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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.

CalPERS board members voted last week to cut the pensions of about 200 former employees of a disbanded job-training agency known as LA Works, unless the four founding cities agree to make a $406,345 payment before July 1.

The cities that formed the East San Gabriel Valley Human Services Consortium joint powers authority — Azusa, Covina, Glendora, and West Covina — have told CalPERS they will not pay because the pension contract is with the disbanded agency, not the cities.

But the CalPERS board members left the door open for one last chance to avoid a 63 percent cut in the pensions of the former consortium employees: 62 retired, 93 separated, 36 retired, and six hired after a pension reform in 2013.

Among nearly a dozen employee letters urging CalPERS not to cut their pensions was one from JuLito Hidalgo, 65, a 15-year employee. He said his $1,600 monthly CalPERS pension and his wife’s $1,800 from Social Security barely cover the mortgage and expenses.

“We are both not in good health,” Hidalgo wrote. “We are both diabetic. We have hypertension and cholesterol issues. I have a heart condition and had two stents from two angioplastys.”

The California Public Employees Retirement System cut pensions for the first time last November, a reduction of about 60 percent for five former employees of Loyalton. The tiny Sierra town voluntarily terminated its CalPERS contract in March 2013.

But Loyalton did not pay the $1.7 million termination fee required by CalPERS to continue making full pension payments. The city council, once deeply divided, is making monthly payments to the retirees to replace the CalPERS pension cut.

The East San Gabriel Valley consortium closed in June 2014 after Los Angeles County supervisors rejected its bid for a new six-year $32 million contract. Auditors said the consortium had overbilled the county $1 million for job training inmates and the unemployed.

A consultant was hired to wind down the consortium operations, the CalPERS board was told, and the consortium board continues to meet. The consortium stopped making monthly payments to CalPERS in July 2015.

Matthew Jacobs, CalPERS general counsel, told the board last month the four cities have a “moral and ethical” obligation to pay for the pensions. He disagreed yesterday with the view of one city official that payment beyond the contract would be a “gift of public funds.”

Jacobs said the “dividing line” is whether the payment is for a private or public purpose, citing a case in which extra pay for judges was ruled not to be a gift of public funds because it served a public purpose.

Board member Theresa Taylor said monthly payments would not be “that much money” if each of the four cities “pitched in.” She said criticism of rising CalPERS rates and calls for pension cuts by city officials suggest giving employees more time to plead for city aid would be futile.

“They have a specific agenda behind what they are saying here,” Taylor said of the remarks reportedly made by two city officials, “and that’s not for defined benefit pension plans.”

The $406,345 payment sought by CalPERS is for two fiscal years. So presumably, after that debt is paid, the annual payment for each of the four cities might begin at roughly $50,000.

But it’s a long-term unpredictable cost that would continue for decades, perhaps as long as the life spans of the consortium employees and their beneficiaries. The termination fee to leave CalPERS and fully fund the pensions is $19.4 million.

Apart from the emotional personal letters to CalPERS, a letter from retirees stating the general issues asked CalPERS to delay action until retirees could address the board “face to face.”

One of the two signers of the letter, Kathryn Ford, received a $100,240 CalPERS pension in 2015, according to the Transparent California website that lists the pensions and pay of individual state and local government employees.

The former chief executive of the consortium, Salvador Velasquez, received an annual pension of $120,777. Velasquez, vacationing out of the country when audit questions arose, was called a “big part of the problem” by a San Gabriel Valley Tribune editorial in June 2014.

“For pension reasons, he is technically retired and retained by the board as a consultant,” the Tribune said. “The board dragged its feet on finding a replacement who could have ferreted out the problems, which obviously were myriad.”

After the six-figure pensions of Velasquez and Ford, consortium pensions listed by Transparent California drop sharply to $51,919 and continue to decline until reaching the lowest annual pension, $1,738.

The Ford letter said PERS attorneys should “research and pursue” city liability for the pensions. City governance of the consortium was built in through “compensated, voting board positions” that were “composed of mayors/councilmembers appointed by each city.”

If holding the cities responsible is not an option, said the letter, retirees request that CalPERS consider merging the consortium pensions into the Terminated Agency Pool without a reduction.

The letter said a merger into the pool without cutting pensions is allowed by state pension law (Section 20577.5) if the board finds that the merger would not impact the pool’s “actuarial soundness.”

A report to the CalPERS board this week said the pool was 249 percent funded as of June 30, 2015, well above the 100 percent considered adequate. The pool fund was valued at $222.5 million last June 30, a slight increase after paying $5.5 million in benefits last fiscal year.

The latest annual valuation of the Terminated Agency Pool, as of June 30, 2014, shows 91 plans, including Loyalton, with 733 retirees and beneficiaries receiving an annual average pension of $6,529.

Going into the pool without pension cuts was not discussed at the CalPERS board yesterday until the president, Rob Feckner, said he received email on the issue. The CalPERS chief actuary, Scott Terando, described the process.

Because employer and employee contributions are no longer available, CalPERS assumes all of the investment and mortality risk for terminated plans. So CalPERS requires employers to pay a lump sump projected to cover all future pension costs.

A termination fee, $19.4 million for the consortium, is based on a risk-free bond rate, now about 2 percent, rather than the risky but higher-yielding rate assumed for the CalPERS investment portfolio, now 7 percent.

The big termination fee, adopted in 2011, is controversial. Several cities have considered leaving CalPERS (Villa Park, Pacific Grove, Canyon Lake) but did not due to the large fee. A federal judge in the Stockton Bankruptcy called the fee a “poison pill.”

The impact on the “actuarial soundness” of the Terminated Agency Pool from accepting the nearly 200 former consortium employees without a pension reduction was not estimated at the board meeting.

CalPERS apparently has a number of employers that, like the East San Gabriel Valley joint powers authority, lack the authority to tax or raise their own revenue and rely only on contracts for their funding. Nonprofit organizations are said to be another example.

Board member Richard Costigan, referring to what some call “barnicles on the bottom of the CalPERS barge,” said the funding sources of some of the 3,500 employer plans are being reviewed to identify weaknesses.

Board member Bill Slaton said CalPERS must have assumed that the East San Gabriel Valley joint powers authority would be in existence as long as a city or county, essentially in perpetuity.

“We don’t have a plan that can operate with organizations that have a fixed term of life,” Slaton said. “It doesn’t work, given our pension system.”

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

Reuters reports, Canada pension funds to invest in Singapore, Indonesia warehouses:

Canada’s two biggest pension funds have agreed to partner with LOGOS, a real estate logistics operator, to invest in warehouses in Singapore and Indonesia, betting on demand from the rise of e-commerce and a burgeoning middle class in southeast Asia.

Canada Pension Plan Investment Board (CPPIB), the top pension fund of the country, said in a statement it will initially commit S$200 million ($142 million) for an about 48 percent stake in LOGOS Singapore Logistics Venture. It will also commit $100 million for a stake of about 48 percent in LOGOS Indonesia Logistics Venture.

CPPIB and Ivanhoé Cambridge, which is the real estate arm of Canada’s second-largest pension fund manager Caisse de depot et placement du Quebec, will be equal partners in both joint ventures, the statement said.

LOGOS, which operates in Australia, China, Indonesia and Singapore, will hold the remaining stake in the ventures.

CPPIB said the deals would pave the way for its first direct real estate investments in Singapore and Indonesia.

Private equity firms and institutional investors are pouring billions of dollars into warehousing and logistics investments in Asia in recent years betting on a boom in demand from e-commerce in the region.

Warburg Pincus, Blackstone Group LP and Hopu Investments were among bidders short-listed to present a potential offer for Singapore-listed Global Logistic Properties , sources told Reuters late last month.

And in January, Warburg Pincus-backed warehouse operator e-Shang Redwood agreed to buy an 80 percent indirect stake in the manager of Singapore-listed Cambridge Industrial Trust (CIT).

CPPIB put out this press release to announce the deal:

Canada Pension Plan Investment Board (CPPIB) announced today that it has entered into two agreements to invest alongside Ivanhoé Cambridge with real estate logistics specialist LOGOS in the LOGOS Singapore Logistics Venture (LSLV) and LOGOS Indonesia Logistics Venture (LILV), which will focus on developing and acquiring modern logistics facilities in Singapore and Indonesia, respectively.

In Singapore, a key global logistics hub, CPPIB will initially commit S$200 million for an approximate 48% stake in the LSLV, which will be seeded by two fully-leased existing multi-storey logistics warehouse facilities as well as one development opportunity. All the seed assets are very well located in established industrial submarkets of Singapore.

Additionally, CPPIB will initially commit US$100 million in equity for an approximate 48% stake in LILV, which has an identified strong pipeline of development opportunities in Greater Jakarta, Indonesia. LILV will develop assets to meet the increasing demand for modern logistics facilities on the back of Indonesia’s compelling macroeconomic fundamentals, rapid e-commerce growth and a growing logistics sector.

“The logistics sector in Southeast Asia continues to grow as a result of the burgeoning middle class and the rise of e-commerce, and presents an excellent opportunity for a long-term investor like CPPIB,” said Jimmy Phua, Managing Director, Head of Real Estate Investments – Asia, CPPIB. “We are looking forward to making our first direct real estate investments in Singapore and Indonesia through well-established, like-minded partners like LOGOS and Ivanhoé Cambridge.”

CPPIB and Ivanhoé Cambridge will be equal partners in both joint ventures, with LOGOS, as the operating partner, holding the remaining stake in the ventures.

“Both Ivanhoé Cambridge and CPPIB are recognised as leading real estate investors around the world, and we are excited to expand our relationship with Ivanhoé Cambridge as well as attracting CPPIB into both our Singapore and Indonesia ventures,” said Stephen Hawkins, Managing Director of LOGOS South East Asia.

“Ivanhoé Cambridge welcomes CPPIB as our co-investment partner with LOGOS in Singapore and Indonesia,” said Rita-Rose Gagné, President, Growth Markets, at Ivanhoé Cambridge. “Increasing our allocation reaffirms our view of the growth potential in Southeast Asia and our confidence in LOGOS as a best-in-class logistics real estate specialist in Asia-Pacific.”

Ivanhoé Cambridge put out this press release on the deal:

For the Singapore venture, LOGOS will continue with its strategy of acquiring and developing high-quality, modern industrial and logistics properties in Singapore with over S$800M in investment capacity. To date LOGOS has acquired interests in three properties, consisting of two multi-storey logistics warehouse facilities and one development site, all of which are fully leased.

For the Indonesia venture, the strategy is to focus on developing and owning high quality, modern logistics properties in Greater Jakarta, Indonesia. The commitments will provide LOGOS with over US$400M in investment capacity. LOGOS has identified a strong pipeline of development opportunities to meet the increasing demand for modern logistics facilities on the back of Indonesia’s compelling macroeconomic fundamentals, rapid e-commerce growth and growing logistics sector.

Concurrent with the establishment of the Indonesia venture, LOGOS is pleased to announce the establishment of an office in Jakarta, expanding LOGOS offices to four countries (Australia, China, Indonesia, and Singapore).

“LOGOS has subsequently established ventures in Singapore and Indonesia which is testament to the growth being experienced in both of these markets and LOGOS’ ability to secure an attractive pipeline of opportunities,” commented John Marsh, Joint Managing Director of LOGOS. “We are also excited that LOGOS is increasingly able to offer its customers a high quality solution across Asia Pacific.”

Stephen Hawkins, Managing Director of LOGOS South East Asia added, “Expanding our relationship with Ivanhoé Cambridge as well as attracting CPPIB into both our Singapore and Indonesia ventures is very exciting. Both Ivanhoé Cambridge and CPPIB are recognised as leading real estate investors around the world.”

“Ivanhoé Cambridge welcomes CPPIB as our co-investment partner with LOGOS in Singapore and Indonesia,” said Rita-Rose Gagné, President, Growth Markets, for Ivanhoé Cambridge. “Increasing our allocation reaffirms our view of the growth potential in Southeast Asia and our confidence in LOGOS as a best-in-class logistics real estate specialist in Asia-Pacific.

“The logistics sector in Southeast Asia continues to grow as a result of the burgeoning middle class and the rise of e-commerce, and presents an excellent opportunity for a long-term investor like CPPIB,” said Jimmy Phua, Managing Director & Head of Real Estate Investments – Asia. “We are looking forward to making our first direct real estate investments in Singapore and Indonesia through well-established, like-minded partners like LOGOS and Ivanhoe Cambridge.

Macquarie Capital (Australia) Limited (together and through its affiliates, Macquarie Capital) acted as exclusive financial adviser to LOGOS for the transaction and as sole lead manager and arranger for both the LSLV and LILV capital raisings.

About LOGOS

LOGOS is an integrated investment and development logistics real estate specialist with operations in Australia, China, Indonesia and Singapore. LOGOS currently has approximately AUD$3.0 billion in assets under management including end values for projects under development. For further information: www.logosproperty.com

So what is this deal all about and why are Canada’s pension giants teaming up with LOGOS to make investments in warehouses in Singapore and Indonesia?

I think it’s pretty self-explanatory. The Caisse and CPPIB are betting on the demand from the rise of e-commerce and a burgeoning middle class in southeast Asia. This is a long-term bet and if you’ve been paying attention to e-commerce trends in North America, you can bet the exact same thing will happen in Asia but with exponential growth.

Canada’s large pension funds are competing with large private equity firms for these logistic warehouses. They not only provide great growth potential, they are pretty much all leased up and will provide stable cash flows (rents) over a very long period.

When I went over HOOPP’s 2015 results last year, Jim Keohane told me that HOOPP is building industrial warehouses in the UK and Amazon will be one of its tenants. I asked Jim back then why Amazon wouldn’t simply invest its own money to build these warehouses and he told me “because it can get a better return on investment elsewhere.”

Other large Canadian pensions (PSP, bcIMC, OTPP, etc.) have also been investing heavily in these industrial warehouses in North America, Europe and Asia typically alongside strategic partners.

Remember, pensions are all about managing assets and long duration liabilities. Real estate and infrastructure are long duration assets. They do carry risks, like illiquidity, currency and political/ regulatory risk in the case of infrastructure, so they’re not a perfect substitute for ultra long bonds, but they generally provide stable yields in between stocks and bonds over a very long period.

And since pension funds are not in the business of flipping real estate and infrastructure assets and have a very long investment horizon, they can easily hold these assets on their books over an economic cycle and ride out any rough patch along the way.

Are there short-term risks to investing in Asia? Of course, I’m worried the Fed might make a policy error and hike rates more often than what the market anticipates, fueling the 2017 US dollar crisis I warned of late last year. This can unleash another Asian financial crisis.

In a CFA luncheon I attended last month, PSP Investment’s President and CEO André Bourbonnais said PSP was “underweight emerging markets” and taking a more cautious stance in both public and private investments there. I agree with Mr. Bourbonnais’s cautious stance on emerging markets.

More locally, Singapore’s growth shock is masking a duller economy and the government recently eased its property rules, diverging path from Hong Kong, a move that was applauded by businesses but shows that policymakers are still concerned about property bubbles there.

Having said this, there are always macro and financial risks involved in these transactions but it’s also important to note the secular trends behind the decision to invest in these industrial warehouses. Even if CPPIB and the Caisse take a short-term hit — a real possibility — over the long run these investments will prove to be very profitable and provide both these large pensions with stable cash flows. And like the Ivanhoé Cambridge press release states, all these warehouses are already fully leased, which shows you demand for these logistical warehouses is extremely strong.

Update: In another mega real estate deal, CPPIB, Singapore’s GIC and The Scion Group LLC (Scion) announced on Thursday that their student housing joint venture entity, Scion Student Communities LP (together with its subsidiaries, “the Joint Venture”), has acquired three US student housing portfolios for approximately US$1.6 billion. Details on this deal can be found 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.

A Secure Choice lawyer thinks private-sector employees can still be automatically enrolled in the new state retirement savings plan, even if the Republican-controlled Congress repeals a regulation exempting state savings plans from federal pension law.

California and a half dozen other states are creating state-run “automatic IRAs” for employees with jobs that do not offer a retirement plan. If employees do not opt out, a payroll deduction will go into their new tax-deferred savings account.

Oregon plans to launch the first state retirement savings plan in July, a small pilot. Like the California Secure Choice lawyer, Oregon Saves also thinks the federal pension law allows an exemption without the specific language of the regulation, a spokesman said last week.

Secure Choice does not plan to begin payroll deductions until at least late in 2019, after preparation and enrollment for businesses with 100 or more employees begins in mid-2018. Smaller businesses, with five or more employees, will be added in the following two years.

An automatic payroll deduction for a tax-deferred Individual Retirement Account is said to be a proven way to increase savings. But it’s opposed by parts of the financial sector as competition and by conservatives as government expansion that could lead to more public debt.

State retirement plans are strongly backed by some public employee unions, who think improving private-sector retirement can help counter pressure to cut government pensions or switch to 401(k)-style individual investment plans, following the corporate trend.

Secure Choice advocates say the program is being created with donations and repayable state loans, will become self-sustaining under legislation that allows no debt liability for employers or the state, and the investments will be managed by private-sector firms.

The plan is needed, say advocates, because more than 75 percent of California’s low-and-moderate income retirees rely exclusively on Social Security and nearly half of workers are on track to retire with incomes below 200 percent of the federal poverty level.

Last month, fast-track legislation to repeal the Obama administration labor regulation, HJR 66 and 67, moved out of the House and to the Senate floor. Gov. Brown sent the California congressional delegation a letter urging opposition to the repeal.

“I understand that Wall Street institutions strongly object to California and other states setting up such systems,” Brown said in the letter, the Sacramento Bee reported. “They think the dollars that move into Secure Choice should instead flow into their own products.

“I consider this a feature, not a defect of Secure Choice. Indeed, we hope to enroll those who historically (have) not been served by the savings industry.”

State Treasurer John Chiang was among 19 state treasurers, including six Republicans, that sent a letter to the Senate opposing the repeal. A Chiang adviser, Ruth Holton-Hodson, has helped coordinate the opposition campaign.

The treasurer is authorized by the legislation that created Secure Choice to appoint an executive director. His board representative, Steve Juarez, said two of the nine board members, Yvonne Walker and Heather Hooper, will assist in the selection expected soon.

A Secure Choice exemption or “safe harbor” from the federal pension law, ERISA (Employee Retirement Income Security Act of 1974), is needed to reduce opposition from business employer groups and the potential for lawsuits.

Chiang and Senate President pro Tempore Kevin de Leon, D-Los Angeles, who first proposed legislation for the program in 2008, joined officials from other states in urging the Obama administration to issue a labor regulation exempting Secure Choice-style programs from ERISA.

A Secure Choice attorney, David Morse of K&L Gates, told the board last week that the regulation specifically says employees with no workplace retirement plan can be automatically enrolled in a state-mandated program that allows employees to opt out.

But the regulation also says it’s only the view of the Labor department, not the only way to create an exemption, and the final determination of whether a program is exempt from federal pension law will be made by the courts.

If the fast-track resolutions are blocked in the Senate, the repeal of the regulation could be pursued through the standard regulatory process, which unlike the fast-track allows public hearings, Holton-Hodson told the board.

Morse said that if the regulation is repealed Secure Choice could return to the original plan to use the exemption provisions in the 1974 federal pension law, with some Labor guidance issued later.

“It’s not like you have to start from zero,” Morse said. ‘We would go back to trying to rely on the old safe harbors to keep the program free from ERISA regulation. So, it doen’t mean that it’s the end of the road.”

Juarez said talks have begun with Morse and the state attorney general’s office about possible modifications in the final Secure Choice legislation signed last September by Brown in a ceremony with De Leon, the author of SB 1234, Chiang and others.

“Our thought is we have to prepare for the worst, but hope for the best,” said Juarez.

Employees would contribute 3 percent of their pay to Secure Choice under the legislation, unless altered by the board. The board also could increase the contribution by 1 percent of pay a year up to 8 percent. Employees would have the option of setting their own rate.

Investments during the first three years would be in U.S. Treasury bonds or the equivalent, giving the board time to develop options for riskier higher-yielding investments protected against losses, possibly by insurance or pooling investments to build a large reserve.

Taking a different path, Oregon Saves investments will be in “target date” or “aged-base” funds that shift the amount of stocks, bonds and other assets to less risky but lower-yielding investments as the employee approaches retirement age.

Oregon Saves options are a conservative “capital preservation” fund to limit the risk of loss and, going the other way, an “investmentment growth” fund with higher yields and a higher risk of loss. The Oregon plan has no guarantee preventing losses.

Secure Choice is operating this fiscal year with a $1.9 million state loan that will be repaid from an administrative fee collected from employee investments that cannot exceed 1 percent of total assets.

Donations totaling $1 million for a feasibility and market study came from very different sources. The California Teachers Association and the SEIU each contributed $100,000 of the match for a $500,000 grant from the Laura and John Arnold Foundation, often vilified by unions for supporting public pension reform.

Yvonne Walker, president of the largest state worker union, SEIU Local 1000, is a member of the Secure Choice board. She joined Jon Hamm, Highway Patrol union executive, in a proposal at a legislative hearing in 2011 on Gov. Brown’s pension reform.

Look at ways to improve retirement security for private-sector workers, the two union officials told lawmakers, instead of only focusing on cutting public employee retirement benefits.

De Leon’s original bill in 2012 drew on proposals from several policy, labor and consumer groups in addition to the National Conference on Public Employee Retirement Systems, said a report last year by the Center for Retirement Research at Boston College.

“The NCPERS plan reflected the recognition by public employees that the quality of their own retirement coverage could be at risk if their counterparts in the private sector lack access to a retirement system,” said the report by Alicia Munnell and others.

A proposed state constitutional amendment, SCA 1 by Sen. John Moorlach, R-Costa Mesa, would prohibit the state from incurring liability for Secure Choice benefit payments and bar state general funds for Secure Choice after the startup and first-year administrative costs.

 

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

Ginger Adams Otis of the New York Daily News reports, Pension Benefit Guaranty Corporation running out of cash to cover union pension funds (h/t, Suzanne Bishopric):

The clock is ticking for 71 penniless union pension funds that rely on a federal insurance company to support their retirees — because the agency itself is also running out of cash, its director said Wednesday.

The Pension Benefit Guaranty Corporation’s limited liquidity is part of the spiraling U.S. pension crisis that threatens to wipe out the retirement savings of more than a million Americans.

The PBGC talked about its reduced circumstances Wednesday as it announced that it is now officially making pension payouts for Teamsters Local 707.

The New York union’s pension fund — covering 4,000 retired truckers across the city and Long Island — hit rock bottom in February.

The PBGC stepped in, as it has with 70 other bankrupt union pensions.

But PBGC only has about a decade’s worth of cash in its coffers, director Tom Reeder warned.

“This is a big issue for us. It’s a big issue for Local 707 and it’s a big issue for others in the same situation across the country,” Reeder said.

“We’re projected to run out of money in eight to 10 years. Many union pension plans are projected to run out in 20 years,” he explained.

“There are going to be people in plans who run out of money after we do, and there will be no water in the well.”

Right now, PBGC has $2 billion in assets built up over 42 years, Reeder said.

The company makes its money through premiums charged to unionized multi-employer pension funds — many of which are caught in an unprecedented financial crunch that’s decimated thousands of union retirees.

Last year, when PBGC was supporting 65 bankrupt plans, it paid out $113 million a month, agency officials said.

In 2017, with even more insolvent plans on its books, PBGC is shelling out even more.

Local 707 alone, with its 4,000 retirees, costs PBGC $1.7 million a month, agency officials said.

In order to keep afloat, PBGC doesn’t try to match a retiree’s union pension. The payouts are cut, often down to about one-third of what the worker is due.

Ex-truckers with Local 707 shared their new financial reality with the Daily News last week.

Ray Narvaez, 77, retired in 2003 after more than 30 years as a Teamster with a $3,400 monthly pension.

Now his monthly take home is $1,100 before taxes.

Narvaez is actually one of the luckier ones in 707.

According to PBGC officials, the average 707 retiree was getting $1,313 a month from the union pension fund.

Now that the fund is broke and dependent on PBGC’s insurance payouts, the average monthly take home is $570, agency officials said.

But that’s nothing compared to the cuts that would hit union retirees if the PBGC went under, said Reeder.

If that were to happen, PBGC would have to rely solely on what it earned from incoming premium payments.

Retirees could expect to see their benefits slashed by 80% . In other words, less than one-eighth of the $570 average check PBGC is able to give Local 707 retirees now.

“The amounts would be negligible. Their retirement payouts would be very low,” a PBGC official said.

The disaster that’s struck Local 707 is looming for several other, much larger Teamster pension funds.

Retirees in construction, mining and the retail and service industries have been hard-hit too.

All of the critically underfunded pensions are multi-employers plans — meaning they were created by various companies that all employed union workers across the same industry. The Teamsters, predominantly a trucking union, has seen its pension funds devastated by stock market crashes and a shrinking employer base.

Two of the largest union pension funds teetering on the brink of insolvency — the Central States Pension Fund and the New York State Teamsters Pension Fund in the Albany region — cover Teamsters.

If the Central States Pension fund goes broke, it could swamp PBGC — if it hasn’t gone broke first.

The majority of union multi-employer pension funds are doing well, as are single-employer union pension funds, Reeder said.

“It’s a minority, but a significant minority, of the multi-employer plans that are in trouble,” he said.

Reeder and many of the union pension funds are pinning their hopes on Congress.

The PBGC is looking for an increase in the premiums it can charge the union funds, which requires Congressional approval.

“It won’t be painless” to shore up the insurance fund, Reeder said.

But it will be far cheaper to do it now than to wait until the last minute, he said.

“We are fairly confident that we will be insolvent on the multi-employer side by 2022 or 2028 barring a legislative change,” he said.

For Edward Hernandez, 67, a retired Local 707 trucker whose monthly pension just got slashed $2,422 to $902 before taxes, the time to sound the alarm was nearly two decades ago.

“I was saying back then to Local 707, ‘Why don’t we do something about it now, let’s go to Washington,’” he said. “Even 15 years ago we were getting letters that our fund was becoming insolvent. Why couldn’t anyone find a way to fix this then?”

Edward Hernandez is right, the time to have done something about this was 20 years ago or even before then, now it’s too late, these Teamsters pensions are hanging on by a thread.

And so is the Pension Benefit Guaranty Corporation (PBGC), the federal agency tasked to backstop these pensions should they become insolvent. Its director, Tom Reeder, is sounding the alarm, unless the agency gets Congressional approval to raise the premiums ii charges union pension funds, it will be insolvent on the multi-employer side, which effectively means pension payout will be slashed even more than they already have been.

I have long warned of the risks of the PBGC so none of this surprises me in the least. I’ve also warned of how the PBGC was making increasingly riskier investments in illiquid alternatives to meet its soaring obligations.

In my last comment, I covered America’s crumbling pension future, explaining in detail why these multi-employer pension plans were designed to fail. Their governance was all wrong to begin with, leaving them exposed to the sharks on Wall Street who raked them on fees while they invested them in stocks and other more illiquid and riskier assets.

And now that catastrophe has struck and there is not enough money to cover even reduced payouts, people are sounding the alarm.

Here is something else to ponder. The PBGC backstops private pension plans, not state, local and city public pensions plans. What happens when they become insolvent? And don’t kid yourselves, many of them are also hanging on by a thread.

What will politicians do then? Emit more pension obligation bonds? Increase property taxes more than they’ve already have? Good luck with both those strategies, it’s like placing a Band-Aid over a metastasized tumor.

The time has come for the United States of America to come to grips with its pension crisis once and for all, to bolster the governance at state pension funds following the Canadian governance model and more importantly, to reform and enhance Social Security and base it on the Canada Pension Plan and the Canada Pension Plan Investment Board which successfully manages the money on behalf of Canadians, investing it across public and private markets all over the world.

As I stated in my last comment, the ongoing pension crisis is deflationary, it’s not good for the economy over the long run because all these millions of Americans will end up retiring penniless, which effectively means less spending from them and less sales and personal income taxes for all governments (too many people underestimate the benefits of defined-benefit plans).

So, if you ask me, part of me wants the PBGC to go broke because only then will it force Congress to implement the radical changes that the country needs to effectively deal with the ongoing pension crisis.

The problem is behind every pension lies a person, someone who contributed to it thinking they would one day be able to retire in dignity ad security. That is what it’s all about folks, keeping a pension promise to hard working people looking to retire with a modest pension. And when that promise is broken, it’s the worst form of betrayal of the social contract.

It also sends the signal to everyone that you cannot rely on your pension to retire so keep saving more and more if you want to avoid pension poverty. More saving means less money spent on goods and services, ie. more deflationary headwinds.

Do you get it? I hope US politicians reading this get it because it’s much bigger than the PBGC going broke, the pension crisis threatens the US economy over the long run and unless it’s dealt with appropriately, it will get worse, and only ensure more inequality and long-term economic stagnation.

Update: After reading this comment, Bernard Dussault, Canada’s former Chief Actuary, shared this with me:

Amidst my crusade for the protection of Defined Benefit (DB) pension plans, I opine that contingency funds are more harmful than helpful for both plan members and sponsors because:

1. they unduly increase the pension expenditures of all concerned DB plans with the objective of safeguarding the pensions accrued through only the small proportion of plan sponsors eventually going bankrupt;
2. not only do contingency funds protect the concerned plans against a risk that improperly relates to business (i.e. bankruptcy) as opposed to pension (i.e. mainly insufficient investment returns),
3. but human nature being what it is, I surmise that the protection provided by a contingency fund might, in order to contain current estimates of pension costs and liabilities, induce the concerned:

• valuation actuaries, colluding or not with their plan sponsors, to be complacent about the soundness of valuation assumptions, e.g. by assuming an aggressive (i.e. too liberal) rate of return on investments;
• investment officers, colluding or not with the plan sponsor, to take undue risks in the selection of investments.

This does not mean that I do not care about the protection of pensions lost pursuant to a bankruptcy. Indeed, as stated in my attached proposed financing policy for DB plans, in such cases:

1. DB plan members shall have priority over secured creditors to amounts covered by a deemed trust, no matter when the security was granted to the lender;
2. The outstanding investment fund shall be maintained of rather than used to buy annuities because:

• the cost of future benefit payments if less expensive if paid from the pension fund;
• after the sponsor’s bankruptcy, the market value of the deficient fund would normally improve.

I thank Bernard for sharing his wise insights with my blog readers.

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

Ginger Adams Otis of the New York Daily News reports, Pension Benefit Guaranty Corporation running out of cash to cover union pension funds (h/t, Suzanne Bishopric):

The clock is ticking for 71 penniless union pension funds that rely on a federal insurance company to support their retirees — because the agency itself is also running out of cash, its director said Wednesday.

The Pension Benefit Guaranty Corporation’s limited liquidity is part of the spiraling U.S. pension crisis that threatens to wipe out the retirement savings of more than a million Americans.

The PBGC talked about its reduced circumstances Wednesday as it announced that it is now officially making pension payouts for Teamsters Local 707.

The New York union’s pension fund — covering 4,000 retired truckers across the city and Long Island — hit rock bottom in February.

The PBGC stepped in, as it has with 70 other bankrupt union pensions.

But PBGC only has about a decade’s worth of cash in its coffers, director Tom Reeder warned.

“This is a big issue for us. It’s a big issue for Local 707 and it’s a big issue for others in the same situation across the country,” Reeder said.

“We’re projected to run out of money in eight to 10 years. Many union pension plans are projected to run out in 20 years,” he explained.

“There are going to be people in plans who run out of money after we do, and there will be no water in the well.”

Right now, PBGC has $2 billion in assets built up over 42 years, Reeder said.

The company makes its money through premiums charged to unionized multi-employer pension funds — many of which are caught in an unprecedented financial crunch that’s decimated thousands of union retirees.

Last year, when PBGC was supporting 65 bankrupt plans, it paid out $113 million a month, agency officials said.

In 2017, with even more insolvent plans on its books, PBGC is shelling out even more.

Local 707 alone, with its 4,000 retirees, costs PBGC $1.7 million a month, agency officials said.

In order to keep afloat, PBGC doesn’t try to match a retiree’s union pension. The payouts are cut, often down to about one-third of what the worker is due.

Ex-truckers with Local 707 shared their new financial reality with the Daily News last week.

Ray Narvaez, 77, retired in 2003 after more than 30 years as a Teamster with a $3,400 monthly pension.

Now his monthly take home is $1,100 before taxes.

Narvaez is actually one of the luckier ones in 707.

According to PBGC officials, the average 707 retiree was getting $1,313 a month from the union pension fund.

Now that the fund is broke and dependent on PBGC’s insurance payouts, the average monthly take home is $570, agency officials said.

But that’s nothing compared to the cuts that would hit union retirees if the PBGC went under, said Reeder.

If that were to happen, PBGC would have to rely solely on what it earned from incoming premium payments.

Retirees could expect to see their benefits slashed by 80% . In other words, less than one-eighth of the $570 average check PBGC is able to give Local 707 retirees now.

“The amounts would be negligible. Their retirement payouts would be very low,” a PBGC official said.

The disaster that’s struck Local 707 is looming for several other, much larger Teamster pension funds.

Retirees in construction, mining and the retail and service industries have been hard-hit too.

All of the critically underfunded pensions are multi-employers plans — meaning they were created by various companies that all employed union workers across the same industry. The Teamsters, predominantly a trucking union, has seen its pension funds devastated by stock market crashes and a shrinking employer base.

Two of the largest union pension funds teetering on the brink of insolvency — the Central States Pension Fund and the New York State Teamsters Pension Fund in the Albany region — cover Teamsters.

If the Central States Pension fund goes broke, it could swamp PBGC — if it hasn’t gone broke first.

The majority of union multi-employer pension funds are doing well, as are single-employer union pension funds, Reeder said.

“It’s a minority, but a significant minority, of the multi-employer plans that are in trouble,” he said.

Reeder and many of the union pension funds are pinning their hopes on Congress.

The PBGC is looking for an increase in the premiums it can charge the union funds, which requires Congressional approval.

“It won’t be painless” to shore up the insurance fund, Reeder said.

But it will be far cheaper to do it now than to wait until the last minute, he said.

“We are fairly confident that we will be insolvent on the multi-employer side by 2022 or 2028 barring a legislative change,” he said.

For Edward Hernandez, 67, a retired Local 707 trucker whose monthly pension just got slashed $2,422 to $902 before taxes, the time to sound the alarm was nearly two decades ago.

“I was saying back then to Local 707, ‘Why don’t we do something about it now, let’s go to Washington,’” he said. “Even 15 years ago we were getting letters that our fund was becoming insolvent. Why couldn’t anyone find a way to fix this then?”

Edward Hernandez is right, the time to have done something about this was 20 years ago or even before then, now it’s too late, these Teamsters pensions are hanging on by a thread.

And so is the Pension Benefit Guaranty Corporation (PBGC), the federal agency tasked to backstop these pensions should they become insolvent. Its director, Tom Reeder, is sounding the alarm, unless the agency gets Congressional approval to raise the premiums ii charges union pension funds, it will be insolvent on the multi-employer side, which effectively means pension payout will be slashed even more than they already have been.

I have long warned of the risks of the PBGC so none of this surprises me in the least. I’ve also warned of how the PBGC was making increasingly riskier investments in illiquid alternatives to meet its soaring obligations.

In my last comment, I covered America’s crumbling pension future, explaining in detail why these multi-employer pension plans were designed to fail. Their governance was all wrong to begin with, leaving them exposed to the sharks on Wall Street who raked them on fees while they invested them in stocks and other more illiquid and riskier assets.

And now that catastrophe has struck and there is not enough money to cover even reduced payouts, people are sounding the alarm.

Here is something else to ponder. The PBGC backstops private pension plans, not state, local and city public pensions plans. What happens when they become insolvent? And don’t kid yourselves, many of them are also hanging on by a thread.

What will politicians do then? Emit more pension obligation bonds? Increase property taxes more than they’ve already have? Good luck with both those strategies, it’s like placing a Band-Aid over a metastasized tumor.

The time has come for the United States of America to come to grips with its pension crisis once and for all, to bolster the governance at state pension funds following the Canadian governance model and more importantly, to reform and enhance Social Security and base it on the Canada Pension Plan and the Canada Pension Plan Investment Board which successfully manages the money on behalf of Canadians, investing it across public and private markets all over the world.

As I stated in my last comment, the ongoing pension crisis is deflationary, it’s not good for the economy over the long run because all these millions of Americans will end up retiring penniless, which effectively means less spending from them and less sales and personal income taxes for all governments (too many people underestimate the benefits of defined-benefit plans).

So, if you ask me, part of me wants the PBGC to go broke because only then will it force Congress to implement the radical changes that the country needs to effectively deal with the ongoing pension crisis.

The problem is behind every pension lies a person, someone who contributed to it thinking they would one day be able to retire in dignity ad security. That is what it’s all about folks, keeping a pension promise to hard working people looking to retire with a modest pension. And when that promise is broken, it’s the worst form of betrayal of the social contract.

It also sends the signal to everyone that you cannot rely on your pension to retire so keep saving more and more if you want to avoid pension poverty. More saving means less money spent on goods and services, ie. more deflationary headwinds.

Do you get it? I hope US politicians reading this get it because it’s much bigger than the PBGC going broke, the pension crisis threatens the US economy over the long run and unless it’s dealt with appropriately, it will get worse, and only ensure more inequality and long-term economic stagnation.

Update: After reading this comment, Bernard Dussault, Canada’s former Chief Actuary, shared this with me:

Amidst my crusade for the protection of Defined Benefit (DB) pension plans, I opine that contingency funds are more harmful than helpful for both plan members and sponsors because:

1. they unduly increase the pension expenditures of all concerned DB plans with the objective of safeguarding the pensions accrued through only the small proportion of plan sponsors eventually going bankrupt;
2. not only do contingency funds protect the concerned plans against a risk that improperly relates to business (i.e. bankruptcy) as opposed to pension (i.e. mainly insufficient investment returns),
3. but human nature being what it is, I surmise that the protection provided by a contingency fund might, in order to contain current estimates of pension costs and liabilities, induce the concerned:

• valuation actuaries, colluding or not with their plan sponsors, to be complacent about the soundness of valuation assumptions, e.g. by assuming an aggressive (i.e. too liberal) rate of return on investments;
• investment officers, colluding or not with the plan sponsor, to take undue risks in the selection of investments.

This does not mean that I do not care about the protection of pensions lost pursuant to a bankruptcy. Indeed, as stated in my attached proposed financing policy for DB plans, in such cases:

1. DB plan members shall have priority over secured creditors to amounts covered by a deemed trust, no matter when the security was granted to the lender;
2. The outstanding investment fund shall be maintained of rather than used to buy annuities because:

• the cost of future benefit payments if less expensive if paid from the pension fund;
• after the sponsor’s bankruptcy, the market value of the deficient fund would normally improve.

I thank Bernard for sharing his wise insights with my blog readers.

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

The Caisse de dépôt et placement du Québec today released its financial results for calendar year 2016, posting a 10.2% five-year annualized return:

La Caisse de dépôt et placement du Québec today released its financial results for the year ended December 31, 2016. The annualized weighted average return on its clients’ funds reached 10.2% over five years and 7.6% in 2016.

Net assets totalled $270.7 billion, increasing by $111.7 billion over five years, with net investment results of $100 billion and $11.7 billion in net deposits from its clients. In 2016, net investment results reached $18.4 billion and net deposits totalled $4.3 billion.

Over five years, the difference between la Caisse’s return and that of its benchmark portfolio represents more than $12.3 billion of value added for its clients. In 2016, the difference was equivalent to $4.4 billion of value added.

Caisse and benchmark portfolio returns

“Our strategy, focused on rigorous asset selection, continues to deliver solid results,” said Michael Sabia, President and Chief Executive Officer of la Caisse. “Over five years, despite substantially different market conditions from year to year, we generated an annualized return of 10.2%.”

“On the economic front, the fundamental issue remains the same: slow global growth, exacerbated by low business investment. At the same time, there are also significant geopolitical risks. Given the relative complacency of markets, we need to adopt a prudent approach.”

“However, taking a prudent approach does not mean inaction, because there are opportunities to be seized in this environment. Through our global exposure, our presence in Québec, and the rigour of our analyses and processes, we’re well-positioned to seize the best opportunities in the world and face any headwinds,” added Mr. Sabia.

RETURNS BY ASSET CLASS

HIGHLIGHTS OF THE ACCOMPLISHMENTS

The strategy that la Caisse has been implementing for seven years focuses on an absolute-return management approach in order to select the highest-quality securities and assets, based on fundamental analysis. La Caisse’s strategy also aims to enhance its exposure to global markets and strengthen its impact in Québec. The result is a well-diversified portfolio that generates value beyond the markets and brings long-term stability.

Bonds: performance in corporate credit stands out

The Bonds portfolio, totalling more than $68 billion, posted a 3.9% return over five years, higher than that of its benchmark. The difference is equivalent to value added of $1.6 billion. Securities of public and private companies and the active management of credit spreads in particular contributed to the portfolio’s return.

In 2016, despite an increase in interest rates at year-end, the portfolio posted a 3.1% return. It benefited from continued investment in growth market debt and from the solid performance of corporate debt, particularly in the industrial sector.

Public equity: sustained returns over five years and the Canadian market rebound in 2016

Over the five-year period, the annualized return of the entire Public Equity portfolio reached 14.1%. In addition to demonstrating solid market growth over the period, the return exceeded that of the benchmark, reflecting the portfolio’s broad diversification, its focus on quality securities and well-selected partners in growth markets. The Global Quality, Canada and Growth Markets mandates generated, respectively, annualized returns of 18.6%, 10.6% and 8.1%, creating $5.8 billion of value added.

For 2016, the 4.0% return on the Global Quality mandate reflects the depreciation of international currencies against the Canadian dollar. The mandate continued to be much less volatile than the market. The Canada mandate, with a 22.7% return, benefited from a robust Canadian market, driven by the recovery in oil and commodity prices and the financial sector’s solid performance, particularly in the second half of the year.

Less-liquid assets: globalization well underway and a solid performance

The three portfolios of less-liquid assets – Real Estate, Infrastructure and Private Equity – posted a 12.3% annualized return over five years, demonstrating solid and stable results over time. During this period, investments reached more than $60.1 billion. In 2016, $2.4 billion were invested in growth markets, including $1.3 billion in India, where growth prospects are favourable and structural reforms are well underway. The less-liquid asset portfolios are central to la Caisse’s globalization strategy, with their exposure outside Canada today reaching 70%.

More specifically, in Real Estate, Ivanhoé Cambridge invested $5.8 billion and its geographic and sector-based diversification strategy continued to perform. In the United States, the Caisse subsidiary acquired the remaining interests in 330 Hudson Street and 1211 Avenue of the Americas in New York and completed construction of the River Point office tower in Chicago. In the residential sector, the strategy in cities such as London, San Francisco and New York and the steady demand for residential rental properties generated solid returns. In Europe, Ivanhoé Cambridge and its partner TPG also completed the sale of P3 Logistic Parks, one of the largest real estate transactions on the continent in 2016. In Asia-Pacific, Ivanhoé Cambridge acquired an interest in the company LOGOS, its investment partner in the logistics sector, alongside which it continues to invest in Shanghai, Singapore and Melbourne.

In Private Equity, la Caisse invested $7.8 billion over the past year, in well-diversified markets and industries. Through the transactions carried out in 2016, la Caisse developed strategic partnerships with founders, families of entrepreneurs and operators that share its long-term vision. In the United States, it acquired a significant ownership stake in AlixPartners, a global advisory firm. La Caisse also acquired a 44% interest in the Australian insurance company Greenstone and invested in the European company Eurofins, a world leader in analytical laboratory testing of food, environmental and pharmaceutical products. In India, la Caisse became a partner of Edelweiss, a leader in stressed assets and specialized corporate credit. It also invested in TVS Logistics Services, an Indian multinational provider of third-party logistics services.

In Infrastructure, la Caisse partnered with DP World, one of the world’s largest port operators, to create a $5-billion investment platform intended for ports and terminals globally. The platform, in which la Caisse holds a 45% share, includes two Canadian container terminals located in Vancouver and Prince Rupert. In India’s energy sector, la Caisse acquired a 21% interest in Azure Power Global, one of India’s largest solar power producers. Over the year, la Caisse also strengthened its long-standing partnership with Australia’s Plenary Group by acquiring a 20% interest in the company. Together, la Caisse and Plenary Group have already invested in seven social infrastructure projects in Australia.

Impact in Québec: a focus on the private sector

In Québec, la Caisse focuses on the private sector, which drives economic growth. La Caisse’s strategy is built around three main priorities: growth and globalization, impactful projects, and innovation and the next generation.

Growth and globalization

In 2016, la Caisse worked closely with Groupe Marcelle’s management team when it acquired Lise Watier Cosmétiques to create the leading Canadian company in the beauty industry. It also supported Moment Factory’s creation of a new entity dedicated to permanent multimedia infrastructure projects, and worked with Lasik MD during an acquisition in the U.S. market. Furthermore, by providing Fix Auto with access to its networks, la Caisse facilitated Fix Auto’s expansion into China and Australia where the company now has around 100 body shops.

Impactful projects

In spring 2016, CDPQ Infra, a subsidiary of la Caisse, announced its integrated, electric public transit network project to link downtown Montréal, the South Shore, the West Island, the North Shore and the airport. Since then, several major steps have been completed on the Réseau électrique métropolitain (REM) project, with construction scheduled to begin in 2017.

In real estate, Ivanhoé Cambridge and its partner Claridge announced their intention to invest $100 million in real estate projects in the Greater Montréal area. La Caisse’s real estate subsidiary also continued with various construction and revitalization projects in Québec, including those underway at Carrefour de l’Estrie in Sherbrooke, Maison Manuvie and Fairmont The Queen Elizabeth hotel in Montréal, as well as at Place Ste-Foy and Quartier QB in Québec City.

Innovation and the next generation

In the new media industry, la Caisse made investments in Triotech, which designs, manufactures and markets rides based on a multi-sensorial experience; in Felix & Paul Studios, specialized in the creation of cinematic virtual reality experiences; and in Stingray, a leading multi-platform musical services provider. La Caisse also invested in Hopper, ranked among the top 10 mobile applications in the travel industry. Within the electric ecosystem, la Caisse reinvested in AddÉnergie to support the company’s deployment plan, aimed at adding 8,000 new charging stations across Canada in the next five years.

In the past five years, la Caisse’s new investments and commitments in Québec reached $13.7 billion, with $2.5 billion in 2016. These figures do not include the investment in Bombardier Transportation and the $3.1-billion planned commitment by la Caisse to carry out the REM project. As at December 31, Caisse assets in Québec totalled $58.8 billion, of which $36.9 billion were in the private sector, which is an increase in private assets compared to 2015.

FINANCIAL REPORTING

La Caisse’s operating expenses, including external management fees, totalled $501 million in 2016. The ratio of expenses was 20.0 cents per $100 of average net assets, a level that compares favourably to that of its industry.

The credit rating agencies reaffirmed la Caisse’s investment-grade ratings with a stable outlook, namely AAA (DBRS), AAA (S&P) et Aaa (Moody’s).
ABOUT CAISSE DE DÉPÔT ET PLACEMENT DU QUÉBEC

Caisse de dépôt et placement du Québec (CDPQ) is a long-term institutional investor that manages funds primarily for public and parapublic pension and insurance plans. As at December 31, 2016, it held $270.7 billion in net assets. As one of Canada’s leading institutional fund managers, CDPQ invests globally in major financial markets, private equity, infrastructure and real estate. For more information, visit cdpq.com, follow us on Twitter @LaCDPQ or consult our Facebook or LinkedIn pages.

You can view this press release and other attachments here at the bottom of the page. You can also read articles on the results here.

I think the overall results speak for themselves. The Caisse outperformed its benchmark by 180 basis points in 2016, and more importantly, 110 basis points over the last five years, generating $12.3 billion of value added over its benchmark for its clients.

There is no Annual Report available yet (comes out in April), but the Caisse provides returns for the specialized portfolios for 2016 and annualized five-year returns (click on image):

As you can see, Fixed Income generated 2.9% in 2016, beating its benchmark by 110 basis points, and 3.7% annualized over the last five years, 60 basis points over the benchmark.

The press release states:

The Bonds portfolio, totalling more than $68 billion, posted a 3.9% return over five years, higher than that of its benchmark. The difference is equivalent to value added of $1.6 billion. Securities of public and private companies and the active management of credit spreads in particular contributed to the portfolio’s return.

In 2016, despite an increase in interest rates at year-end, the portfolio posted a 3.1% return. It benefited from continued investment in growth market debt and from the solid performance of corporate debt, particularly in the industrial sector.

In other words, Bonds returned 3.1% or 140 basis points over its index, accounting for $1.6 billion of the $4.4 billion of value added in 2016, or 36% of the value added over the total fund’s benchmark last year.

That is extremely impressive for a bond portfolio but I would be careful interpreting these results because they suggest the benchmark being used to evaluate the underlying portfolio doesn’t reflect the credit risk being taken (ie. loading up on emerging market debt and corporate bonds and having a government bond index as a benchmark).

I mention this because this type of outperformance in bonds is unheard of unless of course the managers are gaming their benchmark by taking a lot more credit risk relative to that benchmark.

Also worth noting how the outperformance in real estate debt over the last year and five years helped the overall Fixed Income returns. Again, this is just taking on more credit risk to beat a benchmark and anyone managing a fixed income portfolio knows exactly what I am talking about.

It’s also no secret the Caisse’s Fixed Income team has been shorting long bonds over the last few years, and losing money on carry and rolldown, so maybe they decided to take on more emerging market and corporate debt risk to make up for these losses and that paid off handsomely. Also, the backup in US long bond yields last year also helped them if they were short.

Now, before I get Marc Cormier and the entire Fixed Income team at the Caisse hopping mad (don’t want to get on anyone’s bad side), I’m not saying these results are terrible — far from it, they are excellent — but let’s call as spade a spade, the Caisse Fixed Income team took huge credit risk to outperform its benchmark last year, and this needs to be discussed in detail in the Annual Report when it comes out in April.

Going forward, the Caisse thinks the party is over for bonds:

Caisse de Depot et Placement du Quebec, Canada’s second-largest pension fund manager, is reducing its bond holdings and devoting more resources to corporate credit and real estate debt.

“The party is over, that’s why we are going to restructure this portfolio to lower investment in traditional bonds and increase and diversify our investment in credit,” Chief Executive Officer Michael Sabia said in Montreal Friday.

He said the Caisse will reduce the amount of fixed income in its portfolio and increase over the next few years the share of less liquid assets. The fixed-income portfolio will be broken into two portions: traditional fixed income — federal and provincial Canadian bonds — which will become “significantly smaller,” and another section based on credit, such as corporate credit and real estate debt, he said.

“We’re going to put more priority on building that portfolio because we think that can offer us still a relatively low level of risk but somewhat higher returns,” he said of the credit-focused plan. Investment in Canadian provincial and federal bonds will shrink “not dramatically, but bit by bit,” he said.

[Note: I like private debt as an asset class but disagree, it’s not the beginning of the end for bonds]

Apart from Bonds, what else did I notice? Very briefly, excellent results in Real Estate, outperforming its benchmark by 320 basis in 2016. Over the last five years, however, Real Estate has slightly underperformed its benchmark by only 40 basis points.

Again, a word of caution for most people that do not understand how to read these results correctly. The benchmark the Caisse uses to evaluate its Real Estate portfolio is much harder to beat than any of its large peers in Canada.

I’ve said it before and I’ll say it again, the Caisse’s Real Estate subsidiary, Ivanhoé Cambridge, is doing a truly excellent job and it is one of the best real estate investors in the world.

As far as Infrastructure, CDPQ Infra marginally beat its benchmark in 2016 by 30 basis points, but it’s trailing its benchmark by 250 basis points over the last five years.

Again, the benchmark in Infrastructure is very hard to beat (infrastructure benchmark has lots of beta in it which makes it much tougher to beat when markets are surging), so I don’t worry about this underperformance over the last five years. Just like in Real Estate, the people working at CDPQ Infra are literally a breed apart, infrastructure experts in brownfield and greenfield projects.

When Michael Sabia recently came out to defend the Montreal REM project, he was being way too polite. I set the record straight on my blog and didn’t hold back, but it amazes me how many cockroaches are still lurking out there questioning the “Caisse’s governance” on this project (what a joke, they have a blatant agenda against the Caisse and this unique project but Michael Sabia’s mandate was renewed for four more years so he will have the last laugh once it’s completed and operational).

In Private Equity, the outperformance over the index in 2016 was spectacular (520 basis points or 5.2%) but over the last five years, it’s a more modest outperformance (120 basis points). Like other large Canadian pensions, the Caisse invests in top private equity funds all over the world and does a lot of co-investments to reduce overall fees.

[Note: Andreas Beroutsos who formerly oversaw all of La Caisse’s private equity and infrastructure investment activities outside Quebec is no longer there (heard some unsubstantiated and interesting stories). In April, the Caisse reorganized infrastructure and private equity units under new leaders.]

In Public Equities, a very impressive performance in Canada, outperforming the benchmark by 260 basis points in 2016 and by 160 basis points over the last five years. The Global Quality portfolio edged out its benchmark by 30 basis points in 2016 but it still up outperforming it by almost 500 basis points over the last five years.

Again, I question this Global Quality portfolio and the benchmark they use to evaluate it and I’ve openly stated if it’s that good, why aren’t other large Canadian pension funds doing the exact same thing? (Answer: it doesn’t pass their board’s smell test. If these guys are that good, they should be working for Warren Buffet, not the Caisse)

That is it from me, I’ve already covered enough. Take the time to go over the 2015 Annual Report as you wait for the 2016 one to appear in April. There you will find all sorts of details like the benchmarks governing the specialized portfolios (click on image):

Like I said, there are no free lunches in Real Estate and Infrastructure benchmarks but there are issues with other benchmarks that do not reflect the risks being taken in the underlying portfolios (Bonds and Global Quality portfolios, for example).

Net, net, however, I would say the benchmarks the Caisse uses are still among the toughest in Canada and it has delivered solid short-term and more importantly, long-term results.

It’s a tough job managing these portfolios and beating these benchmarks, I know, I’ve been there and people don’t realize how hard it is, especially over any given year. This is why I primarily emphasize long-term results, the only ones that truly count.

And long-term results are what counts in terms of compensating the Caisse’s senior managers (from 2015 Annual Report, click on image):

Again, Mr. Beroutsos is no longer with the Caisse and neither is Bernard Morency. You can see the members of the Caisse’s Executive Committee here (one notable addition last year was Jean Michel, Executive Vice-President, Depositors and Total Portfolio; he has a stellar reputation and helped Air Canada’s pension rise from the ashes to become fully funded again).

The other thing worth mentioning is the Caisse’s executives are paid fairly but are still underpaid relative to their peers at large Canadian funds (fuzzy benchmarks at other shops play a role here but also the culture in Quebec where people get jealous and mad if senior pension fund executives managing billions get paid million dollar plus packages even if that’s what they are really worth).

Lastly, one analyst told me that the Caisse’s ABCP portfolio has contributed roughly 0.5% annualized to the overall results since 2010 stating “this paper was sold at 45 cents to the dollar and now trades at $1 to the dollar”. No doubt ABCP has come back strongly after the crisis, but I cannot verify his figures (will leave that up to you!).

I will embed clips from the Caisse’s press conference as they become available so come back to revisit this comment. If you have anything to add, please email me at LKolivakis@gmail.com.

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.

CalPERS is focusing on avoiding another big loss, not risky attempts to maximize investment earnings.

A shift from stocks and growth investments in September to lower the risk of losses had reduced CalPERS gains by $900 million, the CalPERS board was told on Feb. 13. The post-election market surge has continued since then, increasing the Dow blue-chip average Friday for the 11th day in a row.

CalPERS also sped up its “risk mitigation” policy this month, lowering the trigger for tiny cuts of .05 to .25 percent in the earnings forecast used to discount future pension obligations. Now cuts will occur when annual earnings are 2 percent above the forecast, not 4 percent.

Reflecting a major change of outlook, CalPERS lowered its discount rate from 7.5 percent to 7 percent in December, causing a large increase in employer rates to help fill the projected gap created by a lower investment earnings forecast.

The lower discount rate will be phased in over three years, easing the strain on local government budgets from the fourth CalPERS employer rate increase since 2012. The risk mitigation policy was delayed until fiscal 2020, when the discount rate phase-in is complete.

The policy could gradually lower the discount rate by 1 percentage point over several decades. Whether even the smallest incremental rate decrease, .05 percent, would be enough to cause an employer rate increase is “unique to each individual employer,” Scott Terando, CalPERS chief actuary, told the board.

The lower discount rate adopted in December was mainly a response to Wilshire consultants’ view that CalPERS investments were likely to earn 6.2 percent during the next decade, before rebounding to 7.8 percent in the following two decades.

Critics contend that CalPERS and other public pensions have overly optimistic earnings forecasts that conceal massive debt, avoid needed contribution increases, and encourage risky higher-yielding investments that increase the chances of big losses.

The shift to investments with less risk of loss adopted by the California Public Employees Retirement System in September dropped the earnings forecast to 5.8 percent. It looks like a rare attempt at market timing by an extremely long-term investor.

The new short-term investment allocation is intended to remain in place only until CalPERS completes its usual lengthy review, done every four years, and adopts a new allocation next February, taking effect in July 2018.

Ted Eliopoulos, CalPERS chief investment officer, told the board on Feb. 13 that the investment fund had earned about $900 million less than would have been earned under the previous allocation.

After a dispute with Eliopoulos about the link between the lower discount rate and the short-term investment shift, board member Theresa Taylor said: “I just want to make sure that you guys are exploring all options so that we are not leaving money on the table.”

The CalPERS investment fund, valued at $300.7 billion on Nov. 10, was worth $311.3 billion last week. Some attribute the market rally to the election of President Trump and a Republican-controlled Congress that is expected to cut taxes and roll back business regulation.

Eliopoulos reminded the board that the short-term investment allocation was a response to factors such as uncertain market conditions, the size of the negative cash flow gap, and a greater “downside” risk to the CalPERS funding level.

“That is our primary concern and our primary portfolio priority right now — to try and lower the risk of falling to a lower funding status,” he said.

Rob Feckner, CalPERS board president, made a similar point in a news release when the original risk management policy was adopted in November 2015 with a 4 percent above the earnings forecast trigger, taking effect without delay.

“Ensuring the long-term sustainability of the fund is a priority for everyone on this board, and this policy helps do that,” Feckner said. “It makes significant strides in lowering risk and volatility in the system, and helps lessen the impacts of another financial downturn.”

After a long bull market nearing eight years, CalPERS only has 63 percent of the projected assets needed to pay future pension obligations, little changed from its 61 percent funding level at the market bottom.

You might think that CalPERS would be trying to maximize investment earnings, which are expected to cover two-thirds of the cost of future pensions. Most of the rest is expected from employers, who are on the hook for pension debt, and a smaller share from employees.

But CalPERS is still suffering from a massive $100 billion investment loss during the financial crisis and stock market crash. Its investments plunged from $260 billion to $160 billion, dropping the funding level from 101 percent in 2007 to 61 percent in March 2009.

Now CalPERS has no cushion if the market plunges again. Experts have told the CalPERS board that a funding level that drops below 40 percent, or perhaps even 50 percent, could be a crippling blow.

Raising employer contribution rates (already at an all-time high) and the discount rate (still criticized as too optimistic) high enough to project 100 percent funding could become impractical.

Rising CalPERS employer rates for police and firefighters have already reached 60 percent of pay in cities like Costa Mesa, 50 percent for the Highway Patrol, and 40 percent for Richmond, where a CALmatters/Los Angeles Times project reported some fear bankruptcy.

CalPERS employer rates for the non-teaching employees of school districts are expected to double from 13.9 percent of pay this fiscal year to 28.2 percent of pay in fiscal 2023-24.

With CalSTRS teacher rates that also are more than doubling, the school district pension cost increase next fiscal year, $1 billion, is more than the $744 million funding increase proposed by Gov. Brown’s new budget, the Legislative Analyst’s Office said this month.

While adopting the risk mitigation policy two years ago, the CalPERS board rejected a proposal from a Brown administration board member, Richard Gillihan, to lower the discount rate from 7.5 to 6.5 percent, which would have resulted in a major employer rate increase.

Brown said the incremental lowering of the discount rate was “irresponsible” and would “expose the fund to an acceptable level of risk.” Feckner replied that the policy emerged from concern about putting more strain on cities “still recovering from the financial crisis.”

As a maturing pension system, CalPERS faces new structural problems. The number of retirees will exceed the number of active workers. “Negative cash flow” means some investment funds must be used to help pay annual pension costs.

Last year, CalPERS said, about $5 billion in investment funds was added to $14 billion in employer and employee contributions to pay the $19 billion in pensions received by retirees.

But perhaps the main structural change that made avoiding another major investment loss a top CalPERS priority is what actuaries call the “asset ratio volatility.” In board discussions it’s often referred to as the “volatility level” and quantified. (See risk mitigation staff report)

The investment fund in a maturing pension system becomes much larger than the active worker payroll, which means that replacing an investment loss requires a much larger employer contribution increase.

The California State Teachers Retirement System board was given this example last November:

Replacing a 10 percent investment loss below the earnings forecast 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.

The Illinois Teacher Retirement System this week said it will commit $140 million to two emerging managers, nearly doubling the amount of money the fund had previously committed to emerging manager real estate funds.

The funds are Oak Street Capital and Exeter Property Group — the latter of which is already oversubscribed. TRS will be jockeying with several other pension funds — including the Texas Permanent School Fund and the New York State Teachers fund — to have their commitment accepted.

More from IPE Real Estate:

The pension fund is committing $100m (€95.2m) to Oak Street Capital Real Estate Fund IV and $40m to Exeter Industrial Value Fund IV.

The commitments represent a significant expansion of the programme. The pension fund currently has $79.4m invested with emerging real estate managers.

Oak Street Capital invests in net-lease real estate, a part of the market that US pension funds rarely invest in, according to industry sources.

[…]

There is some uncertainty as to whether the commitment to Exeter Industrial Value Fund IV will be accepted, since it has been oversubscribed for its $1.15bn targeted capital raise.

Illinois Teachers considers Exeter to be an emerging manager. The pension fund told IPE Real Estate that the company “fits within the TRS definition of emerging manager”.

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

The Canada News Wire reports, Canadian pensioners not living as long as expected:

New research finds longevity for Canadian pensioners is lower than anticipated – which may actually be costing defined benefit (DB) plan sponsors.

Canadian male pensioners are living about 1.5 years less than expected from age 65, according to the latest data from Club Vita Canada Inc. – the first dedicated longevity analytics firm for Canadian pension plans and a subsidiary of Eckler Ltd. Female pensioners are living about half a year less than expected.

“Based on our data, some DB plans are overestimating how long their members are currently living and are therefore taking an overly conservative approach to funding their liabilities,” explains Ian Edelist, CEO of Club Vita Canada. “Correcting that overestimation could reduce actuarial reserves by as much as 6% – improving Canadian pension funds’ and their plan sponsors’ balance sheets just by using more accurate, granular and up-to-date longevity assumptions.”

The data comes from Club Vita Canada’s first annual and highly successful longevity study completed in 2016 – one of the largest, most rigorous research studies on the impact of longevity on defined benefit pension and post-retirement health plans.

The newly created “VitaBank” pool of longevity data (provided by Club Vita Canada members) spans a wide range of industries and geographic regions in both the public and private sectors. VitaBank is currently tracking more than 500,000 Canadian pensioners from over 40 pension plans. Unlike the most widely used study to set longevity expectations – the Canadian Pensioners’ Mortality (CPM) study, which relies on data up to 2008 – VitaBank includes fully cleaned and validated data up to 2014.

The Club Vita Canada study brings to the Canadian pension market leading-edge modelling techniques already used by the insurance industry and in other countries. Club Vita U.K. recently released similar results, noting £25 billion could be wiped off the collective U.K. DB deficit by using more accurate longevity assumptions.

“Naturally, the ultimate cost of a pension plan will be determined by how long its members actually live. But assumptions made today really do matter for such long-duration commitments,” explains Douglas Anderson, founder of Club Vita in the U.K. “Club Vita’s data gives DB plan sponsors the tools they need to evaluate their willingness to maintain their longevity risk or offload that risk to insurers.”

About Club Vita Canada Inc. (clubvita.ca)

Club Vita Canada Inc. was created by Eckler Ltd. It is an extension of Club Vita LLP, a longevity centre of excellence launched in the U.K. in 2008 by Hymans Robertson LLP. By pooling robust data from a wide range of pension plans, Club Vita provides its members with leading-edge longevity analytics helping them better measure and manage their retirement plan.

About Eckler Ltd. (eckler.ca)

Eckler is a leading consulting and actuarial firm with offices across Canada and the Caribbean. Owned and operated by active Principals, the company has earned a reputation for service continuity and high professional standards. Our select group of advisers offers excellence in a wide range of areas, including financial services, pensions, benefits, communication, investment management, pension administration, change management and technology. Eckler Ltd. is a founding member of Abelica Global – an international alliance of independent actuarial and consulting firms operating in over 20 countries.

I recently discussed life expectancy in Canada and the United States when I went over statistics on gender and other diversity in the workplace, noting this:

Statistics are a funny thing, they can be used in all sorts of ways, to inform and disinform people by stretching the truth. Let me give you an example. Over the weekend, I went to Indigo bookstore to buy Michael Lewis’s new book, The Undoing Project, and skim through other books.

One of the books on the shelf that caught my attention was Daniel J. Levitin’s book, A Field Guide to Lies: Critical Thinking in the Information Age. Dr. Levitin is a professor of neuroscience at McGill University’s Department of Psychology and he has written a very accessible and entertaining book on critical thinking, a subject that should be required reading for high school and university students.

Anyways, there is a passage in the book where he discusses the often used statistic that the average life expectancy of people living in the 1850s was 38 years old for men and 40 years old for women, and now it’s 76 years old for men and 81 for women (these are the latest US statistics which show life expectancy declining for the first time since 1993. In Canada, the latest figures from 2009 show the life expectancy for men is 79 and for women 83, but bad habits are sure to impact these figures).

You read that statistic and what’s the first thing that comes to your mind? Wow, people didn’t live long back then and now that we are all eating organic foods, exercising and have the benefits of modern medical science, we are living much longer.

The problem is this is total and utter nonsense! The reason why the life expectancy was much lower in 1850 was that children were dying a lot more often back then. In other words, the child mortality rate heavily skewed the statistics but according to Dr. Levitin, a man or woman reaching the age of 50 back then went on to live past 70. Yes, modern science has increased life expectancy somewhat but not nearly as much as we are led to believe.

Here is another statistic that my close friend, a radiologist who sees all sorts of diseases told me: all men will get prostate cancer if they live long enough. He tells me a 70 year old man has a 70% chance of being diagnosed with prostate cancer, an 80 year old man has an 80% chance and a 90 year old man has a 90% chance.”

Scary stuff, right? Not really because as my buddy tells me: “The reason prostate cancer isn’t a massive health concern is that it typically strikes older men and moves very, very slowly, so by the time men are diagnosed with it, chances are they will die from something else.”

Of course, the key word here is “typically” because if you’re a 50 year old male with high PSA levels and are then diagnosed with prostate cancer after a biopsy confirms you have it, you need to undergo surgery as soon as possible because you might be one of the unlucky few with an aggressive form of the disease (luckily, it can be treated and cured if caught in time).

So, much like the US, it seems the recent statistics on life expectancy in Canada are not that good. Again, you need to be very careful interpreting the data because the heroin epidemic has really skewed the numbers in both countries (much more in the US).

But let’s say the folks at Club Vita Canada and Eckler are doing their job well and Canadian pensioners are living less than previously thought. Does that mean that Canadian DB plans are overestimating their liabilities?

Yes and no. Go read an older comment of mine on whether longevity risk will doom pensions where I stated:

I actually forwarded [John] Mauldin’s comment to my pension contacts yesterday to get some feedback. First, Bernard Dussault, Canada’s former Chief Actuary, shared this with me:

True, longevity is a scary risk, but not as much as most think, the reason being that the calculations of pension costs and liabilities in actuarial reports take into account future improvements in longevity.

For example, as per the demographic assumptions of the latest (March 31, 2011) actuarial report on the federal public service superannuation plan (http://www.osfi-bsif.gc.ca/Eng/Docs/pssa2011.pdf), the longevity at age 75 in 2011 is projected to gradually increase by about 1 year in 10 years (2021). For example, if longevity at age 75 was 12.5 in 2011, it is projected as per the PSSA actuarial report to be about 13.5 in 2021

This 1 year increase at age 75 over 10 years is much less than the average 1year increase at birth every 4 years over the 20th century reported by the Society of Actuaries (SOA). However, this is an apple/orange comparison because longevity improvements are always larger at birth than at any later age and were much larger in the first half of the 20th century than thereafter than at any later age.

Bernard added this in another email correspondence where he clarified the above statement:

Annual longevity improvement rates are assumed to apply for the whole duration of the projection period under any of the periodical actuarial reports on the PSSA, i.e. for all current and future contributors and pensioners.

Moreover, the federal public service superannuation plan is actuarially funded, which means that each generation/cohort of contributors pays for the whole value of all of its accrued benefits. In other words, the financing of the plan is such that there is essentially no inter-generational transfer of pension debt from any cohort to the next.

Second, Jim Keohane, President and CEO of the Healthcare of Ontario Pension Plan (HOOPP), sent me his thoughts:

I am not sure how longevity improvements will play out over the coming decades and neither does anyone else. I wouldn’t dispute the facts being quoted in this article, but what I would point out is that these issues are not exclusive to DB plans. They are problems for anyone saving for retirement whether they are part of a DB plan a DC plan or not in any plan. DB plans get benchmarked against their ability to replace a portion of plan members pre-retirement income (typically 60%). If you measured DC plans on the same basis they are in much worse shape, in fact, they only have about 20 to 25% of the assets needed to produce that level of income.

I would also add that Canadian public sector pension plans are in much better shape than their U.S. Counterparts. We use realistic return assumptions and are in a much stronger funded position.

Third, Jim Leech, the former CEO of Ontario Teachers’ Pension Plan (OTPP) and co-author of The Third Rail, sent me this:

Very consistent with my thoughts/observations. It is a shame that “short term” motivations (masking reality by manipulating valuations, migration from DB to DC, elimination of workplace plans altogether, kicking the can down the road, etc) have taken over what is supposed to be a “long horizon” instrument (pension plan).

But Jim Keohane makes a good point – this applies ONLY to DB valuations. Anyone with DC (RRSP), ie. most Canadians, is really jiggered by longevity increases.

No doubt about it, the Oracle of Ontario, HOOPP and other Canadian pensions use much more realistic return assumptions to discount their future liabilities. In fact, Neil Petroff, CIO at Ontario Teachers once told me bluntly: “If U.S. public pensions were using our discount rate, they’d be insolvent.”

Mauldin raises issues I’ve discussed extensively on my blog, including what if 8% is really 0%, the pension rate-of-return fantasy, how useless investment consultants have hijacked U.S. pension funds, how longevity risk is adding to the pressures of corporate and public defined-benefit (DB) pensions.

Mauldin isn’t the first to sound the alarm and he won’t be the last. Warren Buffett’s dire warning on pensions fell largely on deaf ears as did Bridgewater’s. I knew a long time ago that the pension crisis and jobs crisis were going to be the two main issues plaguing policymakers around the world.

And I’ve got some very bad news for you, when global deflation hits us, it will decimate pensions. That’s where I part ways with Mauldin because longevity risk, while important, is nothing compared to a substantial decline in real interest rates.

Importantly, a decline in real rates, especially now when rates are at historic lows, is far more detrimental to pension deficits than people living longer.

What else did Mauldin conveniently miss? He ignores the brutal truth on DC pensions and misses how the ‘inexorable’ shift to DC pensions will exacerbate inequality and pretty much condemn millions of Americans to more pension poverty.

The important point is that last one, a decline in interest rates is far, far more damaging to pension liabilities than an increase in longevity risk.

Last year, I wrote a comment on why ultra low rates are here to stay, and San Francisco Fed President John Williams penned a note today that pretty much agrees with me:

The decline in the natural rate of interest, or r-star, over the past decade raises three important questions. First, is this low level for the real short-term interest rate unique to the U.S. economy? Second, is the natural rate likely to remain low in the future? And third, is this low level confined to “safe” assets? In answer to these questions, evidence suggests that low r-star is a global phenomenon, is likely to be very persistent, and is not confined only to safe assets.

So, if you ask me, I wouldn’t read too much into this latest study stating Canadian pensioners are living less than previously thought and Canadian DB plans are “overestimating” their liabilities (persistent low rates = persistent pension deficits).

Worse still, the stakeholders of these DB plans might take this data and twist it to their advantage by asking to lower the contribution rate of their plans. This would be a grave mistake.

Lastly, I want to bring something to your attention. Last week, after I wrote my comment on a lunch with PSP’s André Bourbonnais, where I stated that the Chief Actuary of Canada is rightly looking into whether PSP’s 4.1% real return target is too high, I received an email from Bernard Dussault, Canada’s former Chief Actuary, stating he didn’t agree with me or others that PSP’s target rate of return needs to be lowered.

Specifically, Bernard shared this with me:

I still do not understand why “suddenly” investment experts (including Keith Ambachtsheer) think that the expected/assumed long term real rate of return will decrease compared to what it has been expected/assumed for so many years in the past.

I look forward to Bourbonnais’ and the Chief Actuary’s rationale if they were to reduce the 4.1% rate below 4.0%.

The rationale I used for the 4% I assumed for the CPP and the PSPP when I was the Chief Actuary is briefly described as follows in the 16th actuarial report on the CPP:

The CPP Account is made of two components: the Operating Balance, which corresponds in size to the benefit payments expected over the next three months, and the Fund, which represents the excess of all CPP assets over the Operating Balance.

In accordance with the new policy of investing the Fund in a diversified portfolio, the ultimate real interest rate assumed on future net cash flows to the Account is 3.8%. This rate is a constant weighted average of the real unchanged rate of 1.5% assumed on the Operating Balance and of the real rate of 4% which replaces the rate of 2.5% assumed on the Fund in previous actuarial reports.

The long term real rate of interest of 4% on the Fund was assumed taking into account the following factors:

• from 1966 to 1995, the average real yield on the Québec Pension Plan (QPP) account, which has always been invested in a diversified portfolio, is close to 4%;
• as reported in the Canadian Institute of Actuaries’ (CIA) annual report on Canadian Economic Statistics, the average real yield over the period of 25 years ending in 1996 on the funds of a sample of the largest private pension plans in Canada is close to 5%, resulting from a nominal yield of about 11.0% reduced by the average increase of about 6% in the Consumer Price Index;
• using historical results published by the CIA in the Report on Canadian Economic Statistics, the real average yield over the 50-year (43 in the case of mortgages) period ending in 1994 is 4.03% in respect of an hypothetical portfolio invested equally in each of the following five areas: conventional mortgages, long term federal bonds (Government of Canada bonds with a term to maturity of at least 20 years), Government of Canada 91-day Treasury Bills, domestic equities (Canadian common stocks) and non‑domestic equities (U.S. common stocks). The assumed real rate of 4% retained for the Fund is therefore deemed realistic but erring on the safe side, especially considering that:

Ø replacing federal bonds by provincial bonds in this model portfolio would increase the average yield to the extent that provincial bonds carry a higher return than federal bonds; and

Ø the 3-month Treasury Bills, which bear lower returns, would normally be invested for the Operating Balance rather than the Fund.

From a larger perspective, assuming a real yield of 4% on the CPP Fund means that the CPP Investment Board would be expected to achieve investment returns comparable to those of the QPP and of large private pension plans.

On the other hand, I think I heard Bourbonnais saying last year at a presentation of the PSP annual report to the Public Service Pension advisory Committee (and I could well have misheard or misinterpreted what he said) that he was reducing the proportion of equities in the PSP fund in order to reduce the volatility/fluctuation of the returns.

If he is really doing this, then that would be a valid reason for reducing the expected 4.1% return. Besides, if he is doing this, I opine that this is not consistent with the PSP objective to maximize returns. Indeed, a more risky investment portfolio carries higher volatility though BUT it is coupled with a higher long term average return (which both the CPP and the PSP funds have achieved on average over at least the last 15 years).

As I explained to Bernard, PSP Investments and other large Canadian pensions are indeed reducing their proportion in public equities precisely because in a historically low rate environment, the returns on public equities will be lower and more importantly, the volatility will be much higher.

I also told him that given my long-term forecast of global deflation, I think more and more US and Canadian pensions should lower their target rate and that the contribution rates should rise.

Of course, someone may claim the only reason PSP and others want to lower their actuarial target rate of return is because it lowers their bar to attain their bogey and collect millions in compensation.

I’m not that cynical, I think there are legitimate reasons to review this target rate of return and I look forward to seeing the Chief Actuary’s report to understand his logic and why he thinks it needs to be lowered.

I would also warn all of you to take GMO’s 7-year asset class return projections with a shaker of salt (click on image below):

GMO may be right but I never bought into this nonsense and I’m not about to begin now. I guarantee you seven years from now, they will be way off once more!