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President-elect Trump has plans to roll back many of President Obama’s marquee orders and laws, most notably the healthcare law and various regulations.

But in 2015, Obama went on a spree of retirement policy-related executive actions. The moves, some more controversial than others, made that year one of the most productive ever in terms retirement policy.

Over at the Brookings Institute, William G. Gale and Joshua Gotbaum write about Obama’s legacy as it relates to retirement policy:

Taken as a whole, the Administration’s actions undertaken in 2015 are likelier to have a positive effect on retirement security than anything that any administration or the Congress has done in many years.

Payroll Savings are Key to Retirement Security. By far the greatest success in saving for retirement occurs when saving is done automatically by deducting funds from a paycheck and having them invested automatically in a professional retirement program. However, under Federal law, such programs are entirely voluntary and employers that provide them must meet the many legal fiduciary, disclosure, and eligibility requirements of the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code. As a result, most employers, especially small businesses with fewer employees, decline to provide these programs.

Auto-IRA: Gridlocked in Washington, Unlocked in the States. In 2008, both major presidential candidates endorsed a proposal [2] by J Mark Iwry (then of Brookings) and David John (then of the Heritage Foundation) to require those small businesses without a plan automatically to enroll their employees in an Individual Retirement Account.

California and other states stepped in and proposed “Secure Choice” programs: a requirement that employers without a plan automatically enroll their employees (who could opt out at any time) into a professionally-managed retirement program, probably an IRA, that would be established by a state board. Legislation establishing such state boards to study and/or implement programs was enacted by California, Illinois, and Oregon.

DOL Allows Businesses to Encourage Retirement Saving without Full Federal Regulation. In July [4], the President announced that DOL would issue regulations and guidance to advance state savings plans. In November, DOL did so, publishing a proposal [5] under which state-sponsored IRA programs would exempt employers from ERISA fiduciary and other requirements.

DOL is doing more than just “legalizing” the IRA model that Illinois has legislated and other states are considering. They have also published a bulletin [6] outlining the ways they are willing to modify traditional ERISA requirements in order to facilitate state-sponsored pension and 401k-type plans. This would significantly increase and improve the options available for states to consider.

Adoption by states of an auto-enrollment requirement would extend coverage to an estimated 50-70 million working Americans who currently have no private retirement savings. It would be the largest expansion of retirement savings in more than 50 years.

Reducing Conflicts in the Marketing of Retirement Plans. After a false start in 2010, this year DOL proposed new regulations intended to limit the “conflict of interest” effects of commissions in biasing the advising and marketing of retirement products. DOL and others had shown that the presence of product commissions led financial advisors to favor the higher-commission retirement options. One survey by the Council of Economic Advisors estimated that biased compensation arrangements might result in extra fees on the order of $17 billion annually. [7]

DOL proposed that all advisors either forego product commissions in favor of asset-based or per-session compensation or that they enter into a legally-enforceable “Best Interests Contract” that both disclosed all fee arrangements and committed the advisor to placing client interests first. Although DOL’s proposal did not go as far as actions taken in the UK and elsewhere – which banned product commissions entirely—it has nonetheless generated substantial controversy. Many financial service firms and advisors argued that the DOL action is unnecessary, that it would reduce the supply of retirement advice, and/or that potential conflicts can be handled through existing industry self-regulation and by the Securities and Exchange Commission. (The SEC had been directed by Congress to provide guidance in 2010, but five years later had failed to reach any agreement.) Various Brookings scholars have studied these issues. Martin Baily and Sarah Holmes, reviewing the academic literature, concluded that conflicted advice is significant and that the approach proposed by DOL could, on net, benefit the country if it incorporated modifications to preserve investor education efforts and to reduce the likelihood that investors would avoid getting any advice at all. [8]

Offering a Federal Private Retirement Savings Option. Frustrated by Congressional unwillingness to legislate the Auto-IRA, the President announced in 2014 that Treasury would set up a voluntary retirement savings plan, My Retirement Account (“MyRA”) allowing voluntary payroll deductions to purchase a special Federal bond “to help millions of Americans save for retirement” [9]. Since the Administration had no authority to require employers to auto-enroll their employees in MyRA and there has not been significant willingness of employers to do so voluntarily, this year the Treasury announced that individuals would be permitted to join MyRA and make automatic contributions directly from their bank accounts. Nonetheless, there’s little evidence that this will lead to significant additional savings.

Limiting Employers’ Ability to Cash Out their Pension Obligations via Lump Sum Payments. ERISA’s intention was to preserve traditional defined benefit (DB) pension plans and ensure that pension commitments, when made, were honored. Ironically, the response by most employers has been instead to limit their DB obligations; DB plans now cover only a small minority of private sector workers and many current DB plan sponsors are “de-risking” either by freezing their plans and purchasing annuities to replace them, or by offering to cash out individual pension obligations via lump sum payment. Unfortunately, the passage of the Pension Protection Act of 2006 accelerated “de-risking” activity.

Read the entire article here.

New Jersey state lawmakers are again pushing a bill that would require the state to make its pension payments on a quarterly basis, instead of once annually.

The bill flew through the state Senate and Assembly unanimously, by votes of 72-0 and 35-0.

Quarterly payments would let the pension funds invest the money sooner, with more time for return on investment.

Gov. Chris Christie has vetoed similar legislation in the past, but this version of the bill might be more palatable.

From NJ.com:

It would require governor to make pension payments on a quarterly basis by Sept. 30, Dec. 31, March 31 and June 30 of each year, instead of at the end of the fiscal year in June. In exchange, the pension fund would reimburse state treasury for any losses incurred if the state has to borrow money to make a payment.

[…]

In his 2014 veto of the bill, Christie called it “an improper and unwarranted intrusion upon the longstanding executive prerogative to determine the appropriate timing of payments” so those expenditures line up with tax collection cycles.

But the change in the bill which would have the pension fund pick up the cost of borrowing if needed may address the governor’s previous concerns.

Asked whether the GOP governor would support the measure, the Senate Republican leader, Sen. Tom Kean Jr. (R-Union), said he believes he will.

The response from unions was lukewarm; they support quarterly payments, but they also support full payments — and they are skeptical that lawmakers can consistently deliver.

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

Frances Schwartzkopff of Bloomberg reports, World’s Best-Funded Pension Market Has a $650 Billion Warning:

No country on the planet is better prepared to pay for its aging population than Denmark. But a nation whose pension industry has been ahead of the curve for decades is now bracing for a fundamental shift that most people probably aren’t prepared for, according to the financial regulator.

Jesper Berg, the director general of the Financial Supervisory Authority in Denmark, wants to warn policy makers of the backlash he says they may face once households understand the risks they run. More specifically, Berg says people haven’t grasped that they will lose money if their banks or the investments their funds make fail.

“While people applaud if money doesn’t go out of their pocket as a taxpayer, they have yet to realize that it will go out of their pocket as a depositor or pensioner or investor,” Berg said in an interview in Copenhagen. “These are enormous amounts of money, so this is an important discussion to have.”

Berg says the FSA has called for talks with politicians and industry representatives to take place in March to discuss the issue.

Privatizing Risk

Denmark’s life insurers hold more than $650 billion in assets, which is roughly 2 1/2 times the size of the economy, according to UBS’s Pension Fund Indicators 2016. At $118,214, assets per capita are among the highest in the world. In Switzerland, the figure is $98,287. In the Netherlands, it’s $79,721.

Berg says the redrawing of financial regulation since the crisis of 2008 has had some profound consequences. New solvency rules for pension funds mean clients are being pushed out of defined benefit plans and into defined contributions plans, to help providers cut their capital requirements. That helps insurers stay solvent. It also frees them to take riskier bets. But, crucially, that risk is transferred to pensioners on an individual basis.

This privatization of risk that has followed the global regulatory overhaul is “the new reality” that “we need to discuss,” Berg said.

Global Leader

Denmark’s warning is worth heeding. The country has been at the forefront of pension reform, ensuring that companies can meet their obligations and that people have enough savings to live comfortably in retirement. It’s repeatedly topped rankings in the Melbourne Mercer Global Pension Index on adequacy and sustainability.

In practical terms, the risk is that a pension fund invests in something “that makes huge losses with the result that pensioners lose money and have to live with lower pensions or stay in the labor market longer,” Berg said.

And demand for risky assets is growing as funds look for ways to generate returns in an era of record-low interest rates. Denmark’s regulator has started looking more closely at funds’ investments in less liquid assets and found that holdings of so-called alternative investments surged 66 percent from 2012 to 2015.

Berg says it’s not the role of the supervisor to question the model. But he’s worried about how well it’s understood.

“While I believe in the economic incentive to privatize risk, my biggest fear is that people aren’t aware of that, and as a consequence we’ll have a backlash,” he said.

A new regulation called the prudent person principle guides funds’ investments, but it’s “still a very general principle,” Berg said. It is for the politicians to decide whether additional rules are necessary and the FSA will provide them with options, “but I just want that discussion to be taken before we have the first meltdown.”

Politicians around the world better heed Jesper Berg’s warning because if they think Brexit, Trump and Marine Le Pen are all part of the anti-establishment revolution, wait till they see millions of retired people succumb to pension poverty. This will really shake up politics like never before.

Last week, I discussed the global pension storm, noting the following:

[…] last week was a great week for savers, 401(k)s and global pensions. The Dow chalked up its best week in five years and stocks in general rallied led by banks and my favorite sector, biotechs which had its best week ever.

More importantly, bond yields are rocketing higher and when it comes to pension deficits, it’s the direction of interest rates that ultimately counts a lot more than any gains in asset values because as I keep reminding everyone, the duration of pension liabilities is a lot bigger than the duration of pension assets, so for any given move in rates, liabilities will rise or decline much faster than assets.

Will the rise in rates and gains in stocks continue indefinitely? A lot of underfunded (and some fully funded) global pensions sure hope so but I have my doubts and think we need to prepare for a long, tough slug ahead.

The 2,826-day-old bull market could be a headache for Trump but the real headache will be for global pensions when rates and risk assets start declining in tandem again. At that point, President Trump will have inherited a long bear market and a potential retirement crisis.

This is why I keep hammering that Trump’s administration needs to include US, Canadian and global pensions into the infrastructure program to truly “make America great again.”

Trump also needs to carefully consider bolstering Social Security for all Americans and modeling it after the (now enhanced) Canada Pension Plan where money is managed by the Canada Pension Plan Investment Board. One thing he should not do is follow lousy advice from Wall Street gurus and academics peddling a revolutionary retirement plan which only benefits Wall Street, not Main Street.

You should read my comment on the global pension storm to understand why I continue to worry about global deflation, the rising US dollar and why bond yields are likely to revisit new secular lows, placing even more pressure on global pensions in the years ahead.

This is why I respectfully disagree with Bob Prince and Ray Dalio at Bridgewater who called an end to the 30-year bond bull market after Trump’s victory. I have serious concerns on Trump and emerging markets and I wouldn’t be so quick to rush out of bonds (in fact, I see the big backup in bond yields as an opportunity to buy more long dated bonds (TLT) and will cover this in a separate comment).

But Jesper Berg’s critical point is this, as defined-benefit pensions become a thing of the past, retirement anxiety will grow as risk is transferred to pensioners, many of which risk outliving their savings and succumbing to pension poverty. This will have profound social, political and economic consequences for all countries.

And he’s absolutely right, this privatization of risk that has followed the global regulatory overhaul is “the new reality” that “we need to discuss.”

Why? Because pension poverty is part of rising inequality, and along with aging demographics, these are major structural forces driving global deflation. You simply cannot have increasing aggregate demand and inflation when a large subset of the population is succumbing to pension poverty.

The other part of Jesper Berg’s warning is equally important, namely, global pensions are responding to record low yields by increasingly shifting their portfolio into illiquid assets. I touched upon it last week when I covered Bob Prince’s visit to Montreal:

So what in a nutshell did Bob Prince say? Here are the main points that I jotted down:

• Higher debt and low rates will impact asset values, limit credit growth and economic growth over next decade
• Monetary policy and asset returns are skewed  (so you will see bigger swings in risk assets)
• Currency swings matter a lot more in a low rate/ QE world (expect higher currency volatility)
• Low rates and low returns are here to stay (expected returns in public markets will be in low single digits over next decade)
• We are reaching an important inflection point where valuations of illiquid assets are nearing a peak at the same time where dollar liquidity dries up.

I emphasized that last point because it’s bad news for many pensions, insurance companies, sovereign wealth funds and endowments piling into illiquid assets like private equity, real estate and infrastructure at historically high valuations.

Not that they have much of a choice. Bob Prince said in this environment, you have three choices:

1. Do nothing and accept the outcome
2. Take more risk
3. Take more efficient risk (like in illiquid assets)

Institutions have been taking more efficient risk in illiquid asset classes but the pendulum may have swing too far in that direction and if he’s right and we’re at an important inflection point, then there will be a big correction in illiquid asset classes.

Even if he’s wrong, expected returns on liquid and illiquid asset classes will necessarily be lower over the next decade, so the diversification benefits of illiquid assets won’t be as strong going forward.

[Note: Admittedly, this is a bit of self-serving point made by the co-CIO of the world’s largest hedge fund which invests only in liquid assets. He’s trying to steer investors away from illiquid to more liquid alternatives like Bridgewater but he forgets that pensions and other institutional investors have a very long investment horizon, so they can take a lot more illiquidity risk.]

Taking more “efficient risk” by investing billions into private equity, real estate and infrastructure makes sense for pensions with a long investment horizon but it’s no panacea and if it’s not done properly, it could spell ruin for many chronically underfunded pensions taking more risk at the worst possible time.

Pension deficits are path dependent. If your pension is chronically underfunded, taking more risk in public or private markets praying for a miracle, then that is not a strategy, that is a recipe for disaster.

What is a better strategy? Politicians need to bolster defined-benefit plans, get the governance and compensation right, bolster the social safety net (enhance the Canada Pension Plan and US Social Security) and set up a system that allows pensions to invest billions in domestic infrastructure.

I’ve discussed my thoughts on this recently going over how pensions can make America great again and why the Canadian federal government is courting large global and domestic funds to develop its infrastructure program.

Of course, pensions have a mission to maximize returns without taking undue risk. This means that if they invest in infrastructure, they will necessarily expect a return on their investment or else they are better off investing elsewhere.

I mention this because I’m a bit dismayed at some of the nonsense I’m reading from Nobel-laureate Paul Krugman warning of an infrastructure privatization scam before even seeing the details of the program. My former BCA colleague Gerard MacDonell loves praising Krugman for being ‘wonderfully non-centrist‘ but there’s is nothing wonderful about spreading nonsense on infrastructure program whose details have yet to be unveiled.

And the problem is that unions read Krugman as if he’s some kind of economic god and take his economic articles very seriously (sure, he’s a brilliant economist but he has a political axe to grind because Clinton undoubtedly promised him a high-profile cabinet position). When I read articles like this one on public risk, private profits, I’m disheartened by the leftist union rhetoric which quite frankly goes against what is in the best interests of public defined-benefit pensions and the economy over the long run.

Let me be a little blunt here, after all I hate skirting around an issue. Yes, we need to address the concerns of unions but we also need a reality check when it comes to infrastructure and courting pensions and private equity firms. Governments are constrained in terms of borrowing and spending and when it comes to managing infrastructure assets, I trust the people at Ontario Teachers, OMERS, the Caisse, CPPIB, PSP, and other large Canadian pensions a lot more than some government bureaucrats who do not have a profit motive.

Does this mean we need more tolls and higher user fees to pay for infrastructure? You bet it does and there’s nothing wrong with this as it’s not only fair for pensions looking to make long-term steady returns on their infrastructure investments, it’s fair for taxpayers and it helps alleviate the fiscal burden on governments.

All this to say, Denmark’s dire pension warning is real and policymakers and the elite intelligentsia better discuss solutions to the global pension crisis like adults, not like left-wing or right-wing adolescent brats that place ideology and politics over logic and what is in the best interest of pensioners and the country over the long run.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

The state’s two largest public pension systems never recovered from huge investment losses during the deep recession and stock market crash in 2008. CalPERS lost about $100 billion and CalSTRS about $68 billion.

Now after a lengthy bull market, most experts are predicting a decade of weak investment returns, well below the annual average earnings of 7.5 percent that CalPERS and CalSTRS expect to pay two-thirds of their future pension costs.

The two systems are still seriously underfunded, CalPERS at 68 percent and CalSTRS at 65 percent. This is not money in the bank. It’s an estimate of the future pension costs covered by expected employer-employee contributions and the investment earnings forecast.

Last week, the CalPERS and CalSTRS boards got separate staff briefings on how the “maturing” of the two big retirement systems creates new funding difficulties. Both are nearing a time when there will be more retirees in the system than active workers.

The California State Teachers Retirement System board, for example, was told that in 1971 there were were six active workers in the system for every retiree. Today CalSTRS only has 1.5 active workers for every retiree, similar to the CalPERS ratio.

A wave of baby boom retirees that began around 2011, and the continuing increase in the average life span of retirees, have added to the growing cost of paying pensions, giving both systems what actuaries call “negative cash flow.”

The annual cost of paying pensions is more than the annual contributions from employers and employees. So, the pension funds are forced to “eat their seed corn” by selling some investments to cover the gap, thus reducing potential investment earnings.

The California Public Employees Retirement System had about $14 billion in contributions in fiscal 2015-16 and pension payments totaling $19 billion. By 2035, the board was told, contributions are expected to be $17 billion and pension payments $35 billion.

Mature pension funds also have another difficulty. The pension investment fund becomes much larger than the active worker payroll, which means that replacing an investment loss requires a larger employer contribution increase.

The CaSTRS board was told that replacing a 10 percent investment loss in 1975, when the teacher payroll and investment fund were about equal, would have required a contribution increase of 0.5 percent of payroll.

Replacing a 10 percent investment loss today, when the investment fund is six times greater than the payroll, requires a contribution increase of 3 percent of pay. CalSTRS has had losses of 10 percent (below the 7.5 percent forecast) four times in the last two decades.

Both systems recently adopted modest “risk mitigation” strategies to reduce losses. When CalPERS earns 11.5 percent or more, half of the excess will be shifted to conservative investments. CalSTRS is shifting 9 percent of its fund to more conservative investments.

Gov. Brown’s modest cost-cutting pension reform gives new CalPERS and CalSTRS employees hired after Jan. 1, 2013, lower pension formulas, capped at the upper end, and possibly higher contributions. Significant employer savings are decades away.

Meanwhile, CalPERS and CalSTRS are still phasing in record high employer contribution increases. And both will be considering more rate increases in the next several months.

A CalPERS rate increase of roughly 50 percent was enacted in three consecutive years: a lower earnings forecast in 2012, an actuarial method that no longer annually refinances debt in 2013, and a longer average life expectancey for retirees in 2014.

A staff survey of more than 600 CalPERS employers in October and early this month found that most are aware of discussions about another drop in the earnings forecast used to “discount” pension debt.

Nearly two-thirds have begun planning for a rate increase with budget forecasts and 13 percent are “prefunding” by contributing more than the required rate. Their top priorities are less volatile and more predictable rates and a phase-in rather than lump-sum increase.

A League of California Cities lobbyist, Dane Hutchings, told the board the association has no formal position on another rate increase. But he thinks most cities expect an increase and pressure to improve funding after new accounting rules expose more pension debt.

Pensions are needed to help cities remain competitive in the job market, Hutchings said, but another rate increase will be painful for some. “We have cities that are very close to filing for bankruptcy,” he said.

The governor unsuccessfully pushed for a major CalPERS rate increase when the risk mitigation streategy was adopted last year. The CalPERS staff is concerned that its consultant, Wilshire, dropped its 10-year earnings forecast to about 6.1 percent, echoing many experts.

“Given that, we think it’s appropriate for this committee to look at our discount rate,” said Ted Eliopoulos, CalPERS chief investment officer.

A Wilshire consultant, Andrew Junkin, told the board the 30-year earnings forecast is still 7.5 percent or more. But, he added, that assumes there is no major investment loss, like one big enough to cause officials to question whether the state should continue to offer pensions.

“I’ll use this phrase, I don’t mean to be inflammatory, there could be a return that puts you out of business somewhere before you get to year 30,” Junkin said.

CalPERS was 100 percent funded in 2007 before the stock market crash dropped funding to 61 percent. Experts have told CalPERS, now only 68 percent funded, that if funding drops below 50 percent getting back to full funding could require impractical rate increases and earnings forecasts.

The board was told that a rate increase must be approved by April to take effect for the state and schools in the new fiscal year beginning next July and for local governments in July 2018.

Supporters suggested a rate increase by April would allow a phase in before a recession, if one is on the way, while being fiduciarily responsible. “Pay now or pay more later,” said board member Richard Gillihan, a Brown administration official.

Alarmed union representatives, backed by some board members, urged the board to go slow and follow the regular two-year process leading to a full “asset liability management” review scheduled in 2018.

Dave Low of the California School Employees Association said many non-teaching school workers have not had a pay raise for five or six years. He said if Brown is not putting money in the state budget to offset a rate increase his members could be harmed.

“If you’re not at the table, you’re probably on the menu,” Low said, apparently referring to an old saying about labor bargaining. “We feel like we are on the menu in this discussion.”

With the consent of other board members, Richard Costigan, chairman of the CalPERS fionance committee, directed staff to prepare a report for the December board meeting on a vote for a rate increase by April.

Unique among large California public pension systems, CalSTRS has been unable to raise employer rates, needing legislation instead. That changed with a long-delayed rate increase two years ago that is phasing in a $5 billion rate increase over seven years.

School district rates will more than double, going from 8.25 percent of pay to 19.1 percent by July 2020. Teachers got a small rate increase, going from 8 percent of pay to 10.25 percent for most and to 9.21 percent for teachers hired after the reform on Jan. 1, 2013.

The state rate (a way that CalSTRS remains unique, since other systems only get contributions from employers and employees) is scheduled to go from 5.5 percent of pay to 8.8 percent.

The legislation also gave the CalSTRS board the new power to raise annual rates for the deep-pocketed state, limited to a 0.5 percent of pay each year. And now for the first time, the CalSTRS board is scheduled to consider an annual state rate increase next April.

If the board maximizes its new power, the current state rate of about 6 percent of pay theoretically could go to 21 percent before the legislation expires in 30 years, when the system would be fully funded if investments hit their earnings target, the board was told last week.

The legislation gave the CalSTRS board another new power to annually adjust school district rates beginning July 1, 2021. But the employer rate is capped at 20.5 percent of pay, allowing only small changes in the phased-in rate reaching 19.1 percent by 2020.

“There is no need to increase state contributions further, based on what we have seen to date, even with the 1 percent return last year,” David Lamoureux, a CalSTRS actuary, told the board last week.

The CalSTRS board is scheduled to review “actuarial assumptions” in February, including estimates of the average retiree life span and probably a discussion of the earnings forecast.

“There is a possibility, depending on where we end up with the assumptions, that it could trigger an increase in the normal cost of more than 1 percent (of pay), and it could increase the member contribution rate,” Lamoureux said.

The “normal” cost is the rate for the pension earned during a year, excluding the debt or “unfunded liability” from previous years usually resulting from investment earnings that fall below the forecast.

Under the pension reform, employees are required to pay half of the normal cost when it increases by 1 percent or more.

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

Robin Respaut of Reuters reports, CalSTRS calculates total fees in likely first for public pension:

The California State Teachers’ Retirement System announced on Wednesday that it had calculated the total costs and fees paid to manage its entire investment portfolio, likely the first public pension fund to do so.

CalSTRS found total expenses, including carried interest, reached $1.6 billion in calendar year 2015, or less than 1 percent of the portfolio’s $186 billion net asset value.

Presented for first time at Wednesday’s meeting of CalSTRS’ board, the new cost report marks a milestone among public pension funds to keep tabs on investment expenses and may motivate other funds to track their fees.

It also comes at a time when public pension funds, which manage the retirement benefits of public sector workers and retirees, face growing pressure to disclose the fees that they pay.

The task was not an easy one, however. CalSTRS has over 600 partnership investments, separately managed accounts, joint ventures and co-investments within its portfolio, and there is no industry standard for cost reporting.

As a result, to tally up all of the carried interest, management fees, partnership expenses and portfolio company fees paid by CalSTRS, information had to be collected one investment at a time through direct engagement.

“To the best of my knowledge, this is the most comprehensive review of investment costs,” Allan Emkin of Pension Consulting Alliance said at Wednesday’s meeting. “On the issue of transparency and disclosure, you will be seen as the new leader.”

On Monday, CalSTRS sister fund, CalPERS, announced it had shared about 14 percent of the profit made on private equity investments in the past year with firms managing its private equity asset class.

CalSTRS took fee disclosure a step further, calculating the fees and costs for its entire portfolio. Of the $1.6 billion, approximately 61 percent was external and internal costs, while 39 percent was carried interest, or profits shared.

CalSTRS said it paid an outside firm to compile the data, with the total cost of the project reaching $425,000 plus 1,500 hours of staff time.

Board members said the report was worth the money because it clarified important investment costs.

“This is absolutely fantastic,” said Board Member Paul Rosenstiel. “I think it’s very well worth the time and the expenditure.”

CalSTRS is leading the way once again with this initiative to be completely transparent by disclosing all the fees it pays out to external managers and track total expenses more closely.

Why is this exercise important? Because in a world of historically low rates, fees and other costs matter a lot more and they can add up fast, eating away at the investment returns over a long period.

You’ll recall last month CalSTRS cut about $20 billion from its external manager program. A big part of this decision was a consequence of this exercise where they delved into what they were paying in fees and what they were receiving in return.

Kudos to CalSTRS as I honestly think it’s essential to be as transparent as possible on every aspect of pension investments, including fees and benchmarks used to evaluate performance of various investment portfolios.

I give CalSTRS an A+ on benchmarks, communication and transparency. It was actually one of the pension funds I used as an example when I wrote a big report on the governance of the federal public sector pension plan back in the summer of 2007 for the Treasury Board of Canada.

Where CalSTRS fails to meet my governance standards is that it still has too much state government interference in its affairs, there is no independent qualified board to oversee its operations and while compensation is solid, it can be significantly improved as they bring more assets internally.

Think about it, they paid 39 percent of $1.6 billion in carried interest in calendar year 2015 which translates into $640 million. That doesn’t include management fees, this is only carried interest (performance fees).

No doubt, pensions need to pay for performance, especially if they cannot replicate it in-house, I totally agree with this. But imagine they took 5% of that $640 million to hire people to manage assets internally across public and private markets, wouldn’t they be better off?

In order to do this, they need to get the governance and compensation right, the way Canada’s large public pensions have done. And that’s where CalSTRS, CalPERS and most US public pensions run into trouble as there is way too much political interference in the operations of their pensions.

Having said this, sometimes you need some political interference to get these large public pensions to disclose things, like fees and total expenses. Here, I applaud California’s State Treasurer John Chiang as he has put the screws on CalPERS and CalSTRS to disclose these fees.

Is it perfect? No, far from it, there are tons of hidden fees that were probably not accounted for because they were hidden and hard to find or because they decided to ignore these fees.

And let’s not make this out to be more than it truly is, an accounting exercise. In fact, Leo de Bever, the former head of AIMCo who ran a similar exercise back in 2009 when AIMCo paid out $174 million in external fees to highlight the need to compensate internal staff properly, shared this with me:

This is just accounting – how hard can this be?

The problem may be that they used to subtract carried interest from return.

Capitalization of some structuring cost can be another issue – there are rules about what is capital and what is not.

Sure, accounting for all these internal and external costs isn’t easy, especially if you don’t have the right systems in place to track all these fees and costs, but let’s not get ahead of ourselves here as there is nothing earth-shattering in tallying up fees and costs and many senior pension fund managers reading this will agree with me.

Still, let me be fair and crystal clear, I am for more transparency when it comes to fees and internal costs, and if CalSTRS is ready to set the standard in terms of reporting fees and costs, then I’m all for it.

In an ideal world, we should be able to read the annual report of any public pension to understand how much was paid out in management fees, how much in performance fees (carried interest), how much for internal salaries, how much to vendors, brokers, consultants, accountants, lawyers, etc. and exactly who received what amount.

This information is readily available but I doubt any public pension is willing to provide such granular detail. However, I remember a long time ago, a senior private equity manager of a large Canadian pension telling me how it would be nice if pensions reported the IRRs of their internal staff relative to their external managers. A lot of things would be nice, but they will never happen.

One thing is for sure, I applaud CalSTRS’ new initiative and hope all other pensions follow suit in terms of disclosing total fees and costs and providing more specific information in terms of external manager fees.

Of course, the devil is in the details. I reached out to Chris Ailman, CalSTRS’ CIO, to discuss this new initiative but he’s tied up in board meetings today.

The latest CalSTRS board meeting (November 16-17) isn’t available yet but it will soon be made public here.

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

Doing what it has never done before, the CalPERS board voted yesterday to slash the pensions of all five former employees of a small Sierra County town, Loyalton, by an estimated 60 percent.

It’s a rare situation in which Loyalton, population 769 in the last census and shrinking since the closure of a century-old sawmill in 2001, voluntarily terminated its CalPERS contract in March 2013 without paying off its $1.7 million pension debt.

A New York Times headline last month said the nation’s largest public pension fund ($300 billion) giving little Loyalton a pay-up-or-else ultimatum would be a “test of ‘bulletproof’ public pensions.”

A staff report said CalPERS went to unusual lengths to avoid blowing a big hole in the Loyalton pensions — 50 telephone calls and 10 collection notices — and waited more than three years before pulling the trigger on the deep pension cuts.

A divided Loyalton city council attempted to get back into CalPERS, talked about getting a loan with installment payments, and pleaded ignorance about the need to pay off the big debt to preserve the pensions of four retirees and one person not yet retired.

The division continued yesterday after the CalPERS board was told the Loyalton city council voted the previous day to make payments from the city budget to replace the roughly 60 percent cut in the pensions, ensuring that retirees receive 100 percent of the promised amount.

Loyalton Councilwoman Patricia Whitley, a former mayor who voted to leave CalPERS, said the council voted unanimously this week to offer the retirees a supplemental city payment to restore their full pensions.

“It’s really not a settled thing,” said Whitley. “The employees have to agree. We have to have some sort of agreement between us, because now it becomes a contract between us and the employees.”

Loyalton Mayor Mark Marin said there was no vote at the council meeting this week, only an understanding, and he was skeptical about the retirees accepting the proposal.

“The employees are not going to go for this,” Marin said. “The city is so broke. They will start paying the benefits. But what happens if the city goes bankrupt? Then people are screwed.”

Marin said some of the retirees are talking to an attorney about possible legal action. A CalPERS staff report said there is a risk that a pension cut could trigger an employee lawsuit against the city requiring CalPERS involvement.

Whitley has said a 50 percent pay raise that may not have been legitimate increased the cost of unaffordable pensions. The CalPERS report said Loyalton generously increased its pension formula to “2.7 at 55” in 2004, more than the “2 at 55” for most state and school workers.

Marin said he has been told that the vote to leave CalPERS may have been illegal because it was done as an “emergency” action. He said city council members wanted to divert the pension contribution to a city museum and other uses.

“PERS has been really good to us,” said Whitley. “They have at least listened to us and taken it to heart. So we have gained some mutual respect, I think. This is really their first case, I guess.”

Marin said he thinks “Pandora’s box” was opened by the CalPERS vote to let Loyalton off the hook for its pension debt: “It’s going to open it up big time. There is going to be other cities doing this crap, because Loyalton got away with it.”

Putting a lien on Loyalton assets or attaching its revenue were mentioned at the CalPERS board in September. But the financially distressed city would be further harmed, the board was told, and cities often are able to block attempts to take their revenue.

Modest annual pensions are shown for three Loyalton retirees in 2015 on Transparent California, a searchable public database on the internet that lists the pay and pensions of state and local government employees and retirees:

Patsy Jardin $36,035, John Cussins $36,034, and Orville McGarity $6,814.

The giant California Public Employees Retirement System, with more than 2,000 pension plans for more than 3,000 government employers, maintains a pool to pay the pensions of retirees in terminated pension plans.

The Terminated Agency Pool paid $4.7 million to 716 retirees and beneficiaries from 93 terminated plans last fiscal year. The pool has a large surplus and was 261.9 percent funded as of June 30, 2014.

If its financial health allows, the pool can under state law continue to pay the full pensions of retirees whose employers did not pay off their debt — but not when, like Loyalton, the employer voluntarily terminates its CalPERS contract.

So, apparently for the first time, CalPERS declared an employer, Loyalton, in default and cut the pensions of its retirees “in proportion” to the amount of the debt. The Loyalton debt was 39.5 percent funded as of March 31, 2013.

An updated calculation could change the estimate of a 60 percent pension cut. Until then, said Whitley, Loyalton won’t know whether the payments offered retirees will be more or less than the annual contributions the city had been making to CalPERS.

The large CalPERS termination fee for Loyalton’s five modest pensions, $1.66 million, is the amount CalPERS expects to need to make the lifetime payments with no new contributions from the city or active employees.

CalPERS had been using its investment earnings forecast, now 7.5 percent, to calculate termination fees before switching in 2011 to a risk-free bond rate, 3.25 percent recently, that sharply boosts the regular debt or “unfunded liability.”

A federal judge in the Stockton bankruptcy said a termination fee that boosted the city’s pension debt from $211 million to $1.6 billion was a “poison pill” if the city tried to move to another pension provider, such as a county pension system.

Several small cities that considered leaving CalPERS did not after looking at the high termination fee, among them Pacific Grove, Villa Park, and Canyon Lake. CalPERS has given employers a hypothetical termination fee in their annual plan valuations since 2011.

The CalPERS viewpoint: If the terminated pool falls short under the collapse of a large pension plan, the funds of all the state and local government plans in CalPERS could be used to cover the shortfall, possibly jeopardizing their ability to pay pensions.

The CalPERS board president, Rob Feckner, said in a news release the Loyalton pension cuts, made with regret, are part of a fiduciary duty to keep CalPERS funding secure by ensuring that employers adhere to contracts.

“When they don’t, the law requires us to act,” he said. “The people who suffer for this are Loyalton’s public servants, who had every right to expect that the city would pay its bill and fulfill the benefit promises it made to them.”

As for two other delinquent employers given demand letters, the CalPERS staff report said, the California Fairs Financing Payment made a “significant” payment last month and expects to be “fully current by June 30, 2017.”

The Niland Sanitary District is voluntarily terminating its CalPERS plan. The staff report said there is reason to doubt Niland’s claim of no active employees since 2013, which will be checked by an audit.

The Illinois State Board of Investment, the entity that manages investments for the pension funds covering the state’s non-school employees and judges, said this week it will yank $2.4 billion from active managers.

It will place that money in passive index funds in a bid to reduce the cost and complexity of its portfolio.

In the last year, the Board has rapidly reduced its allocation to active managers.

From the Wall Street Journal:

The move by the Illinois State Board of Investment, or ISBI, means an agency that oversees $16 billion for state employees, judges and lawmakers will have 35% of its holdings with actively managed investment funds, down from 70% in September 2015.

Limiting the number of active managers will reduce what the board pays in fees and simplify management of the portfolio, said Board Chairman Marc Levine.

[…]

The switch to more passively managed investments in Illinois is being led by Mr. Levine, who became chairman of ISBI in September 2015. Prior to Tuesday’s vote, the board had already terminated a total of nine active money managers over the past 14 months. In March it voted to pull $1 billion from hedge funds.

Two months ago, the board also terminated almost all of the active managers in a separate 401(k)-style plan it manages.

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

Bill Curry and Jacqueline Nelson of the Globe and Mail report, Trudeau touts Canada as safe option for infrastructure investment:

Justin Trudeau is billing Canada as a stable option for international investors amid market uncertainty in the aftermath of the election of Donald Trump in the United States.

Speaking at the end of a day spent courting some of the world’s largest wealth managers, the Prime Minister added a clear political spin to his government’s pitch that investors should be working with Ottawa on infrastructure projects.

“The fact is Canada is lucky to have citizens that are forward-thinking, that are reasonable, that are understanding that drawing in global investment will lead to good Canadian jobs,” he said.

Mr. Trudeau said Canada is attracting attention from people who wonder how the country remains open to investment, trade and immigration during a period of uncertainty, making reference to the “election of the Republican candidate in the United States” without naming Mr. Trump.

Mr. Trudeau is encouraging banks, pension funds, insurance companies and private wealth funds to take equity stakes in Canadian infrastructure projects through a new Canada Infrastructure Bank announced this month. Advocates say such a bank could group public and private funds together for large projects, allowing more construction to proceed more quickly.

Politics aside, some of the investors in attendance gave the government’s presentation an enthusiastic response.

Mark Machin, chief executive officer of the Canada Pension Plan Investment Board, was among the roughly two dozen Canadian-based investors who met Monday morning with Mr. Trudeau and senior ministers to discuss infrastructure spending.

“It’s a terrific initiative,” he said in an interview at the CPPIB’s Toronto headquarters following the meeting. Mr. Machin said the infrastructure plan should “absolutely” attract new money from institutional investors because the bank will offer firms a single point of contact and is promising to do the advanced research in order to prioritize infrastructure projects that are good candidates for private partnerships.

“I would think if this gets off the ground the way it should, then it should result in significant increase in activity in infrastructure,” he said.

The CPPIB announced earlier this month that the assets of the CPP fund have climbed above $300-billion as of Sept. 30, which is up from $287.3-billion the year before.

The CPP fund has just one current investment in Canadian infrastructure: a 40-per-cent share of Ontario’s 407 toll highway, which runs through the Greater Toronto Area.

Mr. Trudeau also met Monday with global wealth managers in the afternoon, among them representatives from BlackRock Inc., which is the largest asset manager in the world.

Executives from the country’s largest banks, pension funds and insurance companies said Monday morning’s meeting affirmed the government’s commitment to developing its infrastructure plan, but several attendees said it was short on details of what the planned infrastructure bank would look like.

Ministers representing the departments of Finance, Transport, Natural Resources and Infrastructure and Communities outlined the types of infrastructure deals and projects that are most interesting to the government. Some executives offered thoughts on what made certain infrastructure deals work well in other parts of the world, and they suggested different investment structures that could work for building new projects such as pipelines and electricity transmission.

“I believe that they have a vision to put together a model which is pretty ground-breaking,” said Ron Mock, chief executive officer of the Ontario Teachers’ Pension Plan, after the session. He noted that private funding models exist in Britain, Australia and Mexico and that Canada could be a leader with its plan. “In terms of the details of how it will actually be executed, I think they are correctly looking to the expertise that exists in the country for input and advice on how to move this agenda forward.”

Attendees characterized the meeting as an early step in gathering input and support for the part of the government’s planned $180-billion spending spree that is counting on an influx of private capital. But some said they were hoping there would be more clarity on what happens next, rather than being asked for another round of input on how to make the plan work.

During the session, the group discussed the widespread interest in so-called “brownfield” assets – where investors buy and operate existing infrastructure, rather than taking on the risk of constructing new projects from scratch. The government has expressed more interest in using private capital in building new infrastructure projects, called “greenfield.”

Questions about how the federal government would align its objectives with the provincial and municipal governments that traditionally control a lot of infrastructure spending were also top of mind for many participants. Constructing new infrastructure where users must pay fees or tolls may be a tricky sell to these lower levels of government and their constituents.

“Clearly the execution of this becomes important, and that in many cases requires the federal, provincial, municipal alignment, which is which is pretty key,” Mr. Mock said. “Because most infrastructure in this country is either provincial or municipal and it’s the federal government that is wanting to initiate such a plan.”

Barbara Shecter of the National Post also reports, Trudeau’s investment pitch wins praise as Ottawa courts world’s most powerful investors:

Prime Minister Justin Trudeau pitched fund managers from around the world on the merits of investing billions in Canadian infrastructure projects Monday, earning praise from some but leaving others with questions about how such deals would work.

Ottawa is setting up a new entity — the Canada Infrastructure Bank — to promote large national and regional projects, including revenue-generating ones it hopes will draw the interest of big institutional investors, including domestic pension funds.

Monday’s meetings in downtown Toronto — a morning session with Canadian pension funds managers and top bankers, and an afternoon discussion with international investors — brought the prime minister and key cabinet ministers face-to-face with some of the money managers they will need to attract to make the bank a success.

Ron Mock, chief executive of the Ontario Teachers’ Pension Plan, said Trudeau and his cabinet have “got their head in the right place” in creating projects that would draw on government money and investment from institutions, such as pension funds.

“They did a great job,” Mock said as he left the morning meeting, which also included Trudeau, Finance Minister Bill Morneau and top representatives from the Caisse de dépôt et placement du Québec and the Canada Pension Plan Investment Board.

But Hugh O’Reilly, chief executive of the Ontario Public Service Employees Union Pension Trust, said many details needed to be ironed out.

“We still have many questions about how this infrastructure bank will work,” he said. “But the federal government acknowledged that — and are looking to pension funds to provide advice.”

The plan, which has $16 billion in assets, will look at opportunities case by case, he added.

After the meeting, Trudeau said he was “tremendously pleased to see so many business leaders at the table.”

“We know that partnerships with the private sector can be done right, and we look forward to working with these significant global investors to see how we can make sure we’re responding to their needs,” he said.

His government has pledged $81 billion over the next 10 years for infrastructure, including public transit and renewable power projects. The first $15 billion will become available in the spring 2017 budget.

A spokesman for the Canada Pension Plan Investment Board called the talks “constructive.”

The Canadian Infrastructure Bank should offer “an intelligent bridge between what investors are looking for and what governments can offer. (CPPIB officials) look forward to seeing the pipeline of potential infrastructure investments.”

The prime minister said he hoped the bank would “be up and running in 2017, but we’re also working very, very hard with experts and listening to people to make sure we get it right.”

Earlier Monday, a few blocks from the Trudeau meeting, Marc Garneau, the transportation minister, told another group of investors Ottawa’s recently announced $10.1-billion funding commitment to upgrade trade transportation corridors does not depend on participation by the private sector.

Garneau said he expects there will be interest from the public–private partnerships to invest in the trade transportation improvements. But even if there isn’t, the federal government will go ahead with the spending.

“The funding is there,” Garneau said in a brief interview after his speech at a conference organized by the Canadian Council for Public-Private Partnerships, which attracted about 1,200 investors, project proponents and governments from around the world.

“If there is not large institutional investors that want to become involved with it, we will still be using the money, as I said in my speech, to reduce bottlenecks and congestion and make our trade transportation corridors as efficient as possible.”

Morneau announced the $10.1 billion in trade transportation funding in his fall fiscal update this month. The trade corridor upgrades are part of a massive boost in planned infrastructure spending.

Garneau said improving transportation corridors is so important for Canada’s trade, it won’t need to wait for private funding. About one-fifth of Canadian goods is shipped by rail, and much of that is destined for export.

Transportation volumes are increasing. Over the past 30 years, the amount of goods moved by rail has increased 60 per cent, while the amount shipped by sea is up 40 per cent.

The $10.1 billion in funding is designed to remove bottlenecks that are slowing traffic on important export corridors.

That doesn’t mean the government is not interested in encouraging private-sector involvement. The new infrastructure bank is intended to foster private investment in projects.

Garneau said Ottawa understands some projects, especially in public transportation, might require tolls to encourage private-sector investment.

“We’re open to that concept,” he said, in answer to a question from the audience.

Matt Scuffham of Reuters also reports, Canada courts sovereign wealth for infrastructure bank:

Canada’s Liberal government is speaking to sovereign wealth funds and global private equity firms as well as domestic pension funds as it ramps up efforts to attract funding for its new infrastructure bank, according to two sources.

The overseas investors that the officials developing the infrastructure bank are speaking to include the Government Pension Fund of Norway, one of the world’s largest sovereign wealth funds, said the sources, who declined to speak on the record because of the sensitivity of the talks.

The government said earlier this month it would set up an infrastructure bank and give it access to C$35 billion ($26 billion) to help fund major projects.

Prime Minister Justin Trudeau and Finance Minister Bill Morneau are attending an event in Toronto on Monday aimed at attracting private investment. The event is part of a series of meetings with private investors ahead of the launch of the bank, which Ottawa hopes will be up and running next year, the sources said.

Trudeau and Morneau had previously expressed a desire to attract investment from Canada’s biggest pension plans such as the Canada Pension Plan Investment Board (CPPIB), the Caisse de depot du Quebec and the Ontario Teachers’ Pension Plan.

A significant proportion of the projects the bank hopes to fund will be built from scratch, known as “greenfield” investments, rather than “brownfield” investments which have already been built.

The Canadian pension funds, among the world’s ten biggest infrastructure investors, have invested more in projects overseas than in their domestic market.

That is partly because they have preferred to invest in existing infrastructure which has established revenue streams and does not carry construction risk. However, that stance is changing as investors seek alternatives to government bonds and volatile equity markets.

Last week, CPPIB’s Chief Executive Mark Machin said in an interview the fund would be open to investing in greenfield projects through the infrastructure bank.

Meanwhile, the Caisse, Quebec’s public pension fund, is planning to build a new 67 kilometer public transit system in Montreal, investing C$3 billion and seeking to supplement that with C$2.5 billion of federal and provincial government funding.

That project could be one of the first to be funded by the new infrastructure bank, the sources said.

Sources said the Ontario Teachers Pension Plan is also planning to invest more in greenfield projects.

Before I start covering the latest developments on Canada’s infrastructure program, I want to correct an error I made last week when I posted that Bert Clark, the former head of Infrastructure Ontario, left that agency to head up the newly created Canadian Infrastructure Development Bank (CIDB).

It turns out that Mr. Clark is Ontario’s new pension leader, now in charge of running the newly created the Investment Management Corporation of Ontario (IMCO). As of now, the federal government has not named a leader for Canada’s new infrastructure bank. I can suggest a few people, including Bruno Guilmette, the former head of infrastructure at PSP Investments (not sure he wants this job but he is more than qualified and has the right connections).

Let me begin my coverage by referring you to a recent post where I explained why Canada’s large pensions are lukewarm on Canadian infrastructure.

In that comment, I went over concerns on governance and ended it with an update sharing some excellent insights from Andrew Claerhout, Senior Vice-President of Infrastructure & Natural Resources at Ontario Teachers’ Pension Plan who responded to Chas’s comment at the end of the Benefits Canada article:

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

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

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

As the Reuters article mentions, OTPP is open to investing in greenfield infrastructure projects of which the first one to likely be funded by the new federal infrastructure bank is the Caisse’s new 67 kilometer public transit system in Montreal.

Prime Minister Trudeau and Finance Minister Morneau pitched their new infrastructure program to Canada’s large pensions but also to sovereign wealth funds like Norway’s Government Pension Fund and Blackrock, the world’s largest asset manager where Mark Wiseman now works.

The thing that is a bit confusing is that typically large pensions and sovereign wealth funds invest in “brownfield” infrastructure which is already operational with known cash flows, but the federal government is not looking to sell stakes in Canada’s existing airports or ports which it owns.

Instead, the newly created Canada Infrastructure Bank will partner up with Canada’s large pensions and other large global funds to invest in greenfield projects which carry a whole new set of risks.

Can this be done successfully? Of course, and some of Canada’s large pensions like the Caisse have already begun working on greenfield projects and they have the internal resources to complete such ambitious projects.

When I mention the right internal resources, let me be very clear. Macky Tall, the head of CDPQ Infra, has assembled an outstanding team full of people with actual project finance and operational experience in large infrastructure projects. These people previously worked at large engineering/ construction companies like SNC-Lavalin and other places where they had to handle budgeting, building and operating large greenfield infrastructure projects.

I’m going to be very honest here, Canada’s large pensions have made outstanding “brownfield” infrastructure investments all over the world but nobody has assembled a team like that at CDPQ Infra to handle the risks and complexities that go along with greenfield projects.

In fact, when it comes to direct infrastructure and real estate investments, CDPQ Infra and Ivanhoé Cambridge, the Caissse’s real estate subsidiary, are truly on another level in terms of operational expertise.

Interestingly, I had a brief chat with Hugh O’Reilly, CEO of OPTrust, this morning in the midst of writing this comment and asked him why he said many details needed to be ironed out on this new infrastructure program.

Hugh repeated that there are a lot of questions on how the federal infrastructure bank will operate but the government is going to address these concerns. He also said the federal government needs to reach out to public-sector unions to address their concerns, “just like the Caisse did.” 

He also told me that OPTrust’s alternatives portfolio is growing and they are investing more and more directly in private equity, real estate and infrastructure. I will cover OPTrust in detail in a future comment and thank Hugh for taking the time from his busy schedule to speak with me (extremely nice man, would like to spend more time with him and James Davis, OPTrust’s CIO, to understand their investments and operations).

Let me end my comment by stating that even though there are a lot of details that need to be worked out, there is no question in my mind that Canada has the requisite expertise to make a successful partnership between the new Infrastructure Bank, Canada’s large pensions and foreign investors interested in investing in large greenfield infrastructure projects.

Importantly, if Canada’s new infrastructure program is successful and they get the governance right at the Canadian Infrastructure Development Bank (CIDB) , it will be a new unique approach to investing in greenfield infrastructure unlike anything else in the world. It will set a new global standard, one that many countries will try to adopt, including the United States where I really believe a Trump administration needs to approach US, Canadian and global pensions to “make America great again”  (Trump’s plan to rebuild America will be a lot harder to pay for than it sounds).

Lastly, please pay no attention whatsoever to Terence Corcoran’s latest, The Liberals’ new ‘infrastructure bank’ is pure central planning at its worst. I’m tired of addressing the drivel coming out of the National Post from the likes of Andrew Coyne and Terence Corcoran who quite frankly haven’t the faintest idea of good governance, investing in infrastructure, and why this plan makes sense for the federal government, Canada’s large pensions, their members and stakeholders, Canadian taxpayers and most important of all, for the Canadian economy over the long run.

Bloomberg put together this interesting graphic, above, of pension funds and endowments that have yanked their money from hedge funds in 2016.

The third quarter of 2016 saw investors pull a net $28 billion from hedge funds — a small slice of the industry’s overall assets under management, but still the highest outflow since 2009.

More details on the trend from Bloomberg:

Unhappy with mediocre results and high fees, pensions in states like Illinois, New York and Rhode Island are slashing their allocations to hedge funds. More than one in four endowments and foundations, from colleges to museums to hospitals, are doing the same or considering it, according to a survey by consultant NEPC. Many are demanding lower fees and better terms to stick around, and usually getting it.

[…]

The backlash is part of a broader rebellion that has seen an avalanche of money move from actively-managed funds to low-cost passive products like index funds. The $3 trillion hedge fund industry, however, has become the poster child for the sins of active management because it charges among the highest fees even as performance lags. That doesn’t sit well in the political world of public pensions and endowments. They face pressure to boost returns as an aging workforce enters retirement and tuitions rise.