Author: Leo Kolivakis

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

Devin Banerjee of Bloomberg reports, Blackstone’s Top Dealmaker Says Now Is The Most Difficult Period He’s Ever Experienced:

Joe Baratta, Blackstone Group LP’s top private equity dealmaker, can’t be too cautious right now.

“For any professional investor, this is the most difficult period we’ve ever experienced,” Baratta, Blackstone’s global head of private equity, said Tuesday, speaking at the WSJ Pro Private Equity Analyst Conference in New York. “You have historically high multiples of cash flows, low yields. I’ve never seen it in my career. It’s the most treacherous moment.”

Private equity managers have tussled with a difficult reality for several years. The same lofty valuations that created ideal conditions to sell holdings and pocket profits have made it exceedingly difficult to deploy money into new deals at attractive entry prices. Several executives, including Blackstone Chief Executive Officer Steve Schwarzman, have pinned those conditions squarely on the Federal Reserve’s near-zero interest rate policies.

Baratta, 45, said Blackstone isn’t finding value in large leveraged buyouts of publicly traded companies. Instead, the New York-based asset manager is targeting smaller companies with low leverage, he said.

‘Net Sellers’

The firm is still selling more assets than it’s buying, according to President Tony James.

“We’re net sellers on most things right now — prices are high,” James said in a Bloomberg Television interview Tuesday. “Interest rates are so low and there’s so much capital sloshing around the world.”

Blackstone finished gathering $18 billion for its latest private equity fund last year. The firm also has an energy private equity vehicle, which finished raising $4.5 billion last year.

Blackstone is close to striking its first deal by a new private equity fund, called Blackstone Core Equity Partners, Baratta said. The vehicle will have a 20-year life span, double the length of a traditional private equity fund.

The core equity fund, which has gotten $5 billion so far, will deploy $1 billion to $3 billion per deal, said Baratta. The transaction the firm is working on is valued at about $5 billion including debt, he said, without elaborating.

Blackstone, founded by Schwarzman and Peter G. Peterson in 1985, managed $356 billion in private equity holdings, real estate, credit assets and hedge funds as of June 30.

No doubt, these are treacherous times for private equity, hedge funds and especially active managers in public markets.

Facing dim prospects, Jon Marino of CNBC reports the barons of the buyout industry are now looking to buy each other out:

The barons of the buyout industry may need to buy one another out next.

KKR, the private equity firm co-founded by Henry Kravis, reportedly sought to tuck lender and investment firm HIG Capital under its growing corporate credit wing. That would mean adding about $20 billion in assets to Kravis’ company. Neither firm responded to a request for comment.

That’s not all; HarbourVest Partners, perhaps looking to take advantage of the discounted pound in the U.K., submitted a bid to buy SVG Capital, a British firm, but was rebuffed late last week. SVG Capital told HarbourVest, which is based in Boston, that it felt the bidder’s offer came up short — and revealed it has had talks with other “credible parties,” as well.

For some, it’s the right move, in order to beef up assets under management.

Public markets haven’t been too friendly to private equity firms’ initial public offerings, and as their senior leaders consider ways to exit long-held positions in their companies, options to net a return are dwindling. Tacking on other businesses could at least help juice management fees for buyers.

But for other private equity firms, it may be the only other option, beyond becoming zombie funds or winding down in the long run.

“The bloom has come off the rose for many big private equity firms,” said Richard Farley, chair of the leveraged finance group at law firm Kramer Levin.

The urge to merge in the private equity industry should be growing, and it comes at a tough time for the private equity industry. Funding could become scarcer, as general partners leading top leveraged buyout firms are weighing whether to do deals. Some of their primary sources of cash — public pensions — are withdrawing from the business, in part because of abusive fee practices at certain firms.

Beyond the secular industry pressures faced by private equity firms, their returns have been compressed by a number of legislative and regulatory measures in the U.S.

In the wake of the global financial crisis, Washington regulators forced banks that fall under the purview of the Treasury Department and the Federal Reserve to scale back how much they lent to private equity buyers’ deals, relative to the earnings before taxes, depreciation and amortization of those companies. Broadly speaking, banks are not permitted to lend more than six times a company’s Ebitda to get a deal done.

Further, leading up to this election there has been a great deal of hand-wringing by private equity executives that carried interest taxation, which allows them to be taxed at around half the going rate ordinary Americans face, may rise in coming years, further crimping profits. One legislative expert, asking to not be quoted, suggested it will remain difficult to pass legislation targeting carried interest, in part because other financial services sector businesses beyond private equity count on the tax break.

“Washington probably isn’t private equity’s biggest enemy,” the source said. “The real pressures are that the industry can’t generate the same kinds of returns their investors got used to.”

Indeed, the (not so) golden age of private equity is long gone and investors better get used to the industry’s diminishing returns. Just look at the private equity returns at CalPERS and other large pensions I cover in this blog, they have been declining quite significantly.

Moreover, the industry faces increased regulatory scrutiny and increased calls to be a lot more transparent on all the fees levied on investors, not that these initiatives are going anywhere.

In April of last year, I warned my readers to stick a fork in private equity. The point I made in that comment was the industry is far from dead but it’s undergoing a major transformation and facing important secular headwinds in a low yield/ high regulatory environment.

Even the best of the best private equity firms, like Blackstone, realize they need to adapt to the changing landscape or risk major withdrawals from clients.

In response, private equity’s top funds are looking to merge and they’re discovering Warren Buffett’s approach may indeed save them from extinction or at least help them navigate what is increasingly looking like a prolonged debt deflation cycle.

There’s a reason why Blackstone’s new fund, called Blackstone Core Equity Partners, will have a 20-year life span, double the length of a traditional private equity fund. Blackstone is implicitly telling investors to prepare for lower returns ahead and it will need to adopt a much longer investment horizon in order to produce better returns over public markets.

This isn’t a bad thing. In fact, by introducing new funds with longer life spans, private equity funds are better aligning their interests with those of their investors. They are also able to garner ever more assets (at reduced fees) which will help them grow their profits. And the name of the game is always asset gathering but it helps when these funds outperform too.

Let me end by informing my readers that Canada’s West Face Capital is aiming to raise $1.5 billion for a new private equity fund to make larger investments:

“We believe attractive market dislocations could occur over the next few years and we are making preparations with our investing partners,” Greg Boland, the head of Toronto-based West Face, said in an e-mail, declining to comment on the details of the fundraising. “The new committed draw fund will augment our ability to respond to large opportunities.”

West Face has reached out to potential investors about the new fund, which will invest in private and public securities and seek control through distressed transactions, said the person, who asked not to be identified because the matter is private.

The hedge fund is touting a 14 percent year-to-date return on its open-ended core fund in the fundraising efforts, the person said.

West Face focuses on event-oriented investing, specializing in distressed situations, private equity, public market investments and other transactions. The fund has been involved in several high-profile investments in recent years, including leading a group who acquired wireless carrier Wind Mobile in September 2014. That business was sold about 15 months later for C$1.6 billion ($1.2 billion) to Shaw Communications Inc., netting a sixfold return for the acquirers.

Not bad at all, while most hedge funds are struggling, some are still delivering exceptional returns and I like reading about Canadian hedge funds that are doing well.

By the way, a friendly reminder that the first ever cap intro conference for Quebec and Ontario emerging managers is taking place next Wednesday, October 5th, in Montreal. Details can be found here.

Also, another conference taking place in Montreal next week (October 5 and 6) is the AIMA Canada Investor Forum 2016. You can find details on this conference here.

I have decided to do my part to cover the first conference as it’s important to help emerging managers get the decent exposure they deserve and I haven’t decided whether I will attend the AIMA conference but there are some very good panel discussions taking place there.

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

Maiya Keidan of Reuters reports, Canada public pension plan ditches 10 computer-driven hedge funds:

Canada’s third-largest public pension plan has halved the number of computer-driven hedge funds in its investment portfolio and put more money into the funds its sticking with, sources with knowledge of the matter told Reuters.

The Ontario Teachers’ Pension Plan this summer pulled cash from 10 of the 20 hedge funds in its portfolio which use computer algorithms to choose when to buy and sell, two of the sources said.

Ontario Teachers’ allocates $11.4 billion to hedge funds, making it the fourth-largest North American investor in the industry, data from research house Preqin showed.

Hedge funds worldwide are under increasing pressure in the wake of poor or flat returns as well as investors’ efforts to cut costs. Data from industry tracker Eurekahedge showed that investors have pulled money from hedge funds globally every month in the four months to end-August.

One of the hedge funds that received more funds from the Ontario Teachers’ Pension Plan said it had told them it was looking for funds which offered a different strategy from other funds.

“They expressed that a lot of strategies today you can mimic with a few exchange-traded funds or create synthetic products and there is no reason to pay management or performance fees,” the source said.

Another hedge fund which the Canada fund dropped said the pension scheme had said it wanted to avoid funds invested in similar underlying assets.

Some of the computer-driven hedge funds the Ontario Teachers’ pulled money from followed market trends, such as Paris-based KeyQuant, which has more than $200 million in assets under management, according to its website.

The Ontario scheme also withdrew $65 million in June from trend-follower Cardwell Investment Technologies, a move which ultimately led to it shutting its doors this summer, one of the sources said.

Those funds to receive a boost offered a more specialist set of skills, such as London-based computer-driven currency hedge fund Sequoia Capital Fund Management, in which the pension fund doubled its investment, a second source said.

I reached out to Jonathan Hausman, Vice-President, Alternative Investments and Global Tactical Asset Allocation at Teachers’ in an email earlier today to discuss this latest move and copied Ron Mock on it.

But knowing how notoriously secretive Ontario Teachers’ gets when it comes to discussing specific investments and investment strategies, especially their hedge funds, I doubt either of them will come back to me on this matter (if they do, I will edit my comment).

Those of you who never met Jonathan Hausman, there is a picture of him now sporting a beard on Teachers’ website along with his biography (click on image):

Jonathan is in charge of a very important portfolio at Ontario Teachers. While most pensions are exiting hedge funds after a hellish year or seriously contemplating of exiting hedge funds, Teachers invests a hefty $11.4 billion in hedge funds, representing roughly 7% of its total portfolio.

While the absolute amount is staggering, especially relative to its peer group, you should note when Ron Mock was in charge of external hedge funds, that portfolio represented roughly 10% of the total portfolio and it had a specific goal: obtain the highest portfolio Sharpe ratio and consistently deliver T-bills + 500 basis every year with truly uncorrelated alpha (overlay strategy).

[Note: When Teachers had 10% invested in hedge funds and hit its objective, this portfolio added 50 basis points+ to their overall added-value target over the benchmark portfolio with little to no correlation to other asset classes. The objectives for external hedge funds are still the same but the overall impact of this portfolio has diminished over the years as hedge fund returns come down, other more illiquid asset classes like infrastructure, real estate and private equity take precedence and Teachers expands its internal absolute return strategies where it replicates these strategies internally, foregoing paying fees to external managers.]

So why is Ontario Teachers’ cutting its allocation to computer-run hedge funds? I’ve already discussed some reasons above but let me go over them again:

• Underperformance: Maybe these particular hedge funds were underperfoming their peers or not delivering the return objectives that was asked of them.
• Strategy/ portfolio shift: Unlike other investors, maybe the folks running external hedge funds at Teachers think the glory days of computer-run hedge funds are over, especially if volatility picks up in the months ahead (read this older comment of mine). Maybe they see value in other hedge fund strategies going forward and want to focus their attention there. Teachers has a very experienced hedge fund group and they are very active in allocating and redeeming from external hedge funds.
• Internalization of absolute return strategies: Many popular hedge fund strategies can be easily replicated internally at a fraction of the cost of farming them out to external hedge funds, foregoing big fees and potential operational risk (I used to work with a very bright guy called Derek Hulley who is now a Director of Data Science at Sun Life who developed such replication strategies for his former employer and since he traded futures, he had intimate and detailed knowledge of each contract when he programmed these strategies, which gave his replication platform a huge advantage over other more generic ones.)
• Cut in the overall allocation to hedge funds: Let’s face it, it’s been a hellish few years for hedge funds and all active managers. If you’re a big pension or sovereign wealth fund investing billions, do you really want to waste your time trying to find hedge funds or active managers that might outperform or “add alpha” in public markets or are you better off directly investing billions in private equity, real estate and infrastructure over the long run?

That last question is rhetorical and I’m not claiming Teachers is cutting its allocation to hedge funds (obviously not) but many of its peers, including the Caisse, have drastically cut allocations to external hedge funds to focus their attention on highly scalable illiquid asset classes.

Now, we can argue whether we are on the verge of a hedge fund renaissance or whether active managers could be ready to shine again but the point I’m making is most large pensions and sovereign wealth funds are more focused on directly or indirectly investing huge sums in illiquid alternatives and I don’t see this trend ending any time soon.

In fact, I see infrastructure gaining steam and fast becoming the most important asset class, taking over even real estate in the future (depending on how governments tackle their infrastructure needs and entice public pensions to invest).

I will end with a point Ron Mock made to me when I went over Teachers’ 2015 results. He stressed the importance of diversification and said that while privates kicked in last year, three years ago it was bonds and who knows what will kick in the future.

The point he was making is that a large, well-diversified pension needs to explore all sources of returns, including liquid and illiquid alternatives, as well as good old boring bonds.

And unlike other pensions, Ontario Teachers has developed a sophisticated external hedge fund program which it takes seriously as evidenced by the highly trained team there which covers external hedge funds.

I was saddened (and surprised) to learn however that Daniel MacDonald recently left Ontario Teachers to move to San Diego where he now consults institutions on hedge funds (his contact details can be found on his LinkedIn profile).

Daniel is unquestionably one of the best hedge fund analysts in the world and one of the sharpest and nicest guys I ever met at Teachers. aiCIO even called him one of the most influential investment officers in their forties (click on image):

He’s even won investor intelligence awards for his deep knowledge of hedge fund investments and none of this surprises me. His departure represents a huge loss for Ontario Teachers’ external hedge fund group.

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

Abhineet Kumar of India’s Business Standard interviewed Prashant Purker, Managing Director & CEO of ICICI Venture Funds, who said they will acquire power assets worth $3.5 billion:

This month, ICICI Venture Funds came up with a new investment platform to acquire conventional power assets. The fund comes at a time when capital goods maker Bharat Heavy Electricals (BHEL) is seeing 45 per cent of its Rs 1.1-lakh core order book face the challenge of stalled or slow moving projects. A large number of this are stuck due to financial constraints that ICICI Venture’s power platform plans to benefit from. Prashant Purker, managing director and CEO of ICICI Venture Funds, spoke to Abhineet Kumar on his plans for that. Edited excerpts:

What is the worth of assets you are targeting to acquire with your $850-million power platform?

We’re targeting to acquire $3-3.5 billion worth of (enterprise value) assets in the conventional power segment across thermal, hydel (hydro electric) and transmission businesses.

Clearly, there are a lot of power assets just getting completed or stuck in the last mile of completion with over leveraged situations at company or sponsor level. They need someone who can buy the assets out, inject equity to complete the project and have the capability to operate these assets on a long-term basis. This platform provides that — Tata Power bring operating capabilities and ICICI Venture provide fund management service as sponsors for the fund.

In return, these assets benefit those investors who need long-term yields. This is ideal for our investors such as Canadian pension fund CDPQ (Caisse de depot et placement du Quebec) as well as sovereign funds Kuwait Investment Authority and State General Reserve Fund of Oman.

As a funds-house, what is your strategy for platforms? Can we expect more such platforms to come in the future?

In 2014, we collaborated with Apollo Global Management to raise first special situation funds for India. We raised $825 million under our joint venture AION Capital Partners. Unlike funds, platforms are dedicated to some sort of investments where assets can be aggregated. Our strategy is to identify situations or opportunities in the market that require certain things to be brought together and then bring it with whatever it takes.

With the pedigree and group linkage, ICICI Venture is in a unique position to achieve this. Among domestic institutions, it is the only one which is truly multi-practice with four investment teams across private equity (PE), real estate, special situation and power assets. Across these four, we have $4.15 billion assets under management and it does not include the fund we raised in the venture capital era. Today, we have the largest dry powder of $1.5 billion across these funds.

It has come with our ability to spot opportunity earlier, and bring together whatever it takes. We will continue to look for new platform opportunities.

What is the update on your PE and real estate funds?

For real estate, we’ve total assets under management of $625 million with two funds fully invested. Now we plan to raise our third fund and have applied to the regulator for approval.

For PE, we are in the process of raising our fourth fund and have concluded interim closing as well as the first two investments. We have also started investing from our fourth fund with a couple of investments — Anthea Aromatics and Star Health Insurance — already made. Our PE fund will remain sector-agnostic and look for growth capital investment opportunities coming from rising consumption. In terms of exits, we have returned nearly half of our third fund to investors from various exits with Teamlease being the latest one where we used the IPO (initial public offering) route. Exit from the rest of the investee companies from the third fund is in the process of using multiple routes of IPOs, secondary sale, or strategic sell-off.

What is the sense you get on limited partners’ view for investments in India as you raise your fourth PE fund?

Limited partners are today happier with exits position than they were a couple of years ago. Obviously, markets can’t just keep absorbing the capital; it has to return. With IPO markets opening up and given the increasing number of secondary deals, the sentiment for investments has improved. We are also seeing larger traction for strategic buy-outs as Indian promoters are fine with giving up controls. Is it that people are hundred per cent convinced to come to India – we are not in that position. People are looking for quality managers. Many funds would not be able to raise money as investors now want to gravitate to a few who have delivered returns and have a track record to show.

As disruption affects businesses across industries, how prepared are your investee companies to face it?

Today, every company has to be on its toes to look at technology – be it health-care or banking. At every company’s board, directors with grey hair are asking about social media presence and how customers are being acquired. So, technological disruption has become truly mainstream.

It is an ongoing process, and they are today definitely more prepared than they were two years back.

Good interview with a bright person who is obviously very well informed on what is going on in India and the opportunities that exist there across private markets.

I bring this particular interview to your attention not because I know Prashant Purker or want to plug ICICI Venture Funds but because they have some very savvy investors on board including the Caisse and Kuwait Investment Authority. 

Why are these two giant funds investing in India’s power assets? Because it’s an emerging market that is growing fast and if pensions find the right partners, they can benefit from this growth investing in public and private markets. 

Power assets are in line with the Caisse’s philosophy under Michael Sabia’s watch, ie. slow and steady returns, which is why it doesn’t surprise me that they opted to invest in this new platform which will invest in power assets that provide a steady long-term yield. 

And the Caisse isn’t the only large Canadian pension fund investing in India. Many other Canadian pension funds invest in India, including the Canada Pension Plan Investment Board (CPPIB) which opened a new office in Mumbai last year to focus on investment opportunities across the Indian subcontinent.

Are there risks investing in India? Of course there are. Extreme poverty, gross inequality, rampant corruption and war with Pakistan are perennial concerns, but this emerging market has tremendous long-term potential even if the road ahead will undoubtedly be very bumpy. And unlike China, India is a democracy with favorable demographics but its infrastructure is nowhere near as developed as it is in China.

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

Rob Kozlowski of Pensions & Investments reports, CPPIB to aid China with pension reform, other issues:

Canada Pension Plan Investment Board, which manages the assets of the C$287.3 billion ($217.4 billion) Canada Pension Plan, Ottawa, signed a memorandum of understanding with the National Development and Reform Commission of the People’s Republic of China to offer its expertise to the country on a variety of issues, a CPPIB news release said Thursday.

The memorandum of understanding includes the CPPIB assisting China’s policymakers “as they address the challenges of China’s aging population, including pension reform and the promotion of investment in the domestic senior care industry from global investors,” the news release said.

“As we continue to deploy capital in important growth markets like China for the benefit of CPP contributors and beneficiaries, there is significant value for a long-term investor like CPPIB in sharing information, experience and successful practices with policymakers as they work toward improving policy frameworks,” said Mark Machin, CPPIB’ president and CEO, in the news release. “We are (honored) to have the opportunity to share our perspective and expertise with Chinese policymakers to tackle the issues of providing for an aging population.”

CPPIB will offer joint training, workshops and pension reform research as well, the news release said.

The memorandum was signed Thursday as part of bilateral agreements between China and Canada. In January, the CPPIB was designated by the China Securities Regulatory Commission for renminbi qualified foreign institutional investor status, granting it broad access to China’s capital markets.

Jacqueline Nelson of the Globe and Mail also discusses this agreement here (subscription required). You can read the news release on CPPIB’s website here.

What are my thoughts? I generally think any bilateral trade agreement with China is a good thing, and the fact the Chinese seized this opportunity to forge stronger ties with Canada’s largest pension fund speaks volumes on the respect they have for Canada’s large, well-governed pensions.

A couple of weeks ago, I discussed the global pension crunch, highlighting the problems Chinese policymakers face with their state pensions, many of which are chronically underfunded and need to be shored up as the population ages and benefits need to be paid out.

And this at a time when China has a $2 trillion black hole to deal with.

In April, I discussed China’s pension gamble, criticizing the use of pensions to inflate stock prices higher as an irresponsible policy which will hurt the Chinese market in the long run.

What can the Chinese learn from CPPIB? A lot. First and foremost, they cam learn the benefits of good governance and why it’s crucial for their state pensions’ long-term success. Admittedly, good governance isn’t something that comes easily in China where the government interferes in everything but this is something that needs to be changed.

Second, they can learn all about the benefits of three major structural advantages that are inherent to the CPP Fund – long horizon, scale, and certainty of assets; and three developed advantages that result from strategic choices they have made – internal expertise, expert partners, and Total Portfolio Approach (click on image below).

Together, these advantages provide CPPIB with a distinct perspective for investment decision-making.

Most importantly, China’s large pensions can forge ties with CPPIB and invest alongside it in big private market deals in China, Asia and elsewhere. This is a win-win for all parties which is why I’m glad they signed this memorandum of understanding.

Unfortunately, all is not well between Canada and China. In particular, I’m a bit concerned when I read Joe Oliver, the former Conservative minister of finance, writing a comment in the National Post saying, We have no choice but to slap a tax on Toronto houses being bought by foreigners.

Really? Apart from being discriminatory against foreigners (ie., Chinese), these taxes don’t address the root cause of lack of affordable housing in Vancouver and Toronto — the lack of supply!! — and they were hastily implemented to appease the poor and middle class without careful consideration how they will negatively impact the economies of British Columbia and Ontario.

A friend of mine who lived in Vancouver and moved back to Montreal put it succinctly when he read CIBC said that Ontario will need to implement foreign buyer tax on housing:

No surprise. This is now a political issue. It is about fighting for the poor rather than protecting the wealth generated by the influx of Chinese. The government has now started the snowball and it will be difficult to reverse.

Very shortsighted thinking. There were many ways to tackle the problem which could have accomplished both objectives (protect wealth and restore some balance to the market). It would have taken longer and been less dramatic.

Everyone outside of Vancouver assumes that this is simply a demand-side issue and that by curbing “Chinese” demand, the problem will go away.  It won’t. It will certainly cause a temporary haircut at the upper end of the market but even after a 50% haircut, the average Joe will not have the means to buy property.

The only way to solve this is to create supply and to do this, the government needs to release land from the agricultural land reserve for development of affordable single family housing.  They have done it before (in White Rock).

They also need to allow construction up and over the mountains on the North Shore. Yes this means cutting down trees and laying havoc to the landscape but there really is not a lot of choice here.

What they are doing now is basically driving away the Chinese and their investment dollars. When you look at the BC economy, they really cannot afford to do this.

No kidding. Bloomberg reports, Foreign Buying Plummets in Vancouver After New Property Tax:

Foreign investors dropped out of Vancouver’s property market last month after the provincial government imposed a 15 percent surcharge to stem a surge in home prices:

Overseas buyers accounted for less than 1 percent of the C$6.5 billion ($5 billion) of residential real estate purchases between Aug. 2 to 31 in Metro Vancouver, according to data released by British Columbia’s Ministry of Finance on Thursday. In the roughly seven weeks prior to that, they’d represented 17 percent of transactions by value.

The Canadian city, nestled between the water and soaring mountains, has long been a favored destination among global property investors, who have been blamed for fomenting escalating prices. The new tax went into effect Aug. 2 amid public pressure in the region, where home prices are almost double the national average of C$473,105.

The plunge in foreign participation joins other signs of a slowdown in Canada’s most expensive property market. Vancouver home sales fell 26 percent in August from a year earlier, while the average price of a detached property declined to C$1.47 million, the lowest price since September 2015, according to the Real Estate Board of Greater Vancouver.

The latest data shows that overseas buyers snapped up C$2.3 billion of homes in the seven weeks before the tax was imposed, and less than C$50 million in the next four weeks. The government began collecting data on citizenship in home purchases on June 10. The ministry said auditors are checking citizenship or permanent residency declarations made by buyers and also reviewing transactions to determine if any were structured to avoid tax.

Across the province, the participation of foreigners dropped to 1.4 percent of transactions by value in August, from 13 percent in the preceding seven weeks.

British Columbia has raised C$2.5 million in revenue from the new levy since it took effect. Budget forecasts released last week indicated that the Pacific coast province expects foreign investors to scoop up about C$4.5 billion of real estate through March 2019.

I bring this issue up because while critics love pointing the finger at Chinese policymakers when they make dumb decisions, maybe we Canadians need to reflect more on the bonehead moves our policymakers take to “defend the poor and working class” (exactly the opposite will happen as Chinese move to Seattle but maybe this will boost Calgary and Montreal’s real estate market).

Anyways, enjoy your weekend and remember, behind the trade agreement with China, there’s an equally important agreement on the pension front which will also benefit Canadians and the Chinese. This is undeniably great news for both countries.

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

Robin Harding of the Financial Times reports, BoJ launches new form of policy easing:

The Bank of Japan has launched a new kind of monetary easing as it set a cap on 10-year bond yields and vowed to overshoot its 2 per cent inflation target on purpose.

Its decision demonstrates that even eight years after the global financial crisis, central bankers are still willing to experiment with monetary policy tools as they struggle to escape from low inflation around the world.

The move marks another effort by Haruhiko Kuroda, BoJ governor, to surprise market expectations by expanding his monetary policy toolkit to signal his determination that Japan escape its decades of on-and-off deflation.

But the question for Mr Kuroda is whether three-and-a-half years of slow progress on prices have damaged the BoJ’s credibility too much for promises of higher inflation to be taken seriously by the public.

“The price stability target of 2 per cent has not been achieved … [and] this is largely due to developments in inflation expectations,” said the BoJ on Wednesday. “Inflation expectations need to be raised further in order to achieve the price stability target.”

Markets initially reacted positively, with the yen losing 1 per cent to ¥102.7 against the dollar, spurring a 1.9 per cent rally in the exporter-sensitive Nikkei 225 equity average, with banks and insurers leading the gains. But scepticism about the BoJ’s overhaul set in and the yen reversed its early losses, appreciating by 1 per cent by mid-afternoon in London.

The BoJ kept interest rates on hold at minus 0.1 per cent — describing further rate cuts as a “possible option for additional easing” — but announced a framework with two main elements.

The first is a pledge to cap 10-year government bond yields at zero per cent. In essence, that means the BoJ is promising to buy any bonds offered for sale at that price.

It will maintain its government bond buying “more or less in line with the current pace” of ¥80tn a year. However, the BoJ will buy fewer very long-term bonds, which should make it easier for banks to earn profits by allowing the yield curve to steepen.

Second, the BoJ has pledged to continue buying assets until inflation “exceeds the price stability target of 2 per cent and stays above the target in a stable manner”.

Although that commitment is vague, it marks a departure for global monetary policy, following the logic of economists such as Paul Krugman by making a deliberate “commitment to be irresponsible”.

If the pledge is credible then it should raise public expectations of the price level in the future. That, in turn, should lower real interest rates and stimulate the economy because loans will be paid back in a devalued currency.

But the BoJ’s credibility is a big question given its struggle to raise inflation over the past three years, with headline inflation running at minus 0.4 per cent in July. Public expectations of future inflation have steadily declined over the past 18 months.

Some analysts were downbeat about the BoJ’s decision not to cut interest rates or expand asset purchases, seeing it as a signal that the central bank has little scope for further easing.

“We are quite sceptical that this change in the framework will loosen financial conditions in any meaningful manner,” said Kiichi Murashima at Citi in Tokyo. “Monetary policy has effectively reached its limit, in our view, and today’s decision appears to show that policymakers share this assessment.”

Masaaki Kanno, at JPMorgan in Tokyo, said the BoJ had “disappointed” by failing to cut rates. He said the pledge to overshoot the inflation target had come too late, at a time “when few people in the market believe that 2 per cent inflation will be achieved anytime soon”.

James Athey at Aberdeen Asset Management added: “The BoJ has reaffirmed its inflation target and will try to overshoot it. This in spite of the fact that it hasn’t hit its current inflation target, doesn’t seem likely to and hasn’t announced anything that might help it get there or beyond any time soon.

“The Bank has effectively told markets that it has a royal flush and the markets are questioning Kuroda’s poker face.”

Tracy Alloway and Sid Verma of Bloomberg also report, The Way the World Thinks About Easy Monetary Policy Is Changing:

It happened so quickly.

While analysts and economists had long debated the efficacy of quantitative easing — the central bank bond purchase programs aimed at lowering borrowing costs to stimulate the economy and stoke inflation — the narrative surrounding such efforts is rapidly shifting. In recent months, there’s been a growing recognition of the limits and downsides to this particular form of monetary easing, underscored by the Bank of Japan’s policy changes announced on Wednesday.

Some 15 years after first experimenting with QE, the BOJ announced that it intends to shift the focus of its policy framework to better finesse borrowing costs by, in effect, anchoring longer-term rates higher, and moving away from a rigid target for expanding the money supply. While market participants expect the central bank to further expand bond purchases and take the rate on a portion of bank balances deeper into negative territory in upcoming meetings, the BOJ’s move is a recognition that its daring strategy to dramatically expand the money supply to fight deflation has delivered a blow to the financial sector’s profitability.

“The biggest takeaway here is that the BOJ is now leading the world into a new era of central banking and is essentially making long-term interest rate, 10-year Japanese government bond yields a focal point in its central banking platform instead of negative interest rate policy,” analysts at TD Securities Inc. led by Mazen Issa, wrote in a note today. “The yield curve control program is an interesting but untested concept. It is one attempt to provide relief for pension funds, [life insurance companies], and banks.”

The program announced on Wednesday helped propel Japanese lenders’ stocks higher, underscoring the evolution in easy monetary policy. The BOJ plans to buy enough 10-year government bonds to keep the yield close to zero percent, while potentially purchasing fewer longer-dated bonds, in a move expected to boost profits for the financial sector and encourage them to lend and invest.

The Bank of Japan had doubled-down on its QE program in February with the surprise introduction of a negative interest-rate policy on a portion of bank reserves, sharply lowering long-term rates — as well as bank stock prices — amid a squeeze on net interest margins for lenders.

Despite the shock-and-awe strategy early in the year, the yen appreciated in the aftermath of the move, while deflation risk remains unabated — with CPI at minus 0.5 percent year-on-year in July — and long-term inflation expectations remain stubbornly low.

Though the BOJ has maintained the minus 0.1 percent charge on some bank balances, its yield-curve commitment — similarly deployed by the Federal Reserve from 1942 to 1951 to lower the U.S. Treasury’s post-war financing costs, but which remains unprecedented in modern times — represents a sea-change in the central bank’s thinking.

The BOJ’s newfound embrace of a yield-curve target is a belated recognition that NIRP can negatively impact financial intermediation and inflation expectations, say analysts.

“The good news is that BOJ has finally acknowledged that NIRP does have some negative impact on intermediation and potentially on inflation expectations – which the BoJ puts at the center of its policy goal,” Morgan Stanley economists led by Takeshi Yamaguchi wrote in research published last week, for instance. “The fear is that this negative impact will wax and positive impact wane. Once the evidence is clear, the result may already have had serious adverse consequence for the real economy.”

Hans Redeker, strategist at the U.S. bank, reckons a negative-yielding flat yield curve has reduced monetary velocity and pushed the yen higher, while a steeper yield curve — allowing financial intermediaries to borrow at low rates and invest at longer maturities — might unleash the animal spirits needed to increase risk-taking.

In a report last week, amid indications from officials that the BOJ would anchor long-end yields higher, Redeker wrote: “Financial sector balance sheets have been dismissed by central banks for too long,” adding that the central bank’s newfound focus on financial-sector profitability represents a belated recognition of banks in aiding the transmission of monetary policy to the real economy.

Tomoya Masanao, head of Japanese portfolio management at Pacific Investment Management Co LLC, in a research note last week, called on the BOJ to scale back JGB purchases at the long-end to steepen the yield curve and aid financial intermediation, arguing that negative long-end rates had facilitated the refinancing of existing debt rather than stimulating new productive investments.

Bankers argue low longer-dated yields and negative rates deliver a blow to their return on assets, offsetting the benefits of lower funding costs — and the BOJ’s apparent capitulation might embolden critics of monetary policy in other advanced economies.

Questions over the effects of QE have already extended away from policymakers at the BOJ. In the U.K., Monetary Policy Committee Member Kristin Forbes suggested in the aftermath of the Brexit referendum that further easing could end up tightening financial conditions rather than loosening them.

“People will earn less on their hard-earned savings — potentially cutting back on spending to reach a target savings pot. Banks will make less money on lending,” she wrote in an op-ed. “Pension and life insurance funds will have a harder time meeting their commitments. Companies may need to put more money into pension schemes — leaving less to spend on workers and investment.”

So the BOJ surprised everyone by not cutting rates or expanding asset purchases further. Instead, it chose to anchor long-term rates higher in an attempt to stoke “animal spirits” and hopefully finally lift inflation expectations higher.

Will it work? I’m highly skeptical and so is the market. As of this writing on Wednesday morning, the yen reversed course and is surging relative to the USD, up 1%, hovering around 100.68 (click on image; this can abruptly change this afternoon if the Fed raises rates):

Remember my warning to always keep an eye on a surging yen as it could trigger a crisis, including another Asian financial crisis because a stronger yen reinforces deflationary headwinds in Asia which can spread all over the world.

This is yet another reason why the Fed shouldn’t raise rates now but we shall see what it decides to do later today. One currency trader I talk to thinks the fact the BOJ didn’t cut rates or expand its asset purchases is a sign the Fed will surprise markets and raise rates on Wednesday.

And while the Bloomberg article above quotes someone as saying “it is one attempt to provide relief for pension funds, [life insurance companies], and banks,” I’d put the emphasis on banks and lifecos, less on pensions (central bankers don’t really care about pensions but they should if they want to stave off deflation).

In fact, if the BOJ fails to stoke inflation expectations higher, it will be forced to cut rates further into negative territory and this will negatively impact banks, life insurers and Japan’s pensions, especially defined-benefit pensions which are already reeling.

Garath Allan and Shingo Kawamoto of Bloomberg recently reported, Negative Rates Not All Bad as Mizuho Sees Pension Business Boost:

Negative interest rates aren’t necessarily all bad news for Japanese banks, as companies flock to lenders for advice on how to manage their pension programs under the policy, according to Mizuho Financial Group Inc.

The Tokyo-based bank sees an opportunity to earn more fees from employers that are shifting toward 401(k)-style retirement plans as sub-zero rates make it more difficult for them to meet existing pension obligations. It’s seeking to expand the 1.7 trillion yen ($16.6 billion) of defined-contribution plans it manages for companies’ employees by 30 percent over the next three years, according to Koji Imuta, a senior manager in the asset-management business development department.

Pension Strain

The Bank of Japan’s negative-rate policy is driving momentum for companies to reconsider their employee pension arrangements, Imuta said in an interview in Tokyo. “Our customers are acutely aware of this as an issue and inquiries are growing,” he said.

Even before the BOJ announced negative rates in January, years of plunging bond yields squeezed returns from retirement funds in a nation where the aging population is also placing a strain on the pension system. Imuta’s goal to increase retirement assets reflects a push by Chief Executive Officer Yasuhiro Sato to boost non-interest income amid the risk that the central bank may take rates further below zero, crimping loan profits.

By arranging pension plans for employers and investing the funds on their behalf, Mizuho will earn fees that could help to reduce the impact of negative rates on profit, Sato said in May, without providing specific targets. The bank has forecast the BOJ’s policy will crimp its net income by 40 billion yen in the year ending March.

More firms are seeking to switch to defined-contribution plans from defined-benefit arrangements because swelling retirement liabilities are jeopardizing their financial health, Imuta said. “We see this as an opportunity,” he said.

The total pension shortfall for listed companies in Japan expanded about 43 percent over the past year to 25.6 trillion yen as of March 31, according to Nomura Holdings Inc. Japanese government bonds with maturities as long as 10 years are yielding less than zero even after a recent steepening of the curve.

Making Switch

Defined-contribution plans exist on top of Japan’s public pension system, allowing employees to select how their money is invested. The amount retirees receive fluctuates depending on returns, unlike traditional defined-benefit pensions where employers must pay out a set amount regardless of how much they earn from investing the pooled funds.

Employers are tailoring their pension programs, with some fully making the shift and closing defined-benefit plans and others maintaining aspects of their existing arrangements, Imuta said.

A total of 5.5 million company employees had defined-contribution plans as of March, up 8.5 percent from a year earlier, according to Ministry of Health, Labour and Welfare figures. More than 5,000 companies including Skylark Co. and Panasonic Corp. offered these to their employees as of July, the data show.

Mizuho plans to take advantage of its April 2016 conversion to an internal company structure to bolster cooperation between its bank and trust units on the pension business, Imuta said. About 250 employees work in Mizuho’s retirement operation across the two units, which previously conducted the business separately.

As you can read, negative rates aren’t all bad news for some Japanese banks as they have been collecting huge fees as companies opt out of defined-benefit pensions into defined-contribution pensions.

Unfortunately this shift out of DB into DC pensions will only exacerbate Japan’s long-term deflation problem because it will shift retirement risk from employers to employees which will succumb to pension poverty once they outlive their savings. This is all part of the global pension crunch I recently discussed and it’s a frightening trend which policymakers will be grappling with for decades.

Now we can all wait for the Fed decision at 2:00 pm sharp. Even though the market isn’t expecting a rate hike, the recent actions from other central banks suggest the Fed might hike now. Stay tuned.

Update: A divided Federal Reserve left its policy rate unchanged for a sixth straight meeting, saying it would wait for more evidence of progress toward its goals, while projecting that an increase is still likely by year-end.

“Near-term risks to the economic outlook appear roughly balanced,” the Federal Open Market Committee said in its statement Wednesday after a two-day meeting in Washington. “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”

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

Jack Dolan of the LA Times reports, The Pension Gap:

With the stroke of a pen, California Gov. Gray Davis signed legislation that gave prison guards, park rangers, Cal State professors and other state employees the kind of retirement security normally reserved for the wealthy.

More than 200,000 civil servants became eligible to retire at 55 — and in many cases collect more than half their highest salary for life. California Highway Patrol officers could retire at 50 and receive as much as 90% of their peak pay for as long as they lived.

Proponents sold the measure in 1999 with the promise that it would impose no new costs on California taxpayers. The state employees’ pension fund, they said, would grow fast enough to pay the bill in full.

They were off — by billions of dollars — and taxpayers will bear the consequences for decades to come.

This year, state employee pensions will cost taxpayers $5.4 billion, according to the Department of Finance. That’s more than the state will spend on environmental protection, fighting wildfires and the emergency response to the drought combined.

And it’s more than 30 times what the state paid for retirement benefits in 2000, before the effects of the new pension law, SB 400, had kicked in, according to data from the California Public Employees’ Retirement System.

Cities, counties and school districts across California are in the same financial vise. After state workers won richer retirement benefits, unions representing teachers, police, firefighters and other local employees demanded similar benefits, and got them in many cases.

Today, the difference between what all California government agencies have set aside for pensions and what they will eventually owe amounts to $241 billion, according to the state controller.

Davis, who was elected in 1998 with more than $5 million in campaign contributions from public employee unions, says that if he had it to do over, he would not support the pension improvements.

“If you’re asking me, with everything I’ve learned in the last 17 years, would I have signed SB 400…. no, I would not have signed it,” Davis, now 73, said in a recent interview at his Century City law office.

The law took effect in 2000, and that same year CalPERS investments were hammered by the bursting of the dot.com bubble. Eight years later, the housing market collapsed and the Great Recession set in, putting the pension fund in a deep hole.

CalPERS had projected in 1999 that the improved benefits would cause no increase in the state’s annual pension contributions over the next 11 years. In fact, the state had to raise its payments by a total of $18 billion over that period to fill the gap, according to an analysis of CalPERS data (click on image).

The pension fund has not been able to catch up, even though financial markets eventually rebounded. That’s because during the lean years, older employees kept retiring and younger ones continued to build up credit toward their own pensions. Pay raises and extended lifespans have magnified the impact of the sweetened benefits.

One of the few voices of restraint back in 1999 belonged to Ronald Seeling, then CalPERS’ chief actuary.

Asked to study differing scenarios for the financial markets, Seeling told the CalPERS board that if the pension fund’s investments grew at about half the projected rate of 8.25% per year on average, the consequences would be “fairly catastrophic.”

The warning made no discernible impression on the board, dominated by union leaders and their political allies.

“There was no real taxpayer representation in that room,” Seeling, now retired and living in a Dallas suburb, said in a recent interview. “It was all union people. The greed was overwhelming.”

The enhanced benefits stand in stark contrast to the financial insecurity facing most Americans in retirement. The vast majority of private sector workers have no pensions and very little retirement savings, and will depend largely on Social Security payments, which average about $16,000 per year.

Union leaders say their generous pensions are preserving the middle-class dream of a comfortable retirement.

“People should not have to work their whole life and never be able to retire,” said Dave Low, executive director of the California School Employees Assn.

“We need to fix the system … but fixing it doesn’t mean taking secure retirements away from the last people who have them.”

***************

State pensions are funded by regular deductions from workers’ paychecks and contributions from the state. CalPERS invests the money to cover future benefits.

The employee contribution, typically determined through collective bargaining, remains fairly constant. The employer contribution fluctuates based on CalPERS investment returns.

By far the largest group of state workers — office workers at the Department of Motor Vehicles, the Department of Social Services and dozens of other agencies — contributed between 5% and 11% of their salary in 2015, and the state kicked in an additional 24%. To fund their more costly benefits, Highway Patrol officers contributed 11.5% of pay and the state added 42%.

Separately, the state pays for lifetime health insurance for retirees who worked at least 20 years.

State agencies don’t have a say in how much they contribute toward pensions. That’s determined by CalPERS, where unions have long had considerable influence. Six of the agency’s 13 board members are chosen by public employees; the others are elected officials and their appointees.

By 1999, the retirement system’s investments had grown to $159 billion, from $49 billion in 1990, making it the largest public pension fund in the country and one of the largest institutional investors in the world.

To labor representatives and their allies on the board, the time seemed right to fix what they described as years of “benefit inequity.” They saw Davis, a Democratic former Assemblyman and state controller, as a savior after 16 years of Republican governors.

His predecessor, Gov. Pete Wilson, took $1.6 billion from CalPERS accounts in 1991 to help close a state budget gap. Wilson also reduced retirement benefits for new state employees, effectively creating a second class of state workers.

In May 1999, board members started work on what became SB 400. The state’s formula for calculating pensions had not changed in 20 years, and retirees had lost ground to inflation, according to background material prepared for the board.

The board invited a long list of union leaders to weigh in. They talked about fairness and about employees’ desire to be treated with respect.

It fell to Michael Picker, an aide to then-state Treasurer Phil Angelides who was sitting in for him that day, to raise what he called the “rainy day question.”

“The bull market has been on such a good run for so long that I continually wake up expecting to find out that the bottom has dropped out from underneath us,” Picker said, according to meeting transcripts.

Picker suggested the board refrain from pushing for expanded benefits until Seeling, the CalPERS actuary, had come up with best- and worst-case scenarios for investments over the next decade.

Board chairman William Crist, an economics professor at Cal State Stanislaus and former president of the faculty union, interrupted with sarcasm.

“I guess the best case for the retirement system is everybody dies tonight,” Crist said, meaning the fund wouldn’t have to pay any benefits. “We could go through a modeling exercise where we make all sorts of different assumptions and make predictions, but that’s really more than I think we can expect our staff to do.”

Despite the objection, Seeling did the analysis, considering three different scenarios.

One assumed that the fund’s investments earned what CalPERS was expecting, an average annual return of 8.25% over the coming decade.

In that case, even with improved pension benefits, the annual contribution required from taxpayers would actually go down. By Seeling’s calculations, it would hover around $650 million a year — $110 million less than the state was currently chipping in.

A second scenario showed what would happen if the investments earned 12.1% per year on average: CalPERS would be so flush that the state would not have to contribute any money.

Then Seeling turned to his most pessimistic assumption: investment growth of 4.4% per year, about half the rate CalPERS was expecting.

That would be “fairly catastrophic,” Seeling said at a May 18, 1999, meeting of the board’s benefits committee.

The scariest part of that scenario was a hypothetical 18% one-year loss in investment value, which would require a multi-billion-dollar bailout from taxpayers.

The discussion was over in a few minutes, and board members did not revisit the issue, according to meeting transcripts. That summer, they approved the benefits expansion, the legislature passed it by overwhelming margins in both houses and the governor signed the bill in September 1999.

In November, CalPERS executives produced an in-house video congratulating themselves, Davis and the sponsoring legislators.

Crist appears, applauding the board for finding a way to ensure secure retirements for state employees “without imposing any additional cost on the taxpayers.”

The measure was “the biggest thing since sliced bread,” Perry Kenny, then president of the California State Employees Assn., says on the video.

No less enthusiastic were unnamed state employees interviewed on-camera. “I have so much I want to do, and I dreaded being too old to enjoy it,” says one, adding that the opportunity to retire comfortably at 55 “opens up a whole new world to me.”

The next year, 2000, the Dow Jones Industrial Average dropped for the first time in a decade, by 6%. The following year, it fell 7%, and then again the next year, by 17%.

CalPERS investments lost 3% in 2008 and 24% in 2009 — wiping out $67 billion in value (click on image).

Crist retired from the board and CSU in 2003. In 2010, his name surfaced in a pay-to-play scandal that rocked CalPERS. After retiring, he had accepted more than $800,000 from a British financial firm to help secure hundreds of millions in investments from the pension fund. Crist was not accused of wrongdoing

His wife said he suffered a stroke three years ago and was unable to respond to questions for this article.

His state pension is $112,000 per year, CalPERS records show.

***************

Although all state employees benefited from SB 400, none hit the jackpot quite like the 6,500 sworn officers then on the California Highway Patrol. Previously, their pensions had been calculated by multiplying 2% of their salary times the number of years they worked. SB 400 raised that to 3%.

It was an innocuous-looking change on paper, but it had a huge effect.

CHP officers who retired in 1999 or earlier after at least 30 years on the job collected pensions averaging $62,218, according to CalPERS data.

For those who retired after 1999, the average pension was $96,270.

The average retirement age for CHP officers is 54. Someone that age without a pension who wanted to buy an annuity to generate the same income for life would have to pay more than $2.6 million, according to Fidelity Investments.

Few Americans have that kind of nest egg.

About a third of those between 55 and 64 have no retirement savings, according to Alicia Munnell, who was an economic advisor to President Bill Clinton and is now director of the Center for Retirement Research at Boston College. For those with savings, the median was $111,000 in 2013, she said.

Jon Hamm, the recently retired chief executive of the California Assn. of Highway Patrolmen, is widely regarded as the father of the “3 at 50” formula, which has been expanded to cover prison guards, police and firefighters across the state.

Hamm said he now worries that “pension envy” could lead to a backlash against public employees.

“If I was in the private sector just struggling to get by, had no dream of retiring, would I be upset?” Hamm asked during a recent interview. “Yeah. And we have to understand that’s a reality.”

Joe Nation, a former Democratic assemblyman who teaches public policy at Stanford’s Institute for Economic Policy Research, sees the same reality bearing down on public employees. He believes their sweetened pensions are not sustainable.

“There’s no way to close this gap without some sort of hit, or financial pain, for those employees,” he said.

He pointed to Detroit, where pensions were cut by nearly 7% after the city went bankrupt in 2013.

California labor leaders insist that could not happen here because state courts have ruled that pension benefits promised on the day an employee begins work can never be reduced.

Pensions have not been cut in any of the three California cities that declared bankruptcy in recent years — Stockton, San Bernardino and Vallejo.

But a number of rulings in those and other California cases have paved the way for a state Supreme Court showdown on whether bankrupt cities can treat retirees like other creditors, forcing them to stand in line hoping for pennies on the dollar of what they are owed.

Nation said he has been vilified by labor leaders for suggesting public employees voluntarily surrender some of their benefits. He comes from a family of public employees and was a union representative in the 1980s when he worked as a flight attendant for Pan Am.

“It’s hard to believe anyone would consider me anti-union,” Nation said. “I’m just a Democrat who can do math.”

***************

When the legislature considered SB 400 in 1999, Democrats championed the expansion of pension benefits. Most Republican legislators voted for it, too — a reflection of the economic optimism of the time.

Dan Pellissier, then an aide to Republican Assembly leader Scott Baugh, said he was surprised that CalPERS thought it could afford such generosity toward future retirees, himself included. But he was not inclined to doubt it.

“It came down to everyone wanting to believe that CalPERS were masters of the universe,” said Pellissier. “I figured, who am I to substitute my judgment for theirs?”

He feels differently now. Pellissier is president of an advocacy group called California Pension Reform, which is seeking to curb retirement benefits.

In the Assembly, Democrats voted unanimously for the bill, as did 23 of 32 Republicans.

Lou Correa, then a freshman Democrat who carried the bill in the Assembly, said he fell victim to inexperience. He remembers seeing actuarial reports and assuming he’d “kicked the tires” and asked the right questions.

Correa, now running for Congress in Orange County’s 46th district, said he should have sought independent financial advice.

In the Senate, it took Deborah Ortiz less than 45 seconds to pitch SB 400 to her colleagues on Sept. 10, 1999. She sponsored the bill because her Sacramento district had the most state workers.

Ortiz recited a few changes to complicated retirement formulas and then pointed to the security staff, the sergeants-at-arms, noting their retirements would be enhanced with a yes vote.

The measure passed unanimously, without debate.

Ortiz now runs a Sacramento nonprofit that resettles refugees and victims of human trafficking.

In a recent interview, she said CalPERS’ assurances that investments growth would cover the costs “made sense at the time,” and there was no real opposition from any of the state government’s financial analysts.

“All of the assumptions across the board were wrong,” Ortiz said. “I don’t think it was anything nefarious. Everyone was just wrong.”

Davis said he took “with a grain of salt” assurances that SB 400 wouldn’t cost taxpayers anything extra. Still, he recalled, CalPERS had seen steady gains in its investments and at the time had billions more than it needed to meet its obligations.

“I believed, when I signed it, it was sustainable,” Davis said. “I knew it might take some tweaks here and there…but nobody on the planet Earth predicted we’d be going through what 2008 brought us.”

In 2003, months into his second term, Davis became the first California governor to be recalled from office. His successor, Arnold Schwarzenegger, tried to rein in pension costs but failed. He blamed fellow Republicans in the legislature for voting against his proposal in return for contributions from the state prison guards union.

In 2012, Gov. Jerry Brown, a Democrat, persuaded the legislature to raise the retirement age for new employees and reduce their benefits slightly. That will save money decades from now, when those employees retire, but it will not reduce the cost of benefits already locked in for active and retired workers.

Lawmakers blocked Brown’s broader effort to create a hybrid retirement system, with some of the state’s contribution steered to 401k accounts, which are much less costly for employers because they don’t guarantee benefits.

Brown also failed in his bid to add independent members to state retirement boards — people with financial expertise and no ties to public employee unions.

The outcome didn’t surprise Ron Seeling. If the board had included truly independent financial experts in 1999 — the state treasurer and controller, he noted, are elected officials dependent on campaign contributions — they might have pushed to save the extra money from the boom years for a “rainy day,” he said.

“They had that surplus, and there was an incredible push to spend it,” said Seeling who collects a $110,000 state pension after a 20-year career at CalPERS.

“Politics and pensions just don’t mix. That’s all there is to it.”

This is a superb article on California’s pension crisis and demonstrates why so many state pensions are crumbling, forcing a looming showdown with taxpayers to bail them out.

In a nutshell, Ron Seeling — CalPERS’ former chief actuary, and the person whose dire investment scenario was completely ignored back in 1999 — is absolutely right, politics and pensions don’t mix well.

I will keep my thoughts brief and to the point but make sure you read them to understand why so many state pensions are in such dire straits:

• First, almost all US state pensions are delusional, clinging on to their pension rate-of-return fantasy (of 8% or 7% nominal rate) in order to avoid hard choices which come along with lowering their investment assumptions which is what they use as a discount rate to value future liabilities.We can argue whether state pension deficits hover around a trillion dollars or whether there is a six trillion pension cover-up, but there is no arguing that they exist and are placing increasing pressure on public finances diverting money from other critical areas (education, infrastructure, etc.).
• After my conversation with HOOPP’s Jim Keohane last week,  Leo de Bever, AIMCo’s former CEO, told me the problem with using funded status as a measure of a pension plan’s health is US state pensions use expected returns to discount their future liabilities and he thinks 7% or 8% nominal expected return is “too high” in this environment. He’s too kind. Neil Petroff, Ontario Teachers’ former CIO once told me bluntly: “If US state pensions were using our discount rate (now less than 5% nominal), they’d be insolvent.”
• Third, state governments are also to blame for this mess as they went years without topping up their public pensions, and that was a very costly mistake. In order to combat the problem, state governments tried (unsuccessfully) to cut benefits or worse still, to shift new employees to defined-contribution plans, which will only exacerbate pension poverty in the United States.
• Fourth, US public sector unions have also contributed to this mess by asking for benefits which quite frankly border on the insane and are unsustainable. The list of public sector US pensioners collecting $100,000++ in retirement benefits is growing and it makes you wonder, what planet do these people live in?!?
• In Canada, defined-benefit pensions are managed much better because they got the governance right (and politics out of pensions), the discount rates used to discount future liabilities are much more realistic, many plans are fully-funded because they have adopted a risk-sharing model where plans sponsors and beneficiaries share the risk of the plan equally, and the pension payouts, while solid, are nowhere near as lavish as what you see in the United States.

When I look at what is going on the United States, it doesn’t surprise me one bit the pension Titanic is sinking. Unsustainable return assumptions and unsustainable pension benefits all add up to an unsustainable retirement system which is flirting with disaster.

In some cities, like Dallas, disaster has already hit their public sector pensions, but that is only the tip of the iceberg. Wait until the next financial crisis hits bringing about global deflation, it will decimate pensions, especially chronically underfunded US public pensions.

And for all of you wondering why Canada’s senior pension officers get compensated extremely well, ask yourself this, would you rather be part of a HOOPP, Ontario Teachers’ or other large Canadian defined-benefit pension, bringing you great news in a tough environment for all active managers, or would you rather be part of an Illinois Teachers Retirement System teetering on collapse, forcing taxpayers to shore it up to the tune of of $421 million next year?

Sure, Dallas, Chicago and Illinois public pensions are among the worst of the bunch, but there is clearly a big, if not huge, public pension mess in the United States that has yet to be addressed adequately. And mark my words, the next financial crisis will expose the US pension crisis once and for all.

What else? As I keep warning you, pension deficits are also a problem for the economy because they are deflationary. More taxpayer money to top up public pensions means less money for goods and services and shifting public pensions into defined-contribution plans, a proposal being discussed in Missouri and elsewhere, will only exacerbate this deflationary trend because it will exacerbate inequality.

Also, DC pensions are NOT DB pensions, they are savings plans which are subject to the vagaries of public markets and are not in the best interests of pension beneficiaries or taxpayers over the long term.

I better stop there but take the time to think through my comments above.

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

The Ontario Teachers’ Federation put out a press release, Surplus funds will further restore inflation protection for retired teachers:

The Ontario Teachers’ Federation (OTF) and the Ontario Government, joint sponsors of the $171.4 billion Ontario Teachers’ Pension Plan (Teachers’), will use a portion of the $13.2 billion surplus in the Plan (as of January 1, 2016) to partially restore inflation protection for teachers who retired after 2009.

“Conditional inflation protection has proven to be an effective tool for managing Plan deficits and now, for the third year in a row, the sponsors will use some of the surplus to partially restore indexing that pensioners lost in recent years,” said OTF President Mike Foulds. “The remainder of the surplus will be kept in reserve to provide benefit and contribution rate stability against future funding challenges such as low interest rates and increasing longevity, both of which increase the Plan’s liabilities.”

Pensioners who retired after 2009 will receive a one-time increase in January 2017 to restore their pensions to the levels they would have been at, had full inflation protection been provided each year since they retired. They will also receive a slightly higher inflation increase next year for the portion of their pensions earned after 2009. Cost-of-living increases for this portion of pension credit will equal 90% of the annual increase in the Consumer Price Index (CPI), up from the current level of 70%. Pension credits earned before 2010 remain fully inflation-protected.

Pensioners who retired before 2010 are unaffected by these latest changes because pension credits earned before 2010 receive full inflation protection. Working members are also unaffected because annual inflation adjustments are determined after retirement.

Last March, Teachers’ reported its third surplus in a decade. A preliminary funding valuation showed that the Plan was 107% funded at the beginning of 2016, based on current benefits and contribution rates.

About Teachers’

With $171.4 billion in net assets as of December 31, 2015, the Ontario Teachers’ Pension Plan is the largest single-profession pension plan in Canada. An independent organization, it invests the pension fund’s assets and administers the defined benefit pensions of 316,000 active and retired teachers in Ontario.

About OTF

The Ontario Teachers’ Federation is the advocate for the teaching profession in Ontario and for its 160,000 teachers. OTF members are full-time, part-time and occasional teachers in all publicly funded schools in the province – elementary, secondary, public, Catholic and francophone.

On Monday, I went over a recent conversation with HOOPP’s Jim Keohane where we discussed markets and I brought up an article he had written with Hugh O’Reilly, President and CEO of OPTrust, which discusses funded status as a better measure of a pension fund’s success.

In that comment,  I stated the following:

No doubt, you need to pay your investment officers properly, especially in private markets like private equity, real estate, and infrastructure which require unique skills sets, but the message that Jim Keohane and Hugh O’Reilly are conveying is equally important, pensions need to focus first and foremost on their funded status, not taking huge risks to beat their policy portfolio benchmark.

The nuance here is that you can’t blindly compare the performance of one pension plan to another without first understanding how their liabilities are determined and what their funded status is.

For example, Ontario Teachers and HOOPP are widely regarded as two of the best pension plans in Canada, if not the world. They both use extremely low discount rates (HOOPP’s is 5.3% and Teachers’ is just below 5% because it’s a more mature plan and its members are older) to determine their liabilities, especially relative to US pensions which use expected returns of 7% or 8% to determine their liabilities (if US pensions used the discount rate HOOPP and Ontario Teachers use, they’d be insolvent).

In 2015, Ontario Teachers returned 13% as growth in its private market assets really kicked in while HOOPP which is more heavily weighted in fixed income than all of its larger Canadian peers only gained 5.1% last year.

A novice might look at the huge outperformance of Ontario Teachers as proof that it’s a better managed plan than HOOPP but this is committing a fatal error, looking first at performance, ignoring the funded status.

Well, it turns out that HOOPP’s funded position improved last year as it stood at 122%, compared to 115% in 2014, placing it in the top position of DB plans when you use funded status as the only real measure of success (less contribution risk relative to other DB plans). And unlike others, HOOPP manages almost all its assets internally and has the lowest operating costs in the pension industry (it’s 30 basis points).

Now, to be fair, Ontario Teachers’ is a much larger pension plan and it too is now fully funded and does a lot of the things HOOPP does in terms of internal absolute return arbitrage strategies and using leverage wisely to juice its returns, but the point I’m making is if you’re looking at the health of a plan, you should focus on funded status, not just performance.

Yes, the two go hand in hand as a pension that consistently underperforms its benchmark will also experience big deficits but it’s not true that a pension plan that consistently outperforms its benchmark will enjoy fully or super-funded status.

Why? Because as I keep hammering on my blog, pensions are all about managing assets AND liabilities. If you’re only looking at the asset side of the balance sheet without understanding what’s driving liabilities, your plan runs the risk of being underfunded no matter how well it performs.

Now, to be fair, I should also point out that unlike Ontario Teachers and HOOPP, most of Canada’s large pension funds (like bcIMC, the Caisse, CPPIB and PSP) are NOT pension plans managing assets and liabilities. They are pension funds managing assets to beat their actuarial target rate of return which is set by their stakeholders who know their liabilities.

Also, unlike many other pension plans, HOOPP, Ontario Teachers and a few other Ontario pensions (like OPTrust and CAAT) have adopted a risk-sharing model which basically states the members and the plan sponsor share the risk of the plan if a deficit occurs. This effectively means that when a deficit persists, members can face a hike in contributions or a reduction in benefits.

In a follow-up comment going over the executive shakeup at CPPIB, I clarified something:

I also want to stress something else, when I compare Ontario Teachers’ to HOOPP, it’s not to claim one is way better than the other. Both of these pension plans are regarded as the best plans in the world so comparing them is like comparing Wayne Gretzky to Mario Lemieux. They also have some key differences in size and maturity of their plans which makes a direct comparison difficult, if not impossible.

The point I’m trying to make, however, is anyone looking to be part of a great defined-benefit plan would love to be a member of HOOPP or Ontario Teachers and I don’t blame them.

As far as CPPIB, I trust Mark Wiseman’s judgment which is why I trust that Mark Machin and his new senior executives are all more than qualified to take over and deliver on the fund’s long term objectives during the next phase which will be far more challenging in a ZIRP and NIRP world.

So the next time you hear some reporter lament about a big shakeup at CPPIB, please refer them to this comment and tell them to relax and stop spreading misleading information.

Ever notice how reporters love reporting BAD news? I guess it sells more newspapers but it’s equally important to report GOOD news.

And this latest decision to use a portion of the surplus funds to restore inflation protection for Ontario teachers who retired after 2009 is great news.

When I went over Ontario Teachers’ 2015 results, I actually spoke to Ron Mock, Teachers’ CEO, about what they are going to do with surplus funds.

I told him it’s best to save the surplus for a rainy day. He agreed but he also told me that this decision is up the Ontario Teachers’ Federation and Ontario’s government and that OTPP can only make recommendations.

I guess everyone got a little something in this decision and they wisely only used a portion of the surplus (what percentage is confidential) to restore inflation protection to teachers who retired after 2009.

Of course, to even contemplate restoring inflation protection, pension plans need a surplus to begin with, and most pension plans are struggling with deficits and can only dream of achieving the funded status of an Ontario Teachers or a HOOPP.

This decision also highlights something else I’ve been discussing, the importance of implementing a shared-risk model so beneficiaries and plans sponsors equally share the contribution risk of the plan if a deficit occurs and enjoy benefits (like lower contribution rate or full inflation protection) when the plan has a surplus.

It’s not rocket science folks. You need good governance, a shared-risk model, an independent and qualified board overseeing qualified investment officers who can deliver outstanding results over the long term and get compensated properly for delivering these stellar returns.

This is why I firmly believe the solution to any retirement crisis centers around large, well-governed defined-benefit plans. If you aren’t convinced, just look at the success of HOOPP and Ontario Teachers’ Pension Plan. The proof is in the pudding, it’s right there staring all of us in the face.

Ontario’s teachers and healthcare workers are very lucky to have their retirement managed by world class pension plans. Unfortunately, too many Canadians don’t have this luxury and fall through the cracks after they retire with little or no savings.

This is why I kept pounding the table to enhance the CPP so more Canadians can retire in dignity and security but a lot more needs to be done.

I’ll give you some examples. Some people don’t contribute directly to the Canada Pension Plan and if they manage to save for retirement, they can only opt for mutual funds that can only invest in public markets and charge huge fees. Why shouldn’t they be able to invest their hard earned savings in the CPP so their retirement can be managed by the CPPIB which invests directly in public and private markets all over the world?

What else? The Registered Disability Savings Plan (RDSP) is a Canada-wide registered matched savings plan specific for people with disabilities. It’s a fantastic plan for people with disabilities and parents who care for children with disabilities. Again, why not offer these people the chance to invest in the CPP so their disability savings can be managed by the CPPIB?

[Note: Of course, the financial services industry wouldn’t be to happy competing with CPPIB or any of Canada’s large, well governed pensions.]

In my last comment going over the 2016 Delivering Alpha conference,  I stated the following:

What are long-term investors like pensions suppose to do? Well, they can read the wise insights of Jim Keohane, Leo de Bever and others on my blog but I have to tell you, there’s no magic bullet in a low growth environment where ultra low and negative rates are here to stay.

I’ve long warned all investors to prepare for lower returns and think it’s going to get harder and harder for large hedge funds and private equity funds to deliver alpha in a ZIRP and NIRP world.

In this environment, I believe large, well-governed defined-benefit pensions with a long-term focus have a structural advantage over traditional and alternative active managers who are pressured to deliver returns on a short-term basis.

So, if you’re retirement savings are being managed by a HOOPP, OTPP, CPPIB, Caisse, PSP, OMERS, bcIMC, AIMCo, OPTrust, and other large, well-governed pensions, you’re very lucky. For the rest of you, try to save a nickel for retirement and prepare for pension poverty.

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

Barbara Shecter of the National Post reports, Mark Jenkins is leaving CPPIB, triggering executive shakeup at pension manager:

Mark Jenkins, global head of private investments at Canada Pension Plan Investment Board, is leaving the pension management organization, triggering an executive shakeup just three months after Mark Machin took over for outgoing chief executive Mark Wiseman.

Jenkins, who joined CPIB in 2008, is leaving on Sept. 16 to take a senior leadership role at The Carlyle Group.

Shane Feeney, who was head of direct private equity for CPPIB, will take over as global head of private investments. Ryan Selwood, who led the organization’s direct private equity activities in Europe, becomes head of direct private equity.

CPPIB also announced that Graeme Eadie, who was head of real estate investments, will now oversee both that department and the infrastructure and agriculture groups at the pension management organization that invests and manages assets on behalf of the Canada Pension Plan.

The CPP Fund was valued at $287.3 billion as of June 30.

Wiseman left CPPIB in June, about four years into an expected five to seven-year run as chief executive, to take a senior role at Blackrock, the world’s largest asset manager. The move surprised many observers, particularly in light of the much longer transition time when Wiseman took over from his CPPIB predecessor David Denison.

The pension organization’s board conducted an internal and external search for Wiseman’s replacement, settling on Machin, a 49-year-old British citizen who had joined CPPIB just four years earlier to oversee international investment activities. Machin was a 20-year veteran of Goldman Sachs, including six years running Goldman’s investment banking division in Asia. In mid-June, he became the first non-Canadian to lead CPPIB.

Jenkins, who graduated from Queen’s University in Ontario, also worked at Goldman Sachs before joining CPPIB, putting in more than 10 years in senior positions within the investment bank’s fixed income and financing groups in New York. He could not be reached for comment, but a source said his new job is expected to involve the debt markets, which was an area of focus earlier in his career.

CPPIB has kept deals moving through the pipeline despite the internal changes. On Monday, the Canadian pension organization teamed up with private equity player TPG Capital to invest US$500 million for a 17 per cent stake in MISA Investments Limited, the parent company of Viking Cruises.

Viking Cruises runs river and ocean cruises, operating more than 61 vessels based in 44 countries.

Scott Deveau and Devin Banerjee of Bloomberg also report, Carlyle Hires Jenkins to Head Global Credit From Canada Pension:

Mark Jenkins is joining Carlyle Group LP as head of global credit, exiting the Canada Pension Plan Investment Board amid a shakeup of the country’s largest pension fund.

Jenkins will oversee most of the Carlyle unit previously run by Mitch Petrick. He will also become a member of Carlyle’s management committee, the Washington-based asset manager said in a statement Monday. He’ll start later this month and be based in New York.

Jenkins’s departure comes less than four months after Toronto-based Canada Pension announced Mark Machin would take over as chief executive officer, replacing Mark Wiseman, who left to become a senior managing director at BlackRock Inc.

Canada Pension will create a new investment unit called Real Assets that will combine real estate investments, infrastructure and agriculture groups under one umbrella to be lead by Graeme Eadie, the fund said in a statement. Eadie has been with Canada Pension since 2005, most recently serving as global head of real estate.

Jenkins, who was global head of private investments and leaves on Sept. 16, will be replaced by Shane Feeney, the pension fund’s current head of direct private equity who has been with Canada Pension since 2010. Feeney will be replaced by Ryan Selwood, the pension fund said.

‘Bench Strength’

“These appointments demonstrate the deep bench strength and investment expertise we have developed at CPPIB,” said Machin. “Graeme, Shane and Ryan have been instrumental in a number of our major transactions and will no doubt continue to provide superb leadership in their new roles.”

Carlyle has been reviewing its global market strategies unit, which houses the firm’s credit and hedge funds, after the division’s leader Petrick left in May. Since then, Carlyle has sold one if its hedge funds, Emerging Sovereign Group, and continued to transition another, Carlyle Commodity Management, toward new investment strategies.

The firm’s credit funds manage loans, structure credit, private debt, energy credit and distressed debt.

“Our credit business is broad and deep with tremendous growth potential,” Bill Conway and David Rubenstein, Carlyle’s co-CEOs, said in the firm’s statement. “Mark is an experienced and proven investment leader who will help take our firm to a new level of success.”

Canada Pension oversees the retirement savings of 19 million Canadians with C$287.3 billion ($219.4 billion) in assets under management.

Carlyle manages $176 billion in private equity holdings, credit assets, real estate and hedge funds. The firm was founded in 1987 by Conway, Rubenstein and Chairman Dan D’Aniello.

Matt Jarzemsky of the Wall Street Journal also reports, Carlyle Taps Pension Fund Executive to Run Credit Investing Operations:

LP hired a senior executive from Canada’s biggest pension fund to oversee debt investing, part of the asset manager’s effort to regroup from setbacks in its credit and hedge funds business.

Washington, D.C.-based Carlyle tapped Mark Jenkins, most recently head of global private investments at Canada Pension Plan Investment Board, for the newly created position, according to a statement.

The hire follows a series of setbacks in Carlyle’s global market strategies arm, which encompasses much of the firm’s investing outside of private equity and real estate. Like its peers, the firm has expanded beyond its roots in corporate buyouts over the years, seeking to diversify, boost assets and appeal to shareholders following its 2012 initial public offering.

Global market strategies has been a sore spot for Carlyle, largely because of struggles at its hedge funds Claren Road Asset Management, Vermillion Asset Management LLC and Emerging Sovereign Group LLC. In May, Mitch Petrick stepped down from a role running the $34.7 billion business. Carlyle tasked longtime private-equity executive Kewsong Lee to rebuild it and has said it is reviewing options to improve the unit’s performance.

Overall, global market strategies’ funds have fallen in four-straight quarters, including a 12% decline the first three months of the year.

Mr. Jenkins is focused on the unit’s credit investing, which includes energy lending, providing capital to mid-sized companies and bets on distressed debt.

Credit is an “established, profitable business” for Carlyle, Mr. Lee said in an interview. “Mark’s hiring makes a strategic statement that we are committed to investing in and growing the credit platform.”

Carlyle has been active in collateralized loan obligations, distressed investing and other areas of credit over the years. It may seek to build on its nascent debt business in Europe or providing bonds and loans to small companies or those with atypical capital needs.

During his eight years at CPPIB, he built the pension fund’s direct-lending business and oversaw its $12 billion acquisition of General Electric Co. ’s private-equity lending business, Antares Capital. Before that, Mr. Jenkins co-led Barclays PLC’s leveraged-finance business in New York and worked in Goldman Sachs Group Inc.’s finance and fixed-income departments.

CPPIB, like other Canadian pensions, takes stakes in funds managed by Carlyle and other firms but also directly invests in companies and other assets. In recent years, the pension has invested in department-store chain Neiman Marcus Group, retailer 99 Cents Only Stores and health-care information technology company IMS Health Inc.

CPPIB promoted managing director Shane Feeney to global head of private investments, succeeding Mr. Jenkins, according to a statement.

Lastly, FINalternatives reports, Carlyle Strengthens Executive Team With Jenkins, Sokoloff Hires:

Global alternative asset giant Carlyle Group has made two additions to its senior management team.

Mark Jenkins, former global head of private placements for the Canada Pension Plan Investment Board (CPPIB), has joined the firm as head of global credit, while it has also brought former Jefferies global head of financial sponsors Adam Sokoloff aboard as an executive in its private equity group.

Jenkins will be based in New York and will start at Carlyle by the end of September, the company said in a statement. During his eight years with CPPIB, he built and oversaw the principal credit investments group, the multi-strategy credit investment platform at CPPIB, led the acquisition of Antares Capital and the expansion of CPPIB’s middle-market direct lending efforts. Prior to CPPIB, he was co-head of leveraged finance origination and execution for Barclays Capital and worked for 11 years at Goldman Sachs & Co.

Sokoloff, meanwhile, joins Carlyle’s private equity efforts after a 14-year stint at Jefferies, where he was global head of the bank’s financial sponsor advisory business. He will be tasked with finding deals for the company’s mid-market funds, according to a Bloomberg article citing an email Sokoloff wrote to clients and friends on Monday.

Sokoloff left New York-based Jefferies in March after the firm merged its junk-rated loans and business into a joint venture with MassMutual Finance Group. Sokoloff was replaced by U.S. sponsors co-head Jeffery Greenip.

Carlyle raised $2.4 billion for its second middle-market equity group in February, according to Bloomberg. The buyout vehicle aims to make control investments of $20 million-$200 million in middle-market businesses.

Carlyle manages $176 billion in private equity holdings, credit assets, real estate and hedge funds across 127 funds and 164 fund of funds vehicles as of June 30, 2016. The firm was founded in 1987 by David Rubenstein, Bill Conway and Dan D’Aniello.

You can read more articles on Mark Jenkins leaving CPPIB here.

So, why is Mark Jenkins leaving CPPIB and more importantly, will CPPIB survive this latest high profile departure?

First, let me address the second question and calm a lot of nervous reporters contacting me worried that CPPIB is going down the drain after the departure of Mark Wiseman and now the departure of Mark Jenkins, global head of private investments.

There is no question in my mind — none whatsoever — that CPPIB can survive not just the departure of a Wiseman or Jenkins but even a Machin. In fact, in the Bloomberg article above, CPPIB’s CEO Mark Machin stressed there is “deep bench strength and investment expertise” in this organization. Mark Wiseman told me the exact same thing after the announcement he is leaving CPPIB a few months ago.

Reporters love making a big stink about these executive shakeups but if you’ve been around Canada’s pension industry long enough, you’ll know it’s all part of the game, especially when a new CEO takes over.

Sometimes new CEOs make minor changes to the executive ranks and sometimes they make drastic changes. Personally, I hate it when they make drastic changes to place their “own people” in key positions because it’s not only costly (ie., huge severance packages for letting go of senior investment officers for reasons other than performance) but it also disrupts the culture of the organization, typically in a negative way.

But I’m not a CEO of a major Canadian pension fund so to be fair, it’s easy for me to make these judgment calls from the outside looking in and to be sure, often there are valid and good reasons to shake things up at the executive ranks (like getting rid of people who aren’t on the same page as you when it comes to the culture of the organization).

Now, let’s go over why Mark Jenkins left CPPIB to join the Carlyle Group. I have never met or spoken to Jenkins so here I’m going to speculate a bit and if I’m off, please be my guest and contact me to let me know.

I personally think Jenkins was disappointed he wasn’t named CEO after Mark Wiseman stepped down to join Blackrock. He probably contacted a global executive search firm to let them know he’s looking to move from CPPIB or more likely, he directly contacted senior executives at the Carlyle Group which is one of several private equity relationships at CPPIB (see the entire list of CPPIB’s private equity partners here).

[Note: Another possibility is Jenkins advised Mark Machin and CPPIB’s board before accepting this offer but that’s not the way things typically go down.]

You have to keep in mind that people like Mark Wiseman and Mark Jenkins are not like you and me. Yes, there is no question they’re exceptionally bright, hard workers with tons of great experience (and in the case of Jenkins, he has the coveted “Goldman pedigree”), but they also have a Rolodex of the who’s who in the GP and LP world.

I underlined LP world for a reason. Blackrock and Carlyle didn’t hire Wiseman and Jenkins for their brains and experience, they’re bringing to the table something far more valuable, key contacts which consist of the top sovereign wealth and global pension funds of the world. And in the asset management business, it’s all about garnering ever more assets so you can collect more fees.

This is especially true for a large alternatives shop like Carlyle which has been struggling lately and losing business to rivals like Blackstone, a powerhouse in alternatives which seems to be closing funds faster than it can open them. It also didn’t help that Carlyle’s venture into hedge funds has been an abysmal failure.

The point I’m trying to make here is it’s one thing having Mark Wiseman or Mark Jenkins meet with your established or prospective limited partners and another having Joe Schmoe even if they have a solid pedigree. Why? Because a Mark Wiseman or a Mark Jenkins can better understand the needs of their clients as they sat in their chairs.

What else can I share with you? I’ll admit when I last spoke with Mark Wiseman, I too was a bit surprised Mark Jenkins wasn’t selected to replace him. I didn’t know of Mark Machin but Mark told me that “Mark (Machin) was his right-hand who built CPPIB’s Asian investments” and understood better than anyone the objectives of the organization and where it needs to go after he leaves (aka, he probably highly recommended Machin to CPPIB’s board of directors and they fully agreed with him).

One last governance note. I’m a little uncomfortable watching senior executives leaving Canada’s large pensions to join private sector funds. It’s great for them to have opportunities others can only dream of but let’s call a spade a spade, it’s a huge governance faux pas, especially if they are directly responsible for investing billions in these funds.

[Note: US public pension funds have tight governance rules barring investment officers from joining a fund they directly invested with for a period of three or five years. Again, this is governance 101.]

Also, after Mark Machin was appointed CPPIB’s new CEO, Leo de Bever, AIMCo’s former CEO, appeared on BNN saying he’s worried Canada’s large pensions are going to become the breeding ground for private funds looking to snatch talent away.

Leo and I spoke last night after I wrote my comment on my conversation with HOOPP’s Jim Keohane. Leo told me that HOOPP was the “first large Canadian pension to hedge against a decline in interest rates” and obviously being first mover on that front really helped HOOPP achieve its enviable super-funded status.

Also, please note I’m not a reporter, I don’t tape my conversations, and I’m not always the best short note taker. I try to do my best when covering pensions and investments, and sometimes I get it right but sometimes I don’t.

Jim Keohane sent me a nice email this morning thanking me for writing the comment on HOOPP and shared this: “I might have worded things slightly differently, but I think you captured the spirit of what we talked about quite well.”

I thank Jim and beefed up my last comment on our conversation so you can all better understand the key measure of success at any pension. Leo de Bever told me the problem with using funded status is that US pensions use expected return to discount their future liabilities and that “7% or 8% discount rate is way too high” (again, if they used Ontario Teachers’ or HOOPP’s discount rate, they’d be insolvent).

I also want to stress something else, when I compare Ontario Teachers’ to HOOPP, it’s not to claim one is way better than the other. Both of these pension plans are regarded as the best plans in the world so comparing them is like comparing Wayne Gretzky to Mario Lemieux. They also have some key differences in size and maturity of their plans which makes a direct comparison difficult, if not impossible.

The point I’m trying to make, however, is anyone looking to be part of a great defined-benefit plan would love to be a member of HOOPP or Ontario Teachers and I don’t blame them.

As far as CPPIB, I trust Mark Wiseman’s judgment which is why I trust that Mark Machin and his new senior executives are all more than qualified to take over and deliver on the fund’s long term objectives during the next phase which will be far more challenging in a ZIRP and NIRP world.

So the next time you hear some reporter lament about a big shakeup at CPPIB, please refer them to this comment and tell them to relax and stop spreading misleading information.

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

On Friday, I had a chance to talk to Jim Keohane, President and CEO of the Healthcare of Ontario Pension Plan (HOOPP). Before I get to to that discussion, you should all read an article Jim and Hugh O’Reilly, President and CEO of OpTrust, wrote for the Globe and Mail back in February, Looking for a better measure of a pension fund’s success:

The world of business is one where people like to quantify and measure things. This drive has led to the old saw: “If it can’t be measured, it can’t be managed,” and, like all sayings, it has its portion of truth. However, our desire to measure progress can also leave us vulnerable to certain pitfalls.

Too often, we head down the path of holding up metrics as accurate barometers of success because they represent things that are easy to understand, quantify and report. This then raises questions for any business. Are we are on the right track? Are we truly doing the right things for success, not just for this quarter or year, but for the long term? And, most important, are we measuring the right things?

For example, if you were in the business of cutting paths through a forest, you might take measurements of how straight your paths were and how quickly you were progressing. But those measurements would be completely meaningless if you were cutting a path through the wrong forest.

This is a bit of what goes on in the pension-fund industry. Many pension funds view themselves as asset managers, and their metrics for gauging success focus on how the asset side of their balance sheet has done in comparison with public market benchmarks. There is some validity to this approach at a micro level, but in terms of measuring organizational success, it is akin to measuring results in the wrong forest.

Canada’s large public-sector pension plans have garnered considerable acclaim as investors on the world stage. But it’s a misnomer to call us asset managers. We are pension-delivery organizations. The nature of the product we deliver to our members means our goals are fundamentally different from organizations that are simply looking to accumulate and grow capital. We are investing to deliver a specific outcome, which is to make the pension payments to our members that they are expecting.

Despite this, people inside and outside the industry have historically looked to a measure that is short-term, easy to report and easy to understand: annual investment returns.

Each year, when the results come out, people sift through the numbers like fortune tellers trying to discern the future from tea leaves. But it’s all sleight of hand, a showy distraction from the real action. Annual investment returns are just one part of the complex business of running a pension plan. Ultimately, to be successful in delivering pensions to our members, the assets have to outperform the liabilities (which are the current and future pension payments owed to our members). We measure this by looking at a plan’s funded ratio. If a plan’s current assets are equal or greater than the present value of current and future pension payments, it is fully funded and has achieved success.

Positive investment returns are generally a good indication of success, but not always. There are scenarios in which investment returns have been positive and the funded ratio has declined, and conversely times when investment returns are negative yet the funded ratio improved.

Our own industry has been as guilty as anyone else in trumpeting annual returns. In a world in which so many people are in a pension rat race to accumulate the biggest pot of money before they retire, it feels normal to celebrate when we’ve been able to make our assets perform faster, higher and stronger. However, if we are honest with ourselves, it’s not the business we’re in. Does this mean that returns don’t matter? Not at all. What it does mean is that as pension plans, our investment approach must be inextricably linked to the goal of keeping the plan fully funded.

Growing and maintaining our funding surplus over time to ensure we can deliver pension benefits to our members leads to very different decision-making, particularly when it comes to risk management, and the nature and mix of assets that we hold in the investment portfolio.

For members, the true value of a defined-benefit (DB) pension plan is certainty at a stage of life when there is little runway to accumulate more. Beyond the dollars that will one day be paid, we give members the confidence that they can count on their pension to be there when they retire and that their contributions will remain as stable as possible during their working years.

When creating certainty is the true goal, taking undue risk with members’ futures for the sake of a few hundred extra basis points in a given year makes no sense at all. That is why both of our organizations have adopted an approach that puts funding first, one in which we balance the need to generate returns with the need to effectively manage risk.

When viewed from this perspective, being good, better or best will not be assessed on the basis of a given year’s investment return. Instead, we will measure success by the plan’s funded status. This measure of success also means that plans will be focused on putting the interests of plan members first in the decision-making process. In so doing, we will be putting stock in another old saw: “If it isn’t measured, it doesn’t matter.”

This is a great article which nicely covers the importance of a pension plan’s funded status as the true measure of long-term success.

Interestingly, over the weekend, Suzanne Bishopric forwarded me a Vox Eu comment on measuring institutional investor performance which argues that the skill set of institutional investment officers is critically important in producing meaningful outperformance in private equity and that institutional investors could improve returns by paying their investment officers more, by letting them share the upside, and by monitoring them better.

No doubt, you need to pay your investment officers properly, especially in private markets like private equity, real estate, and infrastructure which require unique skills sets, but the message that Jim Keohane and Hugh O’Reilly are conveying is equally important, pensions need to focus first and foremost on their funded status, not taking huge risks to beat their policy portfolio benchmark.

The nuance here is that you can’t blindly compare the performance of one pension plan to another without first understanding how their liabilities are determined and what their funded status is.

For example, Ontario Teachers and HOOPP are widely regarded as two of the best pension plans in Canada, if not the world. They both use extremely low discount rates (HOOPP’s is 5.3% and Teachers’ is just below 5% because it’s a more mature plan and its members are older) to determine their liabilities, especially relative to US pensions which use expected returns of 7% or 8% to determine their liabilities (if US pensions used the discount rate HOOPP and Ontario Teachers use, they’d be insolvent).

In 2015, Ontario Teachers returned 13% as growth in its private market assets really kicked in while HOOPP which is more heavily weighted in fixed income than all of its larger Canadian peers only gained 5.1% last year.

A novice might look at the huge outperformance of Ontario Teachers as proof that it’s a better managed plan than HOOPP but this is committing a fatal error, looking first at performance, ignoring the funded status.

Well, it turns out that HOOPP’s funded position improved last year as it stood at 122%, compared to 115% in 2014, placing it in the top position of DB plans when you use funded status as the only real measure of success (less contribution risk relative to other DB plans). And unlike others, HOOPP manages almost all its assets internally and has the lowest operating costs in the pension industry (it’s 30 basis points).

Now, to be fair, Ontario Teachers’ is a much larger pension plan and it too is now fully funded and does a lot of the things HOOPP does in terms of internal absolute return arbitrage strategies and using leverage wisely to juice its returns, but the point I’m making is if you’re looking at the health of a plan, you should focus on funded status, not just performance.

Yes, the two go hand in hand as a pension that consistently underperforms its benchmark will also experience big deficits but it’s not true that a pension plan that consistently outperforms its benchmark will enjoy fully or super-funded status.

Why? Because as I keep hammering on my blog, pensions are all about managing assets AND liabilities. If you’re only looking at the asset side of the balance sheet without understanding what’s driving liabilities, your plan runs the risk of being underfunded no matter how well it performs.

Now, to be fair, I should also point out that unlike Ontario Teachers and HOOPP, most of Canada’s large pension funds (like bcIMC, the Caisse, CPPIB and PSP) are NOT pension plans mnaging assets and liabilities. They are pension funds managing assets to beat their actuarial target rate of return which is set by their stakeholders who know their liabilities.

Also, unlike many other pension plans, HOOPP, Ontario Teachers and a few other Ontario pensions (like OpTrust and CAAT) have adopted a risk-sharing model which basically states the members and the plan sponsor share the risk of the plan if a deficit occurs. This effectively means that when a deficit persists, members can face a hike in contributions or a reduction in benefits.

It’s also important to understand that HOOPP didn’t achieve its super-funded status fortuitously. It went though a deep reflection after the tech crash when it was underfunded and Jim Keohane who was then the CIO went to Denmark to understand how ATP was closely managing its assets and liabilities.

That was a huge moment for Jim Keohane and former CEO John Crocker because the entire culture and focus at HOOPP shifted to managing assets and liabilities a lot more closely. That effectively meant HOOPP started immunizing its portfolio, hedging interest rate risk, long before other DB pensions even thought of it and increased its allocation to fixed income assets, effectively derisking its plan and managing its assets and liabilities more closely.

[Note: In a phone conversation, Leo de Bever, AIMCo’s former CEO, told me that “HOOPP started hedging interest rate risk long before others, including Ontario Teachers.” He also told me at one point, Teachers’ had 25% allocated to real return bonds.]

The timing of that decision proved to be critical as HOOPP now enjoys a funded status that most other DB pension plans can only dream of. I wish my father and his physician friends had access to a HOOPP long ago because that would have made their retirement a lot smoother.

[Note: HOOPP is a private plan which manages pensions of Ontario’s healthcare workers but not Ontario physicians. I’m sure if doctors in Ontario had a choice they too would prefer to fork over their retirement savings to HOOPP than some mutual fund in their RRSP and enjoy a real DB, not DC pension.]

The above rant that was my preamble to my conversation with Jim Keohane on Friday. I also got to LinkIn to Hugh O’Reilly and exchanged messages with him but I will have to cover changes at OpTrust another day when I talk with him and his CIO, James Davis.

I’ve said it before and I’ll say it again, Jim Keohane is one of the smartest and nicest pension fund leaders I’ve ever had the pleasure of meeting. They’re all nice but Jim really takes the time to talk to me and explain things in clear terms. I am very fortunate to have access to him and others when covering pensions and investments.

So what did we talk about? We covered a lot  of topics which I will summarize below. Please take the time to read his insights and any errors are entirely mine and will be edited if needed (I will ask Jim to review my entire comment):

• On Fed policy and buying bonds with negative yields: Jim thinks the Fed is in a bad corner and needs to raise rates in order to have ammunition to combat the next recession. He didn’t say whether he thinks the Fed will raise in September or December but he did say with rates at zero, policy will be more constrained when the next crisis hits. More importantly, he told me that HOOPP will never buy bonds with negative yields. “It just doesn’t make sense. Many institutions are forced to which distorts the market but if you think about it, why buy a bond where you know with certainty you’re payoff is negative?” (Leo de Bever thinks the return on risk in bonds will be low to negative in the coming years).
• On real estate over fixed income: That discussion led to an interesting discussion on bonds. I told him that I view bonds as the ultimate diversifier in a deflationary world and can’t take seriously all this talk of a bubble in bonds or cracks in the bond market. Jim explained to me it’s not a matter of bubbles in the bond market, which he doesn’t believe in either, but rather long term investing. “Why hold bonds over the next 15 years? Bonds are a hedge against a decline in rates but rates have already declined significantly.”Okay, fair enough but if not bonds, then what? He told me he prefers real estate with cap rates at 5-6% over bonds over the next 15 years. “Even if you take a big 20% hit on asset values, you will still come out of ahead just on the differential of rates” (I thought to myself true provided of course we are not entering a prolonged period of debt deflation).
• On the risk of deflation or inflation: Jim didn’t tell me whether he thinks deflation will prevail over inflation but he did tell me that real return bonds are very cheap. “The breakeven trade (spread between nominal and real return bond yield) is at historically cheap levels. Market is calling for long term inflation of 1.3% and bonds are pricing in a depression” (all true but I wouldn’t ignore the bond market’s ominous warning).
• On HOOPP’s real estate investments: We talked about Brexit and how cheap the pound is which makes it cheaper for Canada’s large pensions to invest in the UK. Jim told me that HOOPP invested in UK real estate which is basically a large warehouse and port for technology driven firms like Amazon. “You have them in North America but not in Europe and these are great projects with solid tenants. We are even building one for BM in Sweden.”
• Of course, I had to ask why wouldn’t an Amazon or other tech giants invest its mountain of cash in such real estate projects? Jim told me it’s all about return on investment: “Why tie up their capital in a project yielding 6% or 7% per year when they can earn 12% focusing on other projects? The same goes for banks, why buy real estate when they can put your capital at work and earn more elsewhere?” Excellent point.
• On the benefits of greenfield real estate: In December, HOOPP will be moving from 1 Toronto Street to 1 York Street. The new offices will be just a few blocks from its current location. What is interesting about this building is that it was a greenfield project. In fact, 1 York Street is a new 800,000 square foot, 35-storey, LEED Platinum office development in Toronto’s South Core which already has solid tenants. Jim told me “the cost of construction is cheaper than buying a building and even though it took five years to build, it’s well worth it.” He added: “New buildings are significantly more energy efficient which means HOOPP will collect more rent per square foot and the tenants will benefit from less common costs.” Still, he admitted “there is a big time lag in greenfield real estate projects and it takes expertise to do it right.”
• On Vancouver real estate: Jim told me that article about Canadian pensions unloading Vancouver real estate was way overdone and misleading. “Yes we sold one project but are building an ever bigger project a few blocks down which will be a shopping center with condos. No reporter bothered to contact us so we can explain our real estate projects in Vancouver.”
• On pricey infrastructure: I noted that HOOPP is a “big laggard” in terms of infrastructure relative to its larger Canadian peers but this didn’t seem to phase Jim one bit. “If you look at OMERS Borealis, they have a great infrastructure portfolio but they were first movers. That is great for their members but they haven’t done as many big infrastructure investments in the last few years because deals are a lot pricier as competition is fierce.” I asked whether he still thought pensions are taking on too much illiquidity risk and he said “yes, no doubt about it.”
• On the stock market: We talked about stocks and sectors. Jim told me he thinks many banks are cheap, “selling at book value” and that they are still positive on the energy sector. Given my views on deflation (terrible for financials) and the US dollar, I bit my tongue but also understand his long term view.
• On emerging markets: Jim told me that emerging markets are “ok from a price perspective but vulnerable if global liquidity is weak.” Again, given my views on the US dollar and deflation, I would steer clear of emerging markets until a much better buying opportunity presents itself, say if anothert EM crisis erupts.
• On the big risks that keep him up at night: He told me: “With low rates, there’s a lot of risk out there. Valuations are stretched and there’s nothing cheap out there.
• On HOOPP’s S&P volatility trade: In 2012, HOOPP gained a whopping 17% as everything kicked in, including their liability driven investments and long term option strategy which was basically selling 10-year vol when the S&P was at 1000. I asked him if they are buying long term vol at these levels but he told me “it’s priced high”. He also made an excellent point that “10-year vol swaps are NOT 10-year vol options” and “many investors entering these 10-year vol swap trades are going to get killed.”

Finally, it is worth noting that HOOPP is on track for another stellar year, which doesn’t surprise me as I stated this on my blog a couple of months ago. Given their high allocation to fixed income (44%), it’s not surprising that they will deliver outstanding results (bonds are performing well so far this year).

And what if the bond market cracks and rates shoot up? Jim had an answer for that too: “It’s all about assets vs liabilities. If rates go up, our liabilities will decline significantly, so even if we get hit on fixed income, we will still maintain our fully-funded status.”

Smart guy, real smart and super nice. Jim Keohane reminds me a lot of Ron Mock, another nice guy who really knows his stuff. It’s hardly surprising these two pension plans are the envy of the world.

On that note, please forgive my tardy comment, I’ve been battling an ear infection (swimmer’s ear is very painful) and have been visiting our super hospital frequently (looks like antibiotics are kicking in). If there are any errors or additional information, I will edit this comment.
Once again, I thank Jim Keohane for graciously offering his time and wise insights. There are many reasons why HOOPP is one of the best pension plans in the world, and if you ask me, the number one reason is its amazing leader.

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

Tito Boeri, Pietro Garibaldi, Espen Moen wrote a comment for Vox EU, CEPR’s policy portal, Increases in the retirement age and labour demand for youth (h/t, Suzanne Bishopric):

Most European countries have experienced a dramatic increase in youth unemployment since the beginning of the Great Recession in April 2008. For the Eurozone as a whole, employment for people aged between 15 and 24 fell by almost 17% in six years. In southern Europe, the smallest decline was 34% in Italy, and the largest was 57% in Spain. Other age groups suffered less: 3% for the Eurozone as a whole and, for all older age groups in all countries, between one-third and one-sixth of the employment decline for young workers.

In the Eurozone as a whole, employment for people in the 55-65 age group increased by approximately 10%. Demographic factors do not account for these changes. Both employment levels and employment rates moved in opposite directions for young and senior workers (Figure 1).

The strong increase of youth unemployment was predicted by the research on contractual dualism (Saint-Paul 1993, Boeri 2011). This predicts that youth unemployment will respond more strongly to cyclical fluctuations in countries with strict employment protection in permanent contracts and ‘fire-at-will’ for temporary contract workers (Boeri et al 2015). Boeri and Garibaldi (2007) predicted that immediate declines in youth unemployment after two-tier labour market reforms, even under slow growth scenarios, would be followed by youth disemployment when macroeconomic conditions deteriorate. Research on contractual dualism, however, does not explain why employment rates have diverged for young and old.

Figure 1. Employment rate for young and old workers in the EU15

Portugal in 2007, Spain in 2011, Greece in various stages between 2010 and 2016, and Italy in 2011 all increased the retirement age during the recession. So is the decline in youth employment related to changes in the retirement rules? Research on retirement is typically focused on the supply side. As a result, it ignores trade-offs between young and old workers on the demand side. Vestad (2013) used administrative data to estimate the impact of an early retirement programme on youth employment in Norway, but there is little other research on this topic.

The economics of pension reform and labour demand

The economics of a pension reform and labour demand is more subtle than a simple exogenous shift in labour supply. Most of the individuals involved are already employed and cannot be easily fired. Under a pension reform forcing firms to retain older workers, there are two effects at work.

• First, there is a negative scale effect, due to decreasing returns to scale. The reform forces some of the older workers to stay employed rather than retire. This tends to increase output, but with decreasing marginal returns to scale in production, the marginal product of young workers falls and so does youth hiring.
• Second, there is an effect that depends on the degree of complementarity between young and old workers: the stronger the complementarity, the more likely that the reform could positively affect youth employment.

Which one of the two effects – the scale or the substitution effect – prevails is ultimately an empirical matter.

Italy and the Monti Fornero reform

Italy provides an excellent case study of whether unexpected increases in retirement age can have adverse effects on youth employment. In the middle of a recession, labour markets are typically driven by the demand side. In Italy, employment rates for the 15-24 and 55-64 age groups were almost the same in 2005 (Figure 2). Ten years afterwards, the employment rate for the 55-64 age group was 45%, while the youth employment rate was approximately 12%. In this period, the normal retirement age increased, and the minimum contribution requirement for access to early retirement tightened. In December 2011, the Monti Fornero reform increased the retirement age by up to five years for some categories of workers. We use this policy experiment to estimate the impact of increases in retirement age on youth labour demand.

Figure 2. Employment rate for young and old workers in Italy

We had access to a dataset on Italian firms before and after the reform compiled by the Italian social security administration (INPS). We looked at whether a sudden and unexpected increase in the contributory and age requirements for retirement, which forced firms to keep workers previously entitled to pensions to stay in the payroll, affected labour demand for young workers. We identified the population hit by the changes in retirement rules in each firm, and looked at the dynamics of net hiring in the same firms.

The results are clear. Before and after the reform, firms that were more exposed to the mandatory increase in the retirement age significantly reduced youth hiring compared to those who were less exposed to the reforms. We cannot rule out that the latter firms may have increased their hiring as a result of the reform, due to general equilibrium effects. Nevertheless, we argue that the reform was likely to reduce the labour market prospects of young workers.

We estimate that five workers locked in for one year mean the firm hires approximately one less young person. Firms with more than 15 employees lost 160,000 youth jobs in this period. Of these, 36,000 can be attributed to the reform. We performed robustness checks including rolling regressions across the size distribution, propensity score matching, and a falsification test on the pre-reform years.

Policy implications

Cautiously, we make two points.

Reducing the generosity of pensions in the middle of the European sovereign debt crisis was probably inevitable, despite the severe recession that southern European economies experienced. But this tightening could have been done by reducing pensions for workers who were retiring before the normal retirement age. This would have allowed firms to encourage the least productive older workers to retire. With hindsight (as well as the evidence above), much more should have been done by European policymakers to help and sustain young workers who were about to enter the labour market. The equilibrium for young and old workers in the southern European labour market was not what these policies set out to achieve. We risk a lost generation in Europe.

Also, the retirement age should be as flexible as possible. As far as Italy is concerned, the long-run defined contribution system is viable and sustainable. A system like this, though, has a prolonged transition phase. During the medium-run adjustment to the new system, policy should seriously attempt to increase actuarially neutral flexibility in retirement. From the perspective of broader fiscal coordination, our results suggest that short-sighted fiscal rules that force sudden increases in retirement age during major downturns may backfire. They may cause a prolonged and almost total freeze on new hires, particularly when older workers are locked in by the increase in the retirement age.

Fiscal rules should better focus on fiscal sustainability in the long run. A 2005 reform of the Stability and Growth Pact attempted this, but in words, not in practice. It stated that a short-run deterioration in the budget deficit could be tolerated if, at the same time, a government reduces its long-run liabilities. In practice, however, this principle can only be enforced by explicitly including in the pact any efforts that reduce the hidden liabilities associated with social security entitlements, the most important long-run liabilities in our ageing societies.

This means that a citizen could be given some freedom to retire when he or she wants, provided the size of the pension reflects age and life expectancy. More pensions could be paid under downturns without affecting long-term liabilities, because the additional pensions for early retirees would be lower than those paid to people who retiring later. Therefore this system could be budget-neutral and operate as an automatic stabiliser. A pact that allows for sustainable flexibility in retirement would also help countries facing the huge demographic shock that is associated with the current refugee crisis.

References

Boeri, T. (2011) “Institutional reform and dualism”, Handbook of Labor Economics 4b ed. D. Card and O. Ashenfelter. Elsevier.

Boeri, T. and Garibaldi P. (2007) “Two Tier Reforms of Employment Protection: a Honeymoon Effect?” The Economic Journal 117 (521), F357-F385

Boeri, T., Garibaldi, P. and E. R. Moen (2015) “Graded security from theory to practice”, VoxEU.org, 12 June.

Boeri, T. Garibaldi, P. and E. R. Moen (2016) “A Clash of Generations? “Increase in Retirement Age and Labor Demand for Youth”, CEPR Discussion Paper 11422 and WorkInps Paper 1.

Saint Paul, G. (1993) “On the Political Economy of Labor Market Flexibility”, NBER Macroeconomic Annual 151-192

Vestad, O. L. (2013) “Early Retirement and Youth Employment in Norway”, Statistic Norway.

The theme this week is the global pension crunch which is why I covered developments in China, Chile, Brazil and now looking more closely at the Eurozone’s pension woes.

Today’s comment happens to coincide with the ECB’s monetary policy decision (more on that below) and this was done purposely to demonstrate why Mario Draghi’s worst nightmare is far from over.

Regular readers of my blog will recall that I called checkmate for Europe’s pensions back in March and basically haven’t changed my mind on the dismal prospects and huge challenges Eurozone’s pensions have to contend with.

As far as the findings of the academics above, I’m hardly impressed. They are basically arguing that increasing the retirement age in Greece, Italy, Portugal and Spain after the Great Recession exacerbated youth unemployment in southern Europe and we risk seeing a lost generation in Europe because of these retirement reforms.

Being good academics, the authors claim they “performed robustness checks including rolling regressions across the size distribution, propensity score matching, and a falsification test on the pre-reform years.”

It all sounds so legitimate and “robust”. Unfortunately, it’s mostly academic nonsense and the primary reason why I stopped reading a lot of academic literature on economics.

Do you want to know the real reason why youth unemployment is soaring in Greece and southern Europe?  It’s not because they followed the rest of the developed world and increased the retirement age. It’s because of archaic labor laws that basically protect powerful interest groups and virtually make it impossible to introduce real labor market competition in these countries.

I am going to talk about Greece because I know what that country extremely well. Very bright Greeks, mostly Greeks living outside Greece (and some living there), know exactly what Greece needs in terms of meaningful reforms.

Much has been made lately about how the IMF screwed up with Greece — and to be sure, it did — but little attention is being placed on how successive Greek governments refuse to implement much needed reforms to finally break the bloated public sector which is crippling their economy.

Let me be clear, I have nothing against a well managed and strong public sector but any country that experiences a sovereign debt crisis and keeps expanding its public sector is doomed to fail.

And let me take it a step further and state this: any country that relies on the primacy of its public sector is doomed to fail. I don’t care if it’s Greece, Italy, Spain, Portugal, France or even Canada, a thriving public sector at the expense of a dwindling private sector is a recipe for disaster.

I mention this because in Greece, it’s business as usual as Prime Minister Alexis Tsipras recently announced plans to overhaul the Constitution in order to hire 20,000 civil servants.

You read that right, bankrupt Greece wants to increase its bloated public sector after it went through a major sovereign debt restructuring.

Not surprisingly, Greece is facing another bailout standoff with its creditors amid reports that Eurozone countries will refuse to release additional funds to it this month.

None of this surprises those of us who know Greek politicians all too well. They are crooked, crony liars who will do anything, and I mean anything, to stay in power which is why even in the face of disaster, they succumb to the demands of powerful public sector unions.

The biggest tragedy inflicted upon Greece over the last forty years was this insane expansion of its public sector to epic proportions. It all started with Andreas Papandreou but each successive Greek government since then caught on to the game of handing out goodies to public sector unions to ensure their hold on power.

That’s why I can’t take any Greek politician seriously, whether it’s Yanis Varoufakis peddling his memoirs on Europe’s crisis or even George Papaconstantinou, another former finance minister who rightly notes in his memoirs that it’s game over for Greece.

[Note: My biggest beef with Varoufakis is not that he’s a shameless self-promoter looking to sell his books. In fact, I highly recommend you read his best book, The Global Minotaur. My biggest beef with him is that he’s a master of half truths and was never able to admit that Greece’s bloated public sector was crippling its economy and continues to do so till this day.]

What does all this have to do with Europe’s lost generation and the Eurozone’s pension policy? Europe is a huge structural mess and no matter what the ECB does, it’s losing its battle against deflation.

And while Nobel laureates like Joe Stiglitz discuss the real issues in the Eurozone and how to solve them, I personally believe this fragile union is living on borrowed time and the real issue is how to stop European and Asian deflation from ravaging the global economy.

This is why I can’t take clowns warning of a bond bubble seriously. What world do they live in? Do they not realize how Brexit was Europe’s Minsky moment and the increasingly likely disintegration of the Eurozone will drive US Treasury yields to uncharted territory?

I don’t know, maybe there’s something I’m missing, but from a macro perspective I’m more worried than ever that the global deflation tsunami is gaining steam and unless there is a massive and coordinated fiscal response (by implementing major infrastructure projects all over the world), it’s going to wreak havoc on the global economy for decades (I think it’s already too late).

And when that happens, we’re not going to be talking about Europe’s lost generation, we’re going to be fretting over the entire world’s lost generation.