Author: Leo Kolivakis

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

Back in July, Chris Flood and Chris Newlands of the Financial Times reported on CalSTRS’s private equity woes:

The second-largest US public pension fund has admitted it has failed to record total payments made to its private equity managers over a period of 27 years.

The admission by Calstrs, the $191bn California-based pension fund, prompted John Chiang, the state treasurer of California, to declare he will investigate the failure, which poses serious questions as to how pension fund money is being spent.

The news comes a week after FTfm reported that the state treasurer had voiced “great concern” that fellow pension fund Calpers, the US’s largest at $300bn, also has no idea how much it pays its private equity managers.

Mr Chiang said he would demand clear answers from Calpers over why it does not know how much has been paid in “carried interest” or investment profits over a period of 25 years to the private equity managers running its assets.

A spokesman for Calstrs, which helps finance the retirement plans of teachers, said the fund does not record carried interest. “What matters is the overall performance of the portfolio.”

Following questions from FTfm, Mr Chiang said he would demand Calstrs look into payments of carried interest to its private equity managers.

“Disclosure [of carried interest fees] is very important,” said Mr Chiang, who sits on the administration board of both Calstrs and Calpers.

The revelations come just weeks after US regulators issued an explicit warning to the private equity industry to expect more fines for overcharging investors.

Calpers, which uses more than 100 private equity firms, identified a need to track fees and carried interest better in 2011, but it has taken until now to develop a new reporting system for its $30.5bn private equity portfolio.

But Calstrs, which manages a $19.3bn private equity portfolio and has 880,000 members, said it has no plans to upgrade its systems for tracking and reporting payments to private equity managers.

Margot Wirth, director of private equity at Calstrs, said it used “rigorous checks” to ensure private equity managers took the right amount of carried interest.

All of Calstrs’ partnerships with private equity managers were independently audited, Ms Wirth added. She said the pension fund carried out its own internal audits and employed a specialist “deep dive” team to look at private equity contracts.

Professor Ludovic Phalippou, a finance professor at the University of Oxford Saïd Business School, who specialises in private equity, told FTfm last week: “Calpers’ total bill is likely to be astronomical. People will choke when they see the true number.”

Prof Phalippou said the same would be true of Calstrs, which first invested in private equity in 1998.

Ms Wirth argued it was “wrong to conflate the fees paid to private equity managers with carried interest”.

She said: “Carried interest is a profit split between the investor and the private equity manager. The higher that carried interest is, then the better both the investor and private equity manager have performed.”

The fear is that if sophisticated investors such as Calpers and Calstrs faced difficulties in obtaining accurate information, then it could only be harder for smaller pension funds, endowments and wealth managers that are less well resourced.

David Neal, managing director of the Future Fund, Australia’s A$128bn sovereign wealth fund and one of the world’s largest investors in private equity, said: “There just are not enough decent private equity managers around to justify the fees.”

He added: “We negotiate fee arrangements that transparently reward genuine performance and drive alignment of interest. Where managers cannot meet those expectations, we do not invest. While we work hard at the arrangements with our managers, the industry still has some way to go.”

Fast forward to October where Yves Smith of Naked Capitalism just put out another stinging comment, CalSTRS Board Chairman Harry Keiley, in Op-Ed Rejected by Financial Times, Gave Inconsistent and Inaccurate Information in Carry Fee Scandal (added emphasis is mine):

The staff and board members of California public pension fund CalSTRS continue to embarrass themselves in their efforts to justify their indefensible position on private equity carry fees.

Readers may recall that the biggest public pension fund, CalPERS, had a put-foot-in-mouth-and-chew incident when it said it didn’t track the profits interest more commonly called “carry fees,” which is one of the biggest charges it incurs on its private equity investments. CalPERS added to the damage by falsely claiming that no investors could get that information. After we broke that story and a host of experts and media outlets criticized CalPERS over the lapse and the misrepresentation, CalPERS reversed itself. It asked its general partners for all the carry fee data for the entire history of all of its funds, and obtained it all in a mere two weeks, with only one exception out of the nearly 900 funds in which it has invested.

So what has the second biggest public pension fund, CalSTRS, done? Like CalPERS, it has admitted that it does not track carry fees. But in a remarkable contrast, CalSTRS is attempting to justify inaction by misleading beneficiaries as to how much information it really has and saying that it’s thinking really hard about what (if anything) to do.

The dishonesty of the CalSTRS position is evident in its e-mails with the Financial Times after the pink paper reported that CalSTRS, like CalPERS, did not track carry fees, and California Treasurer John Chiang, who sits on both the CalPERS and CalSTRS boards, said he would press CalSTRS to look into the matter. I became aware of the contretemps when an FT reporter called me to thank me for my work. I asked him how CalSTRS was taking his story. He said they weren’t happy with it and they’d offered CalSTRS the opportunity to publish an op-ed, which was running early the following week. When I failed to see any such article, I contacted the reporter, who said his editor had rejected the article. I then lodged a Public Records Act request (California-speak for FOIA) for the op-ed and all e-mails between CalSTRS and the Financial Times from the date the Financial Times ran the article on CalSTRS’ carry fee tracking.

It’s important to remember that CalSTRS had said, flatly, that it does not know what it pays in carry fees. From the Sacramento Bee on July 2:

Ricardo Duran, a spokesman for the California State Teachers’ Retirement System, said CalSTRS can estimate the fees “within a couple of percentage points” but doesn’t report the figure.

“It’s not a number that we track,” Duran said. “It’s not that important to us as a measure of performance.”

Memo to CalSTRS: if you are estimating, you don’t know for sure.*

After the Financial Times ran its CalSTRS story, Ricardo Duran, CalSTRS’ head of communications, sent a clearly-annoyed e-mail to the Financial Times’ Chris Flood. Duran tried objecting that the so-called carry fee was not a fee because….drumroll..it was not paid directly by CalSTRS to general partners:

The following paragraph talks about [California Treasurer and CalSTRS board member] Mr. Chiang’s demand of CalPERS about how much has been “paid in carried interest.” Carried interest is not a payment but a profit split. I believe [head of private equity] Margot [Wirth] mentioned that distinction as well.

The language throughout the piece conflated carried interest with management/manager fees. That’s fine if that’s the way you want to characterize it. I only ask if you write about CalSTRS and carried interest again, you specifically mention this and attribute it to me or Margot.

So get a load of this: CalSTRS demanding that if the FT ever dare report on CalSTRS’ carry fee reporting again, that it include the staff’s pet position that a carry fee is not a fee, even when that contradicts statements by board members who oversee CalSTRS. Since when do mere employees a California agency have the right to undercut on-the-record statements of top California government officials?

And that’s before you get to the fact that this “carry fee is not a fee” position is bogus. As Eileen Appelbaum, the co-author of Private Equity at Work, wrote:

The email exchange in which CalSTERS argues with the Financial Times over the question of when is a fee not a fee has a certain Alice in Wonderland quality. The CalSTRS representative insists that a fee is not a fee if it takes the form of profit sharing. But profit sharing is clearly a performance fee – a fee paid to the PE investment manager based on the performance of the PE fund.

And as an expert who has been writing about private equity fees for decades said:

Private equity general partners put up around 1% of the money in a fund once you back out management fee waivers. They get 20% of the profits. The part over and above their pro-rata share is clearly a fee. As we lawyers like to say, res ipsa loquitur.

But the best part is Duran’s wounded claim that the FT “conflated” interest with management fees, as if that were inaccurate. This is from the very first limited partnership agreement I looked at from our document trove, KKR’s 2006 fund:

The Partnership will not invest in investment funds sponsored by, and as to which a management fee or carried interest is payable to, any Person….

Gee, KKR says in its own agreement that carried interest is indeed “paid” just like management fees!

But this is all a warm-up to the op-ed that the chairman of CalSTRS’ board, Harry Keiley, submitted to the Financial Times.

[snip]

Go to Naked Capitalism to read the rest of the story, including the rejected op-ed.

Wow, where do I begin? First, let me praise Yves Smith (aka Susan Webber) for lodging a Public Records Act request (California-speak for FOIA) for the op-ed and all e-mails between CalSTRS and the Financial Times and bringing this to our attention.

Second, in sharp contrast to other tirades, I completely agree with Yves Smith, these emails and that editorial are a total embarrassment to CalSTRS and either show gross incompetence on the part of CalSTRS’s private equity staff (Keiley didn’t write that without their input) or more likely, a pathetic attempt to misinform the public on how much has been doled out in management fees and carried interest (“carry” or performance) fees throughout all these years.

Third, and most importantly, I do not buy for one second that the private equity staff at CalPERS or CalSTRS do not track all fees doled out to each GP (general partner or fund) to the penny. If they don’t, they all need to be immediately dismissed for gross incompetence and breach of their fiduciary duties and their respective boards need be replaced for being equally incompetent in their supervision of staff (except keep JJ Jelincic on CalPERS’s board as he’s the only one doing his job, grilling CalPERS’s private equity team and asking tough questions that need to be answered).

I’m not going to mince my words, it’s simply indefensible for any large public pension fund investing billions in private equity, real estate and hedge funds not to track all the fees paid out to the GPs as well as track any hidden rebates with third parties which these GPs hide from their clients, effectively stealing from them.

You might be wondering, how hard is it for a CalPERS or a CalSTRS to track fees and other pertinent information from their private equity fund investments? The answer is it’s not hard at all. Over the weekend, I was looking at buying a few more books in finance (not that I need to add to my insanely large collection) and was looking at one called Inside Private Equity.

I was attracted to the book because one of the authors is Austin Long of Alignment Capital who I met back in 2004 when I was helping Derek Murphy set up private equity as an asset class at PSP Investments. I liked Austin and their approach to rigorous due diligence before investing in a private equity fund (like on-site visits where they pull records off a deal thy pick at random to analyze it and pick a junior staff member at random to ask them soft and hard questions on the fund’s culture).

Anyways, I was reading the foreword of the book which was written by Tom Judge, a former VC investor and inductee to the Private Equity Hall of Fame (1995), and he was writing about how it used to be complicated tracking over 100 partnerships for the AT&T pension fund until he met Jim Kocis, another author of the book, and founder of the Burgiss Group which provides software-based solutions for investors in private equity and other alternative assets (click on image to read passage):

Today the tools Burgiss Group developed support over a thousand clients representing over $2 trillion of committed capital.

Why am I writing this? I’m not plugging Burgiss Group because I simply don’t know them well enough and haven’t performed a due diligence on them but obviously it’s a huge firm with excellent experience in tracking detailed information of PE partnerships on behalf of their clients, providing them with the transparency they need to track their fund investments.

Again, in 2015, it’s simply mind-boggling and inexcusable for a CalPERS or a CalSTRS not to be able to track detailed information on all their fund investments going back decades. This includes detailed information on management fees and carry.

What are CalPERS and CalSTRS hiding? I don’t know but I think John Chiang, the state treasurer of California, is absolutely right to investigate and inform Califonia’s taxpayers on exactly how much has been doled out in private equity, real estate and hedge fund fees over the years at these two giant funds which pride themselves on transparency.

Below, I embedded the three investment committee clips from CalSTRS’s September board meeting. In the first clip, Chris Ailman, CalSTRS’s CIO, discusses their risk mitigation strategies and Mike Moy of Pension consulting Alliance, discusses the performance of private equity in the third clip.

I know they’re excruciatingly long (you can fast-forward boring sections) but take the time to listen to these investment committees as they provide a lot of excellent insights. Not surprisingly, nothing was mentioned on how exactly CalSTRS is going to track and disclose all fees paid to their private equity partnerships (however, in the third clip, Mr. Murphy, a teacher representing the California Federation of Teachers did mention this issue was a huge concern).

If the staff at CalSTRS, CalPERS or anyone else has anything to add, feel free to reach out to me at LKolivakis@gmail.com. I have my views but I don’t have a monopoly of wisdom when it comes to pensions and investments and I welcome constructive criticism on all my comments and will openly share your input, good or bad.

Photo by Stephen Curtin 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.

Saijel Kishan and Katherine Burton of Bloomberg report, Boaz Weinstein’s Revival of Saba Challenged by Pension’s Lawsuit:

For Boaz Weinstein, whose credit fund had hemorrhaged money and investors over the past three years, April seemed like the turnaround moment.

The fund produced the best monthly return in its six-year history, a 10 percent jump that wiped out the pain of March when it suffered its biggest loss ever. From April on, there were no more losses, and he outpaced his rivals as volatility picked up in credit markets. Then on Friday, one of Canada’s largest pension plans and an erstwhile investor, said cheating may have contributed to the big swing — allegations that Weinstein soon called “utter nonsense.”

In a suit filed by the Public Sector Pension Investment Board, once one of the biggest investors in the $1.6 billion Saba Capital Management, the pension fund accused Weinstein of “shortchanging” it by marking down a “significant” portion of the fund’s assets after the retirement plan asked that all its money be returned at the end of the first quarter. The next month, after the pension’s exit, Saba raised the value of the holdings, according to the lawsuit.

Whatever the outcome of the dispute, the accusations could curtail future money-raising for Weinstein, 42, as he seeks to rebuild his business, which has been hit by a 20 percent loss from the beginning of 2012 through last year. The tumble caused clients to pull billions, and employees, including three long-time executives, to leave the firm that once managed $5.5 billion.

‘Fully Vetted’

“Any suit of any nature against a fund manager will be a negative on a due-diligence checklist even if the suit is dismissed,’’ said Brad Balter, head of Boston-Based Balter Capital Management. “It’s not insurmountable, but it will be a hurdle to getting new investors.”

In a statement Sunday, Weinstein said he takes the allegations very seriously, even though they relate to only a “tiny portion” of the pension fund’s investment. “The valuation process was transparent, it was appropriate, it was fully vetted by auditors, counsel and others, and it was entirely fair,” he said. “The suggestion that I manipulated the valuation of two bonds for my personal gain is utter nonsense.”

The court fight could invite scrutiny from the Securities and Exchange Commission, which has cited valuations as one of its priorities this year and anticipates bringing cases involving pricing of portfolios.

SEC’s Concerns

“The SEC has several key concerns and valuation is one of them,’’ said Ron Geffner, a former SEC lawyer. In investigating cases of potential misvaluation, the SEC will look to see if a firm followed the methodologies disclosed in offering documents, its written policies and procedures and other client communications, said Geffner, now at Sadis & Goldberg LLP. If the investment manager deviated from its usual methods, the SEC will ask why the change occurred, he said.

John Nester, a spokesman at the agency, didn’t respond to a message seeking comment outside business hours.

The C$112 billion ($84 billion) pension fund, which oversees the retirement savings of Canadian federal public servants, said it was the Saba Offshore Feeder Fund’s largest investor, having invested $500 million over the course of 2012 and 2013 and accounting for 55 percent of the fund’s assets. The plan said it had asked Saba for its money back early this year, saying Saba’s 2014 losses appeared to be “unrelated to any market development that could or should have adversely affected the fund’s performance had the fund been properly managed,’’ according to the lawsuit.

McClatchy Bonds

Saba couldn’t adequately explain the losses, the Montreal-based pension fund wrote. The pension said it rejected a request by Saba to return capital in three installments, a move that allegedly would hide the redemption from other clients. By late January, clients accounting for 70 percent of the assets in the offshore fund asked for their money back.

The suit filed in Manhattan state court centers on hard-to-sell McClatchy Co. bonds owned by Saba. Between late January and the end of the quarter, there was only one trade done in the bonds that was for greater than $500,000 in notional value. Weinstein was looking to sell about $54 million in the bonds, according to a person familiar with the firm.

Normally, the hedge fund used independent pricing services or brokers who regularly traded the bonds, and these sources valued them at 50 cents to 60 cents on the dollar at the end of the first quarter, the pension plan said. When the pension asked for its money back, Saba used a different process called “bid wanted in competition,” a sort of auction used to trade a block of securities. That method valued the bonds at 31 cents as of March 31. Saba did not sell the bonds, and within a month, returned to its usual pricing methodology, marking the bonds in the 50s, the pension plan said.

Weinstein’s Response

“They did so to stanch further investor defections from the fund and to directly benefit themselves by boosting the residual value of their investments in the fund and other affiliated hedge funds with exposure to the same bonds,” according to the lawsuit. The pension plan, which is represented by law firm Skadden Arps Slate Meagher & Flom LLP, is asking for unspecified compensatory damages and disgorged profits.

Weinstein denied that he changed his pricing methodology in April. “We continued to use the auction to price those (and other) bonds in the second and third quarters of 2015,” he said in the statement. “PSP could have corrected its mistake with a one-minute phone call to me.”

Weinstein said he used the same auction process to sell 29 other bonds, prices that the pension fund didn’t challenge. “We couldn’t discard two of the prices resulting from the auction simply because PSP was unsatisfied with the outcome; to do so would have been improper and unfair to every other Saba investor,” he said. “I am 100 percent committed to treating all of my investors fairly, and I did exactly that in connection with PSP’s redemption.”

‘Price for Liquidation’

Weinstein started Saba — Hebrew for grandfather — in 2009, after he stepped down as co-chief of the credit business at Deutsche Bank AG, where in 2008 he lost at least $1 billion. It was his only losing year out of 11 at the bank, a person with knowledge of the matter said at the time. At Saba, where he trades on price discrepancies between loans, bonds and derivatives, he initially produced strong profits, gaining 11 percent in 2010 and 9.3 percent the following year. Then he struggled as as central banks embraced quantitative easing that reduced volatility in credit markets.

Saba returned 7.6 percent this year through Friday.

Uzi Zucker, an early investor in Saba who pulled some of his money in the first quarter, called the suit unprofessional. “It’s just sour grapes,” he said. “He had to price for liquidation. I never questioned his judgment.”

The case is Public Sector Pension Investment Board v. Saba Capital Management LP, 653216/2015, New York State Supreme Court, New York County (Manhattan).

Antoine Gara of Forbes also reports, Canadian Pension Fund Says It Was Cheated By Boaz Weinstein’s Saba Capital:

The Public Sector Pension Investment board, a pension fund for the Royal Canadian Mounted Police and the Canadian Forces is accusing Boaz Weinstein’s Saba Capital of incorrectly marking assets this year as it sought to redeem a $500 million investment in the hedge fund. PSP said in a Friday lawsuit filed in the New York State Supreme Court Saba and its founder Weinstein knowingly mis-marked assets during the redemption in order to inflate the value of the hedge fund’s remaining assets for investors, including top executives.

Weinstein, a former Deutsche Bank proprietary trader who lost nearly $2 billion for the German bank during the worst of the financial crisis, created Saba Capital in 2009 and quickly took in billions in assets from investors around the world. At its peak, Saba Capital held over $5 billion in assets under management. One of the firm’s most profitable trades was taking the other side of JPMorgan Chase’s so-called London Whale trading debacle in 2012, which cost the bank over $6 billion, but earned Saba significant profits.

When PSP made its $500 million investment in Saba in early 2012, the hedge fund had nearly $4 billion in assets under management. However, in recent years Saba’s assets quickly dwindled amid the fund’s poor performance. By the summer of 2014 Saba’s assets had fallen to $1.5 billion, PSP said in its lawsuit.

In early 2015, PSP reevaluated its investment in Saba and decided to redeem 100% of its Class A shares. At the time, PSP, a $112 billion fund, was Saba’s largest investor. To mitigate the impact of such a large redemption, Saba asked that PSP take its money back in three installments, however, the public pension fund refused.

Saba eventually agreed to a full redemption. PSP alleges that Saba knowingly manipulated its assets to depress their value during the redemption process, thus minimizing its payout.

According to its complaint, PSP accuses Saba of arbitrarily recorded a markdown on some of its bonds during the March 2015 redemption. A month later, Saba then marked its assets upwards. “As a result of defendants’ self-dealing, the Pension Board incurred a substantial loss on its investment in the Fund, for which defendants are liable,” PSP’s lawyers at Skadden, Arps , Slate, Meagher & Flom said in the complaint.

Specifically, Saba is accused of valuing bonds issued by The McClatchy Company using a bids-wanted-in-competition (BWIC) process that created depressed bidding prices that the hedge fund used to value PSP’s investment assets. Other measures from external pricing sources, which the hedge fund had used previously, put the McLatchy bonds at far higher values. Once the redemption was complete, Saba immediately moved away from BWIC valuations and back to those that could be gleaned from external pricing sources.

“[D]efendants used the BWIC process in a bad faith attempt to justify a drastic and inappropriate one-time markdown of the MNI Bonds held by the Master Fund, thereby depriving the Pension Board of the full amount it was entitled to receive upon redemption of its Class A shares of the Fund as of March 31, 2015. By reason of defendants’ unlawful conduct, the Pension Board has suffered substantial damages,” the fund said in its complaint.

In recent weeks Saba partners including Paul Andiorio, George Pan and Ken Weiller were reported by Bloomberg to have left the hedge fund.

Jonathan Gasthalter, a spokesperson for Saba Capital, relied with this comment:

“Saba Capital is disappointed that the Public Sector Pension Investment Board (“PSP”) has chosen to file a meritless lawsuit over the valuation of two securities out of well over a thousand. The difference in value at issue amounts to merely 2.6% of the total of PSP’s former investment with Saba.

As was explained to PSP in writing earlier this year, these two securities were priced using an industry-standard bid wanted in competition (BWIC) process, soliciting competitive bids from every leading broker and dealer in the relevant securities. The BWIC process was fully consistent with Saba’s valuation policy, and was carefully vetted and approved not only by Saba’s internal valuation committee, but by at least four external advisors: auditors, outside counsel, fund administrator, and Saba’s external members of its board of directors.

Contrary to the allegations in PSP’s complaint, Saba did not use the BWIC prices for a single month and solely for purposes of PSP’s redemption, but rather continued to use BWIC pricing as appropriate in the second and third quarters of 2015. Moreover, the results of the BWIC process were accepted by PSP more than 90% of the time, for dozens of securities. In only two instances–the two at the center of PSP’s lawsuit–did PSP take issue with the prices obtained by the BWIC process. PSP’s cherry-picked objection to these two prices has no legal merit.

Saba Capital took great care in redeeming PSP’s investment on a time-table dictated by PSP, including by finding fair and accurate market prices for extremely illiquid positions. Saba Capital looks forward to vindicating its position in court.”

This is an interesting case on many levels. Let me quickly share some of my thoughts:

• First, PSP made a sizable investment in Mr. Weinstein’s hedge fund, having invested $500 million over the course of 2012 and 2013 and accounting for 55 percent of the fund’s assets when it redeemed. I understand scale is an issue for the PSPs and CPPIBs of this world but whenever you make up over 25% of any fund’s assets, you run the risk of significantly influencing the performance of this fund or its ability to garner assets from other investors who aren’t going to invest knowing one investor makes up the bulk of the assets.
• Second, why exactly did PSP invest so much money in this particular hedge fund and what took it so long to exit this fund? Saba Capital Management suffered losses over the past three consecutive years! I would love to know the due diligence PSP’s team performed, especially on the operational front, and understand their rationale after reviewing the people, investment process, operational and investment risks at this fund. It looks like PSP was lulled by the fund’s decent performance in 2010 and 2011 but investing $500 million with a manager who lost $1 billion back in 2008 is crazy if you ask me. There certainly wasn’t a lot of backward or forward analysis on PSP’s part in making such a sizable investment to this hedge fund.
• Third, on the operational front, did PSP perform a due diligence on this fund’s administrator (one that has the expertise to rigorously analyze the fund’s NAV) and was the way the fund prices bonds clearly spelled out in the investment management agreement (IMA)? This lies at the heart of the issue. When you’re investing in a quant/ credit hedge fund that invests in illiquid bonds or derivatives, you need to understand the method it prices these investments and you better be comfortable with it before you sign off on such a sizable allocation. If Mr. Weinstein violated the IMA in any way, then PSP is absolutely right to sue him. If not, PSP will lose this case no matter what it claims. It’s that simple.
• Fourth, this case also highlights why more and more institutional investors are moving to a managed account platform when investing in hedge funds. Go back to read my comments on Ontario Teachers’ new leader and on his harsh hedge fund lessons. Following the 2008 debacle, Teachers’ moved most of its hedge fund investments onto a managed account platform to mitigate operational risk and more importantly, liquidity risk which is currently a huge concern. But even if you have a managed account platform and have transparency, it’s useless unless the underlying investments are liquid. And again, did the manager violate the IMA? That’s the key issue here.
• Fifth, this lawsuit is a black eye for Saba Capital Management which has suffered from redemptions and key departures. As one investor stated in the article, it’s a negative for a due diligence checklist and it will be a hurdle to getting new investors. But the lawsuit also reflects badly on PSP Investments and it will make it harder for this organization to approach top hedge funds which can pick and choose their investors in this tough environment. Nobody wants a litigious pension fund as a client and win or lose, this lawsuit is a lose-lose for both parties involved in the case. Mr. Weinstein claims “PSP could have corrected its mistake with a one-minute phone call to me.” If this is true, then why didn’t PSP call him to rectify the misunderstanding or why didn’t Mr. Weinstein reach out to PSP to make this suit go away?
• Lastly, I would love to know which other pension funds invested in this hedge fund and how this lawsuit and recent redemptions are impacting their impression of the fund.

Those are my brief thoughts on this case. One expert I reached out to shared this with me on this case:

“The situation may have been averted if the proper controls were in place to monitor the fund’s pricing and ongoing monitoring of funds redeeming from it. In this case, it’s a credit hedge fund investing Level 2 assets. The price was most likely derived from broker prices. However, if the controls were put in place, then PSP may have a point and the manager may be at fault.”

There is nothing that pisses off institutional investors more than operational mishaps or fuzzy pricing when they are redeeming from a hedge fund. I remember when I was working at the Caisse investing in hedge funds and we had trouble with a CTA as we wanted to move from a highly levered fund to one of his lower levered funds. It took forever for this manager to execute a simple request and here we are talking about a CTA who invests in highly liquid instruments! I called him a few times and warned him that we weren’t pleased at all and he gave me some lame excuse that the funds were tied up with his administrator.

News flash for all you overpaid hedge fund Soros wannabes out there. When an institutional investor wants to redeem, please stop the lame excuses on your pathetic performance and don’t get cute on pricing. In fact, you should be bending over backwards to accommodate these investors on the way out just as hard as when you were schmoozing them when you wanted them to invest in your fund.

As always, if you have anything to add on this case, you can email me at LKolivakis@gmail.com. Let me end by plugging a couple of Montreal firms that specialize in operational due diligence for hedge funds, Castle Hall Alternatives run by Chris Addy and Phocion Investments which is run by Ioannis Segounis, his brother Kosta, and David Rowen (Phocion specializes in performance, operational and compliance due diligence. In fact, performance analysis is Phocion’s bread and butter which gives them a real edge over their competitors).

As far as a managed account platform, Montreal’s Innocap is still around and provides excellent services to institutional investors looking to gain more transparency on their hedge fund investments and significantly mitigate their operational and liquidity risks (for a small fee, of course, and Innocap also makes sure the hedge fund managers are properly pricing all their investments on a daily basis and raise flags if they see discrepancies in the pricing).

Photo by Joe Gratz 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.

Joseph Cotterill of the Financial Times reports, Ontario Teachers’ eyes London expansion:

Ontario Teachers’, the Canadian pension plan that owns the UK’s High Speed One railway and its National Lottery operator, is planning to expand further in London, tripling the size of its European investment team.

It revealed on Thursday that it aimed to grow its private equity arm by adding staff in infrastructure and in what it calls “relationship investing” — investing in public or nearly-public companies and working closely with the managers.

Teachers’, which has $160bn in assets, this month moved from Leconsfield House, MI5’s former haunt, into a bigger steel-and-glass building overlooking Marylebone’s leafy Portman Square.

Its expansion is expected to lead to further purchases in the UK, where it also owns Birmingham and Bristol airports.

“We own four airports, so why wouldn’t we look at London City Airport?,” says Jo Taylor, Teachers’ European head, highlighting one asset that is coming to the market. (Teachers also owns Brussels and Copenhagen airports.)

“If an asset like London City became available, or an asset like HS2 [HS1’s potential successor] became available for funding, clearly we would be interested,” he adds.

Ontario Teachers’ is one of a rare breed of pension fund investors — many of them Canadian — that are using in-house teams to find and buy assets independently, or alongside buyout firms, as well as paying fees to traditional third-party funds.

They are increasingly seen by some buyout managers as rivals in a market where prices are high and deals scarce.

“They’re the poster boy, the role model if you like, for increasingly active investors in private equity,” says Stephen Gillespie, a partner at Gibson Dunn.

Mr Taylor, a veteran of 3i, the British buyout firm, prefers to talk about partnership.

Expanding in London, in a timezone where the fund can quickly give feedback on investment offers, provides “the ability for us to develop strategic relationships for the plan over the long term”, he says. “Teachers’ is very much focused on partnering.”

Last year it invested in CSC, a coin-operated laundry machine company owned by Pamplona Capital Management. Last week it continued the relationship, buying a stake in Pamplona’s OGF, France’s biggest operator of funeral parlours.

The nature of these businesses — unglamorous, but with inflation-busting cash flows — is not the private equity norm.

Part of the reason Teachers’ has become a large investor in infrastructure — typically a long-term investment — is that its private market returns have to protect future payouts to its more than 300,000 pension members. Public-sector pension plans must be fully-funded under Canadian law. (LK: this is false, only true in the Netherlands)

Ron Mock, chief executive, says the UK is the “model that the rest of the world follows” on infrastructure investment policy.

“It’s about clarity of outcome, it’s the regulatory environment,” he adds. “There’s not a lot of, or hardly any, renegotiation after a deal is done.”

But in both infrastructure and private equity, asset prices are high, as capital is flooding into what are inherently scarce assets from low-yielding public markets.

In buyouts, some question whether Teachers’ edge is simply overpaying and reducing its future returns.

Teachers’ view is that it takes a different perspective to traditional private equity firms by holding investments for the longer term.

Private equity firms can often own businesses for half a decade or more — but the limited lives of funds means they have to sell within a set period.

The nature of leverage, used to juice returns, can also make funds unwilling to inject more capital after the first investment.

“We can provide multiple subsequent rounds of capital,” Mr Taylor says. “We can hold an asset for seven, 10, 12 years . . . we look at these projects with a conservative approach. We’re more likely to apply lower levels of debt.”

In terms of Teachers’ returns, Mr Taylor says the fund has a 24-year record in private equity of 20 per cent net returns.

There is some academic evidence to back this up. In 2014 a Harvard Business School paper found ‘solo’ direct investments in private equity by seven anonymous large institutional investors returned more than public markets between 1991 and 2011.

Although these deals fared better than co-investing in companies alongside private equity managers, their outperformance versus investing in buyout funds was more mixed.

“While direct investments consistently outperform the market, they do not regularly outperform other private equity investments,” the paper argued.

This is an excellent article but let me go through some of my thoughts. First, unlike the Netherlands, there are no laws forcing public sector pension plans in Canada to be fully-funded. It’s too bad because I think everyone should be going Dutch on pensions, including our much touted Canadian funds which are global trendsetters.

Second, I have mixed feelings about Canadian pension funds opening up offices in London, New York, Hong Kong or elsewhere. On the one hand, I understand why they need “boots on the ground” but is it really necessary, especially if they have solid partners in these regions to work with? I’m not convinced about opening up foreign offices and paying people a lot of money for a job that can be done by pension fund professionals in Canada working with solid partners (here I prefer PSP’s approach than CPPIB’s and Teachers’). But if it works and helps reduce fees, maybe there is a rationale for such an approach.

Third, while direct investments in private equity do not regularly outperform other private equity investments, more and more private and public companies are looking for a long-term partner like Ontario Teachers’ when it comes to improving their operations. Even private equity funds are thinking long-term these days, emulating Buffett’s approach.

But don’t kid yourself. Mark Wiseman, president and CEO of CPPIB, told me a few years back that Canada’s pension fund invests and co-invests with top private equity funds because he “can’t afford to hire a David Bonderman.” However, in infrastructure, he told me CPPIB goes direct like most of Canada’s large pension funds.

Fourth, Ron Mock, the president and CEO of Ontario Teachers’, sounded the alarm on alternatives in late April. He knows the current environment is extremely difficult for liquid and illiquid investments but he and his team are always on the hunt for reasonably priced prize assets, especially in infrastructure.

In fact, Ron clearly explained OTPP’s asset-liability approach to investing when we chatted about the plan’s exceptional 2014 results. Everything at Teachers’ is about matching assets to liabilities. So, when I read that Teachers’ recently bought a stake in a French funeral business, I wasn’t surprised. These type of businesses aren’t glamorous but they provide steady cash flows over a long period, just like infrastructure.

Let me end this comment by plugging a firm in Toronto, Caledon Capital Management. I recently met three partners — David Rogers, Stephen Dowd and Jean Potter — here in Montreal and was thoroughly impressed with their approach in helping small and medium sized pension plans and family offices gain a foothold in infrastructure and private equity.

Prior to founding Caledon, David was the SVP at OMERS’ Private Equity and Stephen was the SVP, Infrastructure and Timberland, at Ontario Teachers’ before he joined Caledon last year. Together, they have years of experience working at public pensions which gives them an advantage when they assist their clients on board investment committees, helping them invest in these alternative asset classes.

[Footnote: David Rogers is one of the nicest guys I ever met in the pension fund industry and he helped Derek Murphy, PSP’s former SVP of Private Equity, and I a lot when we prepared the board presentation on private equity back in 2004. Derek, if you’re reading this, contact David at drogers@caledoncapital.com.

Also worth noting that Guthrie Stewart joined PSP Investments in September 2015 as Senior Vice President, Global Head of Private Investments. He will be replacing Derek Murphy in this new role and you can read about him here.]

As always, please remember to subscribe and/ or donate to PensionPulse via PayPal at the top right-hand side and support my efforts in bringing you the very best insights on pensions and investments. I thank all of my institutional supporters who value the work I provide them with.

Photo by  @Doug88888 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.

Stephen Foley of the Financial Times reports, Harvard endowment warns of market ‘froth’:

Harvard is looking for investment managers with expertise as short-sellers, as the world’s biggest university endowment becomes more cautious about the outlook for financial markets.

In its latest annual report, which showed investment returns fell to 5.8 per cent in the year to June, the $38 billion endowment said its managers had started to increase cash holdings and feared that some markets had become “frothy”.”We are proceeding with caution in several areas of the portfolio,” Harvard Management Company chief executive Stephen Blyth wrote in the report.

“We are being particularly discriminating about underwriting and return assumptions given current valuations.

“In addition, we have renewed focus on identifying public equity managers with demonstrable investment expertise on both the long and short sides of the market.”

Mr Blyth, a British-born statistician, was promoted to run the endowment last year after the resignation of Jane Mendillo, whose returns failed to keep pace with those at other Ivy League institutions.

Mr Blyth unveiled an overhaul of Harvard’s asset allocation process which is likely to be examined widely among other institutions.

Endowments such as those at Harvard, and particularly Yale under its chief investment officer David Swensen, have been seen as pioneers in asset allocation and portfolio management theory.

Harvard is ditching its traditional approach of assessing the likely risk and return of each separate asset class and instead focusing on five key factors: the outlook for global equities, US Treasuries, currencies, inflation and high-yield credit.

The result is that Mr Blyth will be sharply scaling back the university’s holdings of overseas equities, dialing up real estate and bond investments, and giving himself more flexibility.

He set out a new promise to beat inflation by 5 per cent a year over 10 years.

The 5.8 per cent gain for the Harvard endowment in the year to June 30 compared with 15.4 per cent the previous year, when global equity markets were rising more sharply.

Its $6 billion allocation to hedge funds also held back performance, returning only 0.1 per cent.

While disappointing hedge fund performance has led some big institutions, including the California public pension fund Calpers, to pull out of the sector all together, Harvard is understood to be happy with its hedge fund portfolio, which outperformed its benchmark in the five previous years.

The endowment’s real estate portfolio was its top performing asset, up 19.4 per cent last year.

So, Mr. Blyth will scale back the endowment’s holdings of overseas equities but dial up real estate and bond investments and is giving himself more flexibility.

Interestingly, the real estate portfolio was the endowment’s top performing asset, up 19.4 per cent last year, which makes me wonder if there’s a performance bias attached to the decision to dial up this asset class while other big investors are dialing down real estate risk.

Mr. Blyth should go back to read David Swensen’s thoughts on real estate in his seminal book, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment (page 116; added emphasis is mine):

“Real estate markets provide dramatically cyclical returns. Looking in the rear-view mirror in the late 1980s, investors generated wild enthusiasm for real estate as historical statistics dominated numbers for traditional stocks and bonds. A few years later, after the market collapse, those same investors saw nothing other than dismal prospects for real estate. poor returns nearly eliminated interest in real estate as an institutional investment asset. Reality lies somewhere between the extremes of wild enthusiasm and despair.”

It’s worth noting that Harvard’s endowment may have hit record assets but as Geraldine Fabrikant of the New York Times reports, its performance is hardly exceptional and it’s lagging its peers:

The Harvard University Management Company, which oversees an endowment of $37.6 billion, the academic world’s largest, generated a 5.8 percent return for its most recent fiscal year, significantly lower than several of its rivals.

The return, for the year that ended June 30, beats the preliminary 5.6 percent figure that Cambridge Associates released as the average for endowments over $3 billion that it tracks.

Still, “the Harvard result was disappointing,” said Charles Skorina, owner of a company that recruits chief investment officers for endowments.

Mr. Skorina noted that Harvard had consistently underperformed its rivals over the last few years despite having one of the biggest and most expensive endowment offices.

While Harvard’s biggest rivals in the universe of large endowments — including Princeton and Yale — have yet to release their returns, several people in the endowment sector said that those schools were all expected to release results of well over 10 percent. The people spoke on the condition of anonymity.

Massachusetts Institute of Technology, for example, just reported a 13.2 percent return. Bowdoin College, a far smaller school with a $1.3 billion endowment, this week reported returns of 14.6 percent.

Still, results varied widely. The University of Texas Management, which has $26.6 billion to manage, reported that it had a weighted 3.5 percent return for its two funds.

Weak returns in the market are expected to depress investment performance at schools where portfolios are limited to stocks and bonds. But schools such as Harvard have access to a range of alternative investments such as private equity, hedge funds and real estate.

In the last fiscal year, private equity and real estate fared particularly well. Although Harvard did not disclose its asset allocation in its most recent report, it had roughly 20 percent of its assets in private equity in the 2014 fiscal year; Yale, by contrast, had about 33 percent of assets in that sector. Harvard’s decision not to provide its asset allocation numbers made it harder to evaluate the impact of allocation decisions on performance.

And although Harvard outperformed the internal benchmarks it sets for itself in all but the “absolute” or hedge fund category, the outperformance may not necessarily have been as impressive as those at other endowments. There were, however, some savvy moves, such as eliminating investment in commodity indexes when such investments were posting steep declines.

Endowment performance is crucial at all colleges because a portion of the returns are used to finance their annual budgets. Harvard relies on the endowment for roughly 35 percent of its yearly expenses.

Still the Harvard endowment’s leadership team has had a lot of turnover ever since Jack Meyer stepped down as its head in 2005. Harvard had — and continues to have — a strategy in which a portion of its money is managed internally and a portion is managed externally by investment firms including hedge funds. It is the only large university to use such an approach. Most endowment chiefs allocate the school’s funds to outside managers.

Before Mr. Meyer’s departure, some members of the Harvard faculty had complained that money managers who worked at the Harvard Management Company were paid enormous sums of money compared with academics. The negative publicity was said to be a factor in Mr. Meyer’s decision to leave, despite a stunning record. He was replaced first by Mohamed El-Erian who had been at Pimco. Mr. El-Erian left in 2007 to return to that firm.

He was followed by Jane Mendillo, who had once worked at Harvard and then ran the endowment for Wellesley College, but she quit in 2014 after returns proved disappointing.

She has since been replaced by Stephen Blyth, who was promoted to president and chief executive after many years at the endowment firm. Mr. Blyth had previously held posts as head of internal management and public markets.

In a long letter released with the performance figures, Mr. Blyth signaled that he intended to keep with Harvard’s history of managing some of its money internally, but he suggested that he would make changes.

For example, he wrote that he would aim to have his internal money managers work more closely with one another by tying their compensation not just to the assets each one managed but also how the endowment as a whole performed.

Still, Harvard may not pay the same sums as private firms, which could lead to difficulties in attracting and keeping talent.

You can read Mr. Blyth’s long letter here. I think his proposed changes to the way managers are compensated is right on the money and here he’s following the compensation model many large Canadian pension funds have successfully implemented.

Below are two figures I want to bring to your attention from HMC’s Annual Report (click on image):

Every single investment fund should post these figures. You will notice the standard deviation of fiscal year endowment returns in Figure 1 is 12.5%, which is a bit high but mostly owing to risks the endowment takes to achieve its return objective.

More importantly, the long-term performance (ten and twenty years) over the domestic and global 60/40 stock-bond portfolios in the second figure is what ultimately matters and it’s stellar (provided these returns are net of all fees and internal costs).

While HCM seems satisfied with their hedge funds, the truth is small and large hedge funds took a beating this summer but the former were better able to navigate through this turbulence.

As far as HMC’s warning of market froth, I would agree that all assets are priced richly but some investors are betting big on a global recovery while others are warning of more pain ahead.

You already know my thoughts. I’m preparing for a long period of global deflation but in the meantime there’s plenty of liquidity in the global financial system to propel risk assets much higher. In the current environment, I continue to steer clear of energy (XLE), oil services (OIH) and metal and mining stocks (XME) and anything related to emerging markets (EEM) and Chinese shares (FXI).

In fact, check out the price destruction in the stocks I covered in my comment on betting big on a global recovery, it’s just brutal (click on image):

On the long side, I still like tech (QQQ), especially biotech (IBB, XBI and SBIO) and keep tracking what top funds are investing in. For example, today I noticed shares of Heron Therapeutics (HRTX) popped 20% after the company announced positive results from its Phase 2 clinical study of HTX-011 in the management of post-operative pain in patients undergoing bunionectomy (click on image).

And who are the top holders of Heron Therapeutics? Who else? The Baker Brothers, Fidelity, Broadfin, Tang Capital Management, ie. the very best biotech funds. This is why I tell you to pick your spots carefully when investing in single biotech names, diversify and focus on companies where you see many top biotech funds investing at the same time.

Still, investing in biotech isn’t for the faint of heart and as I warned you in my comment on time to load up on biotech, it will be extremely volatile. Earlier this week, a tweet by Democratic candidate Hillary Clinton sent biotech shares plunging. It was much ado about nothing and she was right to blast the CEO of that drug company for price gouging.

Photo credit: Flickr/Chaval Brasil 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.

Allison Lampert of Reuters reports, Canadian pension fund does not need to take greater risks:

The top real estate executive of Canada’s second-largest pension fund said he won’t have to make riskier investments to achieve his target of a 7 percent to 8 percent average annual return for the next decade.

Daniel Fournier, chief executive of Ivanhoe Cambridge, the real estate arm of Caisse de depot et placement du Quebec, said on Monday he won’t have to take bigger risks as yields weaken, a strategy he saw many investors take before the global financial crash.

“I don’t think the answer is to go way up the risk curve,” he told reporters in Montreal.

Ivanhoe Cambridge, which owns C$48 billion ($36.22 billion) in assets, generated an average 13 percent return a year over the last five years, a target that is no longer “sustainable” as markets cool, Fournier said.

He said Ivanhoe Cambridge would continue to use the same strategy of striking a balance between higher yielding, opportunistic transactions and the purchase of quality properties that deliver stable but comparatively lower returns.

“It’s the balance between the two that gave us the 13 percent over the last five years and where we’re trying to produce the 7 or 8 percent that the Caisse is expecting from us,” he said.

In January 2015, Ivanhoe Cambridge generated headlines for buying 3 Bryant Park in New York for $2.2 billion, a near-record price for an individual U.S. office building.

While commercial real estate prices have soared in global gateway cities like New York and London, Fournier said that unlike 2007 and 2008, he doesn’t see any froth, or trend of overbuilding in U.S. markets that was prevalent in the run-up to the global crash.

For those of you who don’t know him, Daniel Fournier is one of the most powerful under the radar real estate investors in the world. He heads a very experienced team at Ivanhoe Cambridge and doesn’t get the recognition he truly deserves (he’s a shoo-in to succeed Michael Sabia if he wants the top job at the Caisse in the future).

Fournier might not get paid the big bucks a few of his counterparts are collecting but he’s running one of the best real estate outfits in the world and definitely the best in Canada. In fact, when it comes to real estate, the Caisse’s subsidiary has few competitors in the world.

And when it comes to real estate benchmarks, there too the Caisse is leading its large counterparts in Canada. How do I know? I took the time to read the Caisse’s 2014 Annual Report which was released in late April. It’s packed with excellent information on the performance, benchmarks and a lot of other insights pertaining to the Caisse’s operations.

Below, you can read the real estate performance highlights taken from page 40 of the Caisse’s Annual Report (click on image):

As you can read, the real estate portfolio 10% in 2014, exceeding its long-term target. Moreover, as stated: “all the transactions had the same objective: to sell non-strategic assets so as to focus the portfolio on high-quality assets and to build critical mass in certain sectors and key markets.”

Below, you can view the shift in the sector and geographic exposure of the Caisse’s real estate investments over the last four years (click on image):

While the Caisse still has significant real estate investments in Canada (47%), it’s been growing its U.S. portfolio (so have others in Canada) and reducing its exposure to European real estate. In terms of sectors, the Caisse has been betting big on multi-family real estate over the last few years and shedding its opportunistic hotel assets.

Now, below is the most important table taken from page 48 of the Caisse’s 2014 Annual Report. It shows you the specialized portfolio returns in relation to the benchmark indexes (click on image):

As you can see, the Caisse’s real estate portfolio returned 9.9% in 2014, underperfoming its benchmark which returned 11.1%.  Over a four-year period, the the Caisse’s real estate portfolio returned 12.1% annualized vs a benchmark return of 13.8% annualized.

So, if the Caisse’s real estate subsidiary is underperforming its benchmark over a one and four year period, why am I praising it? Because when I analyze pension funds and their respective performance, it’s all about benchmarks, stupid!

I couldn’t care less about headline performance figures, I want to know the benchmarks governing the underlying portfolios and what risks pension fund managers took to beat their benchmark and whether those risks are appropriately reflected in the benchmark of each investment portfolio.

Similarly, when some hedge fund hot shot was touting their “super high Sharpe ratio,” I would rip into them if they were taking stupid risks in derivatives and trying to pull a fast one on me thinking I’m an idiot.

When I look at the benchmark governing the Caisse’s real estate portfolio (Aon Hewitt Real Estate index, adjusted), I can easily discern that the group at Ivanhoe Cambridge doesn’t have a free lunch when it comes to its real estate benchmark.

Again, I don’t want to beat a dead horse but go back to read my detailed comment on PSP’s fiscal 2015 results, especially the part about their Real Estate benchmark, and I’ll let you draw your own conclusions on who has it easy and who doesn’t when it comes to Canada’s pension plutocrats.

As far as other news related to the Caisse’s private markets, Reuters reports, Caisse, Mexican funds to co-invest in infrastructure projects:

Canadian pension fund manager Caisse de dépôt et placement du Québec said on Monday it has formed an investment platform with a group of leading Mexican institutional investors to put money into infrastructure opportunities in Mexico.

The new vehicle will invest C$2.8 billion ($2.1 billion) over the next five years in energy generation and distribution, along with investments in other areas like transportation and public transit, said the Quebec-based pension fund manager.

Caisse said it plans to commit some C$1.43 billion to the fund and retain a 51 percent stake in the investment vehicle. CKD IM will hold the remaining 49 percent.

The current shareholders of CKD IM are Mexican pension fund managers XXI Banorte, SURA, Banamex, Pensionissste and Infrastructure fund Fonadin. These pension fund managers together manage some 62 percent of Mexican pension fund assets, said Caisse.

“When we look around the world, especially in the infrastructure sector, Mexico stands out as an exceptional country to invest in,” said Caisse Chief Executive Michael Sabia in a statement.

Caisse has been a major infrastructure investor for over 15 years. Its infrastructure portfolio is currently worth more than C$11 billion and includes investments in the Port of Brisbane, Heathrow Airport, Eurostar and Colonial Pipeline in the United States.

The pension fund manager has stated that it plans to double the size of this portfolio by 2018.

“We believe recent reforms in the energy and infrastructure sectors have opened the possibility of win-win partnerships that will benefit the whole Mexican economy,” said Grupo Financiero Banorte CEO Marcos Ramirez Miguel in the joint statement issued by Caisse.

As part of the transaction announced Monday, CKD IM is also acquiring 49 percent of Caisse’s equity investment in the ICA OVT venture, which currently owns four toll road concessions in Mexico.

No doubt about it, Mexico is a big growth market for the Caisse and Michael Sabia has repeatedly gone on record to state this. That country has huge potential but its disorganized crime continues to be a source of major concern.

Still, Mexico’s new breed of cartel killers isn’t dissuading the Caisse from investing there and truth be told, if you read the nonstop coverage of Mexican crime, you’d think the country is a basket case, which it most certainly isn’t.

Also worth noting the Caisse has beefed up its infrastructure team headed by Macky Tall and hired some outstanding professionals with direct infrastructure investment experience. This will come in handy as it prepares to handle Quebec’s infrastructure projects.

Hope you enjoyed reading this comment. If anyone has anything to share, feel free to email me your thoughts (LKolivakis@gmail.com) on this subject. As always, please remember to donate and/or subscribe to this blog (http://pensionpulse.blogspot.com/)  on the top right-hand side via PayPal. Thanks you!

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

Editor’s note: More Pension360 coverage of public pensions’ opposition to BoA’s governance shift can be found here and here.

Michael Corkery of the New York Times reports, Bank of America’s Fight to Keep Brian Moynihan’s Dual Roles:

Forget the Iowa caucuses or the New Hampshire primary. One of the more intense and dogged campaigns is currently being waged by Bank of America to convince shareholders that Brian T. Moynihan should keep his job as both chairman and chief executive.

Top bank executives and one of its board members have pounded the pavement from London to Houston, lobbying dozens of investors. They cut a deal to mollify one outspoken critic, and they enlisted the help of the former Massachusetts congressman Barney Frank, an architect of Wall Street’s regulatory overhaul. Mr. Frank said he agreed to make the case for Mr. Moynihan after discussing the issue with his neighbor, an executive at Bank of America, the nation’s second-largest bank.

The battle engulfing the bank has had, at times, the feel of a local City Council race. It has featured a cast of characters including a Roman Catholic priest, Warren E. Buffett and two giant California pension funds that have mounted an aggressive countercampaign to strip Mr. Moynihan of his chairmanship.

As many as 40 percent of shareholders were expected to vote against Mr. Moynihan from the outset, leaving about 60 percent up for grabs — a huge group that includes major money management firms like T. Rowe Price and BlackRock.

That the vote, scheduled for Tuesday in Charlotte, N.C., has proved so contentious shows the depths of discontent with Bank of America, mostly over how the bank’s board decided to give Mr. Moynihan both titles in the first place. It did so unilaterally last year, overturning a previous shareholder vote in 2009 that required the bank to have a separate chairman and chief executive.

But the battle also illustrates how the byzantine world of corporate governance can consume the time and attention of a company’s leadership.

Bank officials say Mr. Moynihan, chief executive since 2010, earned the right to also become chairman last year, having steered the company through a near-death experience after its costly acquisition of Countrywide Financial in 2008 and Merrill Lynch in 2009. They say there is no conclusive evidence that companies with separate chief executives and chairmen perform better than those that don’t divide the roles.

The two pension funds leading the charge against the bank — the California Public Employees’ Retirement System and the California State Teachers’ Retirement System — argue that an independent chairman would provide better oversight of a bank with a troubled history.

“Since Mr. Moynihan’s appointment as C.E.O. in January 2010, the company has continued to underperform, has failed important Fed stress tests, and has perpetuated a subpar engagement with its shareholders,” the California pension funds wrote in a joint letter to the bank’s lead independent director last month. “Given these missteps, we do not believe now is the time to reduce oversight of management by combining the roles of C.E.O. and chair.”

The pension funds’ sway goes beyond their less than 1 percent ownership of the bank’s shares. They have been calling and writing to the largest shareholders — including some firms they may pay to manage money on behalf of the California pensioners — urging them to vote against the combined role.

For some shareholders, the C.E.O.-chairman vote is more of an incidental bargaining chip. When the issue came up in 2009, for example, union groups that supported separating the roles were also pushing behind the scenes for the right to organize Bank of America employees, according to people briefed on the matter.

If anything, the current contest — which has reached a fever pitch this week — has been an unwelcome distraction for Bank of America just as it had put most of its legal and regulatory troubles behind it.

In 2013, JPMorgan Chase’s chief executive and chairman, Jamie Dimon, faced a similar vote, which had been stoked by the bank’s embarrassing trading loss, known as the London whale. Mr. Dimon prevailed.

Bank of America’s campaign is being run by its general counsel, Gary G. Lynch, and its head of global marketing, Anne M. Finucane, who has labored for years to burnish Mr. Moynihan’s image as a banker willing to work with regulators and community groups to right the wrongs of the financial crisis.

That image was dimmed by the board’s decision last October to overturn a bylaw that required the bank to keep its chairman and chief executive roles separate. The board argued that like most big American companies, Bank of America should have the ability to decide whether to grant its top executive one or both titles.

Still, some shareholders and others were outraged. Sensing his moment, the Rev. Seamus Finn proposed putting the issue to a vote at the bank’s annual meeting in May.

Father Finn, a Catholic priest who advises church groups on investment issues and is chairman of the Interfaith Center on Corporate Responsibility, said the leadership question was not his primary concern, but he figured that a proposal to split the role would probably get him a meeting with the bank’s top leadership.

It worked. Bank of America agreed to give Father Finn what he really wanted — a report detailing what went wrong at Bank of America during the mortgage crisis. And in return, Father Finn said he agreed to dropped his proposal to divide the top positions.

Even though the issue did not make it on the ballot at the annual meeting, the proxy advisory firms Institutional Shareholder Services and Glass Lewis urged the bank’s shareholders to vote against members of the board’s corporate governance committee because of the unilateral decision to combine the titles.

Acknowledging the extent of the shareholders’ displeasure, the bank decided to put the issue to a special vote and started campaigning.

A major player in the effort is the bank’s lead independent director, Jack O. Bovender Jr., a former health care executive and Duke University trustee. Described by a bank colleague as the consummate Southern gentleman, Mr. Bovender has been making the rounds of investors, explaining why the board moved to make Mr. Moynihan both chairman and chief executive.

Mr. Bovender has not been able to win over everyone, though. In a conversation last month, he told Institutional Shareholder Services how he agreed to take a leadership role at the bank only if no other board member wanted to step in.

Mr. Bovender was speaking “tongue in cheek,” a person briefed on the matter said. But apparently the proxy advisory firm did not see it that way, calling his anecdote “particularly telling.”

“While shareholders should be glad that Bovender stepped into this leadership vacuum by accepting the lead director role,” it wrote in its report, “it calls into question the board’s acceptance of an individual without relevant industry experience.”

With I.S.S. and Glass Lewis recommending that the jobs of chief executive and chairman be separated, the bank most likely lost as much as 30 percent of the vote because certain shareholders vote automatically with the proxy firms, people briefed on the matter said.

In trying to win over other investors, the bank has had to navigate somewhat unfamiliar territory. Each large investor approaches these votes differently. Some firms consider the opinions of their portfolio managers and analysts, who recommend whether to buy the bank’s shares. Others allow only their corporate governance committees to weigh in.

Bank of America cannot even lobby its largest shareholder, BlackRock, directly. Because BlackRock is partly owned by another bank, PNC Financial Services, the giant asset manager has to outsource its vote to an independent fiduciary so as not to run afoul of the Bank Holding Company Act.

A BlackRock spokesman declined to name the outside fiduciary, citing “company policy.”

Last week, Bank of America got help from Mr. Buffett, who said in a television interview that Mr. Moynihan deserved both titles.

Then, Mr. Frank voiced support for the combined roles, calling Mr. Moynihan “one of the more constructive” bank leaders in helping shape recent financial regulation.

Mr. Frank is not a Bank of America shareholder. But his endorsement could persuade some unions or progressive-minded investors to break from the California funds and back the bank’s position.

Mr. Frank said he volunteered to speak publicly after discussing it with his neighbor in Newton, a Boston suburb, who works for the bank in communications and public policy. Mr. Frank, who recently joined the board of Signature Bank, a small commercial bank in New York, said the most important oversight of financial companies comes not from its directors but from regulators.

“People expect too much of boards,” he said.

I would have to disagree with Mr. Frank, people should expect a lot more from boards, many of which are filled by incompetent people who are not asking enough questions but are there to collect a cheque.

As far as the central issue, whether or not Mr. Moynihan should carry the dual role of chairman and chief executive, I’d have to agree with the recommendation of I.S.S., Glass Lewis, CalPERS, CalSTRS and New York City’s $165 billion pension funds which will also vote to strip Moynihan of his chairman title:

The funds, overseen by New York Comptroller Scott Stringer, hold 25.2 million shares, which would place them roughly in the top 60 shareholders based on the latest publicly available information.

Investors will vote on Sept. 22 on bylaw changes made last year to give Moynihan the additional job. That move undid a vote by shareholders in 2009 to require an independent chair.

The vote is expected to be close. Other large investors that have also said they will vote to separate the Chairman and CEO roles include the California Public Employees’ Retirement System and California State Teachers’ Retirement System.

Via email, a Bank of America spokesman said the bank has turned itself around since the financial crisis and wants “the same flexibility on corporate governance as 97 percent of the S&P 500. We respectfully recognize that stockholders have varying views, which is why the board committed to holding the vote.”

So, 97 percent of S&P 500 companies don’t split the role of chairman and CEO or have flexibility to decide who occupies such a role? If that’s the case, Congress should pass corporate governance laws making it illegal to occupy a dual role under any circumstance.

For me, it’s pure logic. Why would you want to give the CEO of a major bank, especially one that was embroiled in the mortgage crisis that led to the 2008 crisis, a lot more power? Big U.S. banks aren’t just any old S&P 500 company, they’re systemically important financial institutions and need a lot more scrutiny from regulators, board members and investors.

But Mr. Moynihan has some very big supporters who think he deserves the dual role. One of them is the Oracle of Omaha who came out to give him a vote of confidence at a critical time:

Warren Buffett thinks Bank of America CEO Brian Moynihan is doing a great job.

Business Insider reached out to Buffett, who took a huge stake of Bank of America preferred stock and warrants four years ago, and asked for his take on the bank’s shareholder vote coming up later this month.

To recap: Bank of America’s vote gives shareholders the opportunity to sign off on, or reject, its plan to combine its chairman and CEO role into one under Moynihan.

The plan has some critics, with a small group of shareholders representing less than 1% of its stock banding together to say they’re opposed to the consolidation.

The Oracle of Omaha, according to a representative for Berkshire, is “100% in support of Mr. Moynihan and believes he is doing an outstanding job for Bank of America shareholders.”

“When he took over as CEO, he was handed one of the toughest jobs in the history of American banking.”

The bad news for Moynihan is that neither Berkshire’s preferred shares or warrants hold a vote, meaning Buffett has no recourse to participate in the shareholder vote.

But having the billionaire investor on his side must be heartening for Moynihan.

Sure, having Warren Buffett on your side always helps, but I have to wonder why the Oracle of Omaha is praising Moynihan’s performance. The bank has turned around since the crisis and Moynihan has cleaned up a huge mess but when I look at the performance of Bank of America (BAC) relative to other big U.S. banks, I’m hardly enthralled and neither are many shareholders.

In fact, South Korea’s sovereign wealth fund wants Moynihan out and Deirdre Fernandes of the Boston Globe reports, Wellesley banker faces challenge to his Bank of America leadership:

Brian T. Moynihan, the Boston banker and lawyer who became chief executive of Bank of America, is facing the first shareholder challenge of his five-year tenure as concerns mount over his leadership and the bank’s performance.

Moynihan, a Wellesley resident, has shepherded the nation’s second-largest consumer bank through the financial crisis and its aftermath, settling billions of dollars in federal lawsuits over bad mortgages and faulty foreign-exchange practices, shedding unprofitable units, closing hundreds of branches, and shoring up capital to withstand another economic shock.

But shareholders are wondering whether the 55-year-old executive, known for hard work and sharp thinking rather than salesmanship, is best able to lead the bank into a new era of growth.

On Tuesday, they’ll vote during a special meeting on whether to bless a decision made last year — without consulting shareholders — to expand Moynihan’s authority by making him chairman of the board of directors as well as CEO.

On paper, it may be a vote about corporate governance, but analysts and bank observers say that it has become much more, a test of the confidence shareholders have in Moynihan, the board, and the bank’s direction.

“The stakes are exceptionally high,” said Cornelius Hurley, the director of Boston University’s Center for Finance, Law & Policy. “Is this a referendum on him? Absolutely.”

Moynihan is expected to win the vote, and even if he doesn’t, he would still run the bank’s operations, fetching a $13 million salary. But a smaller margin of victory — less than 60 percent of the vote — could weaken Moynihan, analysts said.

“Now, if he loses the vote, it does mean a damn thing. He’s gotten a clear no vote of confidence,” Richard Bove, a financial analyst with Rafferty Capital Markets LLC, a New York brokerage firm. “The board of directors has gotten a clear vote of no confidence. It’s going to create a crisis for the management for Bank of America.”

Bank of America officials seem well aware of stakes.

Anne Finucane, a Lincoln resident who is global chief of strategy and a vice chairwoman of Bank of America, has been rallying support among the bank’s largest shareholders. One very prominent Bank of America investor, Warren Buffett, has spoken out in favor of Moynihan, crediting him last week with resuscitating the bank.

Former US representative Barney Frank, the Newton Democrat who crafted the post-financial crisis banking law that bears his name, has also backed Moynihan, doing a round of interviews during the past few days. Frank noted that the bank has settled federal charges over its mortgages and that Moynihan was one of the few top banking officials to publicly support the formation of a federal financial watchdog agency, the Consumer Financial Protection Bureau.

“He’s done a pretty good job,” Frank said. “He’s managed problems he has inherited.”

Other banks, including JP Morgan Chase & Co. of New York and Wells Fargo & Co. of San Francisco, have dual CEOs and chairmen, and no research suggests that splitting the roles improves performance, Moynihan supporters add. But several institutional investors, including the Massachusetts pension fund, plan to vote against combining the chairman and CEO roles.

The California public pension funds, the largest in the country, are telling shareholders that management needs stronger oversight from an independent chairman. The pension funds point to the bank’s poor financial performance and a $4 billion accounting error made last year.

The bank has also struggled with its Federal Reserve stress tests, earlier this year earning a warning from regulators about deficiencies in its ability to predict how it would perform in a severe downturn.

Bank of America’s share price closed at $16.33 Wednesday, a 4 percent increase from January 2010, when Moynihan took over. The stock fell 2.9 percent Thursday, to $15.86.

Meanwhile, the stock of its competitors has soared. Shares of Wells Fargo, the nation’s third-largest bank by assets, have nearly doubled in price during that period. The share price of JP Morgan Chase, the nation’s largest bank, has climbed almost 50 percent.

Aeisha Mastagni, portfolio manager for the California State Teachers’ Retirement System, said directors should hold Moynihan accountable for this performance.

“They need to make the decision who’s best positioned to lead Bank of America going forward,” Mastagni said. “Whether they win or lose, it’s going to be close. They’re going to have to reflect on that and what they need to do.”

Moynihan’s rise was somewhat circuitous. As a lawyer, one of his primary clients was Fleet Financial Group, which he advised on acquisitions that helped make Fleet the largest financial institution in New England. Fleet eventually hired Moynihan as deputy counsel and later put him in charge of the bank’s investment and wealth-management unit. Bank of America bought Fleet in 2004; Moynihan continued to lead the combined company’s wealth management operations and then consumer banking.

When former chief executive Ken Lewis abruptly retired following the disastrous acquisition of the mortgage lender Countrywide Financial Corp., the purchase of the investment company Merrill Lynch, and multiple investigations by state and federal authorities, the board turned to Moynihan. He took over as CEO of the sprawling bank in 2010, but by that time shareholders angry with Lewis had already separated the roles of chairman and CEO.

While managing the company — with headquarters in Charlotte, N.C. and a significant presence in New York — Moynihan has remained rooted in Wellesley. He still goes to the dump on the weekends, attends Mass, and on Thursday chaired a Boston gala to raise money for priests’ retirement and health care costs.

Under him, the bank has spent about $70 billion on fines, settlements, and legal costs and cut 15 percent of its employees and 20 percent of its branches and offices. His supporters say Moynihan spent the first two years of his tenure cleaning up past problems and putting the bank on firmer footing.

Deposits have grown by nearly 25 percent to $1.2 billion, and profits are up nearly 70 percent to $5.3 billion in the second quarter, from $3.1 billion in the same period in 2010.

“A simpler, straightforward business model is at the heart of the company’s turnaround since the financial crisis,” said Lawrence Grayson, a spokesman for Bank of America. “Our balance sheet has never been stronger.”

We’ll see how the vote proceeds on Tuesday and there may be a lot more at stake here for Brian Moynihan than whether or not he deserves to be chairman and CEO, which is why the the bank’s board has started lobbying investors, ranging from top-20 investors to small-time, individual shareholders. I don’t question Moynihan’s character, integrity, or intelligence but I do wonder whether he’s the right person to lead this bank during the next phase of (hopefully) expansion.

By the way, you’ll notice U.S. financials (XLF) sold off on Friday following the Fed’s big decision. There’s a reason for this. Big banks make money off spread and need economic growth and an upward sloping yield curve so they can borrow cheap and lend out at higher rates. The Fed’s deflation problem also concerns big banks as well as big hedge funds. These are challenging times for all financial institutions and while the U.S. economy is in better shape than the rest of the world, it’s hardly running on all cylinders and is vulnerable to global economic weakness. This is why the Fed did the right thing and didn’t hike rates this week.

Photo by Sarath Kuchi 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.

Yves Smith of Naked Capitalism wrote another stinging comment, CalPERS Board Members Defend Poor Performance by Staff, Capture by Private Equity (added emphasis is mine):

All of the private equity experts that we asked to look at the video of the latest CalPERS Investment Committee meeting were appalled by the performance not only of CalPERS’ private equity staff but also its board members. As Georgetown law professor Adam Levitin said via e-mail:

It’s shocking to see how many of the CalPERS investment committee are utterly ignorant. Aren’t these people supposed to know something?

And as Andrew Silton, the former Chief Investment Advisor to the State Treasurer of North Carolina, wrote on his website:

What’s the best defense against capture? A strong staff and informed trustees. The CalPERS video strongly suggests that CalPERS is lacking on both fronts.

It is hard to overstate the vehemence of the reactions I’ve gotten to the video of the CalPERS’ last investment committee meeting. In the majority of cases, when I’ve asked for a mere quote, the respondents were so disturbed by what they saw that they penned commentary that ran to multiple pages. For instance, Andrew Stilton, who had stopped financial blogging months ago to pursue his art, felt compelled to come out of retirement to write not just one, but three posts on the Investment Committee meeting train wreck.

CalPERS’ Investment Committee bears significant blame for the poor performance of CalPERS’ staff. Most CalPERS board members seem to regard their job as cheerleading and protecting CalPERS’ senior officers, rather than acting as vigilant protectors of CalPERS’ beneficiaries. This misguided sense of priories was evident when Investment Committee chairman Henry Jones repeatedly undermined fellow committee member JJ Jelincic’s questions. Jones acted as if Jelincic was putting the private equity team members on the spot, when competent industry professionals should have been able to field Jelincic’s questions easily. Similarly, other board members allowed staff to give misleading and incomplete answers.

But even worse than the board’s lax attitude toward oversight is its lack of expertise. The presentation that led Jelincic to pose those not-difficult questions that nevertheless put the CalPERS officer responsible for private equity, Réal Desrochers, on tilt, was an insultingly basic primer on “carry fees,” which is the 20 in the prototypical “2 and 20” private equity fee scheme. The “20” stands for a 20% profit share once a preferred return, typically 8%, has been met. Stunningly, most of the Investment Committee members seemed pleased by the slideshow and acted as if they had learned something from it.

In other words, the board is so utterly lacking in knowledge that it is incapable of providing adequate oversight, even if it were inclined to do more than governance theater. That means that staff operates with no meaningful supervision. The bumbling, evasiveness, and apparent lack of command of what should be basic material is exactly what you’d expect to see as a result of letting the inmates run the asylum.

Yet Investment Committee members display their ignorance as if it were a badge of honor. Consider this speech from the end of the session:

Vice Chairman Bill Slaton: What I’ve gleaned from this, and I’d like to just kind of make some comments at a higher level than where we’ve down in the weeds. It’s very clear to me that the terms and conditions of private equity deals vary by general partner and by vintage. There’s no set process. It’s a negotiation.

It’s also clear to me that there’s a large number of investors for GPs to choose from, that CalPERS is not the only investor out there, and so therefore, our ability to get the industry to change is something that I appreciate that we’re leading on, but we can’t control. But I think we’re making progress.

It’s clear this is a largely unregulated industry that we’re trying now….that the United States is trying to do a better job regulating. And I’m glad that CalPERS is a participant in that.

I read in the press terms like, you know, hide and cheat and steal. I think those are inappropriate terms. I think we have an industry that probably needs more regulation, but I — what I want us to focus on is to make sure that we are gleaning as much data as we can, and that we see the progress that’s attained, and we start to see the reports.

I have faith in this group in front of us that you’re negotiating on behalf of CalPERS, as well as it can be done. So I’m not trying to….and I don’t think we should spend a lot more time trying to find where there’s an error or a problem. I think you all are on to this, that you’re working hard at it, and I think that there’s value in us better understanding what the range of possibilities are. So bring scenarios back to us and how it works, like you did here, is instructive for us. But I don’t think it’s productive for us to spend a lot of time trying to play gotcha.

As Rosemary Batt, co-author of the landmark book Private Equity at Work, said:

I was completely appalled to listen to Bill Slaton as apologist for the staff. It reminded me of the Public Relations Director of Wal-Mart in the documentary, “Is Wal-Mart Good for America?” The notion that the GPs can choose whom they want to, putting CalPERS in a defensive posture, is absurd.

Let’s go through Slaton’s remarks in detail.

Slaton starts out by obliquely criticizing Jelincic’s efforts to get answers to what are simple questions by as being “down in the weeds.” He then parrots the diversion that Réal Desrochers relied on earlier in the meeting, that he couldn’t answer a question from Jelincic because everything was deal-specific. As Oxford professor Ludovic Phalippou said about that exchange, “The PE team line of defence is incredibly amateuristic. I would fail my private equity students if they wrote such a thing in their exam.”

Slaton continues with a claim straight out of the Private Equity Growth Council, the private equity industry’s chief lobbyist, and presumably also invoked by CalPERS’ staff, that private equity agreements are negotiated. Again, as Professor Phalippou, who has read 300 private equity agreements stressed, they are in fact “take it or leave it” agreements. As a former private equity partner said, “General partners have done a masterful job of dividing and conquering the limited partners on the negotiation process.”

Slaton then moves on to another bit of general partner propaganda that he, and apparently CalPERS’ staff, have swallowed, namely, that it is CalPERS that has to compete to get general partners’ attention, and not vice versa. As Elieen Appelbaum, co-author of Private Equity at Work, wrote:

I find these responses, which I am sure are sincere, simply incredible. Public pension funds make the single largest contribution to PE fundraising of any type of investor. Data provided by PitchBook show that public pension funds contributed between 15% and 25% of all funds raised by private equity in the years from 2000 to 2012. In 2013 public pension funds contributed 24.5% of all funds raised by private equity; and in 2014, 21.5%. One might reasonably expect pension funds to demand respect and deference from PE firms when the latter come, hat in hand, seeking capital for their private equity funds. Certainly CalPERS, which makes large investments in private equity year after year and whose lead is followed by many other pension funds should be sought after by GPs, not told by GPs – as is apparently the case – not to make demands because there are many investors for GPs to choose from.

Slaton then notches his defense of private equity up a register and objects to the usage of words like “hide and cheat and steal” when applied to private equity. Perhaps he needs to read the press more extensively or acquaint himself with a dictionary.

Private equity investors were upset when they leaned about fees like “termination of monitoring fees” of tens, sometimes hundreds of millions of dollars, via Gretchen Morgenson of the New York Times, particularly when they realized those fees were not shared with them in management fee offsets. They were similarly stunned to learn from Mark Maremont of the Wall Street Journal that KKR’s captive consulting firm KKR Capstone, was treated by KKR as being an independent contractor. That means KKR charged hundreds of millions of dollars of dollars for KKR Capstone services, when investors had assumed that was already covered by the management fee.

If someone is taking a lot of money out of your investment and hasn’t told you about it, pray tell how is that not hiding?

Similarly, how is it not cheating when KKR shifted nearly $20 million of broken deal expenses onto limited partners, when they should have been borne by co-investors that included KKR affiliates? The SEC deemed KKR’s conduct to be abusive enough to warrant $10 million in fines.

And how is it not stealing when former SEC enforcement chief Andrew Bowden said of private equity general partners, “Investors’ pockets are being picked”?

In other words, Slaton professes to support the effort to get tougher on the industry, as long as no one actually describes its bad conduct in simple, plain English terms. Perhaps he is concerned that the great unwashed public will wise up as to how general partners have fleeced limited partners like CalPERS for years, and the limited partners and overseers like him have done perilously little to prevent it .

Slaton then says, with a straight face, that the private equity team at CalPERS is doing a great job of negotiating, when he has no basis for his opinion. Andrew Silton, who has been the chief investment officer of a substantial private equity portfolio, begs to differ:

Like any large investor, CalPERS must systematically attack every sort of fee and vigorously negotiate deal terms. These are the only two techniques that can give a large institution marginally better performance and control over its private equity program. Clearly, the current team at CalPERS has failed to do both.

Slaton wraps up by saying he has no intention of doing his job as a board member: “I don’t think we should spend a lot more time trying to find where there’s an error or a problem.” Slaton finishes by plainly stating that he regards the work of supervision and governing as “gotcha” and sees it as beneath him. I trust Governor Jerry Brown is paying attention and finds someone else to install in Slaton’s slot.

We see similar undue protectiveness of staff in Henry Jones’ closing remarks. He used the fact that CalPERS has yet to complete its new private equity IT reporting system, PEARS, to justify the inability (and often, refusal) of staff to answer Jelincic’s questions, when he made clear that virtually all of them did not depend on data.

Chairman Henry Jones: Okay. I think it’s also important to realize that earlier in the day, Mr. Eliopoulos did indicate an update on the private equity project, the PEARS project, where he indicated that he has collected about 94 percent of the data that’s necessary to maybe answer a whole host of questions that we’ve been asking, and that he plans to come back to the Committee to present that information to us.

And so I think it’s important that we know. And matter of fact, he also stated in his comments this morning, that they actually went live and parallel on this particular project that they’re working. So it’s getting there.

And I know that we all are interested in understanding some of the complexities of private equity
investment. But I think we need to be patient too to make sure that we get all of the information and get the accurate information, because I think there’s been too many misquotes, too much misinformation that’s been in the public.

And as you know, when information is provided to the press, and many times they go with what they were told, and many times it’s not accurate information coming from our Investment Office. So I would encourage us all to be a little patient, and certainly answer J.J.’s questions when the data is available, or if he has specific requests that he can provide that request to you and – so that it can be responded to.

Jones’ repeated incantation, “We need to be patient” is mind-boggling. CalPERS has been investing in private equity for 25 years. Staff has, or ought to have, the sort of basic, general information that Jelincic has requested at hand.

And notice Jones tried to depict the press as being inaccurate. That’s simply bogus. I challenge Jones to cite a substantive point in which the media has provided faulty information about CalPERS in the recent fee controversy. The proof is that CalPERS does not appear to have asked for, and more importantly, has not gotten, a single retraction.

By contrast, as we’ve seen in the last two Investment Committee meetings, CalPERS’ staff has repeatedly told the board things that are flat out wrong or so heavily spun in favor of private equity general partners as to be incorrect. So how, pray tell, can Jones defend staff as the gold standard of accuracy?

Jones is effectively telling his fellow board members to regard the staff as the only valid source of information. And if board members don’t consult and cultivate independent channels for news and intelligence, they are guaranteed never to challenge staff. That guaranteed that the board will continue to do a poor job of oversight.

CalPERS’ reaction to having its private equity failings exposed has not been to correct these problems, but to attack the people who’ve unearthed them and defend parties who should be held to account. And its board reinforces this pathological response. Sadly, this behavior is guaranteed to produce more self-inflicted wounds and diminish CalPERS as an institution.

The comment above is part of a series the Naked Capitalism blog did “exposing” CalPERS’ Private Equity. If you haven’t read the entire series, I posted the links below:

Executive Summary
Senior Private Equity Officers at CalPERS Do Not Understand How They Guarantee That Private Equity General Partners Get Rich
CalPERS Staff Demonstrates Repeatedly That They Don’t Understand How Private Equity Fees Work
CalPERS Chief Investment Officer Defends Tax Abuse as Investor Benefit
CalPERS, an Anatomy of Capture by Private Equity
CalPERS’ Chief Investment Officer Invokes False “Superior Returns” Excuse to Justify Fealty to Private Equity
CalPERS’ Senior Investment Officer Flouts Fiduciary Duty by Refusing to Answer Private Equity Questions
How CalPERS’ Consultant, Pension Consulting Alliance, Promotes Intellectual Capture by Private Equity

I recently covered CalPERS getting grilled on private equity and expressed my concerns with Yves Smith’s (aka Susan Webber) negative slant on private equity as well as stated where I agree with her:

I got to hand it to Yves Smith, she’s been on top of CalPERS and private equity like a fly on manure, but the problem with Yves is she’s on some crusade to expose private equity’s dirty little secrets and tends to focus exclusively on the negatives, ignoring how important this asset class has been to delusional U.S. public pension funds looking to make their pension rate-of-return fantasy.

Don’t get me wrong, there are plenty of problems in the private equity industry, many of which I cover on my blog, but if you read the rants on Naked Capitalism, you’d think all these private equity funds are peddling is snake oil and that investors are better off investing in a simple 60:40 stock bond portfolio.

This is pure rubbish and spreading such misinformation shows me that Yves Smith doesn’t really know much about proper asset allocation between public and private markets for pension funds that have long dated liabilities and a very long investment horizon. Ask Ontario Teachers’, CPPIB, and many other large pension funds the value-added private equity has provided over public market benchmarks over the last ten years (Canadian funds invest and co-invest with private equity funds, reducing fees, and invest in PE directly, foregoing all fees).

Having said this, I too watched the CalPERS board meeting and the clips Yves Smith posted, and was surprised at how much stonewalling was going on. To be honest, I felt bad for Christine Gogan as she was clearly used as a scapegoat. Her boss, Réal Desrochers and his boss, Ted Eliopoulos, and Wylie Tollette should have been the people answering all these questions and getting grilled by JJ Jelincic.

Now, full disclosure. I used to post my comments on Naked Capitalism and then moved over to posting them on Zero Hedge. I wrote all about it in a 2009 comment on blogging wars and bragging rights. I left both blogs in disgust and let Yves have it for editing my comments and Tyler have it for allowing short-selling gold bug morons to post completely asinine and offensive comments, often attacking me personally but not allowing me to respond with my own comments. 

Both blogs helped me gain “notoriety” (whatever that means in the blogosphere) so I am grateful to them for that and left their respective blogs on my blog roll (they cut mine out of theirs which shows you how infantile they truly are). I now prefer doing my own thing at the margin and not being affiliated with anyone (I post some of my market comments on Seeking Alpha). 

Yves’ latest comment on CalPERS’ capture on private equity is so popular that it got retweeted by Alec Baldwin, a famous actor and potential Democratic candidate. That’s all great for Yves as her popular blog is gaining even more popularity but is she being fair in her brutal criticism on CalPERS board, its private equity staff and the private equity industry?

I think Yves and her panel of academic experts raise many excellent points but when I read her comment I felt like she was being a bit harsh to some board members and even the staff. In fact, if Yves and her panel of private equity experts are so smart, why aren’t they sitting on boards of public pension funds or better yet, running the private equity portfolios at these large public pensions?

It’s always easy to criticize folks from the outside, especially when you hold a Harvard MBA and think you are god’s gift to finance, but what Yves Smith lacks is real-life experience working at a U.S. public pension fund and a bit of humility. 

Admittedly, I’m not the poster child for humility and have done my fair share of heavy criticism on my blog (read my latest on whether hedge funds are doomed), but I feel like telling Yves and her panel of experts to take a step back and realize who they’re directing their criticism to and not to judge them so easily before they understand the constraints they’re operating under. 

Having said this, I watched the investment committee and was also flabbergasted by some of the responses from the board and staff. I know Réal Desrochers and he’s no dummy on private equity. He had a successful track record at CalSTRS and a large sovereign wealth fund before joining CalPERS to take over what most people consider to be a huge private equity mess. He’s spearheading the latest effort to chop external managers by half in an effort to reduce the number of direct private equity relationships and to reduce fees.

But the responses to questions board member JJ Jelincic asked were completely unacceptable and a farce. CalPERS’ private equity staff should have the answers to these questions on their fingertips and if they don’t, they should respond at a subsequent board meeting. If they continue to stonewall, this is a breach of their fiduciary duty and they should be fired. It’s that simple.  

As far as CalPERS’ board members, apart from JJ Jelincic who is doing his job asking tough questions, I’m not terribly impressed. Most these board members need a primer on private equity so they can understand the J-curve, distribution waterfall, and many other topics that they clearly don’t grasp. And it’s not up to CalPERS’ private equity staff to educate board members on this stuff. The board needs to get outside experts to educate them and let these independent experts report solely to the board to maintain their impartiality. [ Update: JJ Jelincic, a member of CalPERS’ board, emailed me this: “Mike Moy and PCA is supposed to be the board’s independent consultant.  That’s what he is paid for.”]

What Yves Smith is exposing here is a fundamental structural flaw with all U.S. public pensions, namely, the lack of proper pension governance. I wrote about it for the New York Times when I discussed the need for independent, qualified board investment boards in a special series debating the public pension problem. 

Importantly, until the United States of America follows Canada and introduces meaningful reforms to the way U.S. public pension funds are governed, its public pension system will remain vulnerable to abuse and will eventually succumb from the weight of chronic pension deficits. Sure, some states will fare much better than others but that’s not saying much when discussing the pathetic state of state pension funds. 

What are the key reforms I’m talking about? Have public pensions supervised by independent and qualified board members that are not politically appointed  hacks; hire qualified pension fund managers and compensate them properly to manage public and private market assets internally; get rid of the pension rate-of return fantasy that delusional U.S. pensions are still clinging to and last but not least, introduce the shared risk pension plan model at all U.S.public pensions. 

Getting back to Yves’ comment on CalPERS’ capture by private equity, one area where I agree with experts is that limited partners need to do a hell of a lot more to tilt the balance of power in their favor. The Institutional Limited Partners Association (ILPA) recently published a press release on its Fee Transparency Initiative, an effort to increase transparency in private equity.  The story was picked up by major media outlets and was the focus of Private Equity International’s Friday Letter.  The full press release and coverage from some of these outlets are provided on the ILPA’s website here.

But that’s not enough. The ILPA which includes CalPERS, CalSTRS, and many other global pension and sovereign wealth funds needs to use its clout to promote significant changes to the way private equity funds (aka GPs or general partners) carry out their business, including the way they report fees and all other expenses charged to limited partners (LPs).

Back in 2004 or 2005, I attended one of these ILPA meetings in Chicago with Derek Murphy, the former head of private equity at PSP Investments. Great for networking and meeting other powerful limited partners but it was a joke in terms hammering out concrete proposals on valuations, fees, and a host of other issues pertaining to improving alignment of interests (I’m being a bit too critical but trust me, I’m not far off).

Anyways, I’m tired and have ranted enough on this topic. If my institutional readers, including CalPERS’ senior managers, have anything to add, please feel free to email me and I will edit and add your comments here (my email is LKolivakis@gmail.com).

Below, I embedded the second part of the CalPERS Investment Committee from August 17th, 2015 (discussion on PE begins at minute 50 of the clip or watch chopped versions on the Naked Capitalism comment). Take the time to watch this clip as it’s an issue pertaining to many other large pension funds that invest in private equity funds.

https://youtu.be/VN1HkGTWk5U

“Most public workers would be exempt from paying any more. Only those workers hired in 2013 or later would have to contribute more to their retirements under the plan.”

What this means is California’s taxpayers are going to get socked with higher real estate taxes to make up the difference.

But California has a huge problem with real estate taxes due to Proposition 13. A close friend of mine who lives near Stanford shared this with me on why homes are so expensive out there:

Unless you are moving out of town most people only buy once in California because of Proposition 13, which limits property taxes to a 2% increase per year anchored at the price you bought your home. There are homes right beside each other where one owner who has been there for 30 years or so is paying a measly $3000 in property taxes and the other owner just moved in and is paying $30000 even if both homes are identical in worth.

There is also no motivation to downsize because of the climate….little 95 year old granny living alone in a 6 bedroom home can get away with a space heater, or even just a good blanket, in her bedroom all winter long. She doesn’t face the heating bills others face on east coast so no need to move to a condo until the inevitable, which by the way, happens on average a decade later around here.

Then you have the self serving local politicians who own homes and argue we can’t possibly build densely or upwards because, oh my god, we might block the sun!!

Lastly, we have the IPOs from time to time (Google, Facebook, LinkedIn, etc.) that instantly make millionaires out of thousands of young adults who have no idea of home values. They just need somewhere to park their cash.

All of this equals expensive homes. We are lucky we got in at all….right after the 2008 crash when everybody was scared to death that the economy would collapse. So now of course we support everything stated above.

So where is the money going to come from to pay for California’s public pension shortfall? Where else? Higher sales and income taxes and higher real estate taxes for new home buyers.

But with taxes in California already sky high, there’s no political incentive to tax people more to pay for public pensions. The exact same thing is going on elsewhere in the U.S. where public pensions are already taking a big bite out of state budgets.

And wait, things are about to get a lot worse. As mentioned in the article above, the aging of California’s public workforce is behind the shift in strategy. As more baby boomers retire, CalPERS estimates that the number of government retirees will exceed the number of working public employees in less than 10 years.

What this means is CalPERS and other U.S. public pensions are going to confront serious longevity risk in the future. It may not doom them but they’d better prepare for it now.

Lastly, according to the Naked Capitalism blog, CalPERS has a serious problem with its private equity portfolio. I’m not going to comment on Yves Smith’s latest rant against private equity and CalPERS. She raises some good points but totally exaggerates or misses other key points. I’ve explained why CalPERS cut its external managers in half and why private equity is important but so is reporting the results and all the fees paid out to these external managers. Failure to do so is a serious breach of fiduciary duties.

Photo by TaxRebate.org.uk 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.

Matthew Cunningham-Cook of the International Business Times reports, At Chicago Pension Fund, Questions Raised On Conflicts of Interest:

Chicago pension officials wanted to know where to deposit the $11 billion that the city’s teachers had saved for their retirement benefits, so they turned in 2014 to the outside consulting firm they’d hired for financial advice. Such consultants are employed to provide guidance that’s expected to be impartial — not shaped by private business relationships that might make its recommendations less than objective.

So when the firm, Callan Associates, told pension trustees at a February meeting to give the cash to a bank called Bank of New York Mellon (BNY), the board’s trustees agreed to follow the advice. What they were not told at that meeting, however, is that BNY pays Callan for both general consulting services and financial education programs.

Those payments, say financial experts, represent an inherent conflict of interest. They effectively strip consultants like Callan of their objectivity by giving them an incentive to push their pension clients to use banks that are paying the consulting firms, the experts say.

Government regulators and auditors have in recent years raised concerns about undisclosed business relationships between financial institutions and consultants who are supposed to provide objective counsel. Auditors have documented lower investment returns at pension funds that rely on consultants with divided loyalties.

In Chicago, the conflicts could prove particularly costly for the city’s taxpayers and 63,000 educators. That’s because the bank Callan recommended, BNY, is a Wall Street behemoth that has repeatedly faced law enforcement action for skimming money from its clients. In fact, just after Chicago handed over teachers’ money to the bank, BNY agreed to pay more than $700 million to settle federal charges against it for defrauding its pension fund clients. Callan had previously faced sanctions from the Securities and Exchange Commission (SEC) for failing to disclose to clients that it was getting payments from BNY Mellon in exchange for referring brokerage business.

Callan did not respond to International Business Times’ questions about its financial relationships. In its marketing material and financial disclosure documents, the firm has said, “We are independently owned and operated with interests that are precisely aligned with those of our clients.”

Ted Siedle, a former SEC attorney, said he sees no alignment of interests for Callan clients.

“It’s clear that Callan has conflicts of interest, and it’s likely those conflicts have an adverse effect on performance,” he told IBTimes.

Feds Taking ‘A Careful Look’

In recent years, conflicts of interest in the shadowy world of finance have drawn increased attention from regulators and policymakers. In the wake of the financial crisis, lawmakers uncovered evidence that banks were pushing clients into investments that the banks themselves were betting against. That prompted deeper concerns about conflicts of interest and ultimately led the U.S. Labor Department to propose a rule mandating that financial advisers to individual investors provide advice that is solely in the interest of their clients.

But while the department has considered a similar rule for those advising pension funds, such an initiative has not moved forward.

In the absence of such a regulation, Rep. George Miller, D-Calif., sent a letter to the Department of Labor in 2014 saying the agency needs to “take a careful look” at conflicts of interest with pension consultants. In response, Phyllis Borzi, the Labor Department official in charge of regulating pensions, said the department was “committed to addressing” such conflicts in regard to pensions.

Evidence of conflicts has been mounting. In 2005, the SEC surveyed 24 major investment consultants and found that 13 had significant conflicts of interests that they had disclosed to investors. One of those firms investigated was Callan Associates. Using the findings of the SEC’s 2005 review, the Government Accountability Office (GAO) later found that pension funds that used conflicted consultants had 1.3 percent lower rates of returns than those that did not. As of 2006, those consultants were helping manage $4.5 trillion of assets.

If the GAO’s estimates are accurate, conflicted consultants cost pension funds $58 billion in unrealized returns every year.

Controversies surrounding financial conflicts of interest have periodically generated headlines.

In 2004 , Mercer, a major consultant, was criticized for receiving money from asset managers it recommended to pension funds, specifically in Santa Clara, California. In 2009, Consulting Services Group was criticized in an investigation for recommending that the pension fund of Shelby County, Tennessee, invest in its own hedge fund, which paid large fees to the company. In 2013, New York’s Superintendent of Financial Services Benjamin Lawsky subpoenaed documents from 20 of the largest investment consulting firms, reportedly to evaluate their potential conflicts of interest (the results of Lawsky’s investigation have not yet been made public).

Most recently, in December 2014, IBTimes reported that the San Francisco pension fund’s consultant, Angeles Investment Advisors, was pushing the city to allocate 10 percent of its portfolio to hedge funds but did not disclose that its own firm reserves the right to collect additional fees from pension clients when those clients invest in hedge funds. Angeles was later fired by the pension fund in favor of a company that claims to have fewer conflicts of interest.

‘The Bank Was Stealing’

In Chicago, where the teachers pension fund trustees are both educators and appointees of Mayor Rahm Emanuel, questions about conflicts of interest were not about investments. Instead, they were about which bank should get the lucrative contract to receive and disburse the pension fund’s $11 billion in assets.

In February 2014, when Callan recommended that pension trustees choose BNY for these so-called custodial services, Callan’s representatives did not explicitly tell pension trustees of their firm’s relationship with BNY or the 2007 SEC enforcement action against the consulting firm. Callan’s 2013 report on Chicago’s private equity investments did briefly mention the firm’s business with BNY, but pension trustees interviewed by IBTimes said they were unaware of the relationship.

At the February meeting, Callan also did not mention any of the ongoing legal issues related to BNY Mellon and its performance as a custodian for pension funds, even though the bank was just then the subject of law enforcement scrutiny. Indeed, one month after Chicago’s gave BNY the deal for custodial services, BNY agreed to pay $714 million to settle claims against it for bilking its pension fund clients by manipulating the rate at which pension funds’ currency holdings are traded internationally.

U.S. Attorney Preet Bharara, who brought the federal charges against BNY, said at the time that public pension funds “trusted the bank to be honest about the financial services it was providing and to deal with them fairly.” But, charged Bharara, BNY “and its executives, motivated by outsized profits and bonuses, breached this trust and repeatedly misled clients” about the currency rates they were charging their clients. Specifically, prosecutors said, the bank got the best currency exchange “rates for itself, gave its customers the worst or close to the worst rates, and kept the difference for itself.”

The federal investigation and lawsuit had been ongoing since 2011 but went unmentioned by Callan in its recommendations. At the time of the settlement, the New York Times reported that a BNY Mellon employee had been quoted in an email asking if it was “time to retire after raping the custodial accounts.”

The $714 million paid by BNY Mellon is negligible, however, compared with estimates provided by investigator Harry Markopolos, who first blew the whistle on the scam in 2011. In an interview with King World News, reported by Business Insider, Markopolos placed the scale of damages far higher — at more than $2 billion. 

IBTimes asked Chicago teachers pension staff members if they had been informed about Callan’s conflict of interest with BNY Mellon and if they are concerned that such a conflict may have encouraged Callan to avoid mentioning the problems surrounding BNY’s custodial services. The fund’s executive director, Charles Burbridge, said that he has “not had the opportunity to look into the issues.”

BNY Mellon declined to comment in response to questions from IBTimes. In a statement in March, the bank declared that it is pleased to put the “matters behind us, which is in the best interest of our company and our constituents.”

Finance experts question whether pension funds should continue to trust their money with BNY Mellon.

“It’s hard to see how any fiduciary can keep doing business with BNY Mellon after these revelations,” Susan Webber, principal of Aurora Advisors, a financial consulting firm, said. “BNY Mellon flagrantly misrepresented its foreign exchange trading practices to customers. Consistently reporting the worst or nearly the worst price of the day to clients means the bank was stealing.”

For Siedle, the former SEC attorney, Chicago’s relationship with its consultant and decision to deposit retirees’ money in BNY is a cautionary tale that should prompt action.

“With the nationwide attack on defined-benefit pensions,” he said, “it is now more urgent than ever that Chicago teachers and other pension funds across the country launch independent investigations into how conflicts of interest have affected their portfolio.”

Ted Seidle, the pension proctologist, is absolutely right, now more than ever U.S. public pension funds need to scrutinize their relationships with external consultants, hedge funds, and of course private equity and real estate funds. They all want a piece of that multibillion dollar public pension pie but trustees need to uphold their fiduciary duty and make sure they’re is proper alignment of interests.

As far as BNY Mellon, they were caught overcharging pension funds on foreign exchange transactions but I’ve got news for you, this type of stuff goes on all the time especially in unregulated currency markets. Big banks and custodians are always trying to screw their clients on F/X trades and to a certain degree, clients know this and allow it (there is a certain give and take in F/X markets but banks and clients need to be reasonable or else they get a very bad reputation and nobody will trade with them).

But as far as Callan Associates, one of the big consulting shops in the U.S., it should have disclosed that BNY pays Callan for both general consulting services and financial education programs. Failure to disclose this is grounds for termination of its contract with Chicago’s pension fund.

When I was investing in hedge funds a long time ago, I’d always use a legal side letter to cover ourselves as much as possible from operational risk or any other negative surprises. Even then, it wasn’t always foolproof.

I’m shocked at how sloppy some contracts are nowadays. It should clearly stipulate that failure to disclose serious conflicts of interest will mean termination of a contract and heavy fines and penalties.

Importantly, these conflicts of interest aren’t just going on in Chicago, they’re going on all over the United States where lack of proper pension governance means the entire public pension fund system is vulnerable to investment consultants fraught with conflicts of interest.

Of course, some consultants are better than others and are offering truly independent and outstanding advice, but for the most part it’s been and continues to be a miserable failure and it’s costing these U.S. public pensions billions in performance and fees.

And Chicago’s pension woes don’t end with consultants’ conflicts. A report recently uncovered that teacher pension perks are not uncommon across Illinois:

Hundreds of school districts across Illinois cover either all or most of their teachers’ retirement contributions.

The issue is in the spotlight as Illinois’ largest district is in the middle of tense contract negotiations and the cash-strapped district is seeking help from legislators.

The Chicago Tribune reports thousands of teachers get a better deal than Chicago teachers.

Some districts, including in suburban Wheeling, say picking up pension costs helps keep them competitive. Some unions have also argued it’s a cost saver because if the money was paid as a salary it would be subject to payroll tax.

Mayor Rahm Emanuel wants teachers to pay the full contribution. The cash-strapped district has paid most of the 9 percent contribution. The Chicago Teachers Union argues that amounts to a pay cut.

I have a question for these public-sector unions: what planet do they live on? Have they not heard of shared risk for their pension plan? They should follow Ontario Teachers’ Pension Plan and implement it immediately along with the governance that has allowed it to become one of the best pension plans in the world.

As far as Illinois, it’s a pension hellhole and I don’t just blame the unions for this sorry state of affairs. Just like in other states, its government has failed to top up its public pensions, which is why pension deficits keep growing. Record low interest rates aren’t helping either and wait till deflation hits pensions and decimates them.

Photo by bitsorf 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.

Dean Beeby of CBC News reports, Document raises questions about Harper retirement policies:

Canada scores poorly among developed countries in providing public pensions to seniors, according to an internal analysis of retirement income by the federal government.

And voluntary tax-free savings accounts or TFSAs, introduced by the Harper Conservatives in 2009, are so far unproven as a retirement solution and are largely geared to the wealthy.

Those are some highlights of a broad review of Canada’s retirement income system ordered by the Privy Council Office and completed in March this year by the Finance Department, with input from several other departments.

The research, compiled in a 30-page presentation deck, was created as the government came under fire from opposition parties, some provinces and retiree groups for declining to improve Canada Pension Plan or CPP payouts through higher mandatory contributions from workers and businesses.

The CPP issue has already become acrimonious in the federal election campaign, with Conservative Leader Stephen Harper saying on Aug. 11 that he is “delighted” to be making it more difficult for Ontario to launch its own version of an improved CPP. The federal Liberals are hoping to use Harper’s clash with Ontario Liberal Premier Kathleen Wynne over pensions to win seniors’ votes in the province and beyond.

A heavily censored copy of the internal document was obtained by CBC News under the Access to Information Act.

The review acknowledges that Canada trails most developed countries in providing public pensions, and is poised to perform even worse in future.

Low among OECD countries

“In 2010, Canada spent 5.0 per cent of GDP on public pensions (OAS/GIS and C/QPP), which is low compared with the OECD (Organization for Economic Co-operation and Development) of average of 9.4 per cent,” it noted.

“The OECD projects that public expenditure on pensions in Canada will only increase to 6.3 per cent of GDP by 2050 – much lower than the 11.6 per cent of GDP projected for OECD countries on average.”

The document also says Canada’s public pensions “replace a relatively modest share of earnings for individuals with average earnings” compared with the OECD average of 34 countries; that is, about 45 per cent of earnings compared with the OECD’s 54 per cent.

“Canada stands out as one of the countries with the smallest social security contributions and payroll taxes.”

The Harper government since at least 2013 has resisted repeated calls to enhance CPP, saying proposed higher premiums for businesses could kill up to 70,000 jobs in an already stagnant economy. Instead, the government has promoted voluntary schemes, such as pooled pension plans for groups of businesses, as well as TFSAs.

Speaking Sunday at a campaign stop in eastern Ontario, Conservative Leader Stephen Harper said, “Our view is that, you know, we have a strong Canada Pension Plan. It is, unlike the arrangements in many other countries, it’s solvent for the next 75 years, for generations to come.”

“Our judgment is [that] what Canadians want and need are additional savings vehicles,” he said.

The document notes that participation rates for TFSAs rise with income, with only 24 per cent of those making $20,000 annually or less contributing, compared with 60 per cent in the $150,000-plus bracket.

The review also acknowledges “it is still too early to assess their effectiveness in raising savings adequacy.”

Much of the document is blacked out under the “advice” exemption of the Access to Information Act, including a section on policy questions. The research may have underpinned a surprise announcement in late May by Finance Minister Joe Oliver that the government was considering allowing voluntary contributions by workers to their CPP accounts.

The review takes issue with Statistics Canada’s data showing a sharp decline in personal savings by Canadians since 1982, arguing that when real estate and other assets are factored in, savings are as high as they have ever been. “Taking into account all forms of private savings suggests no decline in the saving rate over time.”

Ignores evidence?

The provincial minister in charge of implementing the Ontario Retirement Pension Plan, the province’s go-it-alone CPP enhancement, says the internal review shows Harper is ignoring hard evidence.

“This document is further confirmation that Stephen Harper is continuing to bury his head in the sand,” Mitzie Hunter, associate minister of finance, said in an interview. “CPP is simply not filling the gap. … It’s unfortunate that Mr. Harper has really chosen to play politics rather than address serious concerns for retirement security in Canada.”

“TFSAs, which Harper touts as a cure-all, are really untested and they’re only really benefiting the wealthiest Canadians.”

Susan Eng, executive vice-president of CARP, which lobbies for an aging population, said the review cites evidence that single seniors are especially vulnerable to poverty, and that young Canadians and the middle class are not saving enough.

“The government repeats that mandatory employer contributions would be ‘job-killing payroll taxes’ despite the briefing clearly stating that Canada’s social security contributions and payroll contributions are amongst the lowest among similar OECD countries,” she said.

But Harper spokesman Stephen Lecce argues the document also found Canada compares well with other OECD countries on income replacement, ranking third; and that the poverty rate for Canadian seniors is among the lowest in the industrial world.

Lecce also cited a series of measures, including boosting Guaranteed Income Supplement payments and introducing income splitting for pensioners, that together have removed about 380,000 seniors from the tax rolls since 2006.

“Our position is clear, consistent with our Conservative government’s efforts to encourage Canadians to voluntarily save more of their money, we are consulting on allowing voluntary contributions to the Canada Pension Plan.”

So the CBC got hold of an internal document which questions Harper’s retirement policies? All they need to do is read my blog on a regular basis to figure out that there isn’t much thinking going on in Ottawa when it comes to bolstering Canada’s retirement system.

I’ve repeatedly blasted the Harper Conservatives for pandering to Canada’s powerful financial services industry which is made up of big banks, big insurance companies and big mutual fund companies that love to charge Canadian retail investors huge fees as they typically underperform markets.

In the latest pathetic display of sheer arrogance (and ignorance), our prime minister criticized Ontario’s new pension plan, calling it a “tax” and stating he’s ‘delighted’ to slow down Kathleen Wynne’s pension plan.

Amazingly, and quite irresponsibly, the Conservatives pledged to let first-time buyers withdraw as much as $35,000 from their registered retirement savings plan accounts to buy a home, in a yet another election move aimed at the housing market.

Now, think about this. Canada is on the verge of a major economic crisis which will be worse than anything we’ve ever experienced before and instead of bolstering the Canada Pension Plan for all Canadians,  the Conservatives are pandering to big banks which are scared to death of what will happen when the great Canadian housing bubble pops as Chinese demand dries up fast.

Great policy, have over-indebted Canadians use the little retirement savings they have to buy a grossly overvalued house in frigging Toronto, Vancouver or pretty much anywhere else so they can spend the rest of their lives paying off an illiquid asset that will make them nothing compared to a well-diversified portfolio over the next 30 years.

“Yeah but Leo, you can never lose money in housing, especially when you buy in a top location. Never! It’s the best investment, much better than investing in these crazy markets. Plus, you pay no capital gain tax on your primary residence when you sell it.”

I’ve heard all these points so many times that I just stopped getting into arguments with friends of mine who think “real estate is the best investment in the world.” Admittedly, I’ve been bearish on Canadian real estate forever but the longer the bubble expands, the harder the fall.

And mark my words, it will be a brutal decline in Canadian real estate, one that will last much longer than even the staunchest housing bears, like Garth Turner, can possibly fathom. But unlike what Garth thinks, the problem won’t be inflation and rising U.S. interest rates. It’s going to be all about debt deflation and soaring unemployment. When Canadians are out of a job and paying off crushing debt, they won’t be able to afford their grossly overvalued house and lowering rates and changing our immigration policies to bring in “rich Chinese, Russians, Syrians, etc” won’t make a dent to the decline in housing once debt deflation is in motion.

Enough on housing, let me get back to the Harper’s retirement policies and be fair and objective. Unlike the Liberals, I like TFSAs and think they benefit all Canadians who are prudent and save their money. Sure, higher income earners like doctors, lawyers, accountants, dentists, and engineers are the ones that are saving the most using TFSAs but the reason is because they need to save since they have no defined-benefit retirement plan to back them up.

But there are also many blue collar workers and lower income workers who are using their TFSAs too. Yes, they can’t contribute their $10,000 annual limit but they’re contributing whatever they can to save for their future.

I have  a problem with people who categorically criticize TFSAs. We get taxed enough in Canada and this is especially true for high income professionals with no defined-benefit plan. Why in the world wouldn’t we want to encourage tax-free savings accounts?

Having said this, when it comes to retirement, there’s no question in my mind that all these high income professionals and most other hard working Canadians are better served paying higher contributions to their Canada Pension Plan to receive better, more secure payouts in the future.

In other words, enhancing the CPP should be mandatory and the first policy any federal government looks to implement. Period. You simply can’t compare tax-free savings accounts or any other registered retirement vehicle available to having your money pooled and managed by the Canada Pension Plan Investment Board.

Now, the Harper Conservatives aren’t stupid. They know this. They read my blog and know the brutal truth on defined-contribution plans. But they’re caught in a pickle, pandering to the financial services industry and dumb interests groups which claim to look after small businesses.

If our big banks and other special interest groups really had the country’s best interests at heart, they wouldn’t flinch for a second on enhancing the CPP for all Canadians, building on the success of the CPPIB and other large well-governed defined-benefit plans which are properly invested across global public and private markets.

I will repeat this over and over again, good retirement policy makes for good economic policy, especially over the very long run. Canadian policymakers need to rethink our entire retirement system, enhance the CPP for all Canadians and get companies out of managing pensions altogether. We can build on the success of CPPIB (never mind its quarterly results) and other large well-governed DB plans. If you need advice, just hire me and I will be glad to contribute my thoughts.

On that note, back to trading these crazy, schizoid markets dominated by high-frequency algorithms. Don’t worry, the flash crash of 2015 is over, for now. If you watched CTV News in Montreal last night, you saw a lot of nervous investors worried about their retirement. This is why I hate defined-contribution plans because they put the retirement responsibility entirely on the backs of novice investors who will do the wrong thing at the wrong time (like sell in a panic as some big hedge fund loads up on risk assets).

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