron’s DNA and he has little time for mediocrity within or outside Teachers.

Ron is also lucky to have a great senior team backing him up. Whether it’s Jane Rowe, Mike Wissell, Lee Sienna or Wayne Kozun, you’ve got some very smart people at Teachers who really know their stuff. The loss of Neil Petroff who retired earlier this year as CIO of this venerable plan is huge but Ron told me “there’s been progress” in finding a suitable replacement (the person who assumes this role has big shoes to fill).

In private equity, it’s true that Teachers was the first to do direct deals and unlike traditional PE funds, it has a much longer investment horizon. But it’s also true that fund investments and co-investments make up the bulk of Teachers’ private equity investments and I would take all this fluff on direct PE deals with a shaker, not a grain of salt.

There are many myths on Canadian pension funds acting as global trendsetters which are being propagated by the media and the biggest myth is that they do a lot of direct PE deals. This is total rubbish. Canada’s large pensions do a lot of direct real estate and infrastructure investments, not as much as you’d think in terms of private equity where competing with the Blackstones, KKRs, and TPGs of this world is next to impossible, even if you pay your senior pension fund managers outrageously well.

Still, Canada’s large pensions are doing a lot more internal management than their U.S. counterparts and outperforming them in terms of long-term value added over their benchmarks. Why? They have better governance, are able to compensate their senior managers a lot better and some large Canadian pensions, including Teachers and HOOPP, are also able to use considerable leverage intelligently to juice their returns.

When I look at Canada’s large pensions, I don’t get overly impressed. I’m brutally honest when I praise them and when I criticize them. So, when I tell you Ontario Teachers has the best hedge fund program or the Caisse has the best real estate group, I know what I’m talking about. Like I said, it takes a lot to impress me and I’ve been covering pensions for almost eight years on this blog so there’s nothing I’m going to read in the media which is going to make me fall off my chair.

This is why I’m very careful with articles that overtout Canada’s large public pensions. To be sure, they’re delivering outstanding results over the long-run at a much lower cost but the media’s love affair with them is misrepresenting the truth or giving you false impressions that Canada’s large pensions are competing with large dominant global private equity funds (they are but it’s peanuts in terms of their PE portfolios which is made up mostly of fund investments).

What else? While U.S. public pensions can learn a lot from Canada’s large public pensions the latter can learn a lot from their U.S. counterparts when it comes to transparency and communication. This includes making their board meetings publicly available on their websites and just being more transparent on their investments and benchmarks that govern them.

The Canadian pension model has been a success. There’s no denying this but there’s plenty of work ahead to improve the governance at these large Canadian pensions and anyone who claims otherwise is either a fool or part of the entrenched establishment which doesn’t want to rock the boat in any way because it might impact their huge compensation model.

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.

Robin Harding of the Financial Times reports, Japan’s pension fund loses $64bn in third quarter:

The world’s biggest pension fund suffered a grim third quarter, losing $64bn — or 5.6 per cent of its value — as global stock markets fell.

Although much of the loss was likely regained as markets rallied in October, it is a reminder of the risks Japan’s Government Pension Investment Fund is taking after ramping up its equity exposure.

Results from the $1.1tn GPIF are likely to show increased volatility in the future after it changed its target portfolio to 50 per cent equity last year to boost returns and help service Japan’s rising pension bill.

“The volatility of short-term profits may have increased, but from a long-term perspective the risk of a shortfall in pension assets has decreased,” said Yoshihide Suga, the government’s chief cabinet secretary.

Most of the losses came from its holdings of domestic and international equities, which were down 12.8 and 11 per cent respectively, while domestic bonds generated a modest profit.

The losses were almost identical to the GPIF’s benchmark indices for those assets. Since the end of the third quarter, Japan’s Topix stock market index has rallied by almost 12 per cent to close at 1,580 on Monday.

Periods of loss are fairly common for the GPIF, which recorded annual declines in 2007, 2008 and 2010, but they are politically sensitive in Japan because the fund’s assets back basic pensions for most of the population.

It comes after a period of spectacular performance for the GPIF, which returned more than 12 per cent in 2014 as the yen weakened and the Japanese stock market rallied.

The results show the GPIF has largely completed its shift into equities. Equity holdings were towards the bottom of its target range, but that likely reflects the weakness of stock prices at the end of the quarter.

Its attempts to put cash into private equity and alternative investments remain painfully slow, however, with a portfolio allocation of just 0.05 per cent at the end of the quarter. That is equivalent to just $550m.

Japan is unusual in having accumulated assets to support part of its public pension system. The reallocation towards riskier securities is one of prime minister Shinzo Abe’s reforms, aimed at paying the pension bill of the world’s most elderly population, and thus relieving pressure on the public budget.

Political analysts say it has had the dual benefit of boosting the stock market, however, allowing Mr Abe to claim results for his economic programme. A series of smaller public pension funds are in the process of mirroring the GPIF’s asset shift.

Anna Kitannaka of Bloomberg also reports,Japan’s Pension Whale Stands by Stocks After $64 Billion Loss:

Japan’s giant pension manager is unrepentant after a push into equities saw the fund post its worst quarterly result since at least 2008.

There’s no reason to doubt the 135.1 trillion yen ($1.1 trillion) Government Pension Investment Fund’s investment strategy, officials said on Monday in Tokyo as they unveiled a 7.9 trillion yen loss for the three months through September. The slump was GPIF’s first negative return after revamping allocations last October, when it doubled holdings of Japanese and foreign shares.

The loss will test the resolve of the fund’s stewards and of Prime Minister Shinzo Abe, who called for the shift out of bonds to riskier assets such as equities as the government tries to spur inflation. Sumitomo Mitsui Trust Bank Ltd. and Saison Asset Management Co. say that while the public may question the safety of their pension savings, GPIF should be judged on how it meets the retirement needs of the world’s oldest population over a longer horizon.

“They will see some criticism for this. But that’s more of an issue of financial literacy,” said Ayako Sera, a market strategist at Sumitomo Mitsui Trust in Tokyo. “The liabilities of public pensions have an extremely long duration, so it’s best not to carve it up into three-month periods. However, from a long-term perspective, it’s necessary to continue monitoring whether the timing of last year’s allocation was good or not.”

The fund shifted the bulk of its holdings at a “terrible” time, just as stocks peaked, Sera said.

GPIF lost 5.6 percent last quarter as China’s yuan devaluation and concern about the potential impact if the Federal Reserve raises interest rates roiled global equity markets. That’s the biggest drop in comparable data starting from April 2008. The pension manager’s Japan equity investments slid 13 percent, the same retreat posted by the Topix index, and foreign stock holdings fell 11 percent. The fund lost 241 billion yen on overseas debt, while Japanese bonds handed it a 302 billion yen gain.

GPIF is likely to have purchased 400 billion yen of Japanese stocks and 1.7 trillion yen in foreign equities during the July-September quarter after its exposure to the asset class declined following the rout, according to Nomura Holdings Inc.

Equity Rebound

Things are looking up. The Topix rallied 14 percent since the start of the fourth quarter, while a gauge of global shares gained about 7.1 percent. As of Sept. 30, GPIF had 43 percent of its assets in equities around the world.

The asset manager “seriously considered” whether to continue with its current investment mix before deciding it’s the right approach, Hiroyuki Mitsuishi, a GPIF councilor, said on Monday. Short-term returns are more volatile these days, but there’s less risk that GPIF will fail on its long-term objective of covering pension payouts, he said. Fund executives have argued that holding more shares and foreign assets will lead to higher returns as Abe’s inflation push risks eroding the purchasing power of bonds.

“Short-term market moves lead to gains and losses, but over the 14 years since we started investing, the overall trend is upwards,” Mitsuishi said. “Don’t evaluate the results over the short term, as looking over the long term is important.”

Currency Loss

A stronger yen contributed to GPIF’s quarterly loss, with the currency gaining 2.2 percent against the U.S. dollar in the quarter.

GPIF has started to hedge some of its investments against fluctuations in the euro, which it sees declining in the short term on expectations for further central bank easing, the Wall Street Journal reported Tuesday. The fund is in a position to use hedges at any time, Mitsuishi said in response to the report, while declining to comment on whether it had.

GPIF hadn’t posted a quarterly loss since the three months through March 2014. The most recent results included returns from a portfolio of government bonds issued to finance a fiscal investment and loan program, with GPIF providing such figures since 2008. If those are stripped out, the drop was the fund’s third-worst on record, exceeded only by declines in the depths of the 2008 global financial crisis and the aftermath of the Sept. 11, 2001 terror attacks.

“They changed their portfolio knowing something like this could happen, and they’re not going to change their investment policy because of this,” said Tomohisa Fujiki, the head of interest-rate strategy for Japan at BNP Paribas SA in Tokyo. “They reduced domestic bonds and increased risk assets such as stocks, so temporary losses can’t be helped when there’s chaos in the market like in August and September.”

Public Relations

For Tetsuo Seshimo, a fund manager at Saison Asset Management in Tokyo, GPIF gets a pass on its performance given it was in line with benchmark indexes, and a failing grade on its public-relations strategy.

“If you have half your portfolio in stocks, this kind of thing can easily happen,” he said. “However, the public will probably be surprised. The issue is whether they have explained this properly — they haven’t.”

GPIF knows it needs to convince the public that it’s doing the right thing. It unveiled a new YouTube channel on Monday, which will have videos of its press conferences.

“People are probably very interested in GPIF’s results,” said Mitsuishi. “We want to directly explain to them that a long-term view is important.”

For those of you who speak Japanese, you can access GPIF’s YouTube channel here. It’s probably a good idea to have better communication for the sake of Japanese citizens who are worried about their pensions but GPIF should also post clips in English given it is the biggest pension fund in the world.

So, what do I think of GPIF’s record loss in Q3? It’s ugly but not unexpected given it’s shifting assets away from bonds to equities which are much more volatile, especially in a world of record low interest rates, QE, and high frequency trading platforms. Add to this currency losses from a stronger yen and you quickly understand why GPIF lost a staggering $64 billion in Q3.

Interestingly, Eleanor Warnock of the Wall Street Journal reports that Japan’s pension fund is starting to hedge against currency moves:

Japan’s ¥135 trillion ($1.1 trillion) public pension fund has started to hedge a small amount of its investments against currency fluctuations, according to people familiar with the matter.

Japan’s Government Pension Investment Fund started to hedge against fluctuations in the euro in the “short term” due to a negative outlook for the currency amid expectations for further easing by the European Central Bank, the people said.

The fund previously didn’t hedge any of its roughly ¥50 trillion in assets denominated in foreign currencies. A GPIF official declined to comment on whether the GPIF currently was using currency hedging or not, but said that the fund was ready to use currency hedging if deemed necessary.

The decision shows the GPIF becoming shrewder about selectively disclosing information about its investment strategy and also in trying new ways for managing risk on its massive portfolio. Concern about market impact made the fund reluctant to try such tools in the past.

The GPIF used a strategy involving a “tailor-made benchmark” to “quietly hedge” and not attract market attention, said one person with knowledge of the matter.

A rise in volatility in global financial markets has pushed some institutional investors to adopt hedging strategies. Norway’s sovereign wealth fund started hedging equity holdings against currency risk earlier this year, citing a rise in currency market volatility. In the U.S., the U.S. dollar’s gains have pushed more pension funds to adopt hedging strategies in the past year.

A strengthening of the yen helped amplify losses to the GPIF’s portfolio in the July-September quarter. The fund posted its worst performance in the quarter since 2008, as holdings fell 5.59%.

Some large pension funds and sovereign wealth funds around the world don’t hedge their currency exposure, which involves taking positions that would at least partially offset declines in the value of the currencies in which investments are held. Some investment officers believe the effects of currency movements even out over time due to their long investment time frames.

Though the GPIF’s mission is to achieve enough returns to fund pension payouts for the next 100 years, the fund usually reviews its portfolio every five years, and releases quarterly updates on performance.

Hedging could potentially allow the GPIF to soften large fluctuations in quarterly performance. A hedging strategy would also make it harder for hedge funds and other investors to analyze the impact of GPIF’s activity on foreign currency markets.

It’s true, some large pension funds and sovereign wealth funds don’t hedge their currency exposure. Case in point? The Canada Pension Plan Investment Board (CPPIB) which gained a record 18.3% in FY 2015. The value of its investments got a $7.8-billion boost in fiscal 2015 from a decline in the Canadian dollar against certain currencies, including the U.S. dollar and U.K. pound.

By contrast, PSP Investments is 50% hedged in currencies which explains part of its underperformance relative to CPPIB in fiscal 2015. Still, PSP delivered solid results, gaining 14.5% in fiscal 2015.

Of course, relative to GPIF and the Norwegian Pension Fund which is betting on reflation, CPPIB and PSP are peanuts. Interestingly, I would advise GPIF not to follow the Norway’s pension fund and finance real estate investments by selling Japanese bonds (GJBs). I’m increasingly worried about global deflation and for the life of me, I can’t understand why any of these mammoth funds who sell bonds to invest in real estate (at the top of the market).

Also, if they have to diversify out of stocks and bonds, why not take advantage of record low rates to borrow to fund these investments? Are they worried about the Fed preparing to hike rates in December? I wouldn’t worry about that, if the Fed starts hiking, it will exacerbate deflationary pressures and ensure more QE and lower rates for a very long time. Maybe that’s why some of Canada’s large pensions are leveraged to the hilt (the others wish they can but by law, they can’t).

Japan knows all about deflation. Bank of Japan Governor Haruhiko Kuroda has dismissed calls from critics to go slow on hitting the central bank’s 2 percent inflation target and stressed the need to take “whatever steps necessary” to achieve its ambitious consumer price goal. On Monday, he reinforced the need to reinflate prices as a central bank priority:

“If the BOJ were to move slowly toward achieving the price target, wage adjustments would also be slow,” Kuroda told business leaders in the central Japan city of Nagoya, home to auto giant Toyota Motor Corp.

“In order to overcome deflation — in other words, break the deadlock — somebody has to show an unwavering resolve and change the situation. When price developments are at stake, the BOJ must be the first to move.”

Japan relapsed into recession in July-September as slow wage growth and China’s slowdown hurt consumption and exports.

Consumer prices have also kept sliding due largely to the effect of falling energy costs, keeping the BOJ under pressure to expand its massive stimulus programme to meet its pledge of accelerating inflation to 2 percent by around early 2017.

Kuroda said the recent weakness in exports and output was unlikely to hurt companies’ investment appetite for now, as robust domestic demand has made the economy resilient to external shocks.

But he warned that the slowdown in emerging markets, if prolonged, could hurt business sentiment and discourage companies from boosting capital expenditure.

“We’ll ease policy or take whatever steps necessary without hesitation if an early achievement of our price target becomes difficult,” he told a news conference later on Monday.

The BOJ has recently joined government calls for firms to use their huge cash-pile to boost wages and investment, so far with limited success.

While the BOJ cannot directly influence wages, it can help push them up by reinforcing its commitment to achieve its price target, Kuroda said.

“If Japan were to emerge from deflation and see inflation hit 2 percent, it’s important that companies start preparing for that moment by investing more on human resources and capital expenditure,” he said.

He also said that while monetary policy does not directly target currency rates, the BOJ will closely monitor yen moves because of their big impact on Japan’s economy.

“What’s most desirable is for exchange rates to move stably reflecting economic and financial fundamentals,” Kuroda told business leaders.

Interestingly and quite worryingly, Japan’s central bank now owns more than half of the nation’s market for exchange-traded stock funds, and that might just be the start:

Policy makers weighing a deeper foray into equities shows how the world’s third-biggest stock market has become one of the most important Abenomics battlegrounds. The Topix index is up 21 percent since the central bank unexpectedly tripled its ETF budget almost a year ago, and Citigroup Global Markets Japan Inc.’s Tsutomu Fujita says there’s room for them to triple it again. For Amundi Japan Ltd., expanding the program would do more harm than good.

“At a fundamental level, I don’t support the idea of central banks buying ETFs or equities,” said Masaru Hamasaki, head of the investment information department at Amundi Japan. “Unlike bonds, equities never redeem. That means they will have to be sold at some point, which creates market risk.”

These desperate actions of the BoJ to slay Japan’s deflation dragon are another example of central banks trying to save the world. Will they succeed and bring about inflation? That’s what some elite funds preparing for reflation think but global bond markets are yawning and the crash in oil, gold and commodity prices certainly doesn’t bolster the case for massive inflation ahead.

So, Japan’s prime minister Shinzo Abe is taking advice from George Soros, cranking up the risk at public pensions and encouraging Japan’s central bank to do the same. So far, it’s been a losing battle and my fear is that all this government intervention will end up exacerbating Japan’s deflation and ensure the same outcome in China.

George Soros isn’t stupid. He sees the writing on the wall and I’m betting that he and his protege are taking the opposite side of the global reflation bet (I’m willing to bet the same thing for Chris Rokos who just started his global macro fund).

All this to say that losing $64 billion in one quarter isn’t a disaster for Japan’s pension whale. It got harpooned but it’s not a mortal wound. However, if my prediction of a prolonged period of global deflation comes true, Japan, Norway and all global pension and sovereign wealth funds betting on reflation are going to get decimated.

In fact, a new report by the OECD states that pension systems remain under strain in many countries amid slow economic growth and moves by governments to shore up financial stability in the wake of the global financial crisis.

Wait till the great experiment Shinzo Abe and central banks around the world adopted fails spectacularly, then you will see global pensions reeling. Enjoy the global liquidity tsunami while it lasts because when the tide goes out, deflation is going to expose a lot of naked swimmers and wreak havoc on pensions for a very long time.

Photo by Ville Miettinen 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.

Dan Starkman of the Los Angeles Times reports, CalPERS fee disclosure raises question of whether private equity returns are worth it:

The nation’s largest public pension fund peeled back a layer of secrecy to reveal that it has paid private equity managers $3.4 billion in bonuses since 1990, a hefty figure sure to heighten arguments over whether the controversial sector is worth its high risk and expense.

The California Public Employees’ Retirement System said Tuesday that it paid $700 million in so-called performance fees just for the last fiscal year that ended June 30. The disclosure comes as critics increasingly question the wisdom of pension funds investing in such complicated corporate deals as start-ups and leveraged buyouts.

CalPERS officials emphasized that private equity generated $24.2 billion in net profit for the state’s retirees over the 25-year period, a strong performance that they said more than makes up for the sector’s added risk, complexity and cost.

Like many public pension funds, CalPERS has relied on the potentially large returns on private equity investments to help finance benefits for its 1.7 million current and future retirees — and to avoid turning to taxpayers to make up shortfalls.

“Returns from those sorts of investments need to be much higher than returns on assets not bearing similar risks and especially to justify such huge fees,” said David Crane, a Stanford University lecturer in public policy. “From what I read today about CalPERS’ returns on private equity, it’s hard to see that being the case.”

CalPERS’ disclosure, although not the first of its kind, is considered a landmark because of the system’s size and influence in the market. It’s expected to lead major pension funds to demand similar, or even more, disclosures from a multitrillion-dollar industry that has been insulated from calls for reform by the relatively rich returns it generates.

The California State Teachers’ Retirement System, for instance, plans to take up the issue of private equity disclosure at the system’s February board meeting.

“The CalSTRS Investment Committee has asked [its staff] for a greater degree of reporting and cost accounting information, which will require additional resources,” said Ricardo Duran, a spokesman for the nation’s second-largest public pension fund.

The bonuses, known in the industry as carried interest, don’t include annual management fees. Typically, bonuses amount to 20% of profits over a certain target on top of a 2% management fee, a formula known as 2-and-20.

Because of its size, now at about $295 billion in assets, CalPERS has been able to command a somewhat lower bonus rate of about 12%. Still, private equity’s outsized compensation system remains baffling to many.

California State Treasurer John Chiang is sponsoring legislation requiring even more extensive fee disclosure for private equity firms doing business with the state’s pension funds.

“Too much compensation information remains missing, and no amount of profit-sharing returns should cause us to turn a blind eye to demanding full transparency and accountability from firms which call themselves our partners,” Chiang said Tuesday.

“With any other investment class, it would be a no-brainer to demand full disclosure of all fees and costs.”

CalPERS officials, who ordered the review after acknowledging a need to get a better handle on private equity fees, believe they have reaped the benefits of private equity and are satisfied with the performance of the $27.5-billion portfolio, which represents 9% of the total fund.

“We have been rewarded appropriately for the risks that we took,” said Ted Eliopoulos, CalPERS’ chief investment officer.

Crane isn’t so sure. The difficulty in getting out of private equity deals and the high debt loads the sector usually carries raise questions about whether the investments are worth the inherent dangers, he said.

“If the returns were worth the leverage and liquidity risks, then such levels of fees might be worth it,” said Crane, who was an advisor to former Gov. Arnold Schwarzenegger.

The high-stakes business of buying and selling whole companies, dominated by massive global players such as Carlyle Group, Blackstone Group and Kohlberg, Kravis & Roberts, has struggled to shed a swashbuckling image that dates to its roots in the go-go leveraged-buyout boom of the 1980s.

Last week, its board agreed to cut the fund’s expected rate of return to 6.5%, from 7.5%, though in incremental steps that could take 20 years. The move drew criticism from Gov. Jerry Brown, who urged the system to cut the expected return to 6.5% over five years to curb its reliance on higher-risk investments.

Caught in the middle are taxpayers, who must make up for investment shortfalls — a challenge for communities struggling with retirement costs they said are already unsustainable.

In a recent report, CalPERS’ main consultant strongly endorsed the private equity sector, noting that it had an annualized rate of return of 11.9% over the last 10 years, compared with 6.6% for CalPERS’ stock portfolio, and that it performed better than CalPERS’ public stocks over all relevant periods.

Last year, for instance, the private equity portfolio’s 8.9% return blew away the public stock portfolio, which returned an anemic 1%.

But Eileen Appelbaum, senior economist at the Center for Economic and Policy Research, a Washington think tank, countered that CalPERS’ private equity portfolio has failed to meet its own benchmarks over the last one, three, five and 10 years, important measures that seek to account for the added risk that comes with complicated and cumbersome assets.

“Comparing CalPERS’ private equity returns with the overall returns of the pension fund and/or their target return for the pension fund is meaningless,” she said.

Steven N. Kaplan, a finance professor at the University of Chicago, cautioned that although CalPERS’ private equity portfolio has indeed beaten alternatives in the past, even after fees, studies show the rate of outperformance has slowed more recently.

“You should watch it very carefully going forward,” he said.

No doubt about it, the outperformance in private equity has slowed for all pensions investing in big funds and the reason is simple. As more and more pension money chases a rate-of-return fantasy, the returns of these funds are being diluted. Worse still, this is a brutal environment for private equity which is why all these historic returns are meaningless.

The good news is CalPERS is finally dropping its 7.5% expected rate of return to 6.5% but the bad news is that it’s doing it in incremental steps that could take 20 years. They should pass state and federal laws in the United States forcing all U.S. public pensions to slash their expected rate of return immediately to reflect reality of today’s markets.

As far as CalPERS’ private equity, Yves Smith of the naked capitalism blog ripped into their sleight of hand and accounting tricks where they claimed there are no alternatives to PE. Take the time to read Yves’ comment as she raises many excellent points about how the investment staff presented their findings in a way which makes their private equity portfolio look much better than it really is.

For example, apart from plotting private equity returns relative to CalPERS’ overall returns which was mentioned in the article above, Yves notes the following:

In addition, anyone who watches financial markets will notice that the returns from CalPERS’ “global equity” portfolio, which is the “Public Equity” shown in its slides, look peculiarly anemic. That’s because CalPERS has a 50% allocation to foreign stocks. Thus CalPERS’ global equity results are lousy due to CalPERS having a currency bet that turned out badly hidden in it. That in turn is used, misleadingly, to bolster the case for private equity. The fact that CalPERS is underperforming in public equities is a problem it needs to address directly and not use as a trumped-up excuse for not asking tough questions about private equity. 

I couldn’t agree more and I actually had a chat with Réal Desrochers, CalPERS’ Head of Private Equity, long before last year when they were mulling over a new PE benchmark. I agreed with him that their PE benchmark was too hard to beat on good years but I told him that any private market benchmark should reflect the opportunity cost of investing in public markets plus a spread for illiquidity and leverage. Period. [no idea if CalPERS adopted a new PE benchmark]

Yves also raises excellent points on volatility. Basically, the volatility in private equity, real estate and infrastructure appears lower than it really is because of stale pricing due to the illiquid nature of these investments. So, anyone who buys these volatility figures on private equity or other private assets needs to get their head examined.

Where I disagree with Yves and her other experts who raise well-known critiques on private equity is that they downplay the significance of this asset class and why there are intrinsic opportunities in private markets which are not readily available in public markets.

Mark Wiseman, President and CEO of CPPIB, told me that he fully expects private markets to underperform public markets when the latter are roaring but in a bear market, he expects the opposite and over the very long-run this is where CPPIB sees most of the added-value coming from.

The key difference between big Canadian and U.S. public pensions is governance and the ability of the former to go above and beyond fund investments and co-investments in private equity and invest directly in this space, saving a ton on fees. Of course, to do so, you need to pay pension fund managers properly and get the governance right.

By the way, Yves Smith had another scathing comment on CalPERS’ board where she rightly defended board member JJ Jelincic:

The starkest proof of how CalPERS’ board is willing go to extreme, and in this case, illegal steps to defend staff rather than oversee it came in its Governance Committee meeting last month. We’ve chronicled how the board fell in line with recommendation by staff and its new, tainted fiduciary counsel, Robert Klausner, for fewer board meetings, even though CEO Anne Stausboll offered no factual support for of her assertion that her subordinates are overworked or that she has considered, much less exhausted, alternatives for streamlining the process or increasing staffing. Moreover, to the extent that board meeting take a lot of employee time, Stausboll’s stage management of the monthly board meetings via illegal private briefings is a major contributor.

In the next section of this board meeting, Klausner and most of the board participated in what one observer called a “hating on JJ Jelincic” session. Board member JJ Jelincic has engaged in what is an unpardonable sin: he asks too many questions at board meeting and occasionally requests documents from staff. If you’ve looked at board videos (as we have) the alleged “too many questions” are few in number save when staff obfuscates and Jelincic tries to get to the bottom of things.

This section of the Governance Committee meeting clearly shows that the board, aided and abetted by Klausner, is in the process of establishing a procedure for implementing trumped-up sanctions against Jelincic, presumably so as to facilitate an opponent unseating him in his next election. But Jelincic’s term isn’t up until 2018, so from their perspective they are stuck with an apostate in their ranks for an uncomfortably long amount of time. Part of their strategy appears to harass him into compliance with the posture the rest of the board, that of ceding authority to staff and conducting board meetings that are largely ceremonial. We strongly urge you to watch the pertinent portion in full, and have provide a link and annotations at the end of this post.*

And what are Jelincic’s supposed cardinal sins, aside from being too inquisitive? That of using the California Public Records Act (California’s version of FOIA) to request documents that staff refused to produce. Mind you, Jelincic has used the PRA all of three times, in #2029 on June 8, 2015, #2077 on July 14, 2015 and #2084 (a duplicate of #2077, so it is not really a separate request, as far as staff effort is concerned) on July 16, 2015. And these requests were for a small number of recent, readily accessible records. By contrast, virtually all of our Public Records Act requests have been far more difficult to fulfill, so it is hard to depict Jelincic’s modest submissions as burdensome.

And as to the other bone of contention, that Jelincic making these queries is an embarrassment to staff? Yes, as we’ll discuss in detail, staff ought to be embarrassed, since their refusal to provide information is rank insubordination and a further sign of an out-of-control organization that should trouble every CalPERS beneficiary. But if the board weren’t making a stink about Jelincic (almost certainly at the instigation of staff), it’s a virtual certainty that no one would have noticed, since the monthly PRA logs are read by hardly anyone, and certainly not reported on by the media.

So substantively, submitting a mere two Public Record Acts in response to staff intransigence has resulted in the board attacking Jelincic, when any properly-functioning board would be all over staff for their high-handedness in refusing a request for documents by a board member.

Every legal expert we’ve consulted in this matter has been appalled by the refusal of CalPERS’ staff to supply records to a board member when asked. For instance, we contacted two law professors, each at top law schools, both with considerable expertise in trustee matters. Each took a dim view of the notion that staff was trying to duck board member requests for information.

I will let you read the rest of Yves’ comment here but I contacted JJ Jelincic who sent me this reply on CalPERS’ disclosure of private equity fees and naked capitalism’s stinging comments:

The disclosure was a long time coming. It is a step in the right direction. However, it is not complete. It provides 17 years of data but only for the funds that we still have active positions in. It ignores closed funds which is where you see only realized values, not manager estimates.

It also fails to reflect the $1.2 billion in accrued carry. It ignores the $1.3 billion in net management fees CalPERS has paid in just the last 3 years. Portfolio company fees, discounts and waivers remain a black hole but the flash light will come.

I have been told it is a breach of my fiduciary duty to disparage staff so I will not comment on the Naked Capitalism story. I think there is some merit to Dan Primack’s comments on the timing.

The timing JJ is referring to was that CalPERS disclosed PE fees last week during U.S. Thanksgiving when most people aren’t paying attention. In his comment, Fortune’s Dan Primack notes the following:

The pension system, which is the nation’s largest with $295 billion in assets under management, reports that its active private equity fund managers have realized $3.4 billion in profit-sharing between 1990 and June 30, 2015. That is compared to $24.2 billion in realized net gains, which works out to an effective carried interest rate of just 12.3%. For the 2014-2015 fiscal year, the shared profit totaled $700 million on $4.1 billion in realized net gains, or a 14.6% effective carried interest rate.

For context, the industry standard for carried interest is 20%. That would suggest that CalPERS has been a savvy negotiator, but it’s also worth noting what today’s data dump is missing:

1. CalPERS only released data for active funds, as opposed to all of the private equity funds in which it has invested since 1990. Excluded are any fund positions that have been sold or liquidated. A CalPERS spokesman says: “We have limited recourse to seek the data from exited, inactive, sold, liquidated, etc. funds. We felt the best use of our time and resources was to focus on active funds – 98% of cash adjusted asset value is represented. And moving forward we will be consistent in that approach.”

2. We do not know actual carried interest structures for any of the funds, many of which might include preferred returns (i.e., hurdle rates). In other words, certain private equity funds only begin generating carry once they have returned the entire fund plus something like 8%. As such, the realized profit-sharing may be artificially low. Even without a hurdle rate, carry is rarely made effective until a fund repays its principle, meaning carried interest can be artificially low in a fund’s early years (something exacerbated by the pension system’s decision to only report active funds). This could be partially rectified if CalPERS also released data on accrued carried interest — something it requested from its fund managers earlier this year — but it is unclear if such figures will be forthcoming.

I doubt CalPERS will release data on accrued carried interest but Primack is right to point out that this disclosure is only partial and not a full disclosure of all fees paid out to active and closed funds (JJ Jelincic’s comment above highlight the same points and provides figures). He’s also right to point out the realized carry is artificially low.

To conclude, CalPERS big PE disclosure is a step in the right direction but it’s not enough. The senior investment staff need to respect their fiduciary duties and provide full disclosure on all fees and expenses paid out to active and closed private equity funds on their books. I expect the same thing from others who might follow CalPERS’ lead, including CalSTRS and even Canada’s large public pensions which typically keep this information hush and never break it down by fund and vintage year.

Photo by  rocor 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.

Geoffrey Morgan of the National Post reports, TransAlta Renewables gets $200M investment from Alberta fund manager AIMCo:

Alberta’s provincially owned investment management company bought a $200-million stake in a local renewable power provider Monday, the day after the province announced it would phase out coal-fired electricity generation.

Alberta Investment Management Corp., which manages more than $75-billion worth of investments from the province’s government pension funds, bought $200 million worth of TransAlta Renewables Inc. shares Monday from the green-electricity provider’s parent company, TransAlta Corp.

TransAlta Corp. will continue to be the largest investor in the renewables company, and plans to use the proceeds from the sale to pay down its debt.

The deal would make AIMCo the second-largest investor in TransAlta Renewables, with eight per cent of its shares, after parent company TransAlta, which also owns coal-fired power plants throughout Alberta.

AIMCo CEO Kevin Uebelein said in a release that “TransAlta has set forth a bold transition plan that will see it become one of North America’s preeminent clean power companies.”

AIMCo operates at arm’s length from the provincial government, which on Sunday announced a series of new climate change policies that included a 2030 deadline for coal-fired power producers to cut their emissions to zero.

Alberta currently generates 55 per cent of its electricity from coal power, but the province wants to replace two-thirds of that power capacity with renewables by 2030.

Many industry analysts expect utility companies to shut down their coal-fired power plants by that time as a result of the new provincial policies.

Unlike many of its coal-power peers, TransAlta’s shares surged on Monday morning following the government’s announcement. The company’s share price rose nine per cent to close at $5.96.

Trading in the company’s shares was halted leading up to the announcement that AIMCo had acquired a large stake.

RBC Capital Markets analyst Robert Kwan upgraded the company to “sector perform” and said “TransAlta has the potential to benefit from replacement generation.”

TransAlta had been planning to phase out most of its coal generation by 2030 under existing federal regulations, while Edmonton-based competitor Capital Power Corp.’s coal fleet was still expected to operate beyond then.

Kwan said Capital Power is “possibly the biggest ‘loser’ in all of this, but the impact is really far into the future.”

Jeffrey Jones and Jeffrey Lewis of the Globe and Mail also report, TransAlta Renewables acquires wind and hydro assets, sells stake to AIMCo:

TransAlta Renewables Inc. is buying Ontario and Quebec wind and hydro power assets from its parent company, TransAlta Corp., for $540-million and taking on a new big investor: Alberta’s public-sector pension manager.

It’s selling an 8-per-cent stake in the company to Alberta Investment Management Corp., or AIMCo, for $200-million.

TransAlta Renewables, which is currently 76-per-cent owned by TransAlta Corp., is also offering $150-million of shares in a bought deal.

The series of transactions comes a day after TransAlta Corp., Canada’s largest coal-fired power generator, learned that the Alberta government will phase out that form of energy by 2030 under its sweeping plan to fight climate change. The company and a government-appointed negotiator will try to reach an agreement on how to deal with stranded asset value.

It is selling its majority-owned affiliate the Sarnia Cogeneration Plant, Le Nordais wind farm and Ragged Chute hydro facility, adding a total of 611 megawatts of generating capacity. As part of the deal, TransAlta Renewables will issue $175-million in shares to the parent as well as $215-million in unsecured debentures.

The acquisition of long-term contracted generation capacity will support a 5-per-cent increase in dividends, TransAlta Renewables president Brett Gellner said in a statement.

In its budget last month, the Alberta NDP government gave AIMCo, along with other public agencies, a mandate to search out investments in companies that will help the province diversify the economy away from oil and gas.

Kevin Uebelein, AIMCo’s chief executive officer, said the investment is not related to the timing of Alberta’s economic diversification strategy or its climate plan. Still, AimCo is actively scouting for more deals in renewable energy as policies around carbon emissions firm up.

“The short answer is yes,” Mr. Uebelein said in an interview. “As governments move to change the shape of the playing field with regard to carbon taxing and other measures, then these other forms of power generation, the payback calculation will adjust in response to those government actions.”

The AIMCo investment is expected to close on Thursday. As part of the deal, the fund manager gets the right to acquire shares in future financings.

Under the bought-deal financing, TransAlta Renewables will issue 15.4 million subscription receipts at $9.75 each to underwriters led by Canadian Imperial Bank of Commerce and Toronto-Dominion Bank. They will be converted into common shares when the acquisition closes in January, the company said.

Those of you who want to read the details of TransAlta Corporation’s (TSX: TA) $540 million investment by TransAlta Renewables (TSX: RNW) in three of its Canadian assets can click here. Also, AIMCo put out a press release which you can read here.

What do I think of this deal? It’s definitely advantageous to TransAlta Corp. which is suffering from high debt and welcomes the cash infusion. If you ever want to see why you should avoid investing based solely on high dividends, just have a look at TransAlta’s stock over the last five years (click on image):

In fact, 2015 has been a particularly brutal year for TransAlta’s shareholders. Even after Monday’s pop following the Alberta government’s announcement to phase-out of coal generation and accelerate wind and solar power construction, the stock is down more than half this year (but the high dividend yield helped cushion some of that decline). The same goes for TransAlta Renewables Inc. (RNW.TO).

It’s no secret among Canadian portfolio managers that TransAlta Corp. has been poorly managed and that’s why the stock keeps sliding lower. Having said this, if you’re an investor looking for dividend income, I like it better at these levels than where it was a year ago and maybe the company is finally on the right path to a brighter future (that remains to be seen).

As far as AIMCo, the timing of the deal makes it look suspicious but the fund operates at arms-length from the Alberta government and this deal was in the pipeline for months. I think AIMCo is getting in at the right time and investing in renewable energy is a smart long-term play as long as the terms of the deal make sense.

Does this mean we should force green politics on pension funds? Absolutely not! AIMCo didn’t buy a stake in TransAlta Renewables based on green politics, it expects to make money on this deal over the long-run, just like the Caisse expects to make money with its big investment in Bombardier.

On Monday, I had a chance to meet up with Kevin Uebelein, AIMCo’s chief executive officer, here in Montreal where he was on a business trip. The deal was announced after we met but during our lunch, he told me he was waiting for an important email with a big announcement and apologized for checking his phone.

I enjoyed meeting Kevin Uebelein, he’s a very smart and nice guy and he has an interesting background. For those of you who have never met him, here is a picture of him (click on image):

Kevin worked many years at Prudential before moving on to Fidelity Canada and then AIMCo. His experience with a huge insurer prepared him well for managing a major Canadian pension fund as insurance companies are also in the business of managing assets with liabilities.

We talked about many things, most of which will remain off the record, but I’ll share with you a story I liked. He told me about the time Japanese life insurers got whacked hard when the real estate market cratered in Japan in the early nineties. He told me that investment banks and hedge funds came in to buy properties 10 cents on the dollar and they made off like bandits.

He was able to structure a deal to sell properties of Japanese life insurers Prudential was acquiring at 30 cents on the dollar and he told me it was the first time he realized who was at the other end of the insurance policy and why what he was negotiating mattered a lot. He added: “I want everybody at AIMCo to realize who is at the other end of the pension fund and why what we do matters.”

Kevin also told me he wants to attract more people to Edmonton (no easy feat) as well as hire the cream of the crop from Alberta’s universities. I gave him an idea to create an intern program where students and even new hires with little experience are exposed to operations across public and private markets so they understand the two cultures and how it all fits into the bigger picture of a pension fund.

What else can I share with you? He told me he doesn’t believe that a CEO of a major pension fund can carry the CIO hat as well, “especially when you have different clients like we do at AIMCo.” I completely agree and told Gordon Fyfe a long time ago to drop his CIO duties (which he never did because that was the fun part of his otherwise hectic and stressful job) and focus solely on his CEO duties.

At AIMCo, Kevin appointed Dale MacMaster as the chief investment officer. And unlike Roland Lescure at the Caisse who oversees public markets, MacMaster oversees the entirety of AIMCo’s $80 billion portfolio, which is a huge job since he was previously executive vice president for public market investments, a role he held since 2012.

Every CEO of a major pension fund should take note (including Gordon Fyfe who held on to both hats at bcIMC). If you’re in charge of billions, make sure you hire a qualified CIO who can oversee and allocate risk across public and private markets. If this pisses off some of your senior people, tough luck, let them deal with it.

Is it easy finding a very qualified CIO who can fulfill these duties? Of course not. People like Neil Petroff and Bob Bertram who held this position at Ontario Teachers aren’t exactly a dime a dozen. But in my mind, it’s crazy and highly irresponsible to have all the investment people report to the CEO and not to a dedicated CIO whose sole job is to oversee all investments.

What else? On real estate, Kevin told me AIMCo’s Alberta properties are going to get marked down but he expects nice deals to open up in that market over the next few years and they still have class A properties with solid tenants providing them steady income.

All in all, I came away with a very positive view of Kevin Uebelein. He’s a very nice man who thinks through his decisions and always stresses process over performance. He isn’t averse to taking smart risks but he wants to understand the risks AIMCo’s staff are taking across public and private markets.

That was that, I enjoyed our lunch, told him I’d love to keep in touch and he went off to meet more important people. Still, I thought it was very nice of him to take some time to meet me. I also told him to say hello to Gordon Fyfe the next time they meet and he told me he saw him at conference last month where he looked “extremely relaxed” (Victoria suits Gordon a lot more than Montreal where running PSP had huge payouts but a lot more stress).

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