Author: Leo Kolivakis

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

Everett Rosenfeld of CNBC reports, Donald Trump wins the presidency, hails ‘beautiful and important’ win:

Donald John Trump will be the 45th president of the United States, capping a historic and boisterous run by an outsider who captured a loyal following across a swath of America fed up with establishment politics, the news media and elected officials.

His success was only part of a larger, crushing victory for the Republican Party, which retained the House and maintained control of the Senate.

The brash New York businessman will win at least 270 electoral votes, according to NBC News projections, and will take his Republican ticket to the White House in January. Trump had trailed Democrat Hillary Clinton in polling averages for nearly the entire election cycle, but he bucked prognostications by picking up states many pundits deemed out of his reach.

On Twitter, the president-elect called his win “beautiful and important,” while the White House issued a statement that President Obama plans to publicly address the election results, and invite Trump to the White House on Thursday to discuss handing over power.

“Ensuring a smooth transition of power is one of the top priorities the President identified at the beginning of the year and a meeting with the President-elect is the next step,” the White House statement read.

The 70-year-old real estate mogul — who is now the oldest person ever elected to a first presidential term — declared victory early Wednesday, saying Clinton had conceded the election and that it’s time for the nation “to come together as one united people.”

The Republican congratulated his Democratic rival, saying that she waged “a very very hard-fought campaign.” He also commended her for having “worked very long and very hard” over her political career.

“Now it’s time for America to bind the wounds of division — have to get together,” he said. “To all Republicans and Democrats and independents across this nation, I say it is time for us to come together as one united people.”

Trump, who had been criticized by opponents for rhetoric characterized as divisive and racist, pledged, “I will be president for all Americans, and this is so important to me.”

Trump has never before held public office, but he will be joined in the executive branch by Vice President-elect Mike Pence and a host of politicians and business executives who rallied around the GOP nominee.

Although the vast majority of pre-election surveys had indicated a slight advantage for Clinton, Trump’s campaign had frequently predicted that a vein of electoral strength existed beyond the polls, pointing to his massive crowds at his events and online support.

Clinton — who was secretary of state under President Barack Obama, a U.S. senator for New York from 2001 to 2009, and first lady during her husband’s presidency in the 1990s — had been painted as the “establishment” politician, while Trump campaigned as a political neophyte who could “drain the swamp” of government corruption in Washington.

Trump will likely face significant Democratic attempts at opposition after he enters the White House in January. In fact, Trump has elicited strong outcries from liberal and minority groups since he first characterized many Mexican immigrants “rapists” in his June 2015 campaign kickoff.

Trump rose to prominence in a crowded GOP primary field by connecting with voters who felt they had been betrayed by Washington interests. The businessman focused his early pitch on forceful answers to economic issues like trade and immigration, which resonated with those Americans who had stopped believing mainstream Republicans cared about their communities.

Many experts in economics and policy studies have decried Trump’s prescriptions as nearly impossible to implement and unlikely to achieve their desired aims. But supporters, and Trump himself, have contended that his calls for extreme tariffs and mass deportations were opening salvos in forthcoming negotiations.

And Trump, who has been famous for decades as a symbol of wealth and business acumen, channeled the image of a negotiator throughout his campaign. The real estate developer — who co-authored “Trump: The Art of the Deal” — has repeatedly claimed that other countries are taking advantage of the United States, and the White House should work to renegotiate its existing agreements.

Clinton, meanwhile, had campaigned on a set of policy proposals made more liberal for her primary contest against Sen. Bernie Sanders. While Republicans painted Clinton as too liberal — an extension of Obama’s tenure — many on the left expressed discomfort with the former secretary of state, jeering that she was more aligned with right-of-center candidates.

Yet for all of those criticisms, Clinton had appeared ahead in the race, especially after her well-received debate performances. But that lead became more tenuous when the FBI announced just 11 days before the election that it was probing new evidence regarding her use of a private email server while secretary of state. The FBI subsequently said the new probe did not turn up any reason to charge Clinton with a crime, but Democrats, and even some Trump supporters, called foul on the timing of the original announcement: Clinton’s campaign was damaged as voters were reminded of a scandal that had faded from the forefront.

Trump also faced several challenges on his road to the White House, including allegations that he sexually assaulted or harassed multiple women, and several women making such claims came forward after the release of a 2005 video in which he bragged about groping women.

Still, Tuesday’s election results are a strong repudiation of the entire system of Washington politics, not just the Democrats or Clinton. A long list of Republican leaders and luminaries had come out against Trump, or at least refused to endorse their party’s new, de-facto head.

The Trump victory also marks a rejection of the mainstream news media, which extensively covered Trump’s scandals and self-contradictions. Polls showed many of the Republican’s supporters dismissed those reports.

As recently as last week, in fact, pundits on both sides suggested that Trump was not angling to win the election — he was instead interested, they said, in establishing a base of support for profitable post-race enterprises. But after an acrimonious election, Trump will now turn to building a team that can work together to implement his ideas for the country.

Scott Horsely of NPR also reports, Trump Wins. Now What?:

Donald Trump’s presidential campaign, like the business career that preceded it, was unpredictable, undisciplined and unreliable. Despite those qualities — or perhaps, in part, because of them — it was also successful.

So what should we expect from President-elect Trump, mindful that his path to the White House has defied expectations at every turn?

Some of Trump’s ambitions have been clearly telegraphed: He plans to build a wall along the U.S. border with Mexico, deport millions of criminal immigrants, unwind trade deals dating back more than two decades and repeal Obamacare. He has also promised to cut taxes and eliminate numerous government regulations — including power plant rules designed to combat global warming.

With the presidential pen and a friendly Republican Congress, Trump should have little trouble delivering on those promises.

But Trump’s campaign never really revolved around specific policy prescriptions. His agenda is not anchored to ideology but rather shaped by instinct and expedience.

“Trump operates very much from his gut,” said David Cay Johnston, author of The Making of Donald Trump. “The guiding philosophy of Trump is whatever is in it for his interests at the moment.”

When his initial tax plan prompted sticker shock among fiscal watchdogs, Trump readily shaved trillions of dollars off the bottom line. (His new plan is still a budget buster, though.) His impulsive call to ban Muslim immigrants gradually morphed into a vague prescription for “extreme vetting.” And he hastily concocted a plan to help working parents only after his daughter trumpeted a vaporware version at the GOP convention.

That flexibility seems to be just fine with tens of millions of supporters who trust Trump’s instincts and assume his success will boost the country as a whole. The campaign slogan “Make America Great Again,” which Trump trademarked just days after the 2012 election, is both vague and malleable enough to accommodate whatever nostalgic and aspirational vision his followers want to attach to it.

Supporters point to the way Trump rescued a New York skating rink that languished for years in the 1980s under city government supervision.

“What had taken the city over half a decade to botch, my father completed in less than six months, two months ahead of schedule and over a million dollars under budget,” Eric Trump told delegates at the Republican National Convention.

Backers hope the incoming president will bring similar accountability to the federal government.

One of Trump’s first tasks will be staffing up for a new administration. The celebrity businessman who turned “You’re fired!” into a catchphrase will soon be doing a lot of hiring.

“I will harness the creative talents of our people,” Trump told supporters at a victory party early Wednesday. “And we will call upon the best and brightest to leverage their tremendous talent for the benefit of all.”

Friends say assembling high-performing teams is one of the president-elect’s strengths.

“He pushes everybody around him, including you, through comfort barriers that they never thought they could ever shatter,” said Colony Capital CEO Tom Barrack, who delivered a testimonial for Trump at the party convention in July.

Trump’s daughter Ivanka told delegates her father has always promoted on the basis of merit.

“Competence in the building trades is easy to spot,” she said at the convention in July. “And incompetence is impossible to hide.”

In politics and in business, Trump has kept his organizations lean. He had only about one-tenth of the staff Hillary Clinton had, heading into the final months of the campaign.

Trump’s aides are often long on loyalty and short on formal credentials. Politico noted that the chief operating officer of the Trump Organization was initially hired to be a bodyguard, after Trump spotted him working security at the U.S. Open tennis tournament.

Trump may delegate, but there’s no doubt who’s in charge. Even if he fills his Cabinet with big personalities — Newt Gingrich has been floated for secretary of state and Rudy Giuliani for attorney general — Trump is not likely to share the spotlight.

“The only quote that matters is a quote from me!” Trump tweeted this summer, urging journalists to pay no attention to his subordinates. As late as Friday, he boasted that he didn’t need other celebrities to attract large crowds to his rallies.

“I didn’t have to bring JLo or Jay Z,” Trump said, mocking Hillary Clinton’s reliance on big-name warmup acts. “I am here all by myself.”

Trump, who prides himself on being a counter-puncher, can also be expected to use the levers of government to target his political rivals. He has already threatened on live television to appoint a special prosecutor to investigate Clinton.

“Trump’s philosophy, which he’s written and spoken about for many years, is to get revenge,” Johnston said.

Once Trump is in the White House, the news media will remain firmly focused on the new commander in chief.

“Donald is the most masterful manipulator of the conventions of journalism I’ve ever seen,” said Johnston, a Pulitzer Prize-winning former reporter for The New York Times.

Trump has long believed that even bad publicity is better than no publicity. Surprising and provocative statements are both a tool to keep the audience paying attention and a negotiating tactic.

“I always say we have to be unpredictable,” Trump told the Washington Post editorial board.

Everything for Trump is a negotiation. And much of his campaign was based on the idea that the U.S. has been getting a bad bargain.

“You look at what the world is doing to us at every level, whether it’s militarily or in trade or so many other levels, the world is taking advantage of the United States,” Trump told CNN. “And it’s driving us into literally being a third-world nation.”

As a businessman, Trump has a long history of using pressure tactics to drive hard bargains. USA Today found hundreds of examples in which employees and contractors accused Trump of not paying them for their work. They sometimes settled for less than they were owed, rather than face a lengthy legal battle against Trump and his deep pockets.

Similarly, Trump argues that if the U.S. puts pressure on other countries — by imposing import tariffs or demanding payment for military protection — they’ll quickly back down.

Some foreign policy scholars are not convinced this zero-sum mindset is appropriate.

“By threatening to drive harder bargains, he might manage to eke out a slightly larger share of the pie,” said Daniel Drezner of the Fletcher School of Law and Diplomacy at Tufts University. “But he also threatens to blow up that pie in the process.”

The stock market has sent clear signals that investors are worried about the economic fallout from a Trump administration. According to one estimate, the S&P 500 index will be worth 12 percent less under Trump than it would have been had Clinton been elected.

Count on the president-elect to loudly hype any success while downplaying any setback. And if that requires bending the truth a bit, so be it.

“People want to believe that something is the biggest and the greatest and the most spectacular,” Trump wrote in his best-selling 1987 book The Art of the Deal. “It’s an innocent form of exaggeration — and a very effective form of promotion.”

If history is any guide, the new Trump administration will not be overly constrained by facts.

Trump has shamelessly exaggerated the height of his buildings, the size of his profits, and even the number of people who showed up to cheer his presidential bid.

“When you have a huge crowd, and Trump draws huge crowds, there’s no need to exaggerate,” Johnston said. “Except in Donald’s mind where big is never big enough.”

Don’t expect that to stop now that he has achieved the biggest and most powerful office in the land.

Love him or hate him, Donald J. Trump will be the 45th president of the United States. I spent all night watching the US elections, flicking channels from CNN, ABC, CBS, NBC and FOX News, and tweeting on this historic election.

And I’m Canadian but nothing is more exciting to me than watching the actual US election because it can swing either way depending on who captures the swing states.

Last night, when Trump was leading in Florida, I started to believe he was going to pull it off, and when he won Ohio, it was a done deal for me.

People get so emotional when discussing these results but the goal of this post is to look well past the hysteria and understand what is going to happen next when president-elect Trump and his administration take office in the new year.

First, let me begin with something Francois Trahan and Stephen Gregory of Cornerstone Macro put out this morning:

If there is one thing that 2016 has taught us it is to not rule out the unlikely scenario. Indeed, the events surrounding the Brexit vote and now Donald Trump winning the U.S. presidency were unexpected to happen, at least according to the polls and their proponents. So what does all of this mean for the stock market anyway? It’s hard to know exactly what powers congress will convey on the new President but the biggest potential problem as we see things has to do with trade.

At this time, there is already a dynamic for an economic slowdown in place, one that the new president will inherit. Money supply has slowed across the developed world and rates have backed up. All of which will eventually add to a weaker U.S. economy. The real troubles with this story lie overseas where a number of countries have come to rely on the U.S. for trade. If the new President holds true on his promise to tear up trade agreements, then the outlook just got a lot more complicated. Our call for a bear market in 2017 was never about potential U.S. election results. Rather, it is about the consequences that tighter policy will bring to an already fragile world economy. As always, we shall see.

In a recent comment on lessons for Harvard’s endowment, I noted a video update, “A Recipe For Investment Insomnia,” where Francois Trahan and Michael Kantrowicz of Cornerstone Macro cite ten reasons why markets are about to get a lot harder going forward :

1. Growth Is Likely To Slow … From Already Low Levels
2. The Risks Of Zero Growth Are Higher Today Than In The Past
3. The U.S. Consumer No Longer The Buffer Of U.S. Slowdowns
4. The World Is Battling Lingering Structural Problems
5. A U.S. Slowdown Has Implications For The World’s Weakest Links
6. The Excesses Of China’s Investment Bubble Have Yet To Unwind
7. Demographic Trends In Japan … An Insurmountable Problem?
8. Central Banks Have Reached The Limits Of Monetary Policy
9. Slower Growth Is The Enemy Of Portfolio Managers
10. P/Es Are Hypersensitive To The Economy At This Time

These are all ten factors that President Trump will inherit and need to contend with. You should all subscribe to the high quality research Cornerstone Macro puts out as they do an excellent job covering markets and key economic trends around the world.

I might add the risks of global deflation are not fading, and if there is a severe disruption to global trade under Trump’s watch, this will only intensify global deflationary headwinds.

One area which Trump is definitely committed to is spending on infrastructure. Jim Cramer of CNBC said this morning he sees the Treasury department emitting new 30-year bonds to cover the trillion dollar spending program Trump has outlined to revamp airports, roads, bridges and ports.

Here, I will refer the Trump administration to what the Canadian federal government is doing setting up a new infrastructure bank, allowing Canada’s large pensions and other large global investors, to invest in large greenfield infrastructure projects.

I discussed this new initiative and what Canada’s large pensions are looking for in a recent comment where I also shared insights at the end in an update from Andrew Claerhout, Senior Vice-President of Infrastructure & Natural Resources at Ontario Teachers’ Pension Plan.

Why am I mentioning this? Because if Trump’s administration is really committed to “making America great again” and spending a trillion or more on infrastructure, they will need a plan, a blueprint and they definitely should talk to the leaders of Canada’s large pensions, widely considered to be among the best infrastructure investors in the world.

There is another reason why I mention this. The US has a huge pension problem as many public sector pensions are chronically underfunded. There is a growing appetite for infrastructure assets around the world, including in the United States where large public pensions are looking to increase their allocations.

If a Trump administration sets up the right program on infrastructure, modeled after the Canadian one, and establishes the right governance, it will be able to attract capital from US public pensions starving for yield as well as that from Canadian and global pensions and sovereign wealth funds which would welcome such a program as it fits perfectly with their commitment to infrastructure as an asset class.

The big advantage of integrating US and global pensions as part of the solution to rebuilding America’s infrastructure is that it will limit the amount the US needs to borrow and will make this ambitious infrastructure program more palatable to deficit hawks like Paul Ryan (who might not be the speaker of the House come January).

And if it’s done right, it will allow many US public pensions to invest massively in domestic infrastructure, allowing them to collect stable cash flows over the long run, helping them meet their mounting future liabilities. The same goes for Canadian and global pensions which would also invest in big US infrastructure provided the governance is right.

What else can Trump do to make America great again? He should consider bolstering Social Security for all Americans and modeling it after the (now enhanced) Canada Pension Plan where money is managed by the Canada Pension Plan Investment Board.

One thing Trump should not do is follow lousy advice from Wall Street gurus and academics peddling a revolutionary retirement plan which only benefits Wall Street, not Main Street.

Speaking of Wall Street, I just noticed how the stock market is surging as I end this comment, which goes to show you why you should NEVER listen to big hedge funds, gurus or market strategists warning you of doom and gloom if Trump is elected.

I warned all my readers last week when I went over America’s Brexit or biotech moment to ignore all these doomsayers on Trump and go long healthcare (XLV) and especially biotech stocks (IBB and equally weighted XBI) which are surging today.

Unlike many blowhard prognosticators, I put my money where my mouth is and if you made money on my call to go long biotech stocks last week, please do the right thing and contribute to this blog on the top right-hand side under my picture. Thank you.

As for president-elect Trump, he has the toughest job ahead of him but if he surrounds himself with a truly great team and focuses his attention on fixing the economy (not the divisive crap) using pensions to invest in infrastructure, then he might go down in history as a one of the best presidents ever.

In fact, I’m convinced his huge ego will drive him to fulfill this legacy which is why I take all these doomsayer scenarios with a shaker of salt. Never short the United States of America. Period.

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

Robert Benzie of the Toronto Star reports, Infrastructure Ontario to get new boss after CEO moves to public pension corporation:

The head of Infrastructure Ontario (IO) has quietly left the government agency to run a massive new $50-billion public pension corporation.

Bert Clark, who had been president and CEO of the province’s infrastructure arm for more than four years, departed last month for the fledgling Investment Management Corporation of Ontario (IMCO), which will pool and manage public-sector pension funds.

Its founding members are the Ontario Pension Board (OPB) — which administers pensions for provincial government employees and those at agencies, boards and commissions — and the Workplace Safety and Insurance Board (WSIB).

An executive search has begun for Clark’s permanent replacement.

Toni Rossi, divisional president for real estate and lending, is serving as acting president and CEO of the infrastructure agency that is responsible for overseeing the financing and construction of schools, bridges, hospitals, court houses, and public transit projects.

“Bert has been a driving force at IO and made significant contributions to our success. He has demonstrated the potential for the public and private sectors to work together on infrastructure and real estate, and the benefits of doing so. We wish him all the best in his new role at IMCO,” Linda Robinson, IO’s board chair, said in an email Monday.

A former Scotiabank managing director and one-time aide to former premier Dalton McGuinty, Clark is the son of Ed Clark, Premier Kathleen Wynne’s business guru.

In a statement, the WSIB welcomed his appointment as the first CEO of the new corporation effective Oct. 17.

“The WSIB is confident that Mr. Clark’s experience in both the public and private sectors will prove valuable in his leadership of IMCO,” the board said.

“We anticipate a successful partnership which will allow the WSIB to strengthen its investment performance and asset management capabilities to provide secure benefits for workers and maintain stable premium rates for employers.”

The new investment management corporation, which is not bankrolled by the government or taxpayers, will operate as an arm’s length, member-funded, non-profit corporation.

It is expected that other public-service pension funds may eventually join the corporation which was set up in July and will begin its investment operations next year.

Finance Minister Charles Sousa said last summer that it would “enable public-sector organizations to pool assets and create economies of scale.”

“This will increase efficiency when providing pension support and income for injured workers. OPB and WSIB — and public-sector pension plans that may join in the future — will benefit from IMCO’s ability to deliver enhanced services,” he said.

In July, Ontario’s Ministry of Finance put out a press release, Province Establishes Investment Management Corporation of Ontario:

Ontario is working to improve the management of broader public sector investment funds, including public sector pensions, through the creation of the Investment Management Corporation of Ontario (IMCO), which will provide investment management and advisory services to participating organizations in Ontario’s Broader Public Sector (BPS).

Established July 1, 2016 by proclamation of the Investment Management Corporation of Ontario Act, 2015, IMCO will enable BPS organizations to lessen costs by pooling their assets. The larger fund is expected to lower administrative costs, which will help improve return on investments.

The creation of this entity is another step forward in fulfilling Ontario’s commitment to strengthen the retirement income system for Ontario’s workers. Since 2013, the province has advocated for an enhancement to the Canada Pension Plan. Ontario’s sustained leadership on this critical issue, as well as the collaboration with the federal government, provinces and territories, resulted in the recent agreement-in-principle on a national solution, signed on June 20th in Vancouver. With this consolidated approach and creation of IMCO, Ontario is modernizing workplace pensions by providing a new tool for the investment of retirement savings.

The founding members of the IMCO are the Ontario Pension Board (OPB) and the Workplace Safety and Insurance Board (WSIB). With combined investment assets of approximately $50 billion, these two institutions provide the scale to ensure IMCO’s success. IMCO is designed to accept, through a managed process, the membership application of any BPS organization with an investment fund that is interested in accessing its services.

IMCO will not require financial support from the Ontario government or Ontario taxpayers and will operate at arm’s length from government as a member-based non-profit corporation. The creation of IMCO fulfills a commitment made in the 2015 Ontario Budget. It is expected to be operational by Spring 2017.

Three of the IMCO’s initial Board of Directors were appointed July 1 by the Minister of Finance, including David Leith as Chair. The WSIB and OPB have each appointed two Directors to the initial Board. The new board’s main priority will be to prepare the corporation to manage members’ funds in the spring of 2017.

Strengthening workplace pension plans is part of the government’s economic plan to build Ontario up and deliver on its number-one priority to grow the economy and create jobs. The four-part plan includes helping more people get and create the jobs of the future by expanding access to high-quality college and university education. The plan is making the largest infrastructure investment in hospitals, schools, roads, bridges and transit in Ontario’s history and is investing in a low-carbon economy driven by innovative, high-growth, export-oriented businesses. The plan is also helping working Ontarians achieve a more secure retirement.

Quick Facts

• Participation of public sector and broader public sector (BPS) organizations in IMCO will be voluntary.
• Members of IMCO will retain ownership of their assets and responsibility to determine how their assets are invested by IMCO.
• The Ontario Pension Board (OPB) is the administrator of the Public Service Pension Plan (PSPP), a major defined benefit pension plan sponsored by the Government of Ontario. PSPP membership is made up of employees of the provincial government and its agencies, boards and commissions. At the end of 2015, OPB had $23 billion worth of assets under management.
• The Workplace Safety and Insurance Board (WSIB) is an independent agency that administers compensation and no-fault insurance for Ontario workplaces. At the end of 2015, WSIB had $26.3 billion worth of assets under management.
• IMCO will be headquartered in Toronto, the second-largest North American financial services centre by employment after New York.

Background Information

• Investment Management Corporation of Ontario Board Members

Additional Resources

• Read the Investment Management Corporation of Ontario Act (2015)
• Read Facilitating Pooled Asset Management for Ontario’s Public-Sector Institutions.

I have not discussed the creation of the Investment Management Corporation of Ontario (IMCO) because truth be told, the details were murky and it’s not even operational yet (suppose to begin operations in the Spring 2017).

But just by reading the details, I can see why this new pension plan is described as “fledgling” in the article above. I have a lot of questions like why is it voluntary, who are the board members, how are they appointed to ensure they are qualified and independent, and who will help Bert Clark at IMCO?

I can make a few recommendations but my number one recommendation for CIO of IMCO is Wayne Kozun, an Investment Management Executive with over twenty years of experience at Ontario Teachers’ Pension Plan, leading several different departments (click on image):

Wayne recently left OTPP (not sure as to exactly why) but he is an outstanding investment professional with years of experience at one of the best pension plans in the world and he lives in Toronto. Not sure what he wants to do next but he would be a great chief investment officer.

As far as IMCO’s board members, I think they should nominate Carol Hansell to the board as she has tremendous experience at PSP Investment’s board during the ramp-up phase and is highly qualified to sit on this board (click on image):

Again, I am assuming she actually wants to sit on this board (have no idea) but if I was advising OPB, WSB and Ontario’s Ministry of Finance, I would highly recommend Wayne Kozun as a CIO of IMCO and nominate Carol Hansell to its board.

As far as Bert Clark, I don’t know him but he is the son of Ed Clark, a titan of finance in Canada’s banking industry (Ed Clark was the former CEO of TD Bank, has a stellar reputation and is now advising Ontario Premier Kathleen Wynne on business issues, including finding other revenue sources for the cash-strapped province).

I’m sure Bert Clark is very qualified to lead this new Ontario pension but the reality is it sure helps that he is the son of one of Canada’s most powerful banking CEOs ever who is now advising Ontario Premier Kathleen Wynne on “business issues”. Don’t tell me that didn’t help Bert Clark get this nomination.

Sure, Bert Clark has excellent experience as the head of Infrastructure Ontario (IO) but there are many people living in Toronto who are far more qualified to head this new pension plan. I’m a little surprised someone with more pension experience was not placed as the head of Investment Management Corporation of Ontario (IMCO).

Please note I made a HUGE mistake in an earlier version of this comment assuming the federal government had named Bert Clark as the leader of the federal government’s new infrastructure bank (that would have made a lot more sense!).

My sincere apologies, this is what happens when you are trading and blogging at the same time, the two don’t mix well and I read the article all wrong. This was my mistake but my recommendations on Wayne Kozun and Carol Hansell still stand.

As far as Bert Clark, he now has a tough job heading up this new pension plan which quite frankly should be mandatory, not voluntary and I don’t know exactly how it will operate going forward but as long as they get the governance right, hire the right people and compensate them properly and nominate an independent and qualified board of directors, it will all work out well.

So, I welcome Bert Clark as the new head of Investment Management Corporation of Ontario (IMCO) and apologize for my earlier goofball mistake of thinking he was named the head of Canada’s new infrastructure bank (even if that would have made more sense).

One thing we can all agree on is that Ontario has taken the lead over every other province in terms of providing safe, secure workplace pensions and this is yet another example of why this province (rightly) takes pensions very seriously.

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, CPPIB head cautious on Canadian infrastructure:

The head of Canada Pension Plan Investment Board is taking a cautious approach to infrastructure investments in Canada as it retools its portfolio to manage the challenging investment environment.

Executives from the country’s largest pension fund spoke to the House of Commons finance committee on Tuesday to explain the fund’s investment strategy, its need for independence and evolving approach to risk. The discussion comes ahead of the planned increase to the Canada Pension Plan contributions that workers and employers will make to fund their retirement years, in order to boost the benefits they will receive. That is set to begin in 2019.

On the topic of infrastructure – a major, multibillion-dollar federal government spending priority – the pension fund said it would need to see investment opportunities that meet its specific criteria in order to participate in the spending boom.

CPPIB, which is set to announce next week that its assets now exceed $300-billion, currently makes equity-driven investments in infrastructure. It buys portions of toll roads, shipping ports and pipelines in may parts of the world and receives a relatively steady flow of fees in return. The fund also needs to write cheques for more than $500-million to make these investments manageable and worthwhile. These are conditions rarely satisfied by the infrastructure assets available in Canada, although the largest infrastructure investment the pension fund owns is in Canada – the Ontario Highway 407 toll road.

“That’s been one of the biggest challenges in Canada, and around the world, is there’s just not been enough of those scale opportunities in size, but also that are prepared for our type of investments,” Mark Machin, CEO of CPPIB, told the committee. He noted that the pension fund likes to by operational assets, rather than investing in constructing new projects from scratch.

When it comes to creating an infrastructure bank, as was proposed in a report to the Minister of Finance by the Advisory Council on Economic Growth two weeks ago, Mr. Machin said that “the devil would be in the details of how everything’s implemented.” The report was penned in part by committee members Mark Wiseman, former CPPIB CEO, and current Caisse de dépôt et placement du Québec CEO Michael Sabia.

When pressed on the stress that changes in government and policies would put on an infrastructure investment years in the future, Mr. Machin said this would be one of the major risks.

“Infrastructure investments are, by nature, very long-term investments. And therefore the stability of regulatory regimes [and tax regimes] around those investments is very important,” Mr. Machin said.

Mr. Machin was also asked extensively about the pension fund’s risk exposure in the rest of its investments, and the expectation that returns will be “lower for longer” –a theme outlined by the Bank of Canada in recent months.

“It’s a challenging investment environment globally, given central banks’ activity, whether in Japan or in the U.S., Canada and other countries,” Mr. Machin said. CPPIB is trying to further diversify the investments of the fund around the world, to different sectors and strategies to combat this pressure. The fund still has 20 per cent of its investment portfolio in Canada, even as the country represents less than 3 per cent of the global market index.

CPPIB is planning to increase its investment risk tolerance over the next three years, equivalent to a portfolio containing 85-per-cent global equities. But the fund would take a more conservative approach with the money set to come from the expanded CPP contributions. That portfolio will have a lower risk tolerance because it relies more on investment income to pay pensions years into the future than contributions from employees.

You can read the Advisory Council on Economic Growth report, Unleashing Productivity Through Infrastructure, by clicking here. The executive summary and other related documents are available here.

Barbara Shecter of the National Post also reports, Federal infrastructure bank is gaining interest from large pensions, but they fall short of committing:

Canada’s large pensions, which have infrastructure investments around the world from shipping and airports in Britain and Europe to toll roads in Mexico, are expressing interest in joining forces with the federal government’s new infrastructure investment bank.

But they stopped short Wednesday of committing their dollars.

“We look forward to seeing the pipeline of infrastructure investments,” Michel Leduc, senior managing director and head of global affairs at the Canada Pension Plan Investment Board, said a day after the Liberal government pledged $81 billion over the next 10 years to fund public infrastructure including public transit and renewable power projects.

The first $15 billion will become available in the spring budget through the newly established Canadian Infrastructure Bank, designed to attract private sector capital to large national and regional projects with revenue-generating potential.

“An infrastructure bank, executed well, has the potential to be a catalyst of the type of infrastructure investment we have witnessed in Australia, United Kingdom, Chile and United States,” Leduc said.

However, while he said infrastructure investments can provide the pension plan’s beneficiaries with value, particular in a “stubbornly” low-interest environment, not all investments are the same and each must fit with CPPIB’s overall strategy.

“Infrastructure is a very broad concept, perhaps just as broad as any reference to investing in stocks. Some stocks are a good fit with our investment portfolio, some less so,” he said.

Leduc said infrastructure investment has worked in markets in which there is a concerted policy aim to attract productive, long-term capital.

“It doesn’t just happen,” he said.

If it is determined that CPPIB, which invests funds not needed to pay current benefits of the Canada Pension Plan, is interested in partnering with the government, the pension giant would be able to exploit a “home market advantage,” he said.

“We know Canada well… the home market advantage is one we would apply fiercely.”

Federal Finance Minister Bill Morneau told the House of Commons finance committee Wednesday the infrastructure bank is needed to spearhead projects because private institutional investors view the dedicated agency as a means to lower political risk.

PPP Canada, a federal Crown corporation that oversees public-private partnerships on infrastructure projects, doesn’t meet all the needs of the private investors, he said.

Ron Mock, chief executive of the Ontario Teachers’ Pension Plan, said a national infrastructure investment strategy in Canada could be “transformative” in terms of productivity, employments, and return on investment — provided it is guided by a long-term vision of commercial viability and independent governance.

The governance structure will be essential to its success to attracting private capital, he said, suggesting the government appoint a strong, professional, and independent board “to ensure it is run like a business.”

Canadian pension plans “have validated the soundness of this model on the global investment stage,” Mock said.

Since entering the infrastructure arena in 2001, Teachers’ has partnered with governments around the world, and used the plan’s governance and management expertise to add value and improve the productivity of these assets, he said.

“In our experience, countries that develop and implement a long-term vision for infrastructure are some of the most economically progressive and productive countries in the world.”

Mock said an infrastructure institution that combines government and institutional investment capital and risk sharing “will significantly improve the Canadian infrastructure landscape.”

Teachers’ was among the first pension plans to invest in infrastructure assets directly and is one of the world’s largest infrastructure investors, with a portfolio of nearly $16 billion as of the end of last year. The portfolio spans market segments including transportation and logistics, water and waste water, gas distribution, and renewable and conventional energy.

Senior advisors at Toronto law firm Bennett Jones LLP said the government has signaled it would be receptive to unsolicited bids for infrastructure projects, which represents a new opportunity for players experienced in project development.

“We think the energy transmission, water, wastewater, and transportation fields are well-suited to this initiative,” David Dodge, former Governor of the Bank of Canada, wrote in a note to clients with senior business advisor Jane Bird.

Ontario Teachers’ Pension Plan expressed support for the federal infrastructure investment plan and put out a press release which you can read here.

Benefits Canada also covered this story in its article, Governance structure ‘essential’ in federal infrastructure investment plan:

Following the federal government’s announcement yesterday of its plans to invest in infrastructure, one of Canada’s largest pension funds is advising the government that the implementation of a governance structure will be essential to its success in attracting private capital.

“We recommend the government appoint a strong, professional and independent board to ensure it is run like a business, as is the case for Canadian pension plans, which have validated the soundness of this model on the global investment stage,” said Ron Mock, president and chief executive officer of the Ontario Teachers’ Pension Plan, in a press release.

In his Fall Economic Statement yesterday, Finance Minister Bill Morneau said the federal government will invest an additional $81 billion in public transit, green and social infrastructure and transportation infrastructure, along with a number of other measures.

Canada’s largest pension funds, including the Ontario Teachers’, were among the first pension plans to invest directly in infrastructure assets, noted Mock.

“We believe that a government-backed Canadian infrastructure institution that partners government and institutional investor capital and risk sharing will significantly improve the Canadian infrastructure landscape,” said Mock. “It will benefit the Canadian government and, ultimately, Canadians.”

Since it began investing in infrastructure in 2001, Ontario Teachers’ has partnered with governments around the world, leveraging the fund’s governance and management expertise. “In our experience, countries that develop and implement a long-term vision for infrastructure are some of the most economically progressive and productive countries in the world,” said Mock.

The Ontario Teachers’ infrastructure portfolio is diversified across the transport/logistics, water and waste water, gas distribution, renewable and conventional energy industry sectors.

The Canada Pension Plan Investment Board also addressed infrastructure investment yesterday before the House of Commons finance committee. Mark Machin, chief executive officer of CPPIB, said the pension fund would need to see investment opportunities that meet its specific criteria in order to participate in the spending boom, according to the Globe and Mail.

CPPIB infrastructure investments include toll roads, shipping ports and pipelines around the world but the conditions are rarely satisfied by the infrastructure assets available in Canada, said Machin, although the pension fund is invested in the Ontario Highway 407 toll road.

“That’s been one of the biggest challenges in Canada, and around the world, is there’s just not been enough of those scale opportunities in size, but also that are prepared for our type of investments,” said Machin before the committee. He noted that the pension fund likes to buy operational assets, rather than investing in constructing new projects from scratch.

Mark Machin is right, pension funds are more likely to buy an equity stake in operational assets rather than investing in constructing new projects from scratch (greenfield projects).

There is however one big exception to this rule coming from the big, bad Caisse which last year announced it was going to handle some of Quebec’s big infrastructure projects through its subsidiary CDPQ Infra.

Some skeptical analysts think the Caisse can’t make money off public transit but I’m more optimistic and think the CDPQ Infra, led by Macky Tall, is rewriting the rules when it comes to large pensions delving into greenfield infrastructure projects.

The key difference is CDPQ Infra has an experienced team, people who worked at construction and engineering companies like SNC-Lavalin and other people with great project management and project finance experience, so they can handle “construction risk” that goes along with greenfield projects.

Sure, there are pros and cons to any greenfield infrastructure project. The risks are that the project runs into delays, goes way over budget and that cash flow projections are way off (this is why you need an experienced team to handle a major greenfield project).

But if done properly, the benefits are huge because the Caisse will be in control of a major infrastructure project from A to Z, something which is unheard of in the institutional world.

I mention this because some guy called Chas left this comment at the end of the Benefits Canada article:

It’s important to make the distinction between operational infrastructure investments and green field ones (specifically ones utilizing the DBFM model, which is being contemplated here).

Quite rightly, Teachers and CPPIB steer clear of the latter because they are far riskier, require specialized legal expertise, and more recently, the application of Lean construction methods to manage successfully to time and dollar budgets. CPPIB and Teachers lack the necessary expertise to assess such infrastructure investment types, which is certainly not a knock against them.

So at the end of the day, Mock’s and Machin’s commentary as it relates to governance of federal government infrastructure projects is irrelevant. Most of the projects will be non-revenue plays and DBFM (i.e. full life cycle) projects and therefore outside of their permitted investment mandates.

These being P3 projects as well, private equity will be the (P)rivate driver, and I would imagine that their risk/reward profile, for those who know how to size them up, will be attractive.

I asked a friend of mine who is an expert in infrastructure to explain all this to me:

DBFM is a type of Public Private Partnership (P3). The acronym describes the risks transferred to the private sector partner. In this case, Design, Build, Finance, and Maintain.

I think that the concept of establishing an infrastructure bank is to expand horizons and getting more projects done. It is not necessarily just about P3s.

In Europe, the European Investment Bank (EIB) has all sorts of tools that help projects to get financed. These tools do not exist in Canada. In the US, tax exempt muni bonds really go a long way to getting things done.

Anyway, just take a drive around Montreal and Ottawa, fairly obvious that the infrastructure is falling apart.

[Note: Andrew Claerhout, Senior Vice-President of Infrastructure & Natural Resources at Ontario Teachers’ Pension Plan, gave me a much more detailed response to Chas’s comment below in my update at the end of the comment.]

I can vouch for that, Montreal’s roads, bridges, sewer and water pipes are falling apart and infrastructure needs are mounting every year.

Of course, all these infrastructure projects are wreaking havoc on the city’s traffic which is why I avoid downtown Montreal as much as possible.

[Note: When urban planners were building highways in the 50s and 60s, they certainly didn’t plan for so many cars on the road, which is why the traffic nightmare keeps getting worse each year. And as my friend rightly notes, it’s high time that people living in Laval or South Shore pay tolls to come into the city and if they don’t want to, let them use public transit.]

Anyways, let’s get back to the federal infrastructure bank and the role Canada’s large pensions or other large global investors are going to play in funding or investing in these projects.

Ian Vandaelle of BNN reports, Ottawa may struggle to attract foreign infrastructure capital:

Former Alberta Investment Management (AIMCo) chief executive Leo de Bever is skeptical the federal government can attract foreign investment in critical Canadian infrastructure projects.

In an interview on BNN, de Bever, who’s now the chairman of energy service company Oak Point Energy, said foreign capital may prove disinterested in investing in many of the projects coveted by the Trudeau government.

“I don’t think that’s the first place that they’d be looking for,” he said. “The kind of people I talk to about foreign investment want to invest in our resources because they want security of supply [for] their own economies. I don’t think you’re going to get too many people excited about building roads in Canada.”

De Bever said Canadian attitudes toward paying for public infrastructure are at times diametrically opposed to the cash-flow needs of private equity.

“The prevailing wisdom in Canada is still that roads and sewage and so on should be free, and unfortunately infrastructure costs, so it has to earn a return,” he said. “The question is how do you allocate the cost of that infrastructure and if you’re not willing to charge for it, or not charge enough, then you’re not going to attract very much private capital: It’s that simple.”

Smart man that Leo de Bever, take the time to watch this BNN panel discussion below, it’s truly excellent (click here to watch it on BNN’s site). As always, if you have anything to add, email me at LKolivakis@gmail.com.

Update: Andrew Claerhout, Senior Vice-President of Infrastructure & Natural Resources at Ontario Teachers’ Pension Plan shared some very interesting insights regarding Chas’s comment at the end of the Benefits Canada article:

• 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.

I thank Andrew Claerhout for reaching out to me and  sharing these incredible insights on why pensions are not competing with DBFM/ PPPs and are looking instead to invest alongside the federal government in much larger, more ambitious infrastructure projects where they can help it make them economical and profitable over the long run.

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

Peter Levring of Bloomberg reports, Hedge Funds Haven’t Lost Appeal for Biggest Danish Pension Fund:

As a number of prominent pension funds stop using external managers they say charge too much in exchange for paltry returns, the biggest pension fund in Denmark is bucking the trend and sticking with the hedge funds it uses.

“In our case, funds have played a small but a good part in our portfolio,” Carsten Stendevad, the chief executive officer of ATP, which oversees about $118 billion in assets, said in an interview in Copenhagen.

The comments stand out at a time when a number of other pension funds have questioned the sense of continuing to rely on hedge funds to generate extra returns. There are plenty of examples of prominent skeptics. Rhode Island’s $7.7 billion pension fund terminated investments in seven hedge funds, including Brevan Howard Asset Management and Och-Ziff Capital Management Group LLC, it said earlier this month.

The largest U.S. pension plan, the California Public Employees’ Retirement System, voted to stop using hedge funds two years ago. Others who have stuck with the hedge funds they outsource investments to have faced criticism as the decision has led to losses, such as the New York state comptroller. Its loyalty to the industry has cost the Common Retirement Fund $3.8 billion in fees and underperformance, the Department of Financial Services in the U.S. said on Oct. 17.

Hedge fund investors pulled $28.2 billion from the industry last quarter, which is more than at any time since the aftermath of the global financial crisis, according to Hedge Fund Research Inc.

ATP declined to say which funds it uses or how much of its portfolio is managed by the industry. Investors can’t lump all external managers into one bucket and there’s plenty of variety left out there for it to still make sense to outsource to hedge funds, Stendevad said.

“There are so many types of hedge funds and we would look at all of them on a multi-year risk-adjusted return basis,” he said. “Looking at the ones we have, they’re quite different.”

ATP divides its investments into two categories: a so-called hedging portfolio, which is by far the larger of the two and designed to guarantee pensions. Its investment portfolio tries to boost the fund’s returns to top up Danes’ pensions. The fund returned 5.8 percent on its investments in the third quarter. For the first nine months, ATP’s investment portfolio returned 12.3 percent. It made money on private equity, bonds, real estate, infrastructure and credit instruments, but lost money on inflation hedges.

Stendevad said the double-digit returns ATP has generated probably aren’t sustainable, citing extreme monetary policies and the uncertainty created by Britain’s decision to turn its back on the European Union.

ATP will only continue using hedge funds as long as the returns justify doing so, Stendevad said.

“Of course the burden of proof is on them to demonstrate that they can deliver strong risk-adjusted returns,” he said. “And of course those who can do that have a good future. There are many that don’t, but that’s true for all active management to demonstrate added value.”

Stendevad, who joined ATP from Citigroup in the U.S. in 2013, is leaving the fund at the end of this year to spend more time with his family. He will be replaced by Christian Hyldahl, who comes from a position as head of asset management at Nordea.

So what is going on? Didn’t ATP get the memo that good times are over for hedge funds?:

For years they have been the elite of the fund management industry, enjoying colossal fees, gigantic homes and champagne lifestyles.

Now the good times may be over for hedge funds. Investors are taking their money elsewhere.

Last week the $US7.7 billion Rhode Island state pension scheme announced that it would take back half of the $US1.1 billion it had invested with seven hedge funds, including Och-Ziff and Brevan Howard.

Its decision comes after similar moves this year by the New York, New Jersey and Illinois state pension funds, which collectively have redeemed about $US6.5 billion. Kentucky and Massachusetts have also withdrawn money.

According to eVestment, an analytics and data provider, almost $US60 billion has left hedge funds this year, including $US10.3 billion in September.

It is an accelerating trend that began two years ago when the California Public Employees Retirement System (CalPERS), the benchmark for many public sector pension schemes, said that it was redeeming some of its hedge fund investments.

In the context of a $3 trillion industry, $60 billion of withdrawals may not seem like a crisis. But they are causing disquiet.

The main reason is that investors are becoming more cost-conscious. Few are prepared to stump up the gigantic fees charged in the glory years. Chris Ailman, chief investment officer of the $US187 billion California State Teachers Retirement System, spoke for many when in May he said that the industry’s traditional “two-and-twenty” model, where fund managers charge 2 per cent of assets under management and an additional 20 per cent of any profits earned, was broken.

Frankly, investors have decided that many hedge funds do not justify their high fees. According to eVestment, hedge funds delivered a positive return in September for the eighth consecutive month, taking the industry’s average return during the first nine months of 2016 to 4.4 per cent. But that’s poor set against the 9.7 per cent that investment-grade bonds have returned this year, let alone the S&P 500, which was up 6.1 per cent in the same period.

Among the worst performers have been some of the industry’s best-known names. The master fund at Brevan Howard fell by 0.8 per cent in 2014 and by almost 2 per cent last year. To date, it is said to be down by 3.4 per cent this year. Alan Howard, the firm’s billionaire co-founder, has responded by removing management fees on new investments from existing clients. Blaming poor performance on the fund having become too big, after assets under management swelled to $US27 billion in 2014, he has also capped it at $US15 billion.

Another industry legend to have cut fees is Paul Tudor Jones, a hedge fund pioneer, who let go nearly one in six of his staff this year after $US2 billion in redemptions. Other big names to have suffered poor returns this year include John Paulson, the hedgie famed for making billions in 2007 betting on a US housing crash, and Bill Ackman, a regular on America’s business channels.

Several factors have made it harder for the industry to make money. One is ultra-low rates and the rise of passive investing. These mean that many assets now move in tandem, making it harder for investors to add value by stock-picking or by alighting on specific situations or opportunities. Another is that markets are not as inefficient as before. Trading in some assets, notably interest rate products, is now dominated by algorithmic or “black box” traders that make fewer mistakes than human beings. With fewer mortals participating in such markets, there are fewer market anomalies for hedge funds to exploit, making it harder for them to claim an edge.

Poor performance is only one factor, however. Another is growing irritation at the billionaire lifestyles of some of the characters within the industry. This cannot be ignored by those running the retirement funds of public sector workers. Letitia James, the public advocate for New York and the city’s second-highest-ranking public official, told board members of the New York City Employees System this year to dump their hedge fund investments. She told them: “Hedges have underperformed, costing us millions. Let them sell their summer homes and jets and return those fees to their investors.”

Also helping to spark the redemptions have been other reputational hits prompted by tougher action on the part of regulators. Last month Och-Ziff agreed to pay $US412 million in penalties after entering a deferred prosecution agreement to settle claims of alleged bribery in five African countries. Most of the settlement was paid for by Daniel Och, the company’s founder and a former Goldman Sachs trader. Jacob Gottlieb, another big name, is in the process of closing his firm, Visium Asset Management, after one of its fund managers, who subsequently killed himself, was charged with insider trading. Leon Cooperman, another of the industry’s billionaire pioneers, is preparing to fight charges that his firm, Omega Advisors, profited from insider trading.

All these factors have created an unpleasant cocktail for the sector. One of the very best television series this year has been Billions, the story of hedge fund manager Bobby “Axe” Axelrod and Chuck Rhoades, the US attorney who tries to bring him down. The second series airs early next year, but to judge by the way things are going, soon it may look as much of a period piece as the film Wall Street does now.

No doubt, these are hard times in Hedge Fundistan and some investors want these hedge fund gurus to sell their summer homes so they can collect back some of the the gargantuan fees they lost while subsidizing their lavish lifestyles in return for paltry, sub-beta or negative returns.

I’ve been very critical of hedge funds on my blog for a long time. I’ve also warned investors that these are treacherous times for private equity and there’s a misalignment of interests in that industry too.

But with interest rates at historic lows and stock markets looking increasingly vulnerable to a violent shift, the elusive search for alpha continues unabated.

The only problem is when it comes to hedge funds, most investors, like Rhode Island, are meeting Warren Buffett, and realizing they’re not getting what they signed up for, namely, real, uncorrelated and high absolute returns that offer meaningful diversification benefits.

Are there too many hedge funds engaging in the same strategy? No doubt, crowded trades are a huge problem in the industry, especially among the large funds. But the other problem is a lot of hedge funds have gotten way too big for their own good, and more importantly for that of their investors. Too many seem content on collecting that 2% management fee on multibillions but are not offering the returns to justify the hefty fees they charge.

Hedge funds will blame the Fed, low interest rates, ZIRP, NIRP, crowding, high-frequency trading, passive investing, robo-advisors and increased regulations which makes it harder for them to engage in insider trading (and don’t kid yourselves, a lot of hedge funds engaged in this illegal activity in the past).

Whatever the reason, investors are fed up and in a deflationary world where rates are stuck at zero, fees eat up a lot of returns, so it becomes harder to justify paying hedge funds big fees, especially when they consistently under-perform markets over a long period.

So what’s the answer to hedge fund woes? A nice long bear market? Maybe but don’t forget what I always warn you of, most hedge funds stink, charging alpha fees for leveraged beta. This is why their hefty fees are a total disgrace, something which should have been addressed years ago by large institutional investors who have the power collectively to cut these fees down to normal.

Of course, some institutions are more than happy to keep on paying huge fees to hedge funds that (hopefully) are delivering great uncorrelated returns net of fees. Others are tired of playing this game and exiting these investments altogether or putting the screws on their hedge fund managers to lower the fees.

And while some US public pensions are exiting hedge funds or significantly lowering their allocation to them, others like ATP and Ontario Teachers’ Pension Plan are still very committed to these funds.

The key difference? When it comes to hedge funds, both ATP and Ontario Teachers know what they’re doing, they have committed substantial resources to their hedge fund program and have top-notch professionals sourcing and monitoring these external managers. They also use managed account platforms (like Innocap here in Montreal) to address liquidity and other risks.

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

Kirk Falcomer of the PE Hub Network reports, PSP Investments commits €500 mln to European credit platform (added emphasis is mine):

Canada’s Public Sector Pension Investment Board (PSP Investments) has committed €500 million ($735 million) in seed capital to a new European credit platform. The platform, created by David Allen‘s AlbaCore Capital, will focus on private and public credit markets where there are inefficiencies in pricing, including high yield, leveraged loans and direct lending. PSP said it may deploy more capital in partnership with AlbaCore for specific deal opportunities. PSP launched a private debt strategy in November 2015. Earlier this year, the pension fund hired Oliver Duff to lead its strategy in Europe.

PRESS RELEASE

PSP Investments commits €500 million in newly-created European credit platform AlbaCore

Seed Investment in AlbaCore to Add to PSP Investments’ Existing Private Debt Activities in Europe

MONTRÉAL and LONDON, Nov. 1, 2016 /CNW Telbec/ – The Public Sector Pension Investment Board (“PSP Investments”), one of Canada’s largest pension investment managers, announced today a €500 million seed investment commitment made by an affiliate of PSP Investments in a new specialist European credit platform promoted by AlbaCore Capital Limited (“AlbaCore”), recently formed by David Allen. This is one of the largest commitments PSP Investments has made to an external strategy. AlbaCore intends to focus on private and public credit markets where there are significant inefficiencies in pricing, including European high yield, leveraged loans and direct lending. PSP Investments may deploy further capital in partnership with AlbaCore in certain substantial investment opportunities in Europe.

“PSP Investments sees great opportunity in the European credit market and, as such, entered the market earlier this year with the hiring of Oliver Duff to lead our European private debt activities, which focus on sponsor-financed acquisitions, first liens, second liens and other debt instruments across the capital structure,” said David Scudellari, Senior Vice President and Head of Principal Debt and Credit Investments at PSP Investments. “With its expertise and extensive network of relationships, the portfolio team working for AlbaCore is well positioned to source bespoke, attractive transactions that will add to our existing activities,” Mr. Scudellari added.

Private Debt is PSP Investments’ newest asset class. It was created in November 2015 with the objective to deploy over C$5 billion (over €3.4 billion) in debt financings globally. Since inception, the team has committed to over 20 transactions in North America and deployed C$2.4 billion (€1.6 billion). Oliver Duff joined PSP Investments’ London office in September 2016 with the mandate to develop the organization’s presence in the European leverage finance market, build relationships with local partners and contribute to achieving PSP Investments’ deployment goal.

About PSP Investments

The Public Sector Pension Investment Board (PSP Investments) is one of Canada’s largest pension investment managers with C$116.8 billion of net assets under management as at March 31, 2016. It manages a diversified global portfolio composed of investments in public financial markets, private equity, real estate, infrastructure, natural resources and private debt. Established in 1999, PSP Investments manages net contributions to the pension funds of the federal Public Service, the Canadian Armed Forces, the Royal Canadian Mounted Police and the Reserve Force. Headquartered in Ottawa, PSP Investments has its principal business office in Montréal and offices in New York and London. For more information, visit investpsp.com or follow Twitter @InvestPSP.

About AlbaCore

AlbaCore’s specialist European credit platform is focused on opportunities across European corporate credit markets. The platform’s selection process is based on fundamental research focusing on capital preservation and total return.

So who is David Allen and why is PSP seeding his new fund, AlbaCore Capital, with such as substantial investment?

Back in May, Nishant Kumar of Bloomberg reported, Canada Pension’s David Allen Said to Depart to Start Hedge Fund:

David Allen, a money manager in London at the $212 billion Canada Pension Plan Investment Board, is leaving to start his own hedge fund, according to a person with knowledge of the matter.

Allen, who is a managing director responsible for credit investments, will leave Canada’s largest pension fund on Friday and start his own investment firm later this year, said the person who asked not to be identified because the information is private.

The money manager established and managed a credit opportunities fund that has invested more than 9 billion Canadian dollars ($6.9 billion) since he joined the firm in 2010, the person said. The fund returned an annualized 15.3 percent over the last six years, they said.

Allen declined to comment, while Mei Mavin, a spokeswoman for the pension firm, confirmed his departure. “We thank David for his many contributions to CPPIB and wish him all the very best on his new endeavors, ” she said in an e-mailed statement.

Allen was a partner and head of European investments at GoldenTree Asset Management in London before joining the pension fund.

Obviously David Allen is extremely qualified to run a credit fund. Before leaving CPPIB where he racked up huge gains running their European credit portfolio, he worked at GoldenTree Asset Management where he was a member of the Global Investment Committee, Portfolio Manager for US Media, Telecom, Gaming Partner and Head of European Investments (he founded GoldenTree’s European office).

Prior to GoldenTree, he was an Executive Director at Morgan Stanley where he ranked as the #1 High Yield Media analyst in the US according to Institutional Investor Magazine (2002).

Allen has been busy building his team since May. He hired Matthew Courey, former head of high-yield bond trading at Credit Suisse and Joseph Novarro, the former managing partner at investment firm Renshaw Bay, to become the chief operating officer of his private debt fund.

In late September, Allen also hired Bill Ammons away from CPPIB to join his new fund:

Former Canada Pension Plan Investment Board fund manager Bill Ammons has joined David Allen’s new credit startup AlbaCore Capital as a founding partner and portfolio manager.

The new fund is planning to commence operations by the end of the year, according to Reuters. Ammons worked for Allen when they were both portfolio managers at CPPIB.

Allen was a managing director responsible for credit investments at CPPIB, which manages some $217 billion and is Canada’s largest pension fund, before leaving in May of this year to start his own shop in London.

Ammons joined CPPIB in 2010 and worked on its European credit investment team, Reuters noted. He managed a European sub-investment grade credit portfolio investing in leveraged loans, high yield, mezzanine, PIK, converts and distressed positions across the primary, secondary and private credit markets, according to his LinkedIn profile.

Beforehand, he was part of BofAML’s restructuring and leveraged finance team in London, and was previously on the leveraged finance team at Wachovia.

He comes aboard AlbaCore alongside Matthew Courey, who was head of high-yield bond trading at Credit Suisse, and Joseph Novarro, who was managing partner at money manager Renshaw Bay and joins the firm as COO. Both are also founding partners, and the four will reportedly form the nucleus of AlbaCore’s investment and management committees.

David O’Neill, former head of European institutional equity trading for KCG Holdings, also recently joined AlbaCore recently as head of operations and risk management.

Based in London and founded in early June 2016, AlbaCore’s initial size is unknown and details about the strategy or strategies it will pursue remain sparse beyond a concentration in European private and public credit opportunities.

The four founding partners of AlbaCore Capital are featured in the picture above which was taken from their LinkedIn profiles.

So what do I think of this deal to seed AlbaCore Capital? A few brief thoughts:

• I like this deal for a lot of reasons. No question that David Allen and Bill Ammons are excellent at what they do which is why they posted solid numbers while working at CPPIB. Will they keep delivering 15% annualized at AlbaCore? I strongly doubt it but even if they deliver 10% + with low volatility and correlation to stocks and bonds, that will be great for PSP and its members. That all remains to be seen as markets will be far more challenging in the next five to ten years.
• Was this deal cooking for a while? I believe so and think PSP’s President and CEO, André Bourbonnais who was David Allen’s boss at CPPIB, was in talks about this deal ever since Allen departed CPPIB. In fact, I wouldn’t be surprised if Bourbonnais prodded Allen to leave CPPIB, promising him he would seed his new fund or Allen confidentially told him he wanted to start this new fund and would love to have PSP as a seed investor (it helps to have friends in high places). Either way, seed deals of this size don’t happen on a whim.
• I’m not sure if it’s technically a hedge fund (the release calls it a credit “platform”) but seeding this new fund with such a sizable commitment comes with risks and benefits. The risks are the fund will flop spectacularly and PSP will deeply regret its decision to back it up with such a hefty commitment. But if it succeeds, PSP will enjoy the benefits of being an anchor investor, which means it won’t be paying 2 & 20 in fees (not even close) and if it has an equity stake (not sure it does), it will make money off that too (or do some sort of revenue sharing). The specific terms of the deal were not disclosed but I’m sure they were mutually beneficial to both parties.
• Other specifics were not disclosed as well like the specific breakdown of investment activities and geographic exposure within Europe. That likely remains to be determined as AlbaCore will invest opportunistically as opportunities arise in high yield, leveraged loans and direct lending. For PSP, it gains meaningful, scalable access immediately to very qualified portfolio managers who are very much in tune with what is happening in European credit markets.
• This deal represents a significant push for PSP in private debt, a new asset class that makes perfect sense, especially when the economy is slowing and banks aren’t lending. Oliver Duff who leads PSP’s European private debt activities and reports to David Scudellari, Senior Vice President and Head of Principal Debt and Credit Investments at PSP, is very qualified and will use this investment to deploy more capital in partnership with AlbaCore for specific sizable deal opportunities.
• European debt markets are challenging to say the least but that is why it helps to have partners who understand these challenges and can seize opportunities as well as advise PSP as bigger opportunities arise.

All in all, I like this seed deal for a lot of reasons but caution everyone to temper their enthusiasm as the investment landscape will be far more challenging in the next ten years and return expectations across all asset classes need to come down.

Some other thoughts? People will say why didn’t PSP just hire its own team, why seed AlbaCore Capital? Like I stated, PSP gains immediate, scalable access to European private debt markets with this seed investment and it’s not paying 2 & 20 in fees or anywhere close to that amount as a seed investor. Also, this partnership will prove useful for deployment of capital in bigger deals where PSP has the size to invest directly or co-invest along with AlbaCore.

If you want to read more on the rise of private debt as an institutional asset class, click here to read an excellent report from ICG. Also, the figure below was taken from sample pages from the 2016 Prequin Global Private Debt Report (click on image):

As you can see, private debt isn’t an emerging asset class, it’s already here and big pensions like CPPIB and PSP Investments are going to be critical players in this space (CPPIB already is and PSP is on its way there).

There are structural factors that explain the rise of private debt as an asset class, including a slowing economy, historically low rates, bank regulations and in Europe in particular, where the banking sector is a mess and deflation and low growth are here to stay, private debt opportunities will abound especially for PSP, CPPIB and other pensions with a very long investment horizon.

Are there risks to private debt? Of course there are, especially in Europe, but if these deals are structured properly and PSP can take advantage of its long investment horizon, it will mitigate a lot of risks which impact funds with a shorter investment horizon like hedge funds and even private equity funds.

I’ll leave you with some more food for thought, Carlyle is shifting its focus back to lending after its unsuccessful venture into hedge funds:

Carlyle’s first big investment in a hedge fund firm was Claren Road Asset Management, which was founded by four star Citigroup traders in December 2010. Carlyle took a majority stake. A few months later, it bought a stake in the Emerging Sovereign Group (E.S.G.), which started with a seed investment from Julian H. Robertson, the billionaire investor.

It was part of a bigger push by Carlyle to branch out before its initial public offering in 2012. Soon after, it bought a stake in Vermillion Asset Management, a commodities investment manager. Other private equity firms like Blackstone have followed similar strategies, buying hedge fund stakes, as have the family investment offices of extremely wealthy people, like that of the Alphabet chairman, Eric E. Schmidt.

But over the last two years, nearly $8 billion has flowed out of Claren Road. It is bracing for another $1 billion to be withdrawn in the next few quarters. This year, it announced plans to cut ties with E.S.G., selling its majority stake in the $3.5 billion hedge fund. Last year, Carlyle split with the Vermillion founders Chris Nygaard and Andrew Gilbert after deciding to redirect the business toward commodity financing and away from managing money. By the end of the year, its assets in hedge funds are expected to total just $1 billion.

Now, Carlyle will focus on another part of its global markets strategies business: lending. It will focus on private lending to companies, buying distressed debt from companies in sectors like energy, and investing in complex pooled investments like collateralized loan obligations, stepping into the business as banks retrench after the financial crisis. Last month, it hired Mark Jenkins from the Canada Pension Plan Investment Board. Mr. Jenkins helped expand the pension fund’s direct lending.

Carlyle may still face challenges in its global markets strategies unit, and its pivot to lending from hedge funds has been met with some skepticism. During a phone call with analysts after its third-quarter earnings announcement this week, an analyst from JPMorgan Chase questioned whether Carlyle’s experiment in hedge funds might be repeated in its new venture into lending.

“I think in hindsight, you were late to hedge funds, made significant investments and it didn’t end well,” the analyst said, adding, “Why is this different?”

In response, Mr. Conway emphasized that Carlyle had better expertise in private markets, its traditional business, than in the public markets in which its hedge fund investments were mainly invested.

Christopher W. Ullman, a spokesman for the firm said: “We’re building on well-established firmwide strengths. This is a long-term strategic commitment. Credit is an attractive asset class and always will be.”

A little side note, when I covered the big executive shakeup at CPPIB, I stated Mark Jenkins might have approached Carlyle being disappointed that he wasn’t named CPPIB’s new CEO and there may have been a conflict of interest as he was responsible for private markets at CPPIB.

After a high level discussion with a senior manager at CPPIB, I was told that Jenkins was planning his exit for some time and that the appearance of him leaving after Mark Wiseman left to join Blackrock was “unfortunate and coincidental.”

Also, this person told me Jenkins was not directly responsible for investing in Carlyle or any other fund and that these decisions are made in an investment committee which he was part of but not directly responsible for fund investments.

I apologize to Mark Jenkins if my comment added fuel to the conspiracy fire but one thing that still concerns me is all these senior people at CPPIB leaving to join established funds or to start their new fund capitalizing on their key relationships.

Sure, it’s a free market and nothing says they need to stay at CPPIB or PSP for the rest of their career but the governance at these funds needs to be bolstered to make sure there is nothing remotely shady going on and that if a key manager leaves, there is ample time to ensure a successful handover of big investment portfolios.

Yes, CPPIB can handle the departure of a Wiseman, Bourbonnais, Allen, Ammons and Jenkins but if this becomes a regular occurrence, the optics don’t look right and it will become a problem for the fund going forward.

One final note, as you see PSP ramping up its private debt portfolio, think about my recent comments on the Liberals attacking public pensions and the future of retirement plans.

When I say nothing compares to Canada’s large, well-governed defined-benefit plans which invest directly and indirectly across public and private markets, this example of investing in private debt highlights why no defined-contribution, target date or variable benefit plan can compete with Canada’s large DB plans over a long period.

Again, if you have anything to add, shoot me an email at LKolivakis@gmail.com and I’ll be glad to share your insights. Please remember to kindly donate or subscribe to this blog on the top right-hand side under my picture and support my efforts in bringing you the very best insights on pensions and investments.

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

Nicholas A. Vardy, Chief Investment Officer at Global Guru Capital, wrote a comment for MarketWatch, How one man in Nevada is trouncing the Harvard endowment:

This past weekend, I attended a gala reception for over 500 European Harvard alumni gathered in the impressively refurbished main hall of the Deutsches Historisches Museum (German Historical Museum) in Berlin.

Harvard’s President Drew Faust regaled alumni with self-congratulatory statistics on how Harvard is spending the fruits of its current $6.5 billion fund raising campaign, refurbishing undergraduate housing and getting Harvard’ science and engineering departments up to snuff.

There was other news from Cambridge, Massachusetts that President Faust ignored in her polished plea to well-heeled alumni in Berlin.

And that has been the embarrassing performance of the Harvard endowment over the past decade.

For all of Harvard’s fund raising prowess — second only to Stanford — six years of Harvard’s current capital campaign has been barely enough to offset the decline in the value of the Harvard endowment since 2011.

Almost a decade after reaching its peak, the Harvard endowment is smaller today in nominal terms than it was in 2007.

Boasting a value $35.7 billion, Harvard’s endowment tumbled about 5% or $1.9 billion over the past 12 months. A big chunk of the most recent drop stemmed from Harvard endowment forking over $1.7 billion to the university itself– a roughly 30% subsidy to its annual operating budget.

What is of growing concern to Harvard alumni and staff is that Harvard endowment’s investment returns over the past 12 months were a negative 2%. That (yet again) trailed traditional rival Yale, which eked out a 3.4% gain.

Harvard’s Endowment: A State of Crisis

So what is the culprit behind Harvard’s poor investment performance?

Some of last year’s poor performance may be due to bad luck. After a volatile start to the year, Harvard’s portfolio of publicly traded stocks lost 10.2% through June 2016. Throw in a couple of unfortunate blow ups in Latin America, and voila — the Harvard endowment recorded its first annual loss since 2008.

Still, concern about Harvard’s poor investment performance is about more than just a single unlucky year.

Over the past decade, the Harvard endowment has generated an average gain of just 5.7%. Harvard’s five-year track record of 5.9% puts it at the back of the class among its Ivy League rivals, just ahead of Cornell.

Not that the school hasn’t noticed.

The Harvard endowment plowed through several CEOs in recent years. The recently hired former head of Columbia’s endowment will be the eighth CEO to lead the Harvard endowment — including interim heads — in the past 12 years. His predecessor left after just 18 months on the job.

The largest university endowment in the world has not lacked for investment talent. The Harvard Management Company’s staff is chock full of former Goldman Sachs partners and other high-compensated Wall Street investment talent

Nor has Harvard’s staff of around 200 former Masters of the Universe been shy about writing themselves checks for huge salary and bonuses. Former CEO Jane Mendillo earned $13.8 million in 2014. Other top traders at Harvard have made as much as $30 million in a single year.

How Nevada is embarrassing Harvard

Carson City, Nevada, is a long way from Cambridge, Massachusetts.

That’s where Steve Edmundson manages the Nevada State Pension fund — which, at $35 billion, is just about the same size as the Harvard endowment. Nevada’s State Pension fund, however, differs from Harvard in other crucial ways.

First, Steven Edmundson is the only investment professional managing the Nevada State Pension Fund. The University of Nevada, Reno, alumnus has no other internal professional staff.

His investment strategy?

Do as little as possible — usually nothing. That is because Edmundson invests Nevada’s pension fund’s assets in low-cost passive investment vehicles.
Second, Edmundson earns an annual salary of $127,121.75. That’s a long way from the multimillion dollar pay packages collected by top portfolio managers at Harvard. Ironically, his salary also matches just about exactly the $126,379 salary of an Assistant Professor at Harvard — typically a 27-year-old academic who has just completed her Ph.D.

Third, and perhaps most astonishingly, the Nevada State Pension Fund’s investment track record soundly beats the Harvard endowment over the past decade.

While Harvard returned 5.7% annually over the last 10 years, the Nevada State Pension fund has generated annual returns of 6.2%. Over five years, Nevada has extended its lead, returning 7.7% per annum, while has Harvard stagnated at 5.9%. That outperformance of 1.8% per year is a country mile in the investment world.

As it turns out, Nevada is also beating the returns of the nation’s largest public pension fund, the California Public Employees’ Retirement System, or Calpers. Nevada’s investment returns beat Calpers over one-, three-, five- and 10-year periods.

Sure, Calpers is a different beast, managing about $300 billion. However, it also has a staff of 2,636 employees to generate its returns

Edmundson is essentially a one-man band.

What is to be done?

So does Nevada’s outperformance of the Harvard endowment mean it should abandon the famous “Yale model” of endowment investing with its eye-popping allocations to alternative asset classes like private equity, venture capital, and hedge funds?

Should Harvard mimic the Nevada State Pension fund success, fire the bulk of its investment staff, and only invest in low-cost index funds ?

Although that strategy would likely improve Harvard’s investment performance, the answer remains “probably not.”

Over the past 10 years, Yale has generated an annualized return of 8.1% on its endowment with a staff of about 25 investment professionals, by definition staying true Davis Swensen’s original “Yale model.”

And after all, Yale did outperform Nevada’s 6.2% return over the past decade. An outperformance of 1.9% per year is substantial.

So it seems less that the “Yale model” itself is broken than it is Harvard’s investment team that has tripped over itself during the past decade. But it does mean that the Harvard endowment and its overpaid staff of 200 investment professionals has to get its act together.

And it had better do so … and fast.

On Friday, I went over why Harvard’s endowment was called “fat, lazy, stupid” and why the McKinsey report highlighted some disturbing issues where past investment officers manipulated benchmarks in real assets to pad their performance and justify multimillion dollar bonuses.

Over the weekend, I continued reading on Harvard’s endowment and came across this and other articles. In early October, Paul J. Lim wrote a comment for Fortune, 3 Reasons That Harvard’s Endowment Is Losing to Yale’s:

The largest educational endowment in the world is under new management, and it’s easy to see why.

Harvard Management Co., which oversees Harvard’s mammoth $36 billion endowment, has named Columbia University’s investment chief N.P. Narvekar as its new CEO. At Columbia, Narvekar produced annual total returns of 10.1% over the past decade, which trounced the 7.6% annual gains for Harvard.

The hiring comes days after Harvard’s investment fund reported a loss of 2% in the 12 months ended June 30. Making matters worse, rival Yale announced that its $25 billion endowment grew 3.4% during that same stretch, leading the student editors of the Harvard Crimson to declare: “This is unacceptable.”

The prior year wasn’t much better. While Harvard’s endowment gained 5.8% in the prior fiscal year ending June 30, 2015, that performance ranked second-to-last among all Ivy League endowments, earning half the returns of Yale.

Normally, differences of this magnitude can be chalked up to basic strategy. But the fact is, Harvard and Yale invest rather similarly. Instead of simply owning stocks and bonds, both endowments spread their wealth among a broader collection of assets that include U.S. and foreign stocks, U.S. and foreign bonds, real estate, natural resources, “absolute return” funds (which are hedge-fund-like strategies), and private equity.

Still, there are subtle differences between the two approaches. And while most investors don’t have access to—or interest in—exotic alternatives like private equity and venture capital funds, the differences between the performance of the Harvard and Yale endowments offer a few lessons for all investors.

#1) Focus your attention on what really matters.

Academic research shows that deciding on which assets to invest in—and how much money to put in each type of investment—plays a far bigger role in determining your overall performance than the individual securities you select.

But while Harvard and Yale’s investment management teams both spend time concentrating on their “asset allocation” strategies, only one gives it its full attention.

Yale runs a fairly streamlined office with a staff of just 30. That’s because the actual function of picking and choosing which stocks or bonds or real estate holdings to invest in—and how best to execute the actual trades—is farmed out to external managers at professional investment firms.

This allows the Yale Investments Office to spend all its time figuring out the optimal mix of investments based on their needs and the market climate.

Harvard, on the other hand, runs what’s called a “hybrid” system. In addition to setting asset allocation policies and hiring external managers like Yale does, the investment staff at Harvard Management Co. also directly invests a sizeable portion of the endowment itself, selecting securities and being responsible for executing the trades.

This is why HMC employs more than 200 staffers by comparison.

Yet as Harvard’s recent performance shows, it’s hard to be good at all aspects of investing.

Indeed, Robert Ettl—who has been serving as HMC’s interim chief executive and will become chief operating officer under Narvekar—noted in a recent report that the endowment’s disappointing showing “was driven primarily by losses in our public equity and natural resources portfolios.”

Ettl went on to note that “we have repositioned our public equity strategy to rely more heavily on external managers”—a tacit admission that Harvard’s internal equity managers were probably responsible for a decent portion of that poor performance.

And as for the natural resources segment of HMC’s portfolio—which involves owning physical commodities such as timber on plantations owned and managed by Harvard—that lagged its benchmark performance by a massive 11 percentage points in fiscal year 2016. As a result, Ettl said HMC recently replaced the internal head of its natural resources portfolio.

#2) Turnover is never good, especially when it comes to management.

At Yale, David Swensen has managed the school’s endowment for 30 straight years, generating annual returns of about 14% throughout his tenure, far in excess of his peers and the broad market. That long, stable tenure has allowed Yale to maintain such a consistent strategy—of being willing to delve into somewhat risky and illiquid assets including venture capital, private equity, hedge funds, and physical assets—that this approach is now called “the Yale Model.”

Harvard is another story altogether.

When Narvekar assumes his duties at HMC on December 5, he will be the eighth manager to lead Harvard’s investment portfolio—including interim heads—in the past 12 years.

And each manager has put his or her own spin on the underlying investment style, forcing the endowment to switch gears every few years.

For example, Mohamed El-Erian, who briefly ran the endowment before leaving to become CEO and co-chief investment officer at PIMCO, increased the endowment’s use of derivatives and hedge funds and exposure to the emerging markets. El-Erian’s successor Jane Mendillo then took the fund in a more traditional direction. But she had the unenviable job of unwinding HMC’s exposure to El-Erian’s illiquid bets during the global financial crisis.

Every time the endowment deploys new strategies and unwinds old ones, turnover rises. And high portfolio turnover usually leads to poor performance, higher costs, and more taxes.

#3) Don’t try to copy other investors. Success is hard to replicate.

Under both Stephen Blythe, who served for less than a year and a half before taking medical leave, and interim CEO Ettl, Harvard Management has shifted a greater portion of its equity strategy to external managers—in apparent emulation of Yale.Narvekar himself is said to be closer to Yale’s Swensen, operating a relatively small staff that relies exclusively on external managers.

But it’s hard enough for successful managers to replicate their own success. It’s doubly hard trying to emulate other successful investors.

In fact, David Swensen at Yale is on record as saying that individual investors should not even try to copy what Yale is doing with its endowment.

Instead, Swensen tells investors to keep things simple by establishing a broadly diversified portfolio and then using low-cost, low-turnover index funds as vehicles of choice.

Ironically, some investment managers argue that this is a strategy that Harvard’s endowment should focus on as well.

While Harvard’s endowment has beaten the broad stock and bond markets over the past 15 years, on a risk-adjusted basis, it has actually done no better than a basic 60% stock/40% bond approach.

This may explain why financial adviser Barry Ritholtz has argued that rather than trying to emulate the Yale Model, Harvard should be taking a page from Calpers, the giant pension fund manager that invests on behalf of California’s public employees.

A couple of years ago, Calpers made a big splash by saying that it would be cutting back on its use of expensive actively managed strategies, including hedge funds, while focusing more on low-cost index funds, which simply buy and hold all the securities in a given market.

Now those are lessons—low costs, index funds, and buy and hold—that apply to your 401(k) as much as they do to Harvard’s endowment.

Great advice, right? Wrong!! The next ten years will look nothing like the last ten years.

In fact, in their latest report (it was a video update), “A Recipe For Investment Insomnia,” Francois Trahan and Michael Kantrowicz of Cornerstone Macro cite ten reasons why markets are about to get a lot harder going forward :

1. Growth Is Likely To Slow … From Already Low Levels
2. The Risks Of Zero Growth Are Higher Today Than In The Past
3. The U.S. Consumer No Longer The Buffer Of U.S. Slowdowns
4. The World Is Battling Lingering Structural Problems
5. A U.S. Slowdown Has Implications For The World’s Weakest Links
6. The Excesses Of China’s Investment Bubble Have Yet To Unwind
7. Demographic Trends In Japan … An Insurmountable Problem?
8. Central Banks Have Reached The Limits Of Monetary Policy
9. Slower Growth Is The Enemy Of Portfolio Managers
10. P/Es Are Hypersensitive To The Economy At This Time

Also, Suzanne Woodley of Bloomberg notes this in her recent article, The Next 10 Years Will Be Ugly for Your 401(k):

It doesn’t seem like much to ask for—a 5 percent return. But the odds of making even that on traditional investments in the next 10 years are slim, according to a new report from investment advisory firm Research Affiliates.

The company looked at the default settings of 11 retirement calculators, robo-advisers, and surveys of institutional investors. Their average annualized long-term expected return? 6.2 percent. After 1.6 percent was shaved off to allow for a decade of inflation1, the number dropped to 4.6 percent, which was rounded up. Voilà.

So on average we all expect a 5 percent; the report tells us we should start getting used to disappointment. To show how a mainstream stock and bond portfolio would do under Research Affiliates’ 10-year model, the report looks at the typical balanced portfolio of 60 percent stocks and 40 percent bonds. An example would be the $29.6 billion Vanguard Balanced Index Fund (VBINX). For the decade ended Sept. 30, VBINX had an average annual performance of 6.6 percent, and that’s before inflation. Over the next decade, according to the report, “the ubiquitous 60/40 U.S. portfolio has a 0% probability of achieving a 5% or greater annualized real return.”

One message that John West, head of client strategies at Research Affiliates and a co-author of the report, hopes people will take away is that the high returns of the past came with a price: lower returns in the future.

“If the retirement calculators say we’ll make 6 percent or 7 percent, and people saved based on that but only make 3 percent, they’re going to have a massive shortfall,” he said. “They’ll have to work longer or retire with a substantially different standard of living than they thought they would have.”

Research Affiliates’ forecasts for the stock market rely on the cyclically adjusted price-earnings ratio, known as the CAPE or Shiller P/E. It looks at P/Es over 10 years, rather than one, to account for volatility and short-term considerations, among other things.

The firm’s website lets people enter their portfolio’s asset allocation into an interactive calculator and see what their own odds are, as well as how their portfolio might fare if invested in less-mainstream assets (which the company tends to specialize in). The point isn’t to steer people to higher risk, according to West. To get higher returns, you have to take on what the firm calls “maverick” risk, and that means holding a portfolio that can look very different from those of peers. “It’s hard to stick with being wrong and alone in the short term,” West said.

At least as hard though is seeing the level of return the calculator spits out for traditional asset classes. Splitting a portfolio evenly among U.S. large-cap equities, U.S. small-cap equities, emerging-market equities, short-term U.S. Treasuries, and a global core bond portfolio produced an expected return of 2.3 percent. Taking 20 percent out of short-term U.S. Treasuries and putting 10 percent of that into emerging-market currencies, and 10 percent into U.S. Treasury Inflation Protected Securities, lifted the return to 2.7 percent. Shifting the 20 percent U.S. large-cap chunk into 10 percent commodities and 10 percent high-yield pushed the expected return up to 2.9 percent. Not a pretty picture.

Moral of the story: Since most people’s risk tolerance isn’t likely to change dramatically, the amount you save may have to.

I’ve long warned my readers to prepare for a long bout of debt deflation, low and mediocre returns, and high volatility in the stock, bond and currency markets.

If you think buying index funds or using robo-advisors will solve your problems, you’re in for a rude awakening. No doubt, there is a crisis in active management, but there will always be a need to find outperforming fund managers, especially if a long bear market persists.

All this to say that I take all these articles with a shaker of salt. That “one-man phenom” in Nevada was very lucky that the beta winds were blowing his way during the last ten years.

Luck is totally under-appreciated when considering long-term or short-term performance. For example, I read an article in the Wall Street Journal, King of Pain: Fund manager is No. 1 with a 40.5% gain, discussing how Aegis Value’s Scott Barbee survived tough times, wins our contest easily with 12-month skyrocket.

When I drilled into his latest holdings, I noticed almost half the portfolio is in Basic Materials and Energy, and his top holdings include WPX Energy (WPX), Coeur Mining (CDE) and Cloud Peak Energy (CLD), all stocks that got whacked hard in January and came roaring back to triple or more since then.

This transformed Scott Barbee from a zero into a hero but does this mean he will be able to repeat his stellar 12-month returns? Of course not, to even think so is ridiculous (in fact, I recommend he books his profits fast and exits energy and basic materials altogether).

I’m telling you there is so much hype out there and caught in the crosswinds are retail and institutional investors who quite frankly don’t understand the macro environment and the structural changes taking place in the world which will necessarily mean lower and volatile returns are here to stay.

The lessons for Harvard endowment is don’t pay attention to Nicholas Vardy, Barry Ritholtz or any other so-called expert. They all don’t have a clue of what they’re talking about.

As far as replicating the Yale endowment, I think it makes sense to spend a lot more time understanding the macro environment and strategic and tactical allocation decisions, and this is definitely something David Swensen and his small team do exceptionally well (Swensen wrote the book on pioneering portfolio management and he is an exceptional economist who was very close to the late James Tobin, a Nobel laureate and long-time professor of economics at Yale).

But Harvard’s endowment  doesn’t need advice from anyone or to replicate anyone, it has exceptionally bright people working there and their new CEO will need to figure out how to manage this fund by capitalizing on the internal talent and only farming out assets when necessary.

The articles above, however, confirmed my suspicions that several past investment officers got away with huge bonuses that they didn’t really deserve based on the performance of the fund and certain sub asset classes, like natural resources.

On LinkedIn, I had an exchange with one individual who wrote this after reading my last comment on Harvard’s endowment criticizing the benchmarks they were using for their real assets:

This issue is even more critical especially for pensions and endowments which invest more directly into real assets which are typically held for the long-term (not divested yet) as their bonuses tend to be annually paid out based on these real assets’ valuations (which are marked-to-model), hence, can be subject to massage or manipulation if their fiduciary awareness and governance are not deep, etc…

To which I replied:

[…] keep this in mind, pensions have a much longer investment horizon than endowments and they have structural advantages over them and other investment funds to invest in private equity, real estate and increasingly in infrastructure. If they have the skill set to invest directly, all the better as it saves on costs of farming out these assets. Now, in terms of benchmarks governing these private market assets, there is no perfect solution but clearly some form of opportunity cost and spread (to adjust for illiquidity and leverage) is required to evaluate them over a long period but even that is not perfect. Pensions and endowments recognize the need to find better benchmarks for private markets and clearly some are doing a much better job than others on benchmarking these assets. The performance of these investments should be judged over a longer period and in my opinion, clawbacks should be implemented if some investment officer took huge risks to beat their benchmark and got away with millions in bonuses right before these investments plummeted.

Let me give you an example. Let’s say Joe Smith worked at a big Canadian pension fund and took huge opportunistic risks to handily beat his bogus real estate benchmark and this was working, netting him and his team big bonuses right before the 2008 crisis hit.

And then when the crisis hit, the real estate portfolio got whacked hard, down close to 20%. Does this make Joe Smith a great real estate investor? Of course not, he was lucky, took big risks with other people’s money and got away with millions in bonuses and had the foresight to leave that pension before the crisis hit.

Legally, Joe Smith did nothing wrong, he beat his benchmark over a four-year rolling return period, but he was incentivized to game his benchmark and it was up to the board to understand the risks he was taking to handily beat his benchmark.

Here I discuss real estate but the same goes for all investment portfolios across public and private markets. People should be compensated for taking intelligent risks, not for gaming their benchmark, period.

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

The Public Service Alliance of Canada (PSAC) put out a press release, Liberal bill an attack on pensions:

The Liberal government is following the Conservatives’ lead by introducing legislation that will allow employers to reduce pension benefits.

Bill C-27, An Act to amend the Pension Benefits Standards Act, had its first reading in the House of Commons last week.

A target benefit pension plan is a big gamble

This bill will allow employers to shift from good, defined benefit plans that provide secure and predictable pension benefits, into the much less secure form of target benefits.

Unlike a defined benefit plan, where the employer and employees contribute and retirees know how much they can expect when they retire, the amount you receive under a target benefit pension plan is just that, a target. Meaning, the plan aims to give you a certain pension benefit, but there’s no guarantee.

The other big difference is that target pension benefit plans shift the financial risk from the employer to employees and pensioners.

PSAC will oppose this bill

Bill C-27 opens the door to eliminating or reducing defined benefit pension plans. PSAC has opposed target benefit pension plans since the previous Conservative government introduced consultations.

We will continue to resist any move in this direction, and continue to push for retirement security for all Canadians.

A PSAC union member brought this to my attention, providing me with some context:

Bill C-27 was introduced in the Parliament of Canada on October 19th, 2016 and will allow for the conversion of defined benefit pension plans to less secure “target benefit” pension plans. Quite remarkably this legislation has thus far been flying under the mainstream media radar.

In the opinion of the PSAC, Bill C-27 will eventually lead to the demise of “defined benefit” pension plans in the federal jurisdiction and is a component of the Morneau agenda to dismantle the Public Service Superannuation Act.

To say the least, I was shocked when I read this and replied: “Wow, interesting, I thought only the Harper government would try to pull off such sneaky, underhanded things. Hello Trudeau Liberals!” (at least Harper wore his colors on his sleeve when it came to pensions and his government did introduce cuts to MP pensions).

It never ceases to amaze me how politicians can act like slimy weasels regardless of their political affiliation. If Bill C-27 passes to amend the Pension Benefits Standards Act, it will significantly undermine public pensions of PSAC’s members and they are absolutely right to vigorously oppose it.

Who cares if the pensions of civil servants are reduced or shifted to target benefit plans? I care and let me state this, this bill is a farce, a complete and utter disgrace and totally incompatible with the recent policy shift to enhance the Canada Pension Plan (CPP) for all Canadians.

Think about it, on the one hand the Trudeau Liberals worked hard to pass legislation to bolster the Canada Pension Plan and on the other, they are introducing an amendment to the Pension Benefits Standards Act which will open the door to eliminating or reducing defined-benefit plans at the public sector.

The irony is that PSAC’s members helped the Trudeau Liberals sweep into power and this is how they are being treated? With friends like that, who needs enemies?

More importantly, there is no need to amend the Pension Benefits Standards Act to introduce target pension benefit plans because these pensions are safe and secure and managed properly at arms-length from the federal government at PSP Investments.

[Note: I can just imagine what the folks at PSP think of Bill C-27, something like “what the hell is the federal government trying to do here?!?”].

And let me repeat something, just like variable benefit plans which I covered in my last comment, target date benefit plans offer some interesting ways to help people invest properly for retirement, but they too suffer from the same deficiencies of defined-contribution plans because they invest solely in public markets and offer no guarantees whatsoever.

In fact, John Authers of the Financial Times wrote an article on this in the summer, Target-dated funds are welcome but no panacea for pension holes:

Much is riding on target-dated funds. As this week’s FT series on pensions should make clear, defined benefit pensions face serious deficits — but the same mathematics of disappointing returns and ever greater expense for buying an income also applies to defined contribution plans.

DC plans have been poorly designed. For years, 401(k) sponsors were lulled by the equity bull market into allowing members to choose their own asset allocations, and switch between funds and asset classes at will. This was a recipe for disaster, as members tended to sell at the bottom and buy at the top. The strong returns of the 1990s convinced many that they could get away with saving far less than they needed.

The industry and regulators have been alive to the problem, and their response is sensible. Now they offer a default option of a fund that aims to ensure a decent payout by a “target date” — the intended retirement date. These funds automatically adjust their asset allocation between stocks and bonds as the retirement date approaches, which in general means starting with mostly stocks and shifting to bonds as retirement approaches. This (good) idea mimics the best features of a DB plan.

Such funds are undeniably an improvement on the “supermarket” model of the 1990s. Savers avoid the pitfalls of taking too much or too little risk, and regular rebalancing helps them sell at the top and buy at the bottom.

But TDFs have problems, which are growing increasingly apparent. First, are their costs under control? Second, do they have their asset allocation right? And third, can we benchmark their performance?

On costs, the news is good. US regulations require 401(k) sponsors to look at costs, and the response has been to drive down fees. According to Morningstar’s Jeff Holt, TDFs’ average asset-weighted expense ratio stood at 1.03 per cent in 2009, and by last year had dropped to 0.73 per cent — a 30 basis point fall, which in a low return environment could make a very big difference when compounded.

But if TDFs are coming under pressure to limit costs, the pressure over asset allocation is taking them in every direction. They are designed as mutual funds, so they still do not hold the kind of illiquid assets that the best DB funds can fund, such as infrastructure. That is a problem.

So is the entire balance between stocks and bonds. The notion from the DB world was to reach 100 per cent bonds by the retirement date, when the fund could be used to buy an annuity. With low bond yields making annuities expensive, and life expectancy far longer than it used to be, this no longer makes much sense. A 65-year-old, with a decent chance of making it to 90, should not be 100 per cent invested in bonds.

But high equity allocations tend to emphasise that the TDFs expose savers to greater risk than a DB plan. According to Morningstar the average drawdown for 2010 TDFs during the crisis year of 2008 was 36 per cent — a potentially disastrous loss of capital for people about to retire. As stocks rapidly recovered, and as those retiring in 2010 would have been unwise to sell all their stocks, this should not be a problem — but it plainly hit confidence.

The early stages are also a problem. Our 20s and 30s are a time of great expense. Should young investors really be defaulted into heavy equity holdings when the risks that they lose their job are still high, and when they face possible big drains on their income, such as a baby, or downpayments on a first house?

So the “glide path” of shifting from equity to bonds is controversial. And there is no standard practice on it. According to Mr Holt, TDFs’ holdings of bonds at the target date for retirement vary from 10 to 70 per cent.

What about benchmarking? Such differences make it impossible. Asset allocation differences swamp other factors, and are driven by different assumptions about risk.

Establish bands for asset allocation at each age, but allow them to vary according to valuation. Funds designed for retirement should never take the risk of being out of the market altogether. But if, as now, bonds and US equities look overpriced while emerging market equities look cheap, an approach that took US equities’ weighting to the bottom of its band, while putting the maximum permissible into emerging markets, would probably work out well.

There is not, as yet, an incentive to do that, and there needs to be. TDFs, or something like them, should be at the heart of future pension provision. It is good that their costs are under control, but there are ways to make them far more effective: by allowing more asset classes, accepting that people at retirement should still have substantial holdings in equities, and encouraging TDFs to allocate more to asset classes that are cheap.

I agree with Authers, there are ways to make target-dated funds more effective and folks like Ron Surz, President of Target Date Solutions are at the forefront of such initiatives.

But no matter how effective they get, target-dated pensions or variable benefit plans will never match the effectiveness of an Ontario Teachers, HOOPP, Caisse, CPPIB, PSP Investments and other large, well-governed Canadian defined-benefit pensions which reduce costs, address longevity risk (so members never outlive their savings) and invest across public and private markets all over the world, mostly directly and through top funds.

All this to say that PSAC is right to vigorously oppose Bill C-27, it’s a total assault on their defined-benefit pensions, and if passed, this amendment will undermine their pensions, the ability of the civil service to attract qualified people to work for the federal and other governments, and the Canadian economy.

In short, it’s dumb pension policy and if Trudeau thinks he had a tough time in the boxing ring, let him try to pull this off, it will basically spell the end of his political career (this and the asinine housing market policies won’t help the Liberals’ good fortunes).

Stay tuned, more to come on this topic from other pension experts. I will update this comment as experts send in their views and if anyone has anything to add, feel free to reach me at LKolivakis@gmail.com.

Update: Jim Leech, the former president and CEO of the Ontario Teachers’ Pension Plan and co-author of The Third Rail, shared this with me (added emphasis is mine):

I think everyone is missing the point of this bill.

Until now, federal pension legislation has only recognized plans as either DC or DB – there was no provision for a hybrid/risk shared plan.

That is one reason contributing to the switch all the way from DB to DC at many companies – if the DB plan was not sustainable, the only alternative was to move all the way to DC – a middle ground was not available even if the parties wanted a middle ground.

As I understand it, this bill simply allows transition to a risk shared model as an alternative to closing the DB and going all the way to DC.

Greater legislative flexibility is a positive step.

While I agree with Jim, some form of a shared risk model like the one New Brunswick implemented makes perfect sense for all public pension plans, especially if they are grossly underfunded, I’m not convinced the federal government needs to introduce hybrid plans at this stage and share PSAC’s concern that this amendment opens the door to cutting DB pensions altogether.

Also, Bernard Dussault, Canada’s former Chief Actuary, shared these insights with me (added emphasis is mine):

There are two big fairness-related points with this legislation, namely:

• not only does it allow the reduction of future accruing pension benefits of both active and retired (deferred and pensioned) members, a vital right so far covered under federal and provincial (except NB since 2014) pension legislation;
• but it also allows the concerned sponsoring employers to shift to active and retired members the liability pertaining to any current (as at effective date of the tabled C-27 legislation) deficit under any concerned existing DB plan.

As shown in the two attachments hereto, I have been promoting over the past few years that the shortcomings of DB plans can be easily overcome in a manner that would make DB plans much more simple, effective and fair than TB plans. Points not to be missed.

One of the attachments Bernard shared with me, Improving Defined Benefit (DB) plans within the Canadian Pension Landscape, is available here. I thank Bernard and Jim for sharing these insights.

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

Lee Barney of Plan Sponsor reports, A Pension Plan That Makes No Promises (h/t, Suzanne Bishopric):

Variable benefit plans are a type of defined benefit (DB) plan that have been around for decades, according to Matt Klein, a principal and leader of the actuarial services practice at employee benefits consulting firm Findley Davies in Cleveland.

However, few sponsors and retirement plan advisers know about them, he says, estimating that there are fewer than 100 of these types of plans in the United States. Nonetheless, he believes that sponsors and retirement plan advisers might be interested in them since they shift the investment risk off of the sponsor’s shoulders onto the participant’s—while moving the longevity risk over to the sponsor.

Employers continue to shut down their pension plans, redeploying their employees into defined contribution (DC) plans, Klein notes. But unless participants are automatically enrolled into their DC plan at meaningful deferral rates into an appropriate qualified default investment alternative (QDIA), most DC participants fail to make appropriate investment and deferral decisions, he says. The DC system fails to properly prepare most people for retirement, he maintains.

A variable benefit plan is a type of pension plan that, unlike a traditional DB plan that promises a set return every year, fluctuates with the market, he explains. Hence the name variable benefit.

“Sponsors interested in a comprehensive benefits package that will be able to provide employees with a comfortable retirement might want to consider a variable benefits plan, which eliminates the traditional risks associated with defined benefit plans and provides a stable cost and contribution policy that fits better with companies’ goals and objective in the 21st century,” Klein says.

NEXT: Comparison to traditional DB plans

In a traditional DB plan, the employer takes on the investment risk, he explains. But when a pension plan faces a market correction, such as the 2008 financial crises, assets decrease significantly while participants’ promised benefits remain intact, requiring the sponsor to make additional contributions to fund the plan at the precise time when they are typically facing a recession, Klein notes.

Like a traditional DB plans, a variable benefit plan uses an accrual rate whereby the sponsor contributes a percentage of each participant’s salary to the plan each year and ensures that the assets are professionally managed. Unlike a traditional DB plan, however, a variable benefit plan establishes a hurdle rate, which is the percentage return goal for each year, Klein says. If the returns are actually higher than the hurdle rate, the sponsor can increase the participants’ benefits—but if it is lower, they can reduce the benefits, Klein says.

“You would invest the assets in a variable benefit plan very differently than a traditional DB plan,” he adds. “A lot of traditional DB plans are doing some sort of asset/liability matching or glide path strategy, matching bonds to expected cash flows coming out of the plan. With a variable benefit plan, you don’t have the downside risk keeping employers up at night. One way to approach investing in a variable benefit plan is to treat it like an endowment while still being cognizant of the downside risk.”

NEXT: Advantages for participants and sponsors

From the participants’ perspective, the key advantage of a variable benefit plan is that, like a traditional DB plan, when they retire, they receive an annuity that pays them a set monthly income, as opposed to a lump sum they would receive from a DC plan or even a cash balance plan, Klein notes.

He believes that because DC plans are so prevalent today, sponsors and participants are now accustomed to variable returns—and the fact that their balances could decrease—and that they might be more receptive to variable benefit plans.

“Part of my passion here is to try and educate employers and advisers that these plans do exist,” he says. “They meet all of the legal hurdles and requirements of the IRS, DOL and ERISA. They are a win/win for both plan sponsors and plan participants while splitting the investment and longevity risks between the employer and the participant.”

An additional reason an employer might consider a variable benefit plan is that, unlike traditional pension plans that are typically underfunded and that require DB plan sponsors to pay 3% of their underfunding each year to the Pension Benefit Guaranty Corporation (PBGC), variable benefit plans remain 100% or very close to 100% funded. The reason for this is that the benefits rise or decrease as the plan’s returns exceed, meet or fall below the hurdle rate, Klein says. Therefore, variable benefit plan sponsors do not have to pay the annual 3% to the PBGC, only the minimal per-head cost.

Findley Davies has created a white paper comparing the benefits of variable benefit, DB, DC and cash balance plans, titled, “The Future of Retirement Plans: Variable Benefit Plans.” The paper makes the case that variable benefit plans strike the right balance between investment, interest or inflation, and mortality risk. It is available here.

I went through the white paper, “The Future of Retirement Plans: Variable Benefit Plans,” and found it was well written.

The paper begins with the three most significant risks to any retirement plan (click on image):

Of these, the most significant risk is the direction of interest rates, especially when rates are at historic lows. The the lower they go, the higher the liabilities shoot up relative to assets.

Why? Because the duration of liabilities is much bigger than the duration of assets, so for any given decline in interest rates, the increase in liabilities will dwarf and increase in assets.

This is especially true in a low rate environment which is why I’ve always warned my readers a prolonged bout of deflation will decimate many pensions which are already in deeply underfunded territory.

So how does it work? There is an example given in the white paper (click on image):

 

And for the active participant using the same example (click on image):

What are my thoughts? Obviously variable benefit plans are better than defined-contribution plans because they offer a monthly income for life and from an employer’s perspective, they offer the added advantage they remain off the hook if the plan is underfunded as employees will bear cuts (or increases) to their benefits depending on where annual returns lie relative to the hurdle rate.

But let’s not kid ourselves, while variable benefit plans offer some benefits relative to DC plans, they are still far and away inferior to a large well-governed defined-benefit plan which has adopted a shared-risk model among its stakeholders (Ontario Teachers, HOOPP, OPTrust, CAAT for example).

Basically, without going into too much detail, variable pensions suffer from the same deficiencies as DC plans, namely, they only invest in public markets and are subject to the vagaries of the stock market. Only difference is if the plan has a bad year, benefits are automatically adjusted down, which is no skin off the employer’s back. There is zero risk-sharing going on here (employees assume all the risk in bad years).

Go back to read my last comment on Canada’s new masters of the universe where I stated the following:

The brutal truth on defined-contribution plans is they are leaving millions at risk of pension poverty which is why unlike the Andrew Coynes of this world, I kept harping on enhancing the CPP knowing full well Canadians are getting a great bang for their CPP buck.

And when I read about what is happening to Nortel’s pensioners, it infuriates me and reminds me that there is still a lot of work left to do in terms of pension policy in this country, like creating a new large, well-governed public pension here in Montreal in charge of managing the assets of all Canadian DB and DC corporate pensions (Montreal is home to the country’s best corporate DB pensions like CN’s Investment Division and Air Canada Pensions).

When it comes to pensions, nothing, and I mean nothing, compares to a large, well-governed DB pension which has adopted risk-sharing, typically in the form of adjusting inflation protection if the plan is underfunded, not cutting benefits every year depending on how stocks and bonds are doing.

And I would prefer if these were large well-governed public DB pensions like we have in Canada. Smaller DB pensions are struggling and I think it’s high time we consolidate a lot of local and city pensions into the big ones.

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

Theresa Tedesco and Barbara Shecter of the National Post report, Inside the risky strategy that made Canada’s biggest pension plans the new ‘masters of the universe’:

They are among the world’s most famous landlords with stakes in major airports in Europe, luxury retailers in New York and transportation hubs in South America. They rank as five of the top 30 global real estate investors, seven of the world’s biggest international infrastructure investors, and were at the table during six of the top 100 leveraged buyouts in corporate history. And they are Canadian.

The country’s eight largest public pension funds, which collectively manage net assets worth more than $1 trillion, have acquired so much heft in the past decade that they are being lauded in international financial circles as the new “masters of the universe.” Their clout has caught the attention of major Wall Street investment firms angling for their business, as well as institutional investors around the world that are emulating their investing model (click on image).

“Canada’s public-sector pension plans are high profile, widely admired and they’re certainly bigger than they used to be,” said Malcolm Hamilton, a pension expert and senior fellow at the C.D. Howe Institute in Toronto.

A veteran Bay Street denizen, who asked not to be named because his firm has business dealings with many of the funds, added: “Asset by asset, around the world by virtue of their investments through ownership or partnership, they are as much economic ambassadors for Canada as anybody.”

But the vaunted positions these pension-plan behemoths have on the world stage is attracting closer scrutiny — and some skepticism — from industry experts at home, including the Bank of Canada, because of the increased levels of risk they are taking and the potential “future vulnerability” many of them have assumed in the pursuit of growth.

“You’re seeing more and more pension funds taking on greater risk in the past 15 years,” said Peter Forsyth, a professor of computational finance specializing in risk at the University of Waterloo in Ontario.

The eight funds, which account for two-thirds of the country’s pension fund assets or 15 per cent of all assets in the Canadian financial system, are acting more like merchant banks in going after — and financing — blockbuster deals in increasingly riskier locations and asset types.

A major reason behind the pension plans’ thirst for less liquid assets, namely real estate, private equity and infrastructure — much of it in foreign places — is the low-interest-environment that has made traditional assets less desirable. Between 2007 and 2015, the big eight public pension funds’ collective allocation to these types of investments grew to 29 per cent from 21 per cent. And foreign assets jumped to account for 81.5 per cent of assets in 2015 from 25 per cent in 2007 (click on images below).

That strategy collides with their traditional image as conservative, risk-averse guardians of retirement nest eggs. Should investments go wrong, benefits would likely be slashed, contributions could be sharply increased and it is anyone’s guess who would be on the hook if there were major losses.

“On the world stage, they are the cream of the crop, but I think they are taking significant risks and they aren’t acknowledging it,” Hamilton said.

Perhaps more importantly, the pension sector in Canada lacks the same stringent cohesive regulatory oversight as banks and insurers, meaning there are less checks and balances governing a big chunk of everyone’s retirement plans. As a result, some industry participants are questioning whether public pension funds should be more closely examined.

“The pension funds are largely unregulated — what’s regulated is the payments to the beneficiaries. The investments of the pensions are not regulated,” said a veteran Bay Street risk expert who asked not to be named. “And so this is the conundrum they’re in as they move further afield … And it’s a big debate going on right now.”

With net assets ranging from $64 billion to $265 billion, the top eight pension funds — Canadian Pension Plan Investment Board (CPPIB), Caisse de depot et placement du Quebec, Ontario Teachers’ Pension Plan, British Columbia Investment Management Corp., Public Sector Pension Investment Board, Alberta Investment Management Corp., OMERS (Ontario Municipal Employees Retirement System and Healthcare of Ontario Pension Plan (HOOPP) — all rank among the 100 largest such funds in the world, and three are among the top 20, according to a study by the Boston Consulting Group released last February. Only the United States has more public pension funds on the global list.

The country’s giant public pension plans, flush with billions in retirement savings, began flexing their investment muscle on the heels of tougher banking laws following the financial crisis of 2008-2009.

Although Canada emerged as the darling in international financial circles for its resilience during the crisis and resulting recession — and the major banks basked in the glory — their global counterparts did not fare so well, which prompted policymakers to layer on additional regulation for all banks.

These new rules, many of which are contained in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, are supposed to protect the financial sector in times of stress by limiting risk-taking strategies. Canadian pension funds, unencumbered from those onerous banking rules, have been all too eager to rush in.

During the past 10 years, they have accumulated an eclectic mix of prime assets in unprecedented fashion. Among them: a 27-per-cent stake in the Port of Brisbane in Australia; interests in Porterbrook Rail, the second-largest owner and lessor of trains in the United Kingdom; luxury retailer Neiman Marcus Group in New York; Transelec, Chile’s largest electricity transmission company; Heathrow Airport; and Camelot Group, the U.K.’s national lottery operator.

In all, they’ve done 20 deals worth more than US$10 billion during that time, according to the Boston Consulting report.

It’s a deal binge that has created a “new world order” in which “Canada’s pension funds have barged Wall Street to stake a claim to be the new masters of the universe,” a British financial columnist noted last year.

Notably, the Canadian public pensions have invested in less conventional businesses and asset classes, where risks are generally higher than more conservative investments such as stocks and bonds. At the same time, there is potentially even more risk looming because the funds are pushing into asset classes and geographies where they have less experience.

For example, CPPIB in June 2015 paid $12 billion for General Electric Capital Corp.’s GE Antares Capital, a middle-market private-equity sponsor. The pension giant has also made a pair of recent investments in the insurance business.

Earlier this month, the Caisse announced plans to invest US$600 million to US$700 million over four years in stressed assets and specialized corporate credit in India. The Quebec-based pension group forged a long-term partnership with Edelweiss Asset Reconstruction Company, India’s leading specialist in stressed assets, which included taking a 20-per-cent equity stake in Edelweiss.

At the same time, the pension funds are increasingly barging in on the conventional bank business. The CPPIB, which invests on behalf of 19 million Canadians as the investment arm of the Canada Pension Plan, has started tapping public markets by issuing bonds to fund their large-scale deals rather than seek debt financing through the banks.

In June 2015, Canada’s largest public pension fund, with $287.3 billion in assets under management — and the eighth largest in the world — raised $1 billion by issuing five-year bonds. A follow-up offering of three-year notes raised an additional $1.25 billion.

“Pension funds used to stick with a balanced portfolio of public-traded debt and equities and a little real estate,” said Richard Nesbitt, chief executive of the Toronto-based Global Risk Institute in Financial Services. “The Canadian model of pension investment management invests into many more asset classes including infrastructure assets around the globe. Banks are still there providing support in the form of advice and corporate loans. But the banks tend to be more regionally focused whereas the pensions are definitely global.”

Meanwhile, Canada’s large pension funds are also borrowing more money to fund their investments. Since they have long time horizons relative to other investors — decades in some cases — they argue that gives them a competitive advantage in both the deal arena and the ability to tolerate more short-term volatility.

“The pressure has just been getting worse and worse, especially as interest rates continue to decline for public funds to get the returns they used to get,” said Hamilton, a 40-year veteran of the industry and former partner at Mercer (Canada).

Low interest rates have a double-whammy effect: they tend to boost the prices of assets and lower expected returns while at the same time reducing borrowing costs, making it cheaper to borrow money and increasing the incentive to use leverage.

But rather than cutting back their risk exposure, Hamilton said the funds, especially those pension plans that are maturing, are behaving the same way they did during the gravy days of high interest rates years 20 years ago. The reason they are behaving this way is because they can’t afford to suffer lower returns, he said, because either benefits would have to be cut or contributions to the plan raised to keep payouts the same.

“They are levering up and hoping for the best instead of making the tough choices,” Hamilton said. “There are alternatives, but they are not so pleasant.”

Forsyth said a main reason Canadian pension funds have avoided making tough choices is partly because of this country’s stellar record. Unlike the Netherlands, where the central bank forces public pension funds to cut benefits when there’s too much risk on the books, Canada has never really faced a systemic financial meltdown that would induce the government to enact such tough measures.

“There isn’t the same amount of pressure in Canada, because we didn’t have the financial blow-ups they had in other countries,” he said.

The Netherlands is one of only two countries whose pension system achieved the top grade in the prestigious annual Melbourne Mercer pension index in 2015 (the other is Denmark). Canada tied for fourth with Sweden, Finland, Switzerland, the U.K. and Chile, all of which are considered to have a “sound system” with room for improvement.

Nevertheless, Canada’s public pension system has pioneered new approaches to institutional investing and governance, and rates among the best in the world in terms of funding its public-sector pension liabilities.

The key characteristic of the Canadian model is cost savings. Canadian fund managers, unlike other public pension managers, prefer to actively manage their portfolios with teams — employing about 5,500 people (and about 11,000 when including those in the financial and real estate sectors) — an organizational style that allows them to direct about 80 per cent of their total assets in-house.

Cutting out the middleman creates considerable economies of scale by lowering average costs, especially through fees to expensive third parties such as Blackrock Inc. and KKR & Co. LP.

In private equity, for example, managers can charge a fee equal to two per cent of assets and 20 per cent of profits. Hiring internal staff and building up internal capabilities is far less expensive. So much so that the total management cost for most Canadian public funds is 0.3 per cent versus 0.4 per cent for a typical fund that relies on external managers.

[Note: I think this is a mistake, the total management cost for a typical fund that relies on external managers is much higher than 0.4%.]

The management style was pioneered by Claude Lamoureux, former head of Ontario Teachers’ Pension Plan, who was the first to adopt many of the core principles espoused by the late Peter Drucker in the early 1990s on creating better “value for money outcomes.” Now all large Canadians funds operate with these key principles.

“That’s the innovation. It’s a simple story of scale allowing you to disintermediate a distributor,” said a senior Canadian pension executive who asked not to be named.

The strategy may be simple, but it has had a significant impact on the bottom line. The cost savings have added up to hundreds of millions of dollars that have been invested rather than outsourced.

Since 2013, total assets under management for the top 10 major public pension funds have tripled, with investment returns driving 80 per cent of the increase.

Even so, the Bank of Canada issued a cautionary note about the challenges in its 2016 Financial System Review. In a recent study of the country’s large public pension funds, the central bank stated that “trends toward more illiquid assets, combined with the greater use of short-term leverage through repo and derivatives markets may, if not properly managed, lead to a future vulnerability that could be tested during periods of financial market stress.”

In its June 2016 paper, “Large Canadian Public Pension Funds: A Financial System Perspective,” the central bank noted the big eight funds have increased their use of leverage, but the amounts on the balance sheet are not considered high.

However, the BoC cautioned that although balance-sheet leverage — defined as the ratio of a fund’s gross assets to net asset value — varies greatly across the funds and appears “modest as a group,” it is still “not possible to precisely assess aggregate leverage using public sources” because it can take on many forms in addition to what is shown on the balance sheet.

“If not properly managed, these trends my lead in the future to a vulnerability that could create challenges on a severely stressed financial market,” the central bank paper warned.

Oversight for most public pension funds, not including the CPPIB, which is federally chartered, falls to the provinces and their regulators are non-arms’ length organizations created by, and report to, the provinces, which also directly and indirectly sponsor many of the same plans being supervised. In other words, pension regulators are not truly independent the way the Office of the Superintendent of Financial Institutions is to the financial sector.

“Can a regulator staffed by members of public-sector pension plans effectively regulate public-sector pension plans?” said C.D. Howe’s Hamilton. “In particular, can such a regulator protect the public interest if the public interest conflicts with the interests of the government and/or the interests of plan members? I think not.”

Furthermore, he said, most pension fund managers would characterize their behaviour as “prudent and creatively adapting to an unforgiving and challenging environment.”

Over at Ontario Teachers’, chief investment officer Bjarne Graven Larsen, welcomed the central bank’s scrutiny and acknowledged that risk is an integral part of any investment strategy. The trick as the pension plan evolves, he said, is to make sure there is adequate compensation for the amount of uncertainty.

“You have to have risk, that’s the way you can earn a return,” Graven Larsen said. Not every transaction will work out according to plan, of course, but he said the strategy is to ensure that losses will not be too great when assets or market conditions fail to meet expectations, even if that means taking a lower return at the outset.

Ontario Teachers’, the largest single-profession plan in Canada, recently moved its risk functions into an independent department and is also tweaking its portfolio construction in an attempt to account for the largest risks it takes and calibrate other positions to balance the potential downside.

“But you will, over time, be able to harness a risk premium and get the kind of return you need with diversified risk — that’s the approach, what we’ve been working on,” Graven Larsen said.

CPPIB, meanwhile, doesn’t have a designated chief risk officer, a key executive who plays a critical role balancing operations and risk. That absence sets it apart from other major government pension plans and other major Canadian financial institutions such as banks and insurers, according to Jason Mercer, a Moody’s analyst.

“A chief risk officer plays devil’s advocate to other members of management who take risks to achieve business objectives,” Mercer said. “The role provides comfort to the board of directors and other stakeholders that risks facing the organization are being overseen independently.”

For its part, CPPIB officials said they have created a framework that doesn’t rely on a single executive to monitor risk. Michel Leduc, head of global public affairs at CPPIB, said the pension organization has an enterprise risk management system that runs from the board of directors, through senior management, to professionals in each of the pension’s investment departments.

“This decentralized model ensures that individuals closest to the risks and best equipped to exercise judgment have local ownership over management of those risks,” Leduc said.

The risks some critics find worrisome, CPPIB officials see as a strength, courtesy of the funds’ unique characteristics, namely a steady and predictable flow of contributions — about $4 billion to $5 billion a year.

CPPIB in 2014 began shifting the investment portfolio to recognize that the fund could tolerate more risk while still carrying out the pension management’s mandate of maximizing returns without undue risk of loss.

The plan is to gradually move from a mix reflecting the “risk equivalent” of 70-per-cent equity and 30-per-cent fixed income to a risk equivalent of 85-per-cent equity and 15-per-cent fixed income by 2018.

With unprecedented amounts of money pouring into public pensions — fuelled by heightened assumptions from governments about what Canadians should expect to receive — the chorus for closer examination of the sector will likely reverberate.

After all, for all the bouquets tossed at them on the world stage, Canada’s public pension funds still have to prove whether their high-profile investments are worth the risk to those at home.

This article was written last Saturday. I stumbled across it yesterday when I read Andrew Coyne’s article on keeping tax dollars and public pension plans away from infrastructure spending.

I might address Coyne’s latest ignorant drivel in a follow-up comment (he keeps writing misleading and foolish articles on pensions), but for now I want to focus on the article above on Canada’s new masters of the universe.

First, let me commend Theresa Tedesco and Barbara Shecter for writing this article. Unlike Coyne, they actually took the time to research their material, talk to industry experts, including some that actually work at Canada’s large public pension funds (something Coyne never bothers doing).

Their article raises several interesting points, especially on governance lapses, which I will discuss below. But the article is far from perfect and the main problem is it leaves the impression that Canada’s large pension funds are taking increasingly dumb risks investing in illiquid asset classes all over the world.

I believe this was done purposely in keeping with the National Post’s blatantly right-wing tradition of fighting against anything that seems like big government intruding in the lives of Canadians. The problem is that the governance model at Canada’s large pensions was set up precisely to keep all levels of government at arms-length from the actual investment decisions, something which is mentioned casually in this article.

[Note to National Post reporters: Next time you want to write an in-depth article on Canada’s large pension funds, go out to talk to experts who work at these funds like Jim Keohane, Ron Mock and Mark Machin or people who retired from these funds like Claude Lamoureux, Jim Leech, Neil Petroff, Leo de Bever. You can also contact me at LKolivakis@gmail.com and I’ll be glad to assist you as to where you should focus your attention if you want to be constructively critical.]

In a nutshell, the article above leaves the (wrong) impression that Canada’s large pensions are not regulated or supervised properly, oversight is fast and loose, and they’re taking huge risks on their balance sheets to invest in assets all over the world, mostly in “risky” illiquid asset classes.

Why are they doing this? Because interest rates are at historic lows so investing in traditional stocks and bonds will make it impossible for them to attain their actuarial return target, forcing them to slash benefits and raise contributions, tough choices they prefer to avoid.

The problem with this article is it ignores the “raison d’être” for Canada’s large pensions and why they all adopted a governance model which allows them to attract and retain investment professionals to precisely take risks in global public and private markets others aren’t able to take in order to achieve superior returns over a very long period —  returns that far surpass Canadian balanced funds which invest 60/40 or 70/30 in a stock-bond portfolio.

The key point, something the article doesn’t emphasize, is Canada’s well-known balanced funds charge outrageous fees and deliver far inferior results relative to Canada’s large public pension funds over a long period precisely because they are only able to invest in public markets which offer lousy returns given interest rates are at historic lows. Even the alpha masters, who charge absurd fees, are not delivering the results of Canada’s large pensions over a long period.

And it’s not just fees, even if all Canadians did was invest directly in low-cost exchange-traded funds (ETFs) or through robo-advsiors, they still won’t be as well off in the long run compared to investing their retirement savings in one of Canada’s large, well-governed defined-benefit plans.

Why? Because Canada’s large defined-benefit pensions use their structural advantages to invest across public and private markets all over the world, and they’re global trendsetters in this regard.

[Note: This is why last week I argued that Norway’s pension behemoth should not crank up equity risk and is better off adopting the asset allocation that Canada’s large pensions have adopted, provided it gets the governance right.]

The brutal truth on defined-contribution plans is they are leaving millions at risk of pension poverty which is why unlike the Andrew Coynes of this world, I kept harping on enhancing the CPP knowing full well Canadians are getting a great bang for their CPP buck.

And when I read about what is happening to Nortel’s pensioners, it infuriates me and reminds me that there is still a lot of work left to do in terms of pension policy in this country, like creating a new large, well-governed public pension here in Montreal in charge of managing the assets of all Canadian DB and DC corporate pensions (Montreal is home to the country’s best corporate DB pensions like CN’s Investment Division and Air Canada Pensions).

Having said all this, I don’t want to leave the impression that everything at Canada’s large public pensions is just peachy and there is no room to improve their world-class governance.

In particular, I agree with some passages in the article above. Most of the financial industry is subject to extreme regulations, regulations which do not impact Canada’s large pensions in the same way.

This isn’t a bad thing. Some of them are using their AAA balance sheet to intelligently take on more leverage or emit their own bonds to fund big investments in private markets.

A lot of this is discussed in the report the Bank of Canada put out this summer on large Canadian public pension funds. And while the report highlights some concerns, it concludes by stating:

No pension fund can achieve a 4 per cent average real return in the long run without assuming a certain amount of properly calibrated and well-diversified risk. This group of large Canadian pension managers seem generally well equipped to understand and manage that risk. The ability of the Big Eight to withstand acute stress is important for the financial system, as well as for their beneficiaries. They can rely on both the structural advantages of a long-term investment horizon and stable contributions. Moreover, they have reinforced their risk-management functions since the height of the 2007–09 global financial crisis.

No doubt, they have reinforced their risk-management functions since the global financial crisis and some of the more mature and sophisticated funds are monitoring liquidity risks a lot more closely (OTPP for example), but all the risk management in the world won’t prevent a large drawdown if another global financial crisis erupts.

And it is important to understand there are big differences at the way Canada’s large pensions manage risk. As mentioned in the article, CPPIB doesn’t have a chief risk officer, instead they opted to take a more holistic view on risk and have ongoing discussions on risk between department heads (this wasn’t always the case as they used to have a chief risk officer).

Is that a good thing or bad thing? Do you want to have a Barbara Zvan in charge of overseeing risk at your pension fund or not? There is no right or wrong answer here as each organization is different and has a different risk profile. CPPIB is not a mature pension plan like OTPP which manages pensions and liabilities tightly, so it can focus more on taking long-term risks in private markets and less on tight risk management which it already does in a more holistic and individual investment way.

I personally prefer having a chief risk officer that reports directly to the Board, not the CEO, but I also recognize serious structural deficiencies at some of Canada’s large pensions where different department units work in a vacuum, don’t share information and don’t talk to each other (this is why I like CPPIB’s approach and think PSP Investments is also moving in the right direction with PSP One).

Are there risks investing in private markets? Of course there are, I talk about them all the time on my blog, like why these are treacherous times for private equity and why there are misalignment of interests in the industry. Moreover, there are big cracks in commercial real estate and ongoing concerns of pensions inflating an infrastructure bubble.

That is all a product of historic low interest rates forcing everyone to chase yield in unconventional places. We can have a constructive debate on pensions taking on more risk in private markets, but at the end of the day, if it is done properly, there is no question that everyone wins including Canada’s pension leaders which get compensated extremely well to deliver stellar long-term results but more importantly, pension beneficiaries who can rely on their pension no matter what happens in these crazy schizoid public markets.

But I am going to leave you with something to mull over, something the Bank of Canada’s report doesn’t discuss for obvious political reasons.

In 2007, I produced an in-depth report on the governance of the federal public service pension plan for the Treasury Board of Canada going over governance weaknesses in five key areas: legislative compliance, plan funding, asset management, benefits administration, and communication.

If I had to do it all over again, I would not have written that report (too many headaches for too little money!), but I learned a lot and the number one thing I learned is this: there is always room for improvement on pension governance.

In particular, as Canada’s large pensions engage in increasingly more sophisticated strategies across public and private markets, levering up their balance sheets or whatever else, we need to rethink whether there are structural deficiencies in the governance of these large pensions that need to be addressed.

For example, I’ve long argued that the Office of the Auditor General of Canada is grossly understaffed and lacking resources with specialized financial expertise to conduct a proper independent, comprehensive operational, investment and risk management audit of PSP Investments (or CPPIB) and think that maybe such audits should be conducted by the Office of the Superintendent of Financial Institutions or better yet, the Bank of Canada.

In fact, I think the Bank of Canada is best placed to be the central independent government organization to aggregate and interpret all risks taken by Canada’s large pensions (maybe if they did this in the past, we wouldn’t have had the ABCP train wreck at the Caisse).

Just some food for thought. One thing I can tell you is that we definitely need more thorough operational, investment and risk management audits covering all of Canada’s large pensions by independent and qualified experts and what is offered right now (by the auditor generals and other government departments) is woefully inadequate.

But let me repeat, while there is always scope for improving governance and oversight at Canada’s large pensions, there is no question they are doing a great job investing across public and private markets all around the world and their beneficiaries are very lucky to have qualified and experienced investment professionals managing their pensions at a fraction of the cost in would cost them to outsource these assets to external managers (the figures cited in the article above are off).

That is a critical point that unfortunately doesn’t come out clearly in the article above which leaves the impression that all Canada’s large pensions are doing is taking undue risks all over the world. That is clearly not the case and it spreads a lot of misinformation on Canada’s large, well-governed defined-benefit pensions which quite frankly are the envy of the world and deservedly so.

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

Richard Milne and Thomas Hale of the Financial Times report, Norway’s oil fund urged to invest billions more in equities (h/t, Denis Parisien):

Norway’s $880bn oil fund is being urged to invest billions of dollars more in equities and take on more risk in what would be a big shift in its asset allocation away from bonds.

The world’s largest sovereign wealth fund should invest 70 per cent of its assets in shares, up from today’s 60 per cent, at the expense of bonds, according to a government-commissioned report on Tuesday.

The move is highly significant for global markets as the oil fund owns on average 1.3 per cent of every single listed company in the world and 2.5 per cent in Europe.

The report is the latest salvo in a debate on how much risk the long-term investor should take and comes amid growing warnings of dwindling returns for government bonds in particular. The allocation to equities was increased from 40 per cent to 60 per cent in 2007.

“With a higher share of equities the expected return will increase as will the income to the government budget. Yes, it comes with higher risk but we think we are well equipped to handle this risk,” Hilde Bjornland, an economics professor behind the recommendation, told the Financial Times.

The centre-right government will evaluate the recommendations before setting out its own position in the spring. Senior insiders said they expected the allocation change to go through as the report was co-authored by two former finance ministers.

Siv Jensen, the finance minister, told the Financial Times: “We are always thoroughly evaluating how we are running the fund … We know now that we have a very low interest rate regime globally. We have 40 per cent in bonds, and that will affect the return over time.”

Saker Nusseibeh, chief executive of Hermes Investment Management, a UK asset manager, said there was a broader trend of investors looking to increase their equity exposure. “This is about the realisation that you cannot make returns of the same amount that you used to make in the past,” he said.

He added: “If you are a sovereign wealth fund … you will question why you would have so much in fixed income at all.”

The latest survey of fund managers from Bank of America Merrill Lynch shows a rise in cash holdings, which in part reflects “scepticism or outright fear of bond markets”, according to Jared Woodard, an investment strategist at the bank.

In a sign of how the Norwegian debate might unfold, the chairman of the report, Knut Mork, voted against the other eight members and argued the allocation to equities should be cut to 50 per cent. This would give the government a more predictable income stream from the fund, he said.

The Norwegian government is permitted to take out up to 4 per cent of the value of the fund each year to use in the budget. But it is using only about 3 per cent this year.

The report estimated that the fund’s real rate of return was expected to be 2.3 per cent over the next 30 years. A majority of the commission suggested “one potential margin of safety” could be to restrict the government’s ability to take money out of the fund to the level of the expected real return.

Mikael Holter and Jonas Cho Walsgard of Bloomberg also report, Norway Sovereign Wealth Fund Urged to Add $87 Billion in Stocks:

Norway’s $874 billion wealth fund needs to add more stocks as record low interest rates and a weak global economy will otherwise lower returns to just above 2 percent a year over the next three decades, a government-appointed commission recommended.

The Finance Ministry should raise the fund’s stock mandate to 70 percent from 60 percent, the committee, comprised of academics, investors and two former finance ministers, urged on Tuesday. A decision on increasing its stock investments will be made by the ministry, which hasn’t always agreed with the conclusions of similar reviews on the fund’s holdings.

“A higher share of equities increases the expected return, and the contribution to the fiscal budget, but also entails more volatility in the value of the Fund and a higher risk of a decline in its long-run value,” the group said. “The majority is of the view that the this risk is acceptable, provided that there is political will and ability to adapt economic policy to the accompanying increase in risk, in both the short and long run.”

Norway is looking for ways to boost returns that have missed a real return goal of 4 percent as interest rates have plunged globally in the aftermath of the financial crisis. The government is this year withdrawing money from the fund for the first time to make up for lost oil income after crude prices collapsed over the past two years.

“The 60 percent equity share has over time been very good for us because it has given us considerable income from the fund,” Finance Minister Siv Jensen said in an interview after a press conference. “But we have also experienced that there can be swings from one year to another because the stock market moves over time.”

‘Considerably Less’

After getting its first capital infusion 20 years ago, the fund has steadily added risk, expanding into stocks in 1998, emerging markets in 2000 and real estate in 2011 to safeguard the wealth of western Europe’s largest oil exporter.

It’s currently mandated to hold 60 percent in stocks, 35 percent in bonds and 5 percent in real estate. After inflation and management costs, it has returned 3.43 percent over the past 10 years.

The committee said that the expected returns from the fund are now “considerably less” than 4 percent. With the current equity share, the commission predicts an annual real return of just 2.3 percent over the next 30 years.

Still, that didn’t stop the chairman of the commission, Knut Anton Mork, from disagreeing with the majority’s conclusion. The former chief economist at Svenska Handelsbanken in Oslo instead recommended cutting the stock holdings to 50 percent.

“The minority recognizes that the reduction in the oil and gas remaining in the ground over the last decade is an argument in favor of a higher equity share, but considers this less important than the predictability of budget contributions from the fund,” he said.

Lastly, Will Martin of the UK Business Insider reports, The world’s biggest sovereign wealth fund is about to start taking more risks:

Norway’s Global Government Pension Fund, the biggest sovereign wealth fund in the world by assets under management, could be about to start taking a lot more risks if it follows the advice of a government-commissioned report into the way it allocates its assets.

The new report, released on Tuesday, argues that the £716 billion ($880 billion) fund should increase its holdings of shares, and move around £71 billion ($87 billion) of its assets into riskier equity holdings.

This would mean that roughly 70% of the fund’s assets are held in stocks, up from just less than 60% right now. As a result, the fund’s government bond portfolio would shrink substantially.

“A higher share of equities increases the expected return, and the contribution to the fiscal budget, but also entails more volatility in the value of the Fund and a higher risk of a decline in its long-run value,” the report noted.

“The majority is of the view that this risk is acceptable, provided that there is political will and ability to adapt economic policy to the accompanying increase in risk, in both the short and long run.”

Previously, the fund held around 40% in equities before increasing its allocation to 60% in 2007, just before the global financial crisis hit.

Norway’s sovereign wealth fund is looking for new ways to make money given the rock-bottom yields most developed-market government debt has right now, and following the crash in oil that has seen prices for the world’s most important commodity crash from more than $100 per barrel to just more than $50 now, having briefly dropped below $30 early in the year.

The crash has impacted Norway’s economy so much that in 2016 — for the first time in nearly two decades — the fund is expected to  see net outflows, with the Bloomberg reporting February that the government will withdraw as much as 80 billion kroner (£7.99 billion; $9.8 billion) this year to support the economy.

Rock-bottom global bond yields are making things even more tricky, as interest rates close to zero all around the world continue to bite. The eurozone, Switzerland, Sweden, Denmark, and Japan all already have negative interest rates, and rates in most other developed markets are pretty close to zero. In the UK, the rate is 0.25%, while in the USA it is 0.5%.

Low interest rates mean low yields on bonds, meaning that the fixed-income market is not one where there is much money to be made right now, and that has helped drive the recommendation to move more money into stocks.

“With a higher share of equities the expected return will increase as will the income to the government budget. Yes, it comes with higher risk but we think we are well equipped to handle this risk,” Hilde Bjornland, an economist who was part of the team that compiled the report, told the Financial Times.

Should the fund take up the report’s recommendations, it could have a substantial impact on European, and even global markets. The fund’s stock holdings are already so large that if averaged out, it would hold 2.5% of every single listed company in Europe. In the UK for example, the fund has invested almost £50 billion in stocks, spread across 457 different companies.

There are two huge global whales that everyone looks at, Japan’s Government Pension Investment Fund (GPIF) and Norway’s Government Pension Fund Global (GPFG). The latter was created for the following reason:

The Government Pension Fund Global is saving for future generations in Norway. One day the oil will run out, but the return on the fund will continue to benefit the Norwegian population.

As you can imagine, it’s a big deal for Norwegians and global markets what decisions are taken in regards to the Fund’s asset allocation and its investments which are managed by Norges Bank Investment Management.

I am very well aware of Norway’s Government Pension Fund Global because when I wrote my report on the governance of the federal public service pension plan for the Government of Canada (Treasury Board) back in 2007, I used the governance of Norway’s pension as an example on how to improve transparency and oversight.

What I like about Norway’s pension fund is that it’s clear about its investments, takes responsible investing very seriously and is extremely transparent, providing great insights in its reports, discussion notes, asset manager perspectives and of course, in its submissions to the Ministry of Finance.

For example, in its latest publicly available submission to the Ministry on October 14, there is an excellent discussion on how the Fund can properly benchmark unlisted real estate investments, going over three methods:

The first uses data from IPD for unlisted real estate investments, adjusted for autocorrelation. The return series from IPD can be broken down into the countries and sectors in which the fund is invested. The greatest challenge when using IPD data for calculating tracking error is that the time series are updated only quarterly or annually. The relative volatility of equities and bonds is currently calculated using weekly data, equally weighted, over a three-year period. Even an extension of the estimation period to ten years, for example, will yield relatively few observations if the calculations have to be performed on quarterly or annual data.

The second method uses data for shares in listed REITs, adjusted for leverage. The main benefit of using REITs over IPD data is the availability of observable daily prices. To be able to represent the fund’s unlisted real estate investments meaningfully, we need to select individual funds in the markets in which the fund is invested. Their leverage must also be adjusted to the same level as the “equivalent” investment in the fund. This selection process and adjustments to take account of differences in risk profile will to some extent need to be based on criteria that will be difficult for experts outside the bank to verify.

The third method is based on an external risk model developed by MSCI. The Bank has commissioned MSCI to compute a return series for an unlisted real estate portfolio that resembles the GPFG’s portfolio of unlisted real estate investments. An external risk model gives the Bank less insight into, and less control over, the parameters that influence the return series, but has the advantage of being calculated by an independent party.

I will let you read the entire submission to the Ministry of Finance as it is extremely interesting and well worth considering for large pensions that invest in global unlisted real estate and are not properly benchmarking these investments (and I include some of Canada’s large venerable pensions with “stellar governance” in this group).

Now, the latest submission recommending to increase the allocation of global public equities to 70% from 60% and reducing the allocation of global fixed income to 25% from 35% is not yet available on its website in the news section.

It will be posted on the website but I am not very interested in reading their arguments as I don’t agree with this recommendation at all and side with Knut Anton Mork who thinks the allocation should be cut to 50%.

But I also think the allocation to global fixed income should be cut by 10% so that the Fund can invest more in unlisted real estate and infrastructure all over the world (see below).

My reasoning is that over the short, intermediate and even long run, the return on stocks and bonds will be very low and very volatile so now is definitely not the time to crank up the risk in global equities.

Look, Norway’s pension fund can put out all the academic discussion notes it wants on the equity risk premium but when making big shifts in asset allocation, the folks at NBIM really need to think things through a lot more carefully because cranking up the allocation in stocks at this point exposes the Fund to a serious drawdown, one that might take years to recover from, especially if the world falls into a long deflationary cycle (my biggest fear).

Bill Gross rightly noted last month now is not the time to worry about return on capital but return of capital. In his latest comment, he notes that the doubling down strategy of central bankers significantly increases the risk in risk assets.

All this to say that I am surprised Norway’s mammoth pension fund is seriously considering increasing risk by increasing its allocation to global equities at this time.

True, global bonds have entered the Twilight Zone and there are cracks in the bond market, which is why delivering alpha gurus are pounding the table that bonds are dead meat, as are other bond bubble clowns.

But unless someone convinces me that the fading risks of global deflation are credible and sustainable, I still see bonds as the ultimate diversifier in a deflationary world.

One thing is for sure, Fed Chair Janet Yellen isn’t convinced that global deflation is dead which is why her speech last Friday on staying accommodative for longer, overshooting the Fed’s 2% inflation target, was a real game changer for me.

More worrisome, Yellen’s speech was a stark admission the Fed may be behind the deflation curve (or unable to mitigate the coming deflation tsunami) and investors may need to brace for a violent shift in markets, one which could spell doom for equities for a very long time.

And if that is the case, you have to wonder why in the world would Norway risk its savings from oil revenues and flush them down the global stock toilet?

I’m not being cynical doomsayer here, more of a realist. I’ve actually recommended selectively plunging into stocks right now, but that advice carries huge risks and it won’t help a mega fund like Norway’s GPFG.

Admittedly, it’s a mathematical certainty that global bonds are not going deliver great returns over the next ten years, but it might be a lot worse in global stocks, especially when you adjust returns for risk.

So what advice do I have for Norway’s GPFG? Take the time to read my conversation with HOOPP’s Jim Keohane where he admitted HOOPP will never invest in negative yielding bonds, preferring real estate instead.

I personally recommend GPFG follows Canada’s large pensions and ramp up its infrastructure investments which it just introduced into its asset allocation. Generally speaking, there is a growing appetite for infrastructure as large institutional investors are looking for scalable investments that can deliver steady cash flows over a long period.

[Note: Norway’s sovereign wealth fund has bemoaned the smaller scale of infrastructure projects in developing nations after a report to the government called for it be allowed to invest in the asset class, but in my opinion it should exclusively focus on developed nations initially.]

Still, I’m not going to lie to you, infrastructure investments are frothy and they carry their own set of unique risks (illiquidity, regulatory, political and currency risks like what happened to British infrastructure investments post Brexit).

But Norway’s pension has to stop being so excessively reliant on global public markets and start considering the benefits of global private markets. There is a reason why the Canada Pension Plan Investment Board and other large Canadian pensions are scouring the globe for opportunities across public and private markets, delivering excellent long-term results, and I think Norway’s GPFG and Japan’s GPIF need to follow suit, provided they get the governance right (not worried about Norway’s governance even if it’s not perfect, it is excellent).

To be sure, Norway’s GPFG is an excellent fund that is run very well but it’s essentially at the mercy of public markets and far more vulnerable to abrupt shifts in global stocks than large Canadian pensions.

No matter how much risk management it has implemented, at the end of the day, Norway’s GPFG is a giant beta fund and that means it will outperform Canada’s large pensions during bull markets but grossly underperform them during bear markets.

On that note, let me remind all of you once again that it takes a lot of time and effort to research and write these comments. Please kindly show your appreciation by donating or subscribing to PensionPulse on the right-hand side under my picture (you need to view web version on your cell to view the PayPal options on the right-hand side under my picture).