Author: Leo Kolivakis

Neil is a great guy, I’ve been critical of PSP’s silly real estate benchmark which his predecessor implemented (with the full backing of André’s predecessor and PSP’s board back then) but there’s no denying he’s one of the best institutional real estate investors in the world (and woud outperform even with a tougher RE benchmark).

On that note, let me thank Neil, André Bourbonnais, Miville Tremblay (did a great job) and the rest of the CFA Montreal members who did an outstanding job organizing this luncheon (everything was perfect).

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

The Canadian Press reports, Liberals tap former pension fund CEO to help build new infrastructure bank:

The former head of one of the country’s largest pension funds is being tapped to help build a new federal infrastructure bank.

The Liberals are naming Jim Leech as a special adviser to help design the proposed arm’s-length lending machine that could leverage billions in public money and turn it into new highways, bridges and transit projects.

The Liberals plan to infuse the bank with $35 billion in funding to financially backstop projects, with the details of how it will work to be outlined in this year’s federal budget.

The government says Leech will guide the bank’s implementation team and help recruit board members.

The former head of the Ontario Teachers’ Pension Plan has experience investing pension money in profit-generating infrastructure projects.

The Liberals hope that large pension funds like the teachers’ plan will invest in the bank, which will use federal funds to attract private- sector dollars for major projects, possibly generating $4 to $5 in private funding for every $1 of federal money.

Matt Scuffham of Reuters also reports, Canada may fund some infrastructure entirely from private funds:

Canada could finance some future infrastructure projects entirely through private sources, without using government funds, the special advisor for its new infrastructure bank said after his appointment on Friday.

Canada’s Liberal government announced last November it would set up the agency to supplement government investment in projects like new roads and bridges with funding from private investors such as pension and sovereign wealth funds.

The government advisory panel that recommended its creation had said it could look to raise C$4 to C$5 of private funding for every C$1 provided by taxpayers to fund projects.

However, Jim Leech, the pension executive recruited on Friday to advise the government on the bank, said it could go further with private investment on some projects.

“I’m sure that there are many projects that won’t need any investment from taxpayer money. They can be totally funded by the private sector,” Leech said.

New U.S. President Donald Trump has said he would launch a $1 trillion infrastructure spending program financed entirely by private sources. Infrastructure products are traditionally funded by a mix of private and public investment.

Leech said one of the challenges for the infrastructure bank will be that institutional investors such as pension funds traditionally prefer to invest in ‘brownfield’ assets which have already been built, while the greatest infrastructure need is for ‘greenfield’ assets which have yet to be built.

“I think that’s where the logjam is. You have, on the one hand, on a global basis, a lot of money looking for infrastructure to invest in but it doesn’t have the talent within those institutions to be able to assume greenfield.”

The Caisse de depot et placement du Quebec is the only Canadian pension fund making large-scale ‘greenfield’ investments, having agreed to construct one of the world’s largest light rail networks in Montreal, a project which could become a test case.

“I think what the Caisse is doing is very encouraging. I was impressed to see they are building a team within the Caisse which knows how to assess some of this risk. I think that’s good innovation and there are things we can learn from it,” Leech said.

He said the bank would look at ways to make projects “risk tolerable” for financial institutions but declined to specify how they might do that. Infrastructure experts say they could provide guarantees on future returns or backstop some construction risk.

And Janyce McGregor of the CBC reports, Ex-Teachers CEO Jim Leech named special advisor for new Canada Infrastructure Bank:

Prime Minister Justin Trudeau has named Jim Leech special advisor for the new Canada Infrastructure Bank.

Leech is a former CEO of one of the world’s largest pension funds, the Ontario Teachers’ Pension Plan. Since his retirement in 2014, he’s been an adviser to the Ontario Liberal government, leading a review of the sustainability of the province’s electricity sector pension.

In a release from the Prime Minister’s Office Friday, Trudeau referred to Leech’s “immense knowledge and experience,” saying he was “confident that he will help ensure a smooth and successful launch of the Canada Infrastructure Bank.”

The release said Leech will work with the Privy Council Office and the offices of Infrastructure Minister Amarjeet Sohi and Finance Minister Bill Morneau to build an implementation team and get the new organization off the ground. It promises an “open and transparent process” to recruit future board members.

Leech said in a statement Friday he was honoured to be asked to contribute to moving the bank from concept to reality.

“I believe that, if done right, an infrastructure bank will give Canada a competitive advantage in the global quest for infrastructure funding and development,” he said in a release issued by Queen’s University in Kingston, Ont., where he currently serves as chancellor.

The creation of the infrastructure bank was announced in Morneau’s fall economic statement as part of the government’s overall infrastructure investment plans.

Although touted as an effective way to ensure more projects get built quickly across Canada, very little about the new entity has been revealed in the months since.

Bank may manage up to $35B

Legislation to create the bank will come after the federal budget, expected in the coming few weeks.

The bank is intended to work with other levels of government to “further the reach” of federal infrastructure spending using a broad range of financial instruments, including loans and equity investments.

Last fall, the government suggested the bank would manage up to $35 billion: $15 billion from the federal infrastructure funding announced last year and an estimated $20 billion sought from private investors.

The public money, the government said, would fund projects that wouldn’t normally be able to provide a return for private investors.

For other more profitable projects, the bank may attract “as much as four or five dollars in private capital for every tax dollar invested,” Morneau said last fall.

“Potential investors have said projects need to be worth $500 million or more for them to invest,” said Conservative infrastructure critic Dianne Watts Friday. “That’s a lot of risk to put on taxpayers for something that will only benefit the large urban centres.”

The Liberals have touted the new bank as an innovative way to put private capital to work building much-needed infrastructure.

Leech was credited with innovative decision-making during his tenure at Teachers, a highly-influential public pension manager because of its large size and investment scope. He eliminated the plan’s funding deficit and its returns performed among the top-ranked funds of its kind internationally during his tenure.

You can read this press release from the Prime Minister’s Office announcing the appointment of Jim Leech as a special advisor to the newly created federal infrastructure bank.

Over the weekend, I emailed Jim Leech to get his views on this new role. Jim sent me this:

My role is as advisor (pro bono) to help “stand up” the bank. Will focus on governance (board, management), talent (org structure, skill sets, hiring Chair and top management), and process (how projects prioritized/evaluated). Lots to do like what G/L to adopt, risk management, location etc.

When I asked him what he meant by G/L he said:”General Ledger – mundane but remember we are creating a major financial institution from scratch.”

Jim Leech is an excellent choice to gets things going on this new federal infrastructure bank. Apart from Leo de Bever, another retired pension veteran who worked at Ontario Teachers’ and AIMCo and is widely considered as the godfather of direct infrastructure investments in Canada, I don’t think the federal government could have picked a better special advisor.

Jim has tremendous experience and knows all the key people in the pension industry in Canada and abroad. He will make recommendations for the board (I would nominate Leo de Bever as the chair) and will get to work setting up the governance, hiring top management, and focusing on the process and how to quickly and efficiently get things rolling so that these projects can get underway as soon as possible.

Who should lead the new federal infrastructure bank? Good question. Again, I would place Leo de Bever high on the list if he’s interested in that job or chairman of the board, but there are others as well like Michael Sabia and Mark Wiseman who co-authored an article for the Globe and Mail last October on why the private infrastructure bank will put Canada on a path to growth.

Jim Leech hired Mark Wiseman at Ontario Teachers’ to run the fund investments and co-investments before he moved on to head CPPIB. Mark is now working at BlackRock so I’m not sure if he’d give up that high profile job to come back to head up the federal infrastructure bank.

Michael Sabia is the president and CEO of the Caisse but his term is coming to an end, so along with Leo de Bever and Mark Wiseman, I wouldn’t be surprised if he’s high on the list of likely candidates to head up the federal infrastructure bank. Sabia’s baby at the Caisse is the Montreal REM project which he recently defended publicly and he’s a huge believer in developing infrastructure to kick-start and sustain economic growth over the long run.

Who else is a potential candidate to run the new federal infrastructure bank? Neil Petroff, the former CIO of Ontario Teachers’, someone else who Jim Leech knows well and worked closely with in the past. After retiring from Teachers, Neil joined Northwater Capital Management back in 2015 as a Vice Chair and he knows infrastructure investments very well and is plugged in to the key players all over the world.

There are other candidates as well, like Wayne Kozun who was up until recently the senior VP of Public Equities at Ontario Teachers’ and Bruno Guilmette, the former head of infrastructure investments at PSP Investments and someone I worked with in the past when he was putting together his business plan to introduce infrastructure as an asset class at PSP back in 2005.

Another name that was mentioned to me to head up this new federal infrastructure bank is Larry Blain, Senior Director, Global Infrastructure at KPMG and advisor and corporate director of the Canada West Foundation:

Previously, Mr. Blain served as Partnerships BC’s President and CEO, and subsequently as Chair of the Board of Directors. Under Mr. Blain’s leadership, Partnerships BC participated in more than 45 partnership projects with an investment value of $15 billion. Mr. Blain has also been a Director of BC Hydro, the Chair of Powerex, a Director of the Transportation Investment Corporation, and a Director of the UBC Investment Management Trust.

And thus far I’ve only mentioned men. Some women I would strongly consider to be chair of the board or to serve on the board are Eileen Mercier, the former chair at Ontario Teachers’ who is now the new chancellor of Wilfrid Laurier University and Carol Hansell, a former board of director at PSP Investments who was recently awarded the Hennick medal for career achievement. I would certainly tap their expertise for this new federal infrastructure bank.

Now, I am merely speculating here, I have no idea if any of these people are interested in heading the new federal infrastructure bank or taking any role on the board of directors, but the point I am making is there is no shortage of qualified individuals to consider for potential roles.

I’ll leave those decisions up to Jim Leech, he’s more than qualified and much better plugged in than I am to pick the right people for the board of directors and senior management.

One infrastructure expert shared this with me:

It is absolutely essential that they hire the right mix of people from both the pension fund industry and from infrastructure.

They also need to hire Canadians who have experience working with institutions in different geographic markets. The Europeans and Japanese are light years ahead of us in this respect.  We need to learn from some of their models, transform the models to make them uniquely Canadian, and then execute.

There are quite a few infrastructure experts in Canada. One of them is Andrew Claerhout, Senior Vice President at Teachers‘ Infrastructure Group, who shared these great comments with me back in November when the federal government started courting big funds for their infrastructure projects:

• Andrew told me that OTPP, CPPIB, OMERS and the rest of Canada’s large pensions are not interested in small DMBF/ PPP projects which are typically social infrastructure like building schools, hospitals or prisons. Why? Because they’re small projects and the returns are too low for them. However, he said these are great projects for construction companies and lenders because you have the government as your counterparty so no risk of a default.
• Instead, he told me they are interested in investing in “larger, more ambitious” infrastructure projects which are economical and make sense for pensions from a risk/ return perspective. In this way he told me that they are not competing with PPPs who typically focus on smaller projects and are complimenting them because they are focusing on much larger projects.
• Here is where our conversation got interesting because we started talking about Australia being the model for privatizing infrastructure to help fund new infrastructure projects. He told me that while Australia took the lead in infrastructure, the Canadian model being proposed here takes it one step further. “In Australia, the government builds infrastructure projects and once they are operational (ie. brownfield), they sell equity stakes to investors and use those proceeds to finance new greenfield projects. In Canada, the government is setting up this infrastructure bank which will provide the bulk of the capital on major infrastructure greenfield projects and asks investors to invest alongside it” (ie. take an equity stake in a big greenfield project).
• Andrew told me this is a truly novel idea and if they get the implementation and governance right, setting up a qualified and independent board to oversee this new infrastructure bank, it will be mutually beneficial for all  parties involved.
• In terms of subsidizing pensions, he said unlike pensions which have a fiduciary duty to maximize returns without taking undue risk, the government has a “financial P&L” and a “social P & L” (profit and loss). The social P & L is investing in infrastructure projects that “benefit society” and the economy over the long run. He went on to share this with me. “No doubt, the government is putting up the bulk of the money in the form of bridge capital for large infrastructure projects and pensions will invest alongside them as long as the risk/ return makes sense. The government is reducing the risk for pensions to invest alongside them and we are providing the expertise to help them run these projects more efficiently. If these projects don’t turn out to be economical, the government will borne most of the risk, however, if they turn out to be good projects, the government will participate in all the upside” (allowing it to collect more revenues to invest in new projects).
• He made it a point to underscore this new model is much better than the government providing grants to subsidize large infrastructure projects because it gets to participate in the upside if these projects turn out to be very good, providing all parties steady long-term revenue streams.

Basically Andrew Claerhout explains why pensions are not competing with DBFM/ PPPs and are looking instead to invest alongside the federal government in much larger, more ambitious greenfield infrastructure projects where they can help it make them economical and profitable over the long run.

Andrew added this: “Most infrastructure investors focus on brownfield opportunities while the government is most interested in seeing more infrastructure built (i.e., greenfield). The infrastructure development bank is meant to help bridge this divide – hopefully it is successful.”

I certainly hope this new federal infrastructure bank is successful in bridging this divide and I’m happy the government appointed Jim Leech as a special advisor to get things rolling. He has a big job ahead of him when he starts working in March but till then, I hope he enjoys his ski vacation with his family on top of mountain in Okanagan (can’t ask for better ski conditions).

One final note, I recently reported that GPIF is making America great again by investing billions in Trump’s infrastructure project. I updated that comment to state GPIF and Prime Minister Shinzo Abe denied these reports. I think the Japanese would be far wiser to invest in Canada’s infrastructure projects once this new federal infrastructure bank is set up.

As far as US infrastructure, Bloomberg reports that Blackstone is targeting as much as $40 billion for infrastructure deals if the world’s biggest private equity firm re-enters the sector. Interestingly, President Trump and Prime Minister Shinzo Abe both attended Blackstone CEO Stephen Schwarzman’s 70th birthday party in Palm Beach over the weekend where there was a ‘frantic rush to change ‘Chinese decorations to Japanese’.

Care to hazard a guess as to who will be the biggest investor in Blackstone’s new infrastructure fund once it re-enters the sector? Happy birthday Mr. Schwarzman, you and your Blackstone colleagues are about to become a whole lot richer under the Trump administration.

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

Jacqueline Nelson of the Globe and Mail reports, Volatile markets shake CPPIB results:

The Canada Pension Plan Investment Board reported a decline in Canada Pension Plan assets to $298.1-billion in its third fiscal quarter, as a major drop in North American fixed income markets hampered investment results.

CPPIB, which manages the Canada Pension Plan investment portfolio, said Friday that the $2.4-billion decrease in assets through the quarter ended Dec. 31 was caused by a swell in CPP payments made to cover benefits at the end of the calendar year that exceeded the $1.7-billion in investment income the fund produced. The investment portfolio’s return in the quarter was 0.56 per cent, after factoring in all costs.

“The fund’s modest return this quarter reflects the largest quarterly decline in North American fixed income markets since CPPIB’s inception coupled with the Canadian dollar strengthening against most major currencies except for the U.S. dollar, partially offsetting gains in our public equity portfolio,” said Mark Machin, CEO of the CPPIB, in a statement.

The end of 2016 and the election of U.S. president Donald Trump brought broad declines to the bond market, projecting investor expectation of inflation and economic growth in the U.S. CPPIB also takes the strategic position not to not to hedge its investment portfolio against currency fluctuations, which means foreign exchange changes can generate big gains or losses.

Mr. Machin has cautioned in recent months to expect more short-term volatility in the fund’s investment results, as the pension fund adjusts its approach to risk in a way it expects will lead to higher long-term gains. So far, in the nine months of CPPIB’s current fiscal year, the fund has produced a 6.9 per cent investment return, after factoring costs.

The CPPIB said that it expects to see more CPP contributions flow into the CPP Fund during the first part of the 2017 calendar year, which will help to make up payments exceeding contributions at the end of 2016. The fund noted that it receives more contributions annually than it pays out.

On the investment front, the pension fund was highly active in the quarter, particularly in real estate. CPPIB invested in student housing, office buildings and retail. The fund also sold a large stake in a Manhattan office tower.

“Income was generated across investment programs and our teams continue to invest in assets in line with our long-term objectives to deliver solid results,” Mr. Machin added.

The breakdown of CPPIB’s investment portfolio shifted only slightly in the quarter. Equity investments made up 56 per cent of assets at the end of December, and 22.1 per cent of assets are in fixed-income investments such as bonds. Infrastructure and real estate assets made up the remaining 21.9 per cent.

CPPIB reported a 10-year annualized return of 4.8 per cent after factoring inflation, which exceeds the standard set by Canada’s Chief Actuary.

Barbara Shecter of the National Post also reports, CPP Fund assets fall below $300 billion, hit by the biggest decline in fixed income markets in its history:

A decline in North American fixed income markets and seasonal cash outflows cause net assets of the CPP Fund to dip below $300 billion.

The fund, which had assets of $300.5 billion at the close of the second quarter, ended the third quarter on Dec. 31 with assets of $298.1 billion.

The investment portfolio delivered a net investment return of $1.7 billion, or 0.56 per cent after all costs, while Canada Pension Plan cash outflows in the quarter were $4.1 billion.

“The Fund’s modest return this quarter reflects the largest quarterly decline in North American fixed income markets since CPPIB’s inception coupled with the Canadian dollar strengthening against most major currencies except for the U.S. dollar,” said Mark Machin, chief executive of the Canada Pension Plan Investment Board.

He said those factors partially offset gains in the public equity portfolio.

In an interview, Machin said the CPP Investment Board is watching the bond market to try to gauge what the ultimate impact will be of the election of Donald Trump as president of the United States.

“It’s always difficult to tell” what the longer-term direction of the bond market will be, he said. “The received wisdom a few months ago was that we were in a lower for longer (period) and negative rates would continue for as far as you can see, but I think the market took a very different view on the elections in the U.S. and the new administration’s policies being very pro-growth.”

The immediate assumption of an inflationary environment took the wind out the bond markets, but Machin said it remains to be seen what policies will ultimately be put in place, how quickly that will happen, and what the knock-on effects will be around the world.

“The big protection for us ultimately is diversification and finding diversification across asset classes, across geographies, across strategies, and that’s what we’re focused on overall so we create a portfolio that will weather the stresses in any individual market anywhere,” he said.

Investing in the United States will remain an important part of the strategy for CPP Investment Board, which invests funds not needed to pay current CPP benefits.

“The U.S. is the biggest destination for our capital… We’re active across just about every one of our strategies” there, he said.

Machin said CPPIB is seeking out “selective opportunities” in markets that could be characterized as stable and even somewhat buoyant.

“There’s no market that’s distressed right now. Volatility is, if anything, at all-time lows in the equity markets,” he said.

For the first nine months of the year, the CPP Fund increased by $19.2 billion and posted an investment return of 6.9 per cent after all costs. Investment income was $19.4 billion, and CPP cash outflows were $0.2 billion.

The CPP Fund routinely receives more contributions than are required to pay benefits during the first part of the calendar year. This is partially offset by payments exceeding contributions in the final months of the year.

Keith Ambachtsheer, a pension expert and co-founder of KPA Advisory Services, said quarterly changes in capital value of an investment fund “are noise…not signal” – regardless of whether they are positive or negative.

“That’s why most of the content of the quarterly CPPIB reports deal with more important longer term issues,” he said.

These are good articles but I normally don’t discuss quarterly results from CPPIB or even semi-annual results from the Caisse. Why? Because, unless there is a big bomb I’m unaware of, I honestly couldn’t care less about short-term results of any pension, they are totally irrelevant in the longer scheme.

In fact, please repeat after me: “I will stop paying attention to CPPIB’s quarterly results.” Period, end of story. Critics of the Canada Pension Plan and CPPIB will harp all over these articles, trying to put a negative spin on them, I simply ignore them.

So, if quarterly results are so immaterial, why does CPPIB report them? Short answer is they have to by law, all part of good governance, full transparency and regular communication.

Now, truth is last quarter was full of action following Trump’s victory. US long bonds sold off and stocks took off, so a lot of pensions experienced some pretty big losses in their fixed income portfolio last quarter.

Some pensions like HOOPP and Ontario Teachers’ were up huge in their fixed income portfolio going into Q4 (CPPIB’s fiscal Q3), then experienced losses in the last quarter. The Caisse has been short bonds for a long time and they probably made decent money in Q4, but over the last four years, their short duration bet (including carry and roll down) has cost them big returns in their fixed income portfolio.

Looking forward, you know my thoughts on US long bonds. Back in November, I explained why Trump will not trump the bond market, urging institutional investors to load up on long bonds after the backup in yields.

At the beginning of the year, I warned my readers to beware of the reflation chimera and that it most certainly isn’t the beginning of the end for bonds:

I just got off the phone with the president of a major Canadian pension fund who told me that they had another solid year last year. He said they sold US Treasuries in mid-year when the 10-year yield approached 1% “because we didn’t see any more upside” and right before Christmas were itching to buy some 30-year Treasuries when yields popped back over 3.3%. He added: “If yields on the 10-year Treasuries rise back to 3%, we’ll be buying.”

What else did he share with me? Stocks are somewhat over-valued here by a factor of seven on their scale, with ten being significantly over-valued. “This silliness can last a little while longer but people forget the same thing happened back when Ronald Reagan won the elections. Stocks took off then too but after the inauguration, they sank 20% that year.”

No kidding! As I’ve repeatedly stated, most recently in my Outlook 2017: The Reflation Chimera, the best risk-reward in these markets is US Treasuries. I don’t care what Bill Gross, Ray Dalio, Paul Singer, Jeffrey Gundlach say in public, in a deflationary environment, I would be jumping on US long bonds (TLT) every time yields back up violently.

Also, take the time to read my comment on the 2017 US dollar crisis where I painstakingly go over the main macro trends and why all that is happening right now is the US is temporarily shouldering the world’s deflation problems through a higher dollar. There is nothing structural going on in terms of solid long-term growth.

What else? The global pension crisis is alive and well which is why I don’t see yields on the 10-year Treasuries rising anywhere near 3%. Most smart institutional fund managers took my advice and jumped on US long bonds when they yield on the 10-year hit 2.5%.

I started my career at BCA Research back in 1998 after a short stint for the Canada Revenue Agency writing a special report on white collar crime in Canada. At BCA, I helped Mark McClellan write the monthly Fixed Income Analyst (Mark is now the Global Strategist at BCA). Two things I know well: bonds and white collar crooks (Tom Naylor, the combative economist at McGill, taught me everything I need to know on hot money and the politics of debt and bankers, bagmen and bandits).

Speaking of BCA Research, a former colleague of mine from there and later at the Caisse, Brian Romanchuk, wrote a nice comment on his blog explaining why the cyclical situation in the US is still mediocre, stating:

The latest labour market data from the United States remain consistent with my view that the rate of growth is not enough to greatly reduce the mass underemployment that is the reality of the labour market. That said, the market implications are limited, as this is already priced into the curve. The Fed may wish to step up its anemic pace of rate hikes, but they will remain dependent upon the data.

I urge you to read his entire comment here. I think the Fed will raise rates more than once and may even (foolishly) raise three times this year, fueling the US dollar crisis I warned of late last year. That’s when things get sticky for emerging markets and financial markets.

Another BCA Research alumnus, François Trahan of Cornerstone Macro, was recently in Montreal at a CFA luncheon to explain why he is bearish and thinks the yield on the 10-year Treasury note will fall back below 1.3% later this year. I happen to agree with him and think a lot of people aren’t reading these markets right (if you’re an institutional investor, make sure you subscribe to Cornerstone Macro‘s research, it’s truly excellent).

And yet another BCA alumnus and bond guru who later went on to become Steve Cohen’s economist at SAC Capital, Gerard MacDonell, wrote a nice short comment in his blog last night, Ug, Trump rally, which you should all read even if his anti-Trump views are all over it (give it a rest old chap, breathe in, breathe out!!).

I will end my comment here, think a lot of people reading too much into CPPIB’s latest quarterly results should “breathe in, breathe out”. There really isn’t anything to worry about here.

When Mark Machin came to Montreal last fall and was nice enough to meet with me, I told him there will be challenging times ahead but to keep hammering the point that CPPIB will typically outperform in a bear market environment and under-perform in roaring bull markets. And to always focus on the long-term, these short-term results are totally irrelevant.

Of course, just like his predecessor, Mark knows all that, he’s a very smart and nice guy with tremendous experience and knowledge and he’s surrounded by a great group of professionals who are busy investing assets in public and private markets all over the world.

So relax, CPPIB is just fine and so are all of Canada’s large pensions!

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

Michael Sabia, president and CEO of la Caisse de dépôt et placement du Québec, wrote an op-ed for all the major Quebec newspapers including the Montreal Gazette, REM electric train: A Montreal of the possible:

There’s Lightspeed, whose software helps 40,000 businesses across the world manage their sales. Hopper, whose successful use of big data predicts the best time to buy a plane ticket. Rodeo FX, whose special effects in Game of Thrones have won Emmys. There are researchers like Yoshua Bengio, whose work is pushing the boundaries of artificial intelligence. And Moment Factory, whose productions dazzle the planet.

Whether it’s big data or new media, artificial intelligence or virtual reality, Montreal is laying the foundations for its future, thanks to a new generation of entrepreneurs and researchers who think and work differently.

Thinking differently is what we try to do every day at la Caisse. And our Réseau électrique métropolitain project is a good example of thinking differently in undertaking a major public transit initiative.

Why is this project important? Because it’s vital that Greater Montreal propel itself into the economy of tomorrow. Because if we are to succeed as a city, we need infrastructure that moves the city forward rather than slowing its progress. Efficient public transit is essential in enabling Montreal to become a metropolis as dynamic as its entrepreneurs.

As a city, we have a unique opportunity to build an electric train network that will change the face of Greater Montreal. It’s a big responsibility that matches the scale of this almost $6 billion investment.

No matter their point of view on specifics, I think everyone agrees on one thing: Montrealers have waited too long for a transit system that meets their needs.

Rain or shine, they want to get to the airport without worrying about missing their plane due to traffic on Décarie or Highway 20. They want to make the Brossard-Central Station trip in 15 minutes flat. They want trains to run every six minutes during their rush-hour commute from Deux-Montagnes to downtown.

That said, the REM is much more than an effective public transit network. The project will create some 8,500 direct and indirect jobs annually during the four years of its construction. It will inject $3.7 billion of financial adrenaline to boost the local economy. That’s over and above the $5 billion in real estate investments expected along the project’s route, including transit-oriented development within walking distance of stations.

At la Caisse, we estimate that the REM will increase the overall public transit budget for the Greater Montreal area by about 2 to 4 per cent. That includes all capital expenditures — that is a first for Quebec. Put another way, for a comparable annual budget, the Greater Montreal area gets the equivalent of a second métro system.

***

Because the REM is such a transformative project for Greater Montreal, it’s perfectly reasonable that the project be closely scrutinized, and the subject of lively discussion. It’s the opposite that would be surprising.

Legitimate questions are being asked. Our goal at la Caisse is always to find better ways to answer them and to work hard to find the best solutions we can. That’s why I think it is important for us to better explain our timetable and the way we’re working to deliver the project on time and on budget.

We have committed to put the first REM trains in service by the end of 2020. First, because we are absolutely convinced it’s doable. And second, because by getting on with the job, we can more easily integrate into the new Champlain Bridge and help relieve chronic traffic jams in Montreal.

Of course, in Quebec we have had more than our fair share of substantial delays and chronic cost overruns in major infrastructure projects. And that’s precisely why we’ve chosen a different approach for the REM — one that allows us to deliver the project in a much more efficient way. We’re working methodically, with utmost rigour, using a continuous engineering approach. What does that mean? It means we’re always listening to suggestions and working on improvements, non-stop.

So far, we have organized 12 open-door meetings where we heard the views of some 3,000 citizens. We’ve discussed the project with hundreds of city officials, transit administrators and community groups. Many worthwhile improvements have resulted from these exchanges.

To broaden access to the REM for all Montrealers via the main métro lines, we accelerated the opening of three new stations at Édouard-Montpetit, McGill and Bassin Peel. To protect wetlands, we decided to extend a tunnel under the Sources Nature Park. To preserve historical buildings in Griffintown, we will be using elevated tracks. And so on.

This openness has guided us since the beginning, and it will continue to do so in the months ahead. In that spirit, we are currently working with the Environment Ministry to follow up on the recommendations of the BAPE environmental review board, despite our differences on certain issues raised in the report.

We are also using a continuous improvement approach to encourage the bidders who have responded to our call for tenders to deliver their most innovative solutions and technologies. Our open and flexible call for tenders is designed to draw on the very best ingenuity that these consortia have to offer.

This approach, based on flexibility and continuous engineering, is in widespread use elsewhere in the world. It’s an efficient way to continuously improve a project, while ensuring it meets expectations. This way of working — collaboratively and iteratively — is inherent in how the new economy works. That said, it is different from the traditional ways used in Quebec to deliver infrastructure.

As our work continues, we will continue to work with municipalities, remain open and receptive to suggestions from the public, and keep you informed of the progress made as we’ve done in recent months.

The REM was never intended to solve all of Greater Montreal’s transportation problems. But it will make a difference. That’s why those of us at la Caisse are working hard every day to plan and build a transit network that meets the needs of Montrealers. Because, for la Caisse and for me personally, there is only one Montreal. A Montreal of the possible.

The French media in Quebec also covered this story. You can read articles in Le Devoir, Le Journal de Montréal, Canoe Argent, CBC Radio-Canada, and elsewhere but the message is the same.

So what’s this “Montreal of the possible” all about and why is Michael Sabia coming out to publicly defend the Réseau électrique métropolitain (REM) project?

Now that you read the polite, politically correct version the president of the Caisse has eloquently penned above, let me give you the brutal raw truth and I won’t mince my words one bit.

The media in Quebec are full of disgusting parasites always looking for dirt to sell their crappy newspapers. They see corruption everywhere and are being fed total garbage by some people at the STM, FTQ, and other organizations which are working feverishly in the background to discredit this project.

Why are they doing this? Because they view the Caisse and its infrastructure group, CDPQ Infra, as a real threat to their operations and some construction and engineering companies are unhappy because they can’t grease their way into this mega project like they used to do in the old Québécois Wild West days before the Charbonneau commission exposed their crooked ways.

Now, truth be told, the Caisse is undertaking a major “greenfield” infrastructure project to revamp the transportation system in the city of Montreal, a first of its kind for any large Canadian and global public pension fund, so it’s not surprising that critics will scrutinize their every move from A to Z.

But Michael Sabia isn’t stupid. He knew all this going into this project which is why he entrusted it to Macky Tall (featured in picture above), the head of CDPQ Infra, and his team. Tall is a first rate infrastructure manager with the highest integrity and he hired people with solid experience in project financing and management, people with the highest integrity to oversee every aspect of this big project, including the calls for tender and understanding/ integrating the views and concerns from various agencies and concerned citizens.

Is CDPQ Infra perfect? Of course not, they will make mistakes along the way and that is normal for a project of this scale and scope. Name me one major infrastructure project in Canada or anywhere in the world that has never run into problems, it simply doesn’t exist.

But if you read the garbage being written in Quebec’s slanderous media, you’d think CDPQ Infra is run by a bunch of crooked, incompetent and inexperienced hacks. Total and utter nonsense which is why I stopped reading these articles, they only irritate me.

I’ve said it before and I will say it again, if I had a choice of going back to the old ways we were building infrastructure in Quebec or have the Caisse overseeing this mega project with first rate governance and a material financial interest, there’s no doubt in my mind I’d opt for the latter precisely because the Caisse has an interest in delivering this project on time and within budget.

Macky Tall and his infrastructure team at CDPQ Infra are getting a bum rap, all undeserved, but this is Quebec, the sewer of Canadian media (not that media outlets in other provinces are any better) so I’ve grown accustomed to reading sensationalized garbage which grossly distorts reality.

When all is said and done, I am sure Tall and his team will deliver the goods on time and within the budget allocated for this project. I can guarantee you that this wouldn’t have been the case had we gone back to the old ways of doing things.

As far as Sabia and his “Montreal of the possible” article, he is right on many things, including how this project will create many direct and indirect jobs, but the reality is this city is so congested that it’s starting to impact many businesses in a detrimental way. We desperately need this REM project to be completed on time and from what I am told, it will be positive for residential real estate on the outskirts of Montreal because people will be able to live there and easily come to the downtown core to work in a few minutes.

And while I am on this subject of congestion in Montreal, can the “geniuses” at Transport Quebec and the City of Montreal finally get it right with the l’Acadie circle near Rockland shopping center, the Decarie expressway, the Turcot interchange and countless other traffic nightmares in and around the city? We are living in third world conditions here and wasting precious time in horrible traffic jams that can be easily solved with better planning and engineering.

Montreal of the possible? This city, much like it’s media and politics, is a sewer but what do I know, I’m just a grumpy old man who loathes endless traffic jams and countless pot holes.

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

Kirk Falconer of PE Hub Network reports, bcIMC to acquire European credit business Hayfin from PE owners:

Hayfin Capital Management LLP, a European private debt investment firm, has agreed to be acquired by British Columbia Investment Management Corp (bcIMC). No financial terms were disclosed, however, Sky News reported the deal’s value to be about £215 million (US$268 million). The Canadian pension fund bought a majority stake in Hayfin from the company’s founding shareholders: TowerBrook Capital Partners, PSP Investments, Ontario Municipal Employees Retirement System (OMERS) and Future Fund. London-based Hayfin, established in 2009, said bcIMC will commit “significant capital” to its managed funds and support its long-term growth.

PRESS RELEASE

Hayfin’s institutional shareholding sold to bcIMC

January 31st 2017

Hayfin Capital Management LLP (“Hayfin” or “the firm”), a leading European credit platform with €8.2bn in assets under management, today announces that British Columbia Investment Management Corporation (“bcIMC”) has agreed to acquire the majority shareholding in the firm from the existing consortium of institutional shareholders. The transaction will support Hayfin’s long-term growth plans and simplify its ownership structure, with Hayfin’s management and employees remaining substantive shareholders alongside bcIMC.

bcIMC, a Canadian investment manager which manages approximately C$122bn in assets, is acquiring 100% of the shares owned by Hayfin’s current institutional shareholders – TowerBrook Capital Partners, PSP Investments (“PSP”), the Ontario Municipal Employees Retirement System (“OMERS”), and The Future Fund. bcIMC is also committing significant capital to the funds that Hayfin currently manages and will be supportive of the future development of the business. Hayfin’s principal focus will remain managing assets for third parties; the day-to-day independence of the Hayfin team over operations, investments, and personnel will be unaffected by the change in ownership.

Tim Flynn, CEO of Hayfin Capital Management, commented: “This long-term investment from bcIMC will provide the access to capital and streamlined ownership structure to realise our ambition of becoming Europe’s leading credit platform. What won’t change under the new ownership arrangements is the independence of Hayfin’s experienced team of credit investment professionals, or our commitment to delivering high-quality returns for the third-party investors whose capital we manage.”

Jim Pittman, Senior Vice President of Private Equity at bcIMC stated: “We see this as a strategic long-term investment in a leading company that has the potential to generate value-added returns for our clients. Having known the Hayfin team since inception, I’m confident in their strategy and ability to further expand their business and raise additional capital through their funds.” He continued, “Our investment in Hayfin provides bcIMC with access to one of Europe’s leading credit platforms as both a majority shareholder and an investor in its funds across the spectrum of credit products.”

The financial terms of the deal are undisclosed. Completion of the transaction is subject to regulatory approval.

Mark Kleinman of Sky News also reports, Canadian pensioners swoop on Quorn lender Hayfin in £215m deal:

A giant Canadian pension fund will this week swoop to take control of a UK-based lender which counts The Racing Post and ‎Quorn, the meat substitute food manufacturer, among its clients.

Sky News has learnt that the British Columbia Investment Management Corporation (BCIMC) will announce on Tuesday that it has agreed to buy a majority stake in Hayfin Capital Management in a deal worth roughly £215m.

The deal will underline a growing appetite to invest in alternative lenders, many of which have been established over the last decade to exploit gaps left by traditional banks.

A regulatory clampdown after the 2008 financial crisis has made it harder for conventional banks to lend to companies on economically attractive terms‎, paving the way for the emergence of competitors such as Hayfin and Ares Capital Management.

Sources said that BCIMC, which manages more than C$120bn (£73.2bn) of assets, would buy out Hayfin’s existing institutional shareholders: Towerbrook Capital Partners, Australia’s sovereign wealth fund and two other Canadian pension funds.

Hayfin’s management and employees will retain their shareholdings following the deal.

The company, which has €8.2bn (£7bn) under management, has built a ‎successful business by lending money to medium-sized European companies since its launch by former Goldman Sachs partners in 2009.

It has lent more than €9bn (£7.7bn) since it was set up, with other corporate customers including Sunseeker, the luxury yacht-builder.

It also operates a strategy called special opportunities, and has business lines in maritime credit and healthcare, as well as offering asset management services to institutional clients.

The deal with Hayfin is expected to see the British Columbia-based fund commit significant funds for its expansion, although the London-headquartered lender will retain day-to-day autonomy over its operations and investments.

Insiders said the deal was attractive to Hayfin’s management because it would simplify the company’s ownership structure, as well as providing a platform for future growth.

In 2015, ‎Hayfin sold its portfolio of owned assets to The Future Fund, Australia’s state-backed investor.

A Hayfin spokeswoman declined to comment on Monday, while BCIMC could not be reached.

I love when I read bcIMC “could not be reached,” it reminds me of the old tight-lipped days at PSP Investments when Gordon Fyfe was at the helm and they hardly ever put out a press release unless the organization had to by law.

Well, bcIMC isn’t PSP, and there is a bit more transparency there but you can feel the new culture with Gordon at the helm is much more tight-lipped. There is nothing evil or sinister behind this veil of secrecy, Gordon’s philosophy was always the only press release that counts is the annual report.

But regular communication is part of good governance. Other large Canadian public pension funds are much more transparent and proactive in getting their message out, embracing social media platforms like Twitter, LinkedIn, and YouTube, but in order to do this, you need to have content (interviews, articles, etc.).

That’s not Gordon Fyfe’s style. He shuns the media and doesn’t like giving interviews to Bloomberg, CNBC or other news outlets. In the last ten years, I think he only gave one rare interview. Like I said, it’s not his style, he keeps information close to his chest and doesn’t like discussing operations apart from when he has to in the Annual Report.

Not surprisingly, Gordon did have the good sense to hire Jim Pittman from PSP to head Private Equity at bcIMC (Jim left PSP on his own, on good terms, and took some time to think about his next move).

Jim is a very smart and nice guy, worked hard at PSP to develop fund investments, co-investments, and direct investments. He too is reserved by nature and shuns the spotlight. You won’t find any interview or even a picture of him on the internet apart from some AVCJ Forum that took place back in 2013 which he attended (click on image):

That is Jim on the upper left side when he was VP at PSP Investments (for some reason, bcIMC doesn’t post bios or pictures of their senior executives and board members on its website).

Anyways, enough about that, let me get into this deal. It’s obvious that Jim Pittman knows Hayfin Capital Management and its senior managers extremely well. Headquartered in London, Hayfin has offices in Amsterdam, Frankfurt, Luxembourg, Madrid, Paris, New York and Tel Aviv. It specializes in sourcing, structuring and managing European private debt investments while operating complementary business lines across corporate, maritime and alternative credit.

In the press release announcing the bcIMc deal,  Jim states he knows the “Hayfin team since inception”,which leads me to believe he and Derek Murphy (the former head of PE at PSP) seeded this credit platform or more likely, they got together with Ontario Teachers’, OMERS and others to seed it.

Either way, it doesn’t matter now that bcIMC has agreed to acquire the majority shareholding in Hayfin from the existing consortium of institutional shareholders (remember, it’s a small club in Canada, all the senior pension fund managers know each other very well).

Does the deal make sense for all parties? Well, obviously if they agreed to the terms bcIMC offered them or else they wouldn’t sign off on this deal.

What does bcIMC get from this deal exactly? It can allocate more money into the European private debt market through an experienced partner that knows the space well and share in its success as it owns the majority shares now. It is also likely is getting preferential treatment on fees that others won’t get (unless there is some clause against this).

What is the outlook for European private debt? That’s a good question. Barring a total collapse of the Eurozone, which looks increasingly likely, there are many structural issues plaguing Europe’s debt markets and smart investors are trying to capitalize on them.

Those of you that don’t know about private debt as an asset should read this ICG report, The Rise of Private debt as An Asset Class. Preqin puts out an annual report on private debt markets (you can read a sample from last year’s report here). And more specifically to Europe, EY put out a report back in October looking at the outlook for European private debt which provides interesting insights, like key issues for investors (click on chart which is from Preqin):

Notice the top four concerns are pricing/ valuations, deal flow, performance and fulfilling investor demands. Interestingly, regulation is a concern but nothing urgent since unlike the United States where President Trump is moving full steam ahead to deregulate the financial services industry,  in Europe, things move extremely slowly on the regulatory front.

Private debt is a complicated asset class in terms of barriers to entry for large pensions. It’s hard for Canadian pension funds to directly compete with specialized credit funds or platforms which is why they prefer to partner up with them to allocate into this space, sometimes hiring groups that worked at investment banks to work for them or just seeding their operations.

Back in November, I discussed how PSP Investments seeded a European credit fund, AlbaCore Capital, run by David Allen who used to work at CPPIB and was head of European investments at GoldenTree Asset Management in London before joining that pension fund.

PSP invested a significant stake in this investment to develop its European private debt capabilities. It obviously believes in this asset class over the long run even if there are concerns about the future of the Eurozone, valuations, deal flows, etc.

For bcIMC and PSP, they are firmly entrenched now in European private debt, and hopefully these partnerships will help them deliver great returns in an increasingly competitive space facing all sort of issues.

One thing is for sure, Tim Flynn, Hayfin’s CEO, is an experienced credit manager who knows European private debt markets extremely well:

Mr Flynn serves as Hayfin’s Chief Executive Officer. Prior to joining Hayfin, Mr Flynn was a partner at Goldman Sachs, where he co-headed the European Leveraged Finance and Acquisition Finance businesses. Mr Flynn was also a member of Goldman Sachs’ firm-wide Capital Committee.

Before joining Goldman Sachs, Mr Flynn was a corporate finance lawyer at Sullivan & Cromwell, a New York-based law firm.

Mr Flynn graduated from Columbia Law School, where he was a Harlan Fiske Stone Scholar and an Editor of the Columbia Law Review. Mr Flynn graduated from Georgetown University with a Bachelor of Science.

His team is equally experienced and again, this isn’t an easy space for pensions to just start lending directly. They need the expertise of these funds which have developed long standing relationships with key players.

How will bcIMC’s investment into Hayfin and PSP’s investment into AlbaCore end up? I hope it ends up well for their beneficiaries but there will be a few hitches and challenges along the way.

Still, private debt is an important asset class for many institutional investors looking to improve their returns and take advantage of regulatory and structural issues hindering European and US debt markets.

Take the time to watch this clip at Citywire’s first Modern Investor forum where they brought together five institutional players to size up the investment case for private debt. You can read the accompanying article here.

Also, the financial crisis continues to leave its mark on European banks. And as yet, there are no apparent business solutions in sight. US institutions though are doing better, reporting high levels of assets. Take the time to watch this DW clip here.

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

Back in early December, Aliya Ram of the FT reported, Danish pension fund halves outsourced money:

Denmark’s biggest pension fund has halved the amount of money it outsources to external asset managers over the past two years, arguing that increased scrutiny of costs and transparency has made hiring them untenable.

ATP, which manages DKr806bn (£91bn) for 5m Danish pensioners, used to allocate more than a third of its DKr101bn (£11.4bn) investment assets to external fund managers.

However, Kasper Lorenzen, the chief investment officer, told FTfm that this has halved to 19 per cent since December 2014, a loss of DKr19.3bn (£2.2bn) for the industry.

“Some of these more traditional, old-school mandates, where you hire some asset manager, and then they track a benchmark and try to outperform by 14 basis points . . . we kind of tried to get rid of that,” Mr Lorenzen said.

He added that after the financial crisis investors wanted cheaper options. “I think the main thing is that there is more focus on costs. I think there is more transparency. There are really low-cost implementation vehicles [out] there.”

ATP joins a growing group of asset owners that have pulled money from active managers in favour of cheaper, passively managed funds, or more complicated investments in infrastructure, financial derivatives and property.

The California State Teachers’ Retirement System, the third-largest pension plan in the US, told FTfm in October that it plans to pull around $20bn from its external fund managers. It has already shifted $13bn of its assets in-house over the past year.

Alaska Permanent Fund, which manages $55bn, said this summer that it will retrieve up to half its assets from external managers, while AP2, the Swedish pension scheme, dropped mandates from external managers earlier this year. AP2 has moved more than $6bn from asset managers to internal investment staff over the past three years.

Railpen, the £25bn UK pension scheme, also said last year it had achieved £50m of annual cost savings by cutting the number of external equity managers it worked with from 17 to two, and managing more money internally.

The active industry has come under pressure for failing investors with poor returns and high fees in an era of low interest rates where returns are more difficult to come by.

Last month the UK regulator sharply criticised the industry for charging high fees and generating significant profits despite failing to beat benchmarks.

There is nothing new or surprising about ATP’s decision to significantly cut its traditional external managers. There is a crisis in active management that has roiled the industry and many large institutional investors are bringing assets in-house, especially in the more traditional mandates where they can significantly cut costs and gain the same or better performance.

And it’s not just large pensions that are cutting external managers. Attracta Mooney of the FT reports, CIO of £12bn pension pot threatens to cull external managers:

Chris Rule, the man charged with investing £12bn on behalf of more than 232,000 current and former local authority workers in England, begins his meeting with the Financial Times earlier this month by apologising.

Standing in his office in Southwark in the south of London, he explains the air-conditioning is on the blink. It is a crisp, cold January evening, but Mr Rule’s small office, located in a building that also houses London Fire Brigade’s headquarters, is sweltering. It has been all day.

The building managers are on the case, he says, but for now the only way to cool down is to resort to shirt sleeves and big glasses of cold water.

Mr Rule seems unperturbed, if a little hot. It is hard to imagine that many chief investment officers across London would so easily shrug off such an uncomfortable office environment. But the father of three has other things on his mind, namely the radical overhaul happening across the UK’s local authority pension funds.

In 2015 George Osborne, the chancellor at the time, called on the 89 local authority retirement funds across England and Wales to create six supersized pension pots or “British wealth funds”.

The plan was that these funds would work together to reduce running costs and invest more in infrastructure. Since then, proposals for the formation of eight local authority partnerships have been put forward to the government for approval.

Mr Rule is the chief investment officer of one of these pools: the Local Pensions Partnership, or LPP, which was set up to oversee the combined assets of the London Pensions Fund Authority and the Lancashire County Pension Fund. The two pension schemes’ plans for a partnership predates Mr Osborne’s proposals, but his demands cemented their efforts.

Mr Rule says: “People [across local authorities] have done a lot of heavy lifting over the past 12 months and got the sector massively further forward than many stakeholders or commentators would have believed was possible in that space of time.”

Last month, LPP received the seal of approval from the government, when Marcus Jones, the UK minister for local government, signed off its plans. But the minister flagged some concerns, not least the size of the fund. LPP is short by almost half the £25bn figure Mr Osborne indicated he wanted the pooled funds to manage.

“It is no secret that the minister would like us to be that magic £25bn [in assets]. But it is important to realise that we are up and running; we are live today,” Mr Rule says.

LPP, which began operating in April 2016, is one of the few local authority partnerships that is already functioning. It has also received regulatory approval from the UK’s financial watchdog, unlike the majority of the other local authority pots.

Mr Rule’s job at LPP is highly pressured, especially at a time when record-low interest rates are hurting returns and driving up liabilities for retirement schemes. LPP has been tasked with undertaking the majority of the work that the two local authority funds once did, from asset allocation to pension administration.

The 38-year-old is at pains to stress that LPP has already used its increased scale to reduce costs for its two founding funds, despite falling far short of the desired level of assets.

The partnership has a far bigger allocation to infrastructure than other local authority pools. “At the size we are, we are already getting significant discounts when we are negotiating with third-party managers,” he says.

The former Old Mutual fund manager is now focused on axing asset managers in favour of running more money internally in order to cut costs.

“Our intention is to expand our internal capability, develop new internal strategies and therefore be able to insource more of the assets. That is clearly where we get the greatest fee savings, because we can operate at a much lower cost.”

Last November, LPP launched a £5bn global equity fund, consisting of the pooled cash of the LPFA and LCPF. About 40 per cent of the assets are managed internally by LPP, while a trio of fund houses — MFS, Robeco and Magellan — run the remaining 60 per cent.

Morgan Stanley, Harris Associates and Baillie Gifford, which previously ran equities for the pension funds, were axed as a result. This move is expected to save £7.5m a year in investment management costs. The trend of cutting managers is set to continue as part of Mr Rule’s aim of running around half of LPP’s assets internally, up from a third currently.

The managers most at risk are those running equities: Mr Rule would like to manage about 80 per cent of LPP’s investments in stock markets internally.

But he adds: “I would never expect to be 100 per cent internal. There will always be areas that we want to go and get [external] expertise for.

“We are only going to allocate money internally where we believe that is better than anything we can get externally. There is no point saving £5m in costs if it costs us £30m in returns.”

If LPP manages more money itself, it needs to grow its investment team. There are 25 investment staff positions at LPP, almost double the combined size of the now-defunct investment teams at the two founding pension funds. Some of the LPP positions, however, are yet to be filled.

Mr Rule admits that convincing employees to switch from private sector asset management, where higher salaries are the norm and offices have working air con, is a difficult task.

“If they don’t care about anything apart from money, we are going to have a challenge attracting and retaining them because there is always going to be someone that will pay more than us,” he says. “We can offer people a degree of autonomy that perhaps they would not have in a traditional asset manager.”

As Mr Rule continues to extol the virtues of a career in a local authority pension fund, it starts to become clearer why he left the private sector.

“There is always a bit of a conflict with an asset management firm, and I say that having worked all my career in asset management firms. As an individual, sometimes it can cause you to question the merit of what you are doing,” he says. “We are the asset owner. It is not about how we can generate fee income and profitability for the [company]. We have a different lens we look through.”

For a young 38-year old buck, Mr. Rule has huge responsibilities but at least he gets the name of the game. When you work for an asset management firm, it’s all about gathering assets. This goes for firms working on traditional mandates (beating a stock and bond benchmark) and it also goes for elite hedge funds shafting clients on fees.

When you work for a pension, your objective is to maximize the overall return without taking undue risk and in order to achieve this objective, pensions need to cut costs wherever they can, especially in a low return/ low interest rate world.

Rule is right, pensions can’t go 100% internal but many are cutting costs significantly wherever they can. And I agree with him when he states the following: “We are only going to allocate money internally where we believe that is better than anything we can get externally. There is no point saving £5m in costs if it costs us £30m in returns.”

Go back to read an older comment of mine when Ron Mock was named Ontario Teachers’ new leader where I went over the first time we met back in 2002 when he was running Teachers’ massive external hedge fund program:

Ron started the meeting by stating: “Beta is cheap but true alpha is worth paying for.” What he meant was you can swap into any index for a few basis points and use the money for overlay alpha strategies (portable alpha strategies). His job back then was to find the very best hedge fund managers who can consistently deliver T-bills + 500 basis points in any market environment. “If we can consistently add 50 basis points of added value to overall results every year, we’re doing our job.”

He explained to me how he constructed the portfolio to generate the highest possible portfolio Sharpe ratio. Back then, his focus was mainly on market neutral funds and multi-strategy funds but they also invested in all sorts of other strategies that most pension funds were too scared to invest in (strategies that fall between private equity and public markets; that changed after the 2008 crisis). He wanted to find managers that consistently add alpha – not leveraged beta – using strategies that are unique and hard to replicate in-house.

The key message? Beta is cheap!! Why pay some asset management firm big fees especially in traditional stock and bond mandates when most of them are incapable of beating an index over a long period? The same goes for hedge funds charging alpha fees for leveraged beta? Why pay them a ton of fees when they too consistently underperform a simple stock or bond benchmark over a long period? That too is insane!

Now, I know the arguments for active management. We went from a big alpha bubble which deflated to a mega beta bubble where the BlackRocks, Vanguards and a whack of Robo-advisors are inflating a giant beta bubble, indiscriminately shoving billions into ETFs, and it’s all going to end badly.

Moreover, just like François Trahan of Cornerstone Macro who was in Montreal last week, I am openly bearish and you’d think in a bear market active managers will outperform all these beta chasers, but it’s not that simple. Most active managers will perform even worse in a bear market, incapable of dealing with the ravages of a brutal decline in stocks.

Having said this, there will always be a market for good active managers, whether they are traditional asset management firms or elite hedge funds or private equity funds, so whenever pension fund managers think they are better off outsourcing assets to obtain their actuarial rate-of-return target, they should do so and gladly pay the fees (as long as they are not getting the big shaft on fees).

Pension fund managers don’t mind paying fees when they get top performance and great alignment of interests, but when they don’t, they just bring assets internally and cut costs, even if that means lower returns on any given year (over the long run they are better off with this strategy).

An example of where it makes sense to outsource assets, especially in illiquid markets, is in a recent deal involving the UK’s Universities Superannuation Scheme. Dan Mccrum of the FT reports, UK universities pension plan in novel deal with Credit Suisse:

The pension plan for UK universities has snapped up most of a $3.1bn portfolio of loans to asset managers, in a collaboration with Credit Suisse which highlights the shifting roles of banks and investors in the continent’s capital markets.

The £55bn Universities Superannuation Scheme has agreed to provide debt financing to private equity and asset management groups that have raised so-called direct lending funds. These funds make loans to medium-sized businesses, displacing traditional bank lending.

It comes as Credit Suisse undertakes a reordering of its business designed to reduce activity which requires large commitments of capital, in favour of advising clients in return for regular fees.

In the first deal of its kind for a UK pension fund, the collaboration begins with the Swiss investment bank offloading most of a portfolio of loans and loan commitments made in 2014 and 2015, typically lasting five to seven years. The bank, which retains a small portion of the original lending, will manage the pool of loans and arrange new financing for USS on the same basis.

Ben Levenstein, head of private credit and special situations for USS, said the pension fund allocates a quarter of its capital to investments where it can earn a higher income than equivalent securities in public markets, which can be easily bought and sold. “We do have a tolerance for illiquid assets,” he said.

The $3.1bn of existing lending commitments to groups such as GSO Capital Partners, part of the alternative investment group Blackstone, will eventually be backed by around $6bn of lending to medium-sized businesses, in competition with commercial banks.

“Non-bank lending is a structural shift in capital markets, and the asset managers want a funding source not reliant on bank financing,’’ said Jonathan Moore, co-head of credit products in Europe, the Middle East and Africa for Credit Suisse.

Several years of very low interest rates have forced pension funds to search for unusual sources of income, at the same time as regulatory changes have caused many banks to conserve capital. Since 2013, $119bn has been raised for direct lending, by more than 200 investment funds, according to Preqin, a data provider.

The funds typically lend to businesses with earnings before interest, taxes, depreciation and amortisation of less than €50m, too small to access public debt markets. A borrower might expect to pay 600-800 basis points above interbank borrowing costs, for a five-year loan.

Asset managers boost investment returns by raising debt against the funds. The lending commitments arranged by Credit Suisse are so-called senior loans, financing half the value of the underlying portfolio at low risk. The typical cost of such funding is around 250-300 basis points over interbank borrowing costs, according to participants in the market.

While the deal may be a model for institutional investors to follow, USS is unusual among large UK pension schemes which offer defined benefits to members in retirement. USS remains open to new members and continues to make new investments as contributions flow in.

Private debt is a huge market, one which many Canadian pension funds have been pursuing aggressively through private equity partners, in-house managers or by seeding new credit funds run by people that used to work at large Canadian pensions. In this regard, I’m not sure how “novel” this deal between Credit Suisse and the UK’s Universities Superannuation Scheme really is (maybe by UK standards, certainly not by Canadian ones).

Lastly, it is worth noting that while many pensions are rightfully focusing on cutting costs and insourcing assets wherever they can, large endowments funds like the one at Harvard, are moving in the opposite direction, adopting Yale’s model which is based on outsourcing most assets to top external asset managers.

The key difference is that top US endowments have a much shorter investment horizon than big pensions and they allocate much more aggressively to illquid private equity, real estate and hedge funds. They have also perfected the outsourcing model which has served many of them well and have developed long-term, lasting relationships with top traditional and alternative asset managers.

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

Alvin Powell of the Harvard Gazette reports, Course change for Harvard Management Company:

Explaining that challenging investment times demand “we adapt to succeed,” the new head of the Harvard Management Company (HMC) announced sweeping internal changes today, including a major shift in investment strategy, workforce reductions, and a compensation system tied to the overall performance of the University’s endowment.

N.P. Narvekar, who took over as HMC’s president and chief executive officer on Dec. 5, immediately began executing his reorganization, announcing four new senior hires: Rick Slocum as chief investment officer, and Vir Dholabhai, Adam Goldstein, and Charlie Savaria as managing directors.

“Major change is never easy and will require an extended period of time to bear fruit,” Narvekar said in a letter announcing the moves. “Transitioning away from practices that have been ingrained in HMC’s culture for decades will no doubt be challenging at times. But we must evolve to be successful, and we must withstand the associated growing pains to achieve our goals.”

Founded in 1974, HMC has overseen the dramatic growth in the University’s endowment that has made it, at $35.7 billion, the largest in higher education. Made up of more than 13,000 funds, many of them restricted to particular purposes, the endowment is intended to provide financial stability year to year for the University. In the last fiscal year, which ended on June 30, endowment funds provided $1.7 billion, more than a third of the University’s $4.8 billion budget. Such endowment income supports Harvard’s academic programs, science and medical research, and student financial aid programs, which allow the University to admit qualified students regardless of their ability to pay.

During the 1990s and early 2000s, returns on Harvard’s endowment regularly outstripped those of other institutions, making HMC a model for endowment management. Since the market crash of 2008, however, endowment performance has been up and down. Last year, endowment returns fell 2 percent, dropping the value below the $36.9 billion high-water mark reached in the 2008 fiscal year.

Narvekar has decided to shift from the policy of using both in-house and external fund managers that had made HMC’s approach to investing unique. In recent years, he said in his letter, competition has intensified for both talent and ideas, making it tougher to both find and retain top managers and exploit “rapidly changing opportunities.”

In what he called “important but very difficult decisions,” Narvekar announced that the in-house hedge fund teams would be leaving HMC by July, and the internal direct real estate investment team would leave by the end of the calendar year. The natural resources portfolio, meanwhile, will remain internally managed. Altogether, he said, the changes will trim HMC’s 230-person staff roughly in half.

“It is exceptionally difficult to see such a large number of our colleagues leave the firm, and we will be very supportive of these individuals in their transition,” Narvekar said. “We are grateful for their committed service to Harvard and wish them the very best in their future endeavors.”

The changes are in step with an overall strategy shift that will move away from what Narvekar called a silo investing approach, wherein managers focus on specific types of investments — whether stocks, bonds, real estate, or natural resources — to one in which everyone’s primary goal is overall health and growth for the endowment.

The problem with the silo approach, Narvekar said, is that it can create both gaps and duplication in the overall portfolio.

“This model has also created an overemphasis on individual asset class benchmarks that I believe does not lead to the best investment thinking for a major endowment,” Narvekar added.

Narvekar sees his incoming “generalist model,” which is employed at some other universities, as fostering a “partnership culture” in which the entire team debates investing opportunities within and across asset classes.

Narvekar, who previously oversaw the endowment at Columbia University, said he would encourage managers to be open-minded and creative as they move forward, adding that the generalist model is flexible enough that, under the proper circumstances, it could again allow for hiring in-house managers down the road.

“While I don’t expect a large portion of the portfolio to be managed internally as a practical matter … nothing is out of bounds in the future,” he said.

Narvekar expects a five-year transition period for the changes to be fully implemented, and although he warned that investment performance will likely be “challenged” this year, by the end of the calendar year organizational changes should have taken hold and HMC will look and act differently.

In effect, HMC’s compensation structure will move away from a system where managers are compensated based on how their siloed investments perform relative to benchmarks. The new system, to be implemented by July, will be based on the endowment’s overall performance.

In a press release, Narvekar said he has known the four executives brought aboard to implement the changes for much of his career. Three of them — Dholabhai, Goldstein, and Savaria — have earlier experience at the Columbia Investment Management Co. where Narvekar was CEO. The fourth, Slocum, who starts as chief investment officer in March, comes to Harvard from the Johnson Company, a New York City-based investment firm. He has worked at the Robert Wood Johnson Foundation and the University of Pennsylvania.

In addition to his experience at Columbia, Dholabhai, who starts on Monday, was most recently the senior risk manager for APG Asset Management US. Goldstein, who starts on Feb. 6, comes directly from Columbia, where he was managing director of investments. Savaria, who also starts on Monday, co-managed P1 Capital.

“I am pleased to welcome four senior investors to HMC who bring substantial investment expertise and deep insight into building and working in a generalist investment model and partnership culture,” Narvekar said. “I have known these individuals both personally and professionally for the majority of my career, and I value their insights and perspectives.”

The last time I discussed Harvard’s ‘lazy, fat, stupid’ endowment was back in October where I drilled down to examine criticism of another dismal year of performance and ‘mind blowing’ compensation.

HMC’s new president, N.P. Narvekar, wasted no time in setting a new course for Harvard’s endowment fund. In essence, he’s basically admitting that Yale’s endowment model which relies primarily on external managers is a better model and he’s also putting an end to insane compensation tied to individual asset class performance.

Narvekar is absolutely right: “The problem with the silo approach is that it can create both gaps and duplication in the overall portfolio. This model has also created an overemphasis on individual asset class benchmarks that I believe does not lead to the best investment thinking for a major endowment.”

I don’t believe in the silo approach either. I’ve seen first-hand its destructive effects at large Canadian pension funds and I do believe the bulk of compensation at any large investment fund should be tied to overall investment results (provided all the asset class benchmarks accurately reflect all the risks of the underlying portfolio).

At the end of the day, whether you work at Harvard Management Company, Yale, Princeton, or Ontario Teachers’ Pension Plan, the Caisse, CPPIB, it’s overall fund performance that counts and senior managers have to allocate risk across public and private markets to attain their objective.

Now, US endowment funds are different from large Canadian pensions, they have a shorter investment horizon and their objective is to maximize risk-adjusted returns to more than cover inflation-adjusted expenses at their universities, not to match assets with long-dated liabilities.

Still, Narvekar and his senior executives now have to allocate risk across public an private market external managers. And while this might sound easy, in an low interest rate era where elite hedge funds are struggling to deliver returns and shafting clients with pass-through and other fees, it’s becoming increasingly harder to allocate risk to external managers who have proper alignment of interests.

What about private equity? Harvard and Yale have the advantage of being premiere endowment funds which have developed long-term relationships with some of the very best VC and PE funds in the world but even there, returns are coming down, times are treacherous and there are increasing concerns of misalignment of interests.

And as Ron Mock recently stated at Davos, you’ve got to “dig five times harder” to find deals that make sense over the long run to bring in a decent spread over the S&P 500.

All this to say that I don’t envy Narvekar and his senior managers who will join him at HMC. I’m sure they are getting compensated extremely well but they have a very tough job shifting the Harvard Endowment titanic from one direction to a completely different one and it will take at least three to five years before we can gauge whether they’re heading in the right direction.

What else worries me? A lot of cheerleaders on Wall Street cheering the Dow surpassing the 20,000 mark, buying this nonsense that global deflation is dead, inflation is coming back with a vengeance and bonds are dead. Absolute and total rubbish!

When I read hedge funds are positioned for a rebound in the oil market and they’re increasing their bearish bets on US Treasuries, risking a wipeout, I’m flabbergasted at just how stupid smart money has become. Go read my outlook 2017 on the reflation chimera and see why one senior Canadian pension fund manager agrees with me that it’s not the beginning of the end for US long bonds.

In fact, my advice for Mr. Narvekar and his senior team is to be snapping up US Treasuries on any rise in long bond yields as they shift out of their internal hedge funds and to be very careful picking their external hedge funds and private equity funds (I’d love to be a fly on the wall in those meetings!).

Below, Bloomberg reports on why Harvard’s new fund manager is copying Yale, farming out money, ending on this sobering note:

Mark Williams, a Boston University executive-in residence who specializes in risk management, said the moves mark the end of a long, painful realization that its strategy was failing, a capitulation he considered “long overdue.”

Williams said the move will mark an opportunity for outside managers eager to oversee funds for such a prestigious client: “It’s going to be a bonanza for those money shops.”

That’s what worries me, a bunch of hedge funds and other asset managers lining up at Harvard’s door begging for an allocation, looking for more fees. But I trust Narvekar and his senior team will weed out a lot of them. For the rest of you, pay attention to what is going on at Harvard, it might be part of your future plans.

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

Tawfik Hammoud and Vinay Shandal of BCG recently wrote an op-ed for the Globe and Mail, Canada needs to work on its private-equity game:

When you look at who attended last week’s World Economic Forum in Davos, it’s striking how many are global investors or work for large funds – and in particular, private-equity firms.

The question Canadians should be asking themselves is, how do we ensure that Canada receives its fair share of the trillions of dollars deployed by global investment funds, including real estate, infrastructure, venture capital and private equity? How can our entrepreneurs and company owners benefit from this growth capital and the opportunities that come with it?

How can we create an investment ecosystem that gives rise to more Canadian investment firms led by top professionals?

The global investors who gathered in Davos, Switzerland, have much to be thankful for. Business is thriving and the various private asset classes’ performance keeps pumping up demand, especially relative to fixed income and public equities. Take private equity, for example: 94 per cent of investors in a recent survey count themselves satisfied with the returns, and more than 85 per cent say they intend to commit more or the same amount of capital to private equity next year. As a result, the capital flowing into private equity is unprecedented, established firms are raising record amounts of money and fund oversubscription is common.

More than 600 new private-equity funds were created last year alone and the industry is holding $1.3-trillion (U.S.) of “dry powder,” or uninvested capital, that is sitting on the sidelines waiting to be invested. While the merits and operating model of private equity can and should be debated (as they were when former private-equity man Mitt Romney ran for president in the 2012 U.S. election), there is no denying its growing importance in many economies. Carlyle Group and Kohlberg Kravis Roberts & Co. (and their portfolio companies) employ more people than any other U.S. public company outside of Wal-Mart Stores Inc.

The sector’s roaring success might also be the biggest risk to its future. There might be such a thing as too much money, after all.

A swath of new entrants is pouring into private assets, searching for yield in a world of low interest rates. Chinese, Middle Eastern and other emerging markets investors are on the rise and have quadrupled their outbound investment over the past few years. Sovereign wealth funds, pension plans, insurance companies and even some mutual funds are allocating money to the private markets and borrowing from their playbooks. So much money chasing a limited number of opportunities has pushed prices up: historically high multiples combined with lower levels of leverage are putting pressure on returns. Private-equity deal multiples, for example, have exceeded the peaks last seen in 2006-07 for larger transactions (deals above $500-million) and deals above $250-million are also flirting with these highs. But most indicators still point to a favourable outlook as long as the credit markets remain fluid and fund managers continue to create value during their ownership period.

Canadian pension funds, many of which were present at Davos, are increasingly active in this crowded field. They have invested time and money to develop direct capabilities and increasingly stronger investment teams. In many regards, they are years ahead of their peers around the world. However, outside of our pension funds and a few select local firms, Canada tends to punch under its weight. We lack the kind of developed investment ecosystems that are thriving in other countries. As an example, the United States has 24 times more private-equity funds than Canada and has raised nearly 40 times more capital over the past 10 years.

The point is broader: Canada should be attracting more foreign direct investment, including money from global investment firms. FDI in Canada has grown by just 2 per cent a year since 2005, compared with an average of 7 per cent for all OECD countries and 8 per cent for Australia. As a percentage of GDP, Canada still sits in the middle of pack of OECD countries, but 30 per cent of that investment is driven by mining and oil and gas and is heavily skewed to M&A as opposed to greenfield investment (relative to other countries).

Something doesn’t add up. Canada is a great place to put money to work. We are a country with low political risk, competitive corporate taxes, an educated and diverse labour force, liquid public markets and a real need for infrastructure investments. Yet, we are net exporters of capital: foreign investors are often not finding Canadian opportunities as attractive as they should.

For all the criticism the investment industry sometimes faces, it would be a real miss if we failed to show long-term, growth-minded investors that Canada is an attractive place to put their money to work. We want global investors writing cheques for stakes in Canadian companies, so they can help improve their productivity, invest in technology, create new jobs, and grow global champions in many industries. If investors don’t hear our compelling story, Canada and many of its companies could be left on the sidelines as they watch all this dry powder get deployed in other markets.

This is an excellent op-ed, one that I want all of you to read carefully and share with your industry contacts. The last time I saw Tawfik Hammoud of BCG is when we worked together on a consulting mandate for the Caisse on sovereign debt risks (back in 2011). He is now the global head of BCG’s Principal Investors & Private Equity practice and is based in Toronto (all of BCG’s team are very nice and bright people, enjoyed working with them).

So, what’s this article all about and why is it important enough to cover on my blog?  Well, I’ve been short Canada and the loonie since December 2013, moved all my money to the US and never looked back. I know, Canadian banks did well last year but investing in the Canadian stock market is a joke, it’s basically composed of three sectors: financials, telecoms and energy.

Ok, now we’re in January 2017, the Bank of Canada recently “surprised” markets (no surprise to me or my buddy running a currency hedge fund in Toronto) by stating they are on guard and ready to lower rates if the economic outlook deteriorates, sending the loonie tumbling to about 75 cents US (it now stands at 76 cents US).

You would think global investors, especially large US investors, would be taking advantage of our relatively cheap currency to pounce on Canadian public and private assets.

Unfortunately, it doesn’t work that way. Canada isn’t exactly a hotbed of private equity activity. Yes, our large Canadian public pensions invest in private equity, mostly through funds and co-investments and a bit of purely direct investments, but the geographic focus remains primarily in the United States, the UK, Europe and increasingly in Asia and Latin America.

Sure, we have great private equity companies in Canada like Brookfield Asset Management (BAM), our answer to Blackstone (BX), the US private equity powerhouse, but even Brookfield focuses mostly outside Canada for its largest private equity transactions.

So why? Why is Canada’s private equity industry under-developed and why are global and domestic private equity powerhouses basically shunning our economy, especially now that the loonie is much cheaper than it was a few years ago?

The article above cites Canada’s stable political climate, competitive corporate tax rate and diverse and highly educated workforce but I think when it comes to real entrepreneurial opportunities, Canada lags far behind the United States and other countries.

Now, we can argue that maybe Canada’s large pensions should do more to invest in and even incubate more domestic private equity funds (they already do some) but the job of Canada’s pension fund managers isn’t to incubate domestic private equity funds or hedge funds, it’s to maximize returns taking the least risk possible by investing across global public and private markets.

Only the Caisse has a dual mandate of investing part of its assets in Quebec’s public and private markets and we can argue whether this is in the best interests of its beneficiaries over the long run (the Caisse will talk up its successes but I’m highly skeptical and think Quebec pensioners would have been better off if that money was invested across global markets, not Quebec).

In my opinion, the biggest problem in Canada is the culture of defeatism and government over-taxation (on individuals) and over-regulation of industries. At the risk of sounding crazy to some of you tree hugging left-wing liberals, Canada needs a Donald Trump which will cut out huge government waste and insane regulations across the financial and other industries, many of which are nothing more than a government backed oligopoly charging Canadians insane fees (look at banks, mutual funds and telcom fees and tell me we don’t need a lot more competition here).

My close buddies reading this will laugh as they recently blasted me for voting Liberal in the last election. Yes, I too voted for “boy wonder” mostly because I was sick and tired of Harper’s arrogance but Trudeau junior’s ineptitude, inexperience and recent comments on Alberta’s tar sands and ridiculous and needless cross country tour just pissed me off enough so I will be returning to my conservative economic roots during the next election even if O’Leary wins that party’s leadership race (love him on Shark Tank, not so sure how he would be as our PM).

Politics aside, we need to ask ourselves very tough questions in Canada and across all provinces because it’s been my contention all along that far too many Canadians are living in a Northern bubble, erroneously believing that we can afford generous social programs forever. Canadians are in for one rude awakening in the not too distant future.

What else pisses me off about Canada? Unlike the United States where the best of the best rise to the top regardless of the color their skin, gender, sexual orientation, religious beliefs and disabilities, there is a pervasive institutionalized racism that is seriously setting this country back years, if not decades (you can disagree with me but I’m not going to be politically correct to assuage your hurt feelings, Canada lacks real diversity at all levels of major public and private organizations).

So, before Canada can rightfully argue that it deserves a bigger chunk of the global private equity pie, we need to reexamine a lot of things in this country on the social, cultural and economic front, because the way I see it, we’re not headed in the right direction and have not created the right conditions to attract foreign investment from top global private equity funds.

As always, these are my opinions, you have every right to disagree with me but I’m not budging one iota and I can back up everything I’ve written above with concrete facts, not fake news.

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

Lawrence Delevingne of Reuters reports, Struggling hedge funds still expense bonuses, bar tabs:

Investors are starting to sour on the idea of reimbursing hedge funds for multi-million dollar trader bonuses, lavish marketing dinners and trophy office space.

Powerful firms such as Citadel LLC and Millennium Management LLC charge clients for such costs through so-called “pass-through” fees, which can include everything from a new hire’s deferred compensation to travel to high-end technology.

It all adds up: investors often end up paying more than double the industry’s standard fees of 2 percent of assets and 20 percent of investment gains, which many already consider too high.

Investors have for years tolerated pass-through charges because of high net returns, but weak performance lately is testing their patience.

Clients of losing funds last year, including those managed by Blackstone Group LP’s (BX.N) Senfina Advisors LLC, Folger Hill Asset Management LP and Balyasny Asset Management LP, likely still paid fees far higher than 2 percent of assets.

Clients of shops that made money, including Paloma Partners and Hutchin Hill Capital LP, were left with returns of less than 5 percent partly because of a draining combination of pass-through and performance fees.

For a graphic on the hedge funds that passed through low returns, click on image below:

Millennium, the $34 billion New York firm led by billionaire Israel Englander, charged clients its usual fees of 5 or 6 percent of assets and 20 percent of gains in 2016, according to a person familiar with the situation. The charges left investors in Millennium’s flagship fund with a net return of just 3.3 percent.

Citadel, the $26 billion Chicago firm led by billionaire Kenneth Griffin, charged pass-through fees that added up to about 5.3 percent in 2015 and 6.3 percent in 2014, according to another person familiar with the situation. Charges for 2016 were not finalized, but the costs typically add up to between 5 and 10 percent of assets, separate from the 20 percent performance fee Citadel typically charges.

Citadel’s flagship fund returned 5 percent in 2016, far below its 19.5 percent annual average since 1990, according to the source who, like others, spoke on the condition of anonymity because the information is private.

All firms mentioned declined to comment or did not respond to requests for comment.

In 2014, consulting firm Cambridge Associates studied fees charged by multi-manager funds, which deploy various investment strategies using small teams and often include pass-throughs. Their clients lose 33 percent of profits to fees, on average, Cambridge found.

The report by research consultant Tomas Kmetko noted such funds would need to generate gross returns of roughly 19 percent to deliver a 10 percent net profit to clients.

‘STUNNING TO ME’

Defenders of pass-throughs said the fees were necessary to keep elite talent and provide traders with top technology. They said that firm executives were often among the largest investors in their funds and pay the same fees as clients.

But frustration is starting to show.

A 2016 survey by consulting firm EY found that 95 percent of investors prefer no pass-through expense. The report also said fewer investors support various types of pass-through fees than in the past.

“It’s stunning to me to think you would pay more than 2 percent,” said Marc Levine, chairman of the Illinois State Board of Investment, which has reduced its use of hedge funds. “That creates a huge hurdle to have the right alignment of interests.”

Investors pulled $11.5 billion from multi-strategy funds in 2016 after three consecutive years of net additions, according to data tracker eVestment. Redemptions for firms that use pass-through fees were not available.

Even with pass-through fees, firms like Citadel, Millennium and Paloma have produced double-digit net returns over the long-term. The Cambridge study also found that multi-manager funds generally performed better and with lower volatility than a global stock index.

“High fees and expenses are hard to stomach, particularly in a low-return environment, but it’s all about the net,” said Michael Hennessy, co-founder of hedge fund investment firm Morgan Creek Capital Management.

INTELLECTUAL PROPERTY

Citadel has used pass-through fees for an unusual purpose: developing intellectual property.

The firm relied partly on client fees to build an internal administration business starting in 2007. But only Citadel’s owners, including Griffin, benefited from the 2011 sale of the unit, Omnium LLC, to Northern Trust Corp for $100 million, plus $60 million or so in subsequent profit-sharing, two people familiar with the situation said.

Citadel noted in a 2016 U.S. Securities and Exchange Commission filing that some pass-through expenses are still used to develop intellectual property, the extent of which was unclear. Besides hedge funds, Citadel’s other business lines include Citadel Securities LLC, the powerful market-maker, and Citadel Technology LLC, a small portfolio management software provider.

Some Citadel hedge fund investors and advisers to them told Reuters they were unhappy about the firm charging clients to build technology whose profits Citadel alone will enjoy. “It’s really against the spirit of a partnership,” said one.

A spokesman for Citadel declined to comment.

A person familiar with the situation noted that Citadel put tens of millions of dollars into the businesses and disclosed to clients that only Citadel would benefit from related revenues. The person also noted Citadel’s high marks from an investor survey by industry publication Alpha for alignment of interests and independent oversight.

Gordon Barnes, global head of due diligence at Cambridge, said few hedge fund managers charge their investors for services provided by affiliates because of various problems it can cause.

“Even with the right legal disclosures, it rarely passes a basic fairness test,” Barnes said, declining to comment on any individual firm. “These arrangements tend to favor the manager’s interests.”

Interestingly, Zero Hedge recently reported that Citadel just paid a $22 million settlement for front-running its clients (great alignment of interests!). Chump change for Ken Griffin, one of the richest hedge fund managers alive and part of a handful of elite hedge fund managers in the world who are highly regarded among institutional investors.

But the good fat hedge fund years are coming to an abrupt end. Fed up with mediocre returns and outrageous fees, institutional investors are finally starting to drill down on performance and fees and asking themselves whether hedge funds — even “elite hedge funds” — are worth the trouble.

I know, everybody invests in a handful of hedge funds and Citadel, Millennium, Paloma and other ‘elite’ multi-strategy hedge funds figure prominently in the hedge fund portfolios of big pensions and sovereign wealth funds. All the more reason to cut this nonsense on fees and finally put and end to outrageous gouging, especially in a low return, low interest rate world.

“Yeah but Leo, it’s Ken Griffin and Izzy Englander, two of the best hedge fund managers alive!” So what? I don’t care if it’s Ken Griffin, Izzy Englander, Ray Dalio, Steve Cohen, Jim Simons, or even if George Soros started taking money from institutional investors, nonsense is nonsense and I will call it out each and every time!

Because trust me, smart pensions and sovereign wealth funds aren’t stupid. They see this nonsense and are hotly debating their allocations to hedge funds and whether they want to be part of the herd getting gouged on pass-through and other creative fees.

Listen to Michael Sabia’s interview in Davos at the end of my last comment. Notice how he deliberately avoided a discussion on hedge funds when asked about investing in them? All he said was “not hedge funds”. The Caisse has significantly curtailed its investments in external hedge funds. Why? Because, as Sabia states, they prefer focusing their attention on long-term illiquid alternatives, primarily infrastructure and real estate, which can provide them with stable yields over the long run without all the headline risk of hedge funds that quite frankly aren’t delivering what they are suppose to deliver — uncorrelated alpha under all market conditions!!

Now, is investing in infrastructure and real estate the solution for everyone? Of course not. Prices have been bid up, deals are very expensive and as Ron Mock stated in Davos, “you have to dig five times harder” to find good deals that really make sense in illiquid private alternatives.

And if my long-term forecast of global deflation materializes, all asset classes, including illiquid alternatives, are going to get roiled. Only good old US Treasuries are going to save your portfolio from getting clobbered, the one asset class that most institutional investors are avoiding as ‘Trumponomics’ arrives (dumb move, it’s not the beginning of the end for bonds!).

By the way, I know Ontario Teachers’ Pension Plan still invests heavily in hedge funds but I would be surprised if their due diligence/ finance operations people would let any hedge fund pass through dubious fees on to their teachers. In fact, OTPP has set up a managed account platform at Inncocap to closely monitor all trading activity and operational risks of their external hedge funds.

Other large institutional investors in hedge funds, like Texas Teachers’ Retirement System (TRS), are tinkering with a new fee structure to get better alignment of interests with their external hedge funds. Imogen Rose-Smith of Institutional Investor reports, New Fee Structure Offers Hope to Besieged Hedge Funds (click on image):

You can read the rest of this article here. According to the article, TRS invests in 30 hedge funds and the plan has not disclosed how it will apply this new fee structure.

I think the new fee structure is a step in the right direction but if you ask me, I would get rid of the management fee for all hedge funds managing in excess of a billion dollars and leave the 20 percent performance fee (keep the management fee only for small emerging hedge fund managers that need it).

“But Leo, I’m an elite hedge fund manager and my portfolio managers are expensive, rent costs me a lot of money, not to mention my lifestyle and my wife who loves shopping at expensive boutiques in Paris, London, and New York and needs expensive cosmetic surgery to stay youthful and look good as we keep up with the billionaire socialites.”

Boo-Hoo! Cry me a river! Life is tough for all you struggling hedge fund managers charging pass-through fees to enjoy your billion dollar lifestyles? Let me take out the world’s smallest violin because if I had a dollar for all the lame, pathetic excuses hedge fund managers have thrown my way to justify their outrageous fees and mediocre returns, I’d be managing a multi-billion dollar global macro fund myself!

If you’re an elite hedge fund manager and are really as good as you claim, stop charging clients 2% to cover your fixed costs, focus on performance and delivering real alpha in all market environments, not on marketing and asset gathering (so you can collect more on that 2% management fee and become a big fat, lazy asset gatherer charging clients alpha fees for leveraged beta!).

I’m tired of hedge funds and private equity funds charging clients a bundle on fees, including management fees on billions, pass-through fees and a bunch of other hidden fees. And trust me, I’m not alone, a lot of smart institutional investors are finally putting the screws on hedge funds and private equity funds, telling them to shape up or ship out (it’s about time they smarten up).

Unfortunately, for every one large, smart institutional investor there are one hundred smaller, dumber public pension plans who literally have no clue what’s going on with their hedge funds and private equity funds. Case in point, the debacle at Dallas Police and Fire Pension System which I covered last week.

I’m convinced they still don’t know all the shenanigans that went on there and I bet you a lot of large and small US public pensions are in the same boat and petrified as to what will happen when fraud, corruption and outright gross incompetence are uncovered at their plans.

For all of you worried about your hedge funds and private equity funds, get in touch with my friends over at Phocion Investment Services in Montreal and let them drill down and do a comprehensive risk, investment, performance and operational due diligence on all your investments, not just in alternatives.

What’s that? You already use a “well-known consultant” providing you cookie cutter templates covering operational and investment risks at your hedge funds and private equity funds? Good luck with that approach, you deserve what’s coming to you.

On that note, I don’t get paid enough to provide you with my unadulterated, brutally honest, hard-hitting comments on pensions and investments. Unlike hedge funds and private equity funds charging you outrageous fees, I need to eat what I kill by trading and while I love writing these comments, it takes time away from what I truly love, analyzing markets and looking for great swing trading opportunities in bonds, biotech, tech and other sectors.

Please take the time to show your financial appreciation for all the work that goes into writing these comments by donating or subscribing to the PensionPulse blog on the top right-hand side under my beautiful mug shot. You simply won’t read better comments on pensions and investments anywhere else (you will read a bunch of washed down, ‘sanitized’ nonsense, however).

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

This is a bilingual comment, bear with me, I will translate the key points below. Julien Arsenault of La Presse Canadienne reports, Sabia repart de Davos avec beaucoup d’interrogations:

Que ce soit en raison des risques géopolitiques, de la montée du protectionnisme ou de l’arrivée du républicain Donald Trump à la Maison-Blanche, le président et chef de la direction de la Caisse de dépôt et placement du Québec (CDPQ), Michael Sabia, repart du Forum économique de Davos avec de nombreuses interrogations.

Tout cela n’est toutefois pas suffisant pour l’inciter à modifier les stratégies mises en place au cours des dernières années par l’investisseur institutionnel, dont l’actif atteignait 254,9 milliards en date du 30 juin dernier.

«Je n’ai pas changé d’avis. Avec un monde incertain, notre stratégie est de bien sélectionner les actifs et de nous éloigner, dans la mesure du possible, des risques du marché», a-t-il dit, jeudi, au cours d’un entretien avec La Presse canadienne, avant de quitter les alpes suisses.

M. Sabia a donné comme exemple la cimenterie de Port-Daniel, dont la construction a été marquée par des dépassements de coûts de l’ordre de 450 millions avant que la CDPQ prenne le contrôle du projet en y injectant 125 millions de plus. En redressant des actifs de la sorte, le grand patron de la Caisse estime qu’il est possible de créer de la valeur indépendamment de la volatilité des marchés, ce qui mitige les risques.

L’institution continuera également à se tourner vers les infrastructures ainsi que l’immobilier, des actifs «stables» à long terme, a précisé M. Sabia.

À l’instar des nombreux participants du Forum, le dirigeant de la Caisse a pris part à des ateliers dans lesquels les discussions ont tourné autour des visées protectionnistes de M. Trump, qui deviendra vendredi le 45e président des États-Unis.

«Beaucoup semblent convaincus que cette nouvelle administration mettra en vigueur des politiques au coeur des préoccupations du monde des affaires et qui vont dynamiser l’économie rapidement en 2017, a dit M. Sabia. J’ai trouvé cela surprenant, parce que c’est très axé sur le court terme.»

Il dit avoir du mal à comprendre l’optimisme de certains à Davos en raison d’un «mur de risques». Il cite l’arrivée de M. Trump, la sortie attendue du Royaume-Uni de l’Union européenne et d’importantes élections à venir en Europe, notamment en France et en Allemagne.

M. Sabia estime qu’il faut donner six mois à la nouvelle administration républicaine à Washington, étant donné qu’elle veut «faire des choses difficiles». Déjà, Wilbur Ross, désigné par M. Trump pour devenir secrétaire américain au Commerce, a prévenu que le nouveau gouvernement se pencherait rapidement sur l’Accord de libre-échange nord-américain (ALENA).

Le sujet des infrastructures a été largement discuté à Davos, puisque plusieurs représentants de firmes d’ingénierie et d’investisseurs institutionnels – qui se tournent vers ces actifs pour diversifier leur exposition aux risques – étaient présents.

«Ç’a été une confirmation qu’il s’agit d’un vecteur de croissance important dans le monde», a affirmé M. Sabia, lorsque questionné quant au message qu’il a tiré des discussions.

En date du 31 décembre dernier, la valeur du portefeuille de la Caisse dans les infrastructures était de 13 milliards, comparativement à 10,1 milliards en 2014.

Par ailleurs, malgré les visées protectionnistes de M. Trump, M. Sabia ne s’est pas inquiété pour l’avenir de la cimenterie de Port-Daniel, qui vise les États-Unis comme principal marché d’exportation.

Si le 45e locataire de la Maison-Blanche veut vraiment aller de l’avant avec son intention d’injecter 1000 milliards US dans l’économie, les États-Unis n’auront d’autre choix que de laisser entrer du ciment en provenance de l’extérieur, croit M. Sabia.

«L’offre aux États-Unis ne serait pas suffisante pour répondre à une telle demande, a-t-il estimé. Selon moi, la priorité que cette administration veut mettre sur les infrastructures représente une belle occasion.»

Michael Sabia, president and CEO of the Caisse, was in Davos last week with the world’s elites trying to figure out what a Trump administration means for the Caisse’s long-term strategy.

He basically has not changed his mind stating “it’s an uncertain world” and the Caisse will continue to select value stocks and try to minimize market risk as much as possible, mostly by focusing its attention on long-term asset classes like infrastructure and real estate which provide stable yields over the long run.

Sabia also notes that he is surprised by the optimism surrounding the new administration noting that many people think it will reinvigorate the US economy quickly in 2017 but there are still many obstacles, including key elections in Europe and how Brexit will unfold.

Sabia said we need to give the Trump administration at least six months to implement difficult policies which include renegotiating key trade deals like NAFTA. Overall, he was encouraged to see many representatives of big infrastructure and engineering companies at Davos and thinks infrastructure spending will be a key driver of growth going forward and some Canadian companies, like la cimenterie de Port-Daniel, a controversial cement plant the Caisse invested in, will benefit from US spending on infrastructure.

Last week, I shared Ron Mock’s thoughts from Davos as Ontario Teachers’ eyes a new tack. Ron stated that Teachers already invests in brownfield US infrastructure but these new greenfield projects the new administration is eying take a long time to set up and likely won’t be ready until late in Trump’s second term (if he gets a second term) or well after he departs.

My take on all this? There is way too much “Trumptimism” (Trump optimism) out there and like I stated in my outlook 2017, this silliness is propagating the reflation chimera, making US long bonds the best risk-return asset in the world.

But Ray Dalio talked about “animal spirits” being unleashed after Trump’s victory and how it’s the end of the thirty year bond bull market as we head back to the future.

Let me be crystal clear here. I couldn’t care less what Ray Dalio, Paul Singer, Kyle Bass state publicly, I still maintain that global deflation risks are extremely high and think we are entering a danger zone, one where the surging US dollar can continue rising to a level which could bring about the next global crisis.

When I hear bond bears claiming long bond yields will continue rising, I tell them to go back to school because they clearly don’t understand macro trends. A rising US dollar means lower US import prices and lower inflation expectations going forward, which are both bond friendly.

More importantly, the US is temporarily shouldering the rest of the world’s deflation problems but it’s far from clear what Trump’s administration means for emerging markets and if they aren’t careful, protectionist policies will only reinforce global deflation, ushering in a new era of ultra low growth and zero or negative interest rates.

Ironically, all the tough talk on Mexico is driving the Mexican peso lower, making it that much better for German and American car manufacturers to invest there, even if Trump imposes tariffs on cars made in Mexico. President Trump is trying to talk the US dollar down, striking a protectionist tone in his inauguration speech, but this might be short-lived as the US is still a net importer and traditionally wants a stronger dollar.

And let’s pretend the US dollar continues to weaken relative to the rest of the world and Trump manages to renegotiate trade deals quickly to put “America first”. What will that mean? A higher euro and yen going forward and more unemployment in these regions struggling with deflation. Not exactly the recipe to “make America great again” in the long run.

Michael Sabia is right to leave Davos with more questions than answers. He’s also right to question the irrational optimism which has sent global risk assets higher following Trump’s victory.

John Maynard Keynes once stated “markets can stay irrational longer than you can stay solvent.” It’s my favorite market quote of all time and what it means is you can see huge market dislocations persist for a lot longer than you think but at one point, gravity takes over and all the silliness comes crashing down.

I think the second half of the year will bring about a sobering reality that global deflation is far from dead and if Trump’s administration isn’t careful, it will reinforce the global deflationary tsunami headed our way.