Category: Pension Newsroom

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

Adam Mayers of the Toronto Star reports, CPP’s success may signal bigger pensions ahead:

The Canada Pension Plan expects to have assets worth $1 trillion before the middle of this century.

As recently as 17 years ago, in the first year of the plan’s Investment Board, there was just $18 million in the bank. All that money was invested in Canadian government bonds. The CPP Investment Board was a coupon clipper.

Today, our national retirement scheme is a global giant, closing in on $300 billion. By 2030 it projects to be worth $500 billion. Two-thirds of all it owns is outside Canada and there isn’t a corner of the globe where it doesn’t look for opportunity.

We get royalties from intellectual property, dividends from public and private investments. Its biggest single public stock holding worth $2.3 billion is in IMS Holdings, an American company that provides IT services to the global healthcare industry. Number two is Apple.

Our plan invests in Japanese drug companies, owns nursing homes in France and seniors’ apartments in Florida. There are 17 ports in Britain, Ontario’s 407 ETR and toll roads in Chile. Its real estate holdings include prestige shopping centres and office towers in many global capitals. There is income from investments in farmland, software and internet and telecom networks. It owns stakes in electrical utilities and water treatment plants.

Based on this success — and our contributions — the CPPIB’s actuaries believe there will be enough money to pay pension obligations at current levels for the next 75 years. That’s an enviable position when many national pension plans are in trouble.

But the CPP wants to go further. It wants an even better return. So, it’s changing the mix of its investments to add more stocks and private companies, and fewer government and corporate bonds.

It’s a “modest evolution” being done in a “prudent and gradual manner,” says the CPPIB’s senior managing director Ed Cass, who is responsible for the CPPIB’s overall investment strategy.

He says it can be done safely because the CPP has deep pockets and a perpetual time horizon: The “next quarter” is 25 years, not three months.

This may eventually mean a bigger pension, or lower CPP premiums for us. Cass can’t say. The CPPIB’s mandate is to safely and profitably invest on our behalf. Ottawa and the premiers decide how much we get and how much we pay into the plan. Their third option is do nothing and keep the additional funds for a rainy day.

We sat down with Cass, who at 53 is as eclectic as the CPP’s holdings: He holds a degree in theoretical physics from Queen’s University and a law degree from Osgoode Hall.

Here’s an edited version:

What can average investors learn from the CPP?

Well, they can’t replicate what we do because we have advantages of size and scale.

But there are three things. The most important is risk tolerance. A 27-year-old should be able to take a lot more risk than a 91-year-old. We have a 75 year time horizon and so our assumptions are based on that.

The second is diversify. Diversification is the one free lunch.

It’s true, we can go to a level that’s impossible for the small investor. But there’s a ton of things individuals can do. Through Exchange Traded Funds (ETFs) you can get access to the U.S., European and Japanese stock markets. Importantly, you get diversification in terms of currency exposure.

The last thing is patience. If you can afford to be patient, be patient. If you’re changing your portfolio frequently it’s likely you’re incurring a lot of costs. Having a plan and sticking to it is very important.

What is your view of the economic outlook?

There are a number of forces that give us a lot of optimism. We think the gradual convergence of emerging market economies with developed markets is a positive development.

We think low rates may persist in the short term, but not over the long term. We see growth coming back. Not quite what we experienced in previous decades, but something approaching that.

What about interest rates?

The new normal for the overnight bank rate might be 3.50 per cent or 3.75 per cent. (That rate is currently 0.5 per cent and determines consumer rates.)

When might this happen?

Forecasting the path of rates is fraught with danger. We are confident that over our horizon, which is decades, things will normalize.

Why are you buying ports and university dorms?

They are things that are similar to bonds and have very predictable payments. As an example, take the Highway 407 (40 per cent owned by CPP). It is very easy to predict cash flow over time and it has a high income yield. That looks a lot like a bond.

The CPPIB has decided to take more investment risk. What does that mean?

Risk appetite is linked to investment horizon. We have a very long horizon, somewhere in the order of 75 years. That’s how far we look out.

Our default reference was 65 per cent equities and 35 per cent bonds, which is the (default) of an average investor. But our capacity to prudently take risk is greater than an average investor. So, we want to move to 85 per cent equities and 15 per cent bonds.

What it means is that we want a very diversified portfolio, a very safe portfolio, but one that targets a higher risk appetite than in the past.

Why now?

This is not a reaction to the current environment. This is something more fundamental. It’s predicated on those longer term views.

When you say “why now” you must place it in the context of an organization that is on an enduring path. We have undertaken several transitions since that first transfer of funds 17 years ago.

We’ve gone from 100 per cent bonds to a diversified portfolio, and from all domestic to truly global. We’ve grown from $18 million to over $280 billion today. We accomplished this in less than two decades.

So, when you consider the shift along the return/risk spectrum in this light, it is really a modest evolution. We have an exceptionally long horizon, as well as a certainty of assets. As a result, the Board concluded we can and should seek higher returns prudently.

Does that mean better pensions?

If the fund is widely successful you could increase benefits, or reduce contributions. Those are the two most logical things, but that’s a policy decision. Our statutory objective is to maximize returns without undue risk of loss.

A good interview with Ed Cass who was appointed to the position of Senior Vice President and Chief Investment Strategist at CPPIB a little over two years ago.

Mr. Cass is obviously a very smart guy, holding a Bachelor of Science (Honours) degree in Theoretical Physics from Queen’s University and a Bachelor of Laws from Osgoode Hall Law School, but the message he lays out here is very simple and clear: CPPIB is a global powerhouse with deep pockets and a very long investment horizon and can take risks in public and private markets and patiently sit through any economic cycle.

Now, I think it’s important Canadians understand some of the key takeaways from this brief interview (I will add some insights):

• CPPIB is a global powerhouse that invests across public and private assets. It invests and co-invests with top private equity funds, top hedge funds, and invests directly in real estate, infrastructure and natural resource assets all over the world. This diversification across geographies and public and private markets and the ability to invest directly in large transactions is something that no individual Canadian investor and even mutual fund can do at the scale and scope of CPPIB.
• CPPIB has huge comparative advantages over mutual funds, private equity funds, and even other large Canadian pension funds. You can read about these advantages here.
• CPPIB is massive but cost efficient. Never mind that flimsy and grossly biased study from the Fraser Institute claiming it is an extremely costly plan. Real experts who understand large pensions like Keith Ambachtsheer and his partners at KPA Advisory Services tore into that study as did I for its dumb comparisons and faulty conclusions (word to the wise: never blindly trust anything that comes out of the Fraser Institute which is bankrolled by Canada’s powerful financial services industry that has its own agenda on pensions).
• CPPIB is opportunistic and very patient. Go back to read my comments on CPPIB bringing good things to life and a more recent one on CPPIB going on a massive agri hunt. These are huge, scalable deals that no Canadian mutual fund can engage in and to be honest, apart from PSP Investments, very few other large Canadian pension funds can engage in.
• CPPIB has a great leader at its helm. I won’t hide it, I like Mark Wiseman and think very highly of him. We don’t always see eye to eye on everything but when I talk to him and listen carefully to what he says, he comes across as an exceptionally bright, nice, hard-working leader who really understands and believes in the long view and has done an outstanding job leading this mammoth pension fund. He has put in place the right people to lead his teams and they are all doing a great job.

As far as what Ed Cass says on interest rates, I beg to differ as I think ultra low rates and the new negative normal are here to stay for years, especially once the global deflation tsunami hits us.

Then again, with China manipulating its stock market and central banks fighting deflation tooth and nail, things might be a lot better in the global economy than meets the eye. I trade stocks every day and I’m baffled at some the moves in the resource sector.

For example, shares of Teck Resources (TCK) are up another 9% at this writing on Wednesday mid-day (click on image):

Amazingly, the share price of Teck hit a low of $2.56 (USD; I only trade U.S. shares even though it was best to buy this one in Canada earlier this year) on January 13th and is now breaking out and in a position to make a new 52-week high if this momentum carries through.

And it’s not just Teck, a sample of stocks I track leveraged to global growth are indeed acting as if oil will double this year and the global economic recovery is well under way (click on image):

I remain highly skeptical of all these counter-trend rallies no matter how powerful they are and think they’re largely driven by algos and momo traders. Having said this, one Canadian hedge fund manager told me this morning: “Things have changed, adapt and leave it alone.”

Maybe things have changed, maybe the world is in much better shape than we think, or maybe we are all smoking some hopium like those nuns I mentioned in my last comment on China’s pension gamble, believing in fairy tales and unicorns. I don’t know but since mid-January the explosive moves have been in emerging markets (EEM), Chinese shares (FXI), energy (XLE), metals and mining (XME) and industrials (XLI).

So, Ed Cass is right, focus on ETFs, diversify and rebalance your portfolio when there are huge market dislocations like we had at the start of the year. Unlike him, I prefer to play U.S. ETFs (I am long USD over a very long period because I think the U.S. has the best economy by far) and I would say rebalance every time an ETF goes way above it 200-day moving average or way below its 400-day moving average (for oversold trends, I prefer using the 400-day moving average).

As far as books, I have about 300 books on finance but the ones I recommend to individuals are classics like William Bernstein’s The Four Pillars of Investing and The Intelligent Asset Allocator or Marc Litchenfeld’s Get Rich With Dividends. Of course, a simple and cheap classic to read on stocks is Peter Lynch’s One Up on Wall Street (a real classic). 

On that note, it’s back to the stock market for me and trying to make sense of these schizoid markets driven by algos, high frequency traders and unscrupulous hedge fund sharks.

The aggregate funding status of the country’s multiemployer pension plans dropped 4 percent in the second half of 2015, according to a report by Milliman.

[See the report here.]

The aggregate funding level now sits at 75 percent; the funding drop was due to flat investment returns.

More from Pensions & Investments:

“Multiemployer plans continued to be stuck in a rut in 2015,” said Kevin Campe, principal and consulting actuary at Milliman and co-author of the report, in a news release. “Currently, at least 76 plans with $28 billion of shortfall are projected to be insolvent at some point. These plans may be beyond help at this point, and several more may be headed in this direction.”

As of Dec. 31, 192 plans were more than 100% funded with an aggregate surplus of roughly $4 billion, down from 279 plans with an aggregate surplus of roughly $6 billion as of June 30.

Also as of Dec. 31, 264 plans were less than 65% funded, with an aggregate shortfall of $77 billion, accounting for more than half of the $151 billion aggregate shortfall for all multiemployer pension plans, and up from 214 plans as of June 30.

For the funding ratio to remain at 75% at the end of 2016, the pension funds would have to achieve an aggregate 5.5% return in 2016, Milliman estimated. Returns of 11% or more for the year are needed to return to the 79% level seen as of June 30, 2015. A flat return could lower the funding ratio to approximately 72%; a -5% return could drop the funding ratio below 70%. For the first month and a half of 2016, the assessed plans returned roughly -3% in aggregate, Milliman noted.

Read the full study here.

Sometime in the next few weeks, the U.S. Treasury Department will make a crucial decision: whether to approve benefit cuts to the Central States Pension Fund, one of the largest pension funds in the country, that represents hundreds of thousands of truckers across the country.

The decision is important because it could set a precedent for other troubled multiemployer plans to take similar action.

From the Washington Post:

The potential cuts are possible under legislation passed by Congress in 2014 that for the first time allowed financially distressed multi-employer plans to reduce benefits for retirees if it would improve the solvency of the fund.

[…]

Consumer advocates watching the case say the move could encourage dozens of other pension plans across the country that are facing financial struggles to make similar cuts.

If Treasury approves the fund’s proposal, then retirees could see their paychecks shrink by July 1. The move would give the fund at least a 50 percent chance of lasting for another 30 years as opposed to running out of cash in 10 years if no changes are made, Nyhan said. A decision is expected by May 7.

[…]

Out of the 10 million workers and retirees covered by multi-employer pension plans, roughly 1 million people are in plans that could run out of money over the next two decades, according to estimates from the PBGC. Already, three other pension plans that pay benefits to truck drivers and ironworkers have applied to the Treasury to have their pension benefits reduced.

The proposal introduced in September by Central States would cut benefits for current workers and retirees by 23 percent on average, though exact amounts would vary based on people’s age, health status and where they worked.

If the cuts are approved, they would still be put to a vote among the plan’s 400,000 participants. But even if they vote down the plan, the Treasury has the authority to enact the cuts anyway to keep the PBGC solvent.

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

The Wall Street Journal reports on China’s Pension Gamble:

Beijing recently announced that it will allow state pension funds to invest in stocks, with the hope of lifting returns and aiding equity-market liquidity. This might even be a good idea, assuming China follows through on other market reforms.

State pensions have been restricted to bank deposits and government bonds, but China Daily reports that they will now be able to invest up to 30% of individual accounts in equities, funded by mandatory employee contributions. The move could channel some 600 billion yuan ($92.64 billion) into stocks.

State pensions lack adequate funding to support the country’s rapidly aging population, and investing in assets with higher returns could help make up the shortfall. A 2013 study by the Shanghai Institute of Finance and Law estimated that 8.2 trillion yuan must be pumped into pension funds merely to support civil-service retirees over the next 30 years. Meanwhile, their yields have dipped as low as 2%.

Institutional investors could also reduce volatility in China’s markets, which are still dominated by retail investors. Most small investors are inexperienced, with more then half having a high-school education or less.

The immediate impact on both pension funds and the stock market will be slight. Chinese stocks have been on a roller coaster, so regulators are expected to release funds gradually and restrict initial investments to blue chips. Provincial pension funds are also reluctant to shift money from banks, where investments give them leverage over lending decisions.

The policy’s impact will also be reduced if entrepreneurial companies can’t list on stock exchanges. The China Securities Regulatory Commission approves all initial public offerings and determines their pricing and timing. So it isn’t surprising that IPOs have been marked by corruption and rent-seeking. Three CSRC officials handling IPO approvals were arrested in 2015 for suspected graft.

A two-year reform plan toward a more transparent and fair registration-based system was expected to start earlier this year. But new CSRC chairman Liu Shiyu announced last month that the reforms will be done “in a gradual manner,” without providing a timeline. Funneling pension cash into stocks could be dangerous if reforms stall and pension funds become another tool for the government to manipulate stock prices.

Since markets tumbled in June, the government has been on a buying frenzy. Two entities owned by China’s securities regulator and sovereign-wealth fund spent 1.8 trillion yuan buying stocks between June and November, according to Goldman Sachs. Individual investors have come to believe that regulators will rescue the market when prices decline. This perception will grow when state pensions are involved.

Creating a mature stock market requires more than pumping in additional funds. China’s capital markets need wholesale reforms that minimize political interference more than they need pension money.

Last July, I covered China’s pension fund to the rescue, stating the following:

My advice to China’s policymakers, stop tampering with the markets, you’re only going to turn a steep correction into a deep depression. Your pension funds can invest in Chinese equities but if they don’t have the right governance and are told when to buy and sell equities, they’re doomed to fail and they will lose a pile of dough which will create an even bigger problem down the road.

I’m far more worried about China now than anything else. If its stock market bubble bursts in a spectacular fashion, it will wreak havoc on China’s real economy and reinforce global deflation pressures.

In fact, China’s central bank has already admitted defeat in war on deflation. At a time of slowing economic growth and massive corporate debts, a deflationary spiral would be China’s worst nightmare. It  could potentially spell doom for developed economies as China’s deflation will reinforce the Euro deflation crisis and potentially create global deflation that eventually hits the United States.

The global reflationists remain unfettered.  They say get ready for global reflation. I think they’re way too optimistic and confusing short-term trends due to currency fluctuations, neglecting to understand that the long-term deflationary headwinds are picking up steam. There is a reason why 30-year U.S. bond yields are plunging and it’s not just Greece. China and global deflation are much more worrisome.

Last week, I discussed whether the surging yen will trigger another crisis and then followed that up with a comment on whether we should worry about another Asian financial crisis.

A lot of people are getting excited about global growth given how oil prices rebounded after the collapse of Doha talks but I think they’re completely missing the bigger macro risks out there.

What are those bigger macro risks? I’ve been warning you about them ever since I wrote my Outlook 2016, going over the risks of further deflation in emerging markets, especially in Asia, and how a full-blown currency war there will export deflation to the rest of the world.

At this writing, the NASDAQ just went red, biotechs are getting slammed, but the yen is weakening, which is generally good news for global risk assets. The stock market is extremely volatile. Meanwhile, the yield on the 10-year U.S. Treasury bond hasn’t really budged, it’s still hovering around 1.78% which tells you the bond market isn’t getting to excited about oil’s rebound following Doha.

In fact, while Jamie Dimon is warning that the Treasury rally will turn to a rout, Bill Gross is warning investors that China growing at 6% is one of many investor delusions which will be exposed.

And Jeffrey Gundlach, the widely followed investor who runs DoubleLine Capital, said on a webcast last week that the Federal Reserve’s rate hike cycle “increasingly likely” looks like a one and done scenario this year:

Gundlach, who oversees $95 billion for Los Angeles-based DoubleLine, said the Fed should be cautious with raising rates because of the “gentle downward” trajectory in nominal gross domestic product.

The U.S. economy is growing at a pace below 1 percent in the first quarter, according to the Atlanta Federal Reserve’s GDPNow forecast model.

Already, Federal Reserve chair Janet Yellen has been “talking conservatively” about interest rates because it is an election year in the United States, Gundlach said.

Gundlach said the Standard & Poor’s 500 index will struggle and trade “sideways” because earnings continue to be persistently downgraded.

Last year, Gundlach correctly predicted that oil prices would plunge, junk bonds would live up to their name and China’s slowing economy would pressure emerging markets. In 2014, Gundlach correctly forecast U.S. Treasury yields would fall, not rise as many others had expected.

Gundlach said he is still avoiding junk bonds. “The easy money has been made,” Gundlach said. He said the high-yield downgrades resemble the cycle in 1998 and 2007-2008.

DoubleLine has been purchasing Puerto Rico municipal debt as well as commercial mortgage-backed securities.

I’m not even sure the Fed will proceed with a one and done rate hike this year. In fact, if deflationary pressures increase in China, Singapore, South Korea, Indonesia, Malaysia and Japan, you might see the Fed stand pat for the rest of the year, worried that any increase in rates could trigger a crisis in Asia.

And while Gundlach is avoiding junk bonds, I’m increasingly worried of the unprecedented boom in China’s $3 trillion corporate bond market which is starting to unravel:

Spooked by a fresh wave of defaults at state-owned enterprises, investors in China’s yuan-denominated company notes have driven up yields for nine of the past 10 days and triggered the biggest selloff in onshore junk debt since 2014. Local issuers have canceled 61.9 billion yuan ($9.6 billion) of bond sales in April alone, and Standard & Poor’s is cutting its assessment of Chinese firms at a pace unseen since 2003.

While bond yields in China are still well below historical averages, a sustained increase in borrowing costs could threaten an economy that’s more reliant on cheap credit than ever before. The numbers suggest more pain ahead: Listed firms’ ability to service their debt has dropped to the lowest since at least 1992, while analysts are cutting profit forecasts for Shanghai Composite Index companies by the most since the global financial crisis.

“The spreading of credit risks is only at its early stage in China,” said Qiu Xinhong, a Shenzhen-based money manager at First State Cinda Fund Management Co. “Many people have turned bearish.”

It’s no wonder a top adviser to the Chinese government has warned that Beijing risks a currency blow-up akin to Britain’s traumatic ordeal in 1992 and is openly calling for a 15% devaluation of the yuan.

Great, just what the world needs, another Big Bang out of China will will clobber global risk assets and send everyone scurrying back to the safety of good old U.S. bonds.

But investors remain undeterred, dipping back in emerging markets (EEM) even if some analysts are warning it’s a head fake. Indeed, the rally in emerging markets (EEM), Chinese shares (FXI), energy (XLE), metals and mining (XME) and industrials (XLI) since the start of the year vindicate a lot of funds who bet big on a global recovery last year.

Just look at a sample of stocks leveraged to global growth and the move in Industrials (XLI) since the start of the year below and you’d be hard pressed to worry about any global economic shock (click on images):

My take? I think there are a lot of short sellers who got burnt in Q1 but if you think these rallies in sectors leveraged to global growth are going to continue in the second half of the year, you should be smoking up with the nuns growing medical marijuana, which is the image I embedded above.

On that note, I wish central bankers, Chinese interventionists, and global greenshoots the best of luck navigating this market as we head into the second half of the year. Keep your eyes peeled on the U.S. dollar, the yen and emerging market currencies. Something is going to break and it’s not going to be pretty.

In light of a consultant report showing CalPERS may have lost out on $2 billion in investment gains since divesting from tobacco-related assets 15 years ago, the pension fund announced on Monday it would review its divestment policy.

The review includes consideration of whether to re-invest in tobacco.

From CalPERS:

The California Public Employees’ Retirement System’s (CalPERS) Board of Administration (Board) today laid out a path to review all of the System’s existing divestment initiatives, including tobacco. Based on directions given to CalPERS staff, the Board will consider reinvestment in tobacco after thorough review, study, and stakeholder input. The process is expected to take between 12 and 24 months and will culminate with a decision in early 2018. All non-tobacco divestments will be reviewed according to a new loss threshold policy, to be developed during the same time period.

“Divestment as an investment strategy presents a challenging conflict for CalPERS, as it often pits social responsibility against our fiduciary duty as outlined in the California Constitution,” said Henry Jones, CalPERS Board Vice President and Investment Committee Chair. “As a California public agency, we are sensitive to the policy issues surrounding divestment causes. But we’re also obligated to ensure that we maximize our investment returns on behalf of our members. We now have a clear path forward.”

Today’s direction from the Board follows three months of debate and discussion about how to create a process to periodically review CalPERS’ divestments from an investment and fiduciary perspective. It also comes on the heels of an October 2015 report from the Board’s investment consultant, Wilshire, which shows that CalPERS has lost approximately $8 billion from its various divestments, as of December 31, 2014. Tobacco was responsible for approximately $3 billion in losses.

Read the full statement here.

There were several pension-related items of interest that developed in the final days of Kentucky’s legislative session.

First, lawmakers passed a budget that would infuse an extra $1.2 billion in contributions to the state pension systems over the next two years.

From Pensions & Investments:

Under the bill, the $17 billion Kentucky Teachers’ Retirement System, Frankfort, would receive an additional $498.54 million in fiscal year 2017 and $474.72 million in fiscal year 2018. The $11 billion Kentucky Retirement Systems, Frankfort, would receive an additional $98.19 million and $87.57 million in each of those periods, respectively.

The bill includes a $125 million permanent fund to help shore up the pension funds. Funding would come from a surplus in the state’s public employee health insurance fund. Gov. Matt Bevin previously proposed a $500 million permanent fund, a repository that would help fund future pension costs.

Additionally, House lawmakers failed to pass a controversial, sweeping pension transparency bill that would have disclosed investment contracts and lawmaker pension amounts. The bill was passed by the Senate last month.

Details from WFPL:

The bill would have revealed how much and to whom the pension systems pay to invest pension funds. Kentucky law exempts the investments from open records laws.

Last fall, the Kentucky Retirement Systems Board of Trustees reported that its annual investment expenses are running 75 percent higher than reported in previous years.

Chris Tobe, a former Kentucky Retirement Systems trustee who has been critical of the system, said investment managers should compete to manage Kentucky’s pension assets in public view.

“We need to have open contracts and some kind of documentation and bidding process. Secret backroom deals is not good government,” he said.

[…]

On the last day of the legislative session, Senate leaders attempted to revive the bill by lumping it with language from an Area Development District oversight bill that the House favored, and also taking out some of the controversial provisions. But the bill still languished in the House.

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 actuaries recommend that the annual state payment for state worker pensions increase $602 million in the new fiscal year to $5.35 billion, nearly doubling the $2.7 billion paid a decade ago before the recession and a huge investment loss.

It’s the largest annual state rate increase since CalPERS was fully funded in 2007. And it’s the third year in a row that the state rate increases have grown: up $459 million in 2014, $487 million in 2015, and now $602 million for the fiscal year beginning July 1.

The annual state actuarial valuation prepared for the CalPERS board next week also shows that the debt or “unfunded liability” for state worker pensions grew to $49.6 billion as of last June 30, up from $43.3 billion the previous year.

And as the debt went up, the funding level went down. The five state worker pension plans had 69.4 percent of the projected assets needed to pay future pension obligations last June, a small decline from 72.1 percent in the previous year.

The funding level of the California Public Employees Retirement System, with 1.8 million active and retired state and local government members, has not recovered from a huge loss during the financial crisis and recession.

The entire system (state workers are less than a third of the total members) was 102 percent funded with a $260 billion investment fund in 2007. By 2009 the investment fund had dropped to about $160 billion and the funding level to 62 percent.

Now the total investment fund, which was above $300 billion at one point last year, is valued at $290 billion this week, according to the CalPERS website, and the latest reported funding level is 73 percent.

In recent years, CalPERS has phased in three rate increases for lowering the earnings forecast from 7.75 to 7.5 percent, adopting a more conservative actuarial method intended to reach full funding in 30 years, and getting new estimates that retirees will live longer.

The CalPERS board clashed with Gov. Brown last November when adopting a “risk reduction” strategy that could slowly raise rates over several decades by lowering the pension fund investment earnings forecast to an annual average of 6.5 percent.

Gov. Brown said in a news release the CalPERS risk reduction plan is “irresponsible” and based on “unrealistic” investment earnings. His administration had urged the CalPERS board to phase in the big rate increase over the next five years.

The CalPERS board president, Rob Feckner, said the go-slow decision emerged from talks with consultants, staff, stakeholders and concern about putting more strain on cities “still recovering from the financial crisis.”

The 3,000 cities and local governments in CalPERS have a wide range of pension funding levels, some low and a few with a surplus. If they are able, CalPERS has encouraged them to contribute more than the annual rate to pay down their pension debt.

Brown could have proposed a new state budget in January that gives CalPERS more than the state rate, paying down state worker debt. But legislators may have more urgent priorities and powerful unions want to bargain pay raises.

Critics contending that California public pensions are “unsustainable” often point to a large retroactive state worker pension increase, SB 400 in 1999, that contained a generous Highway Patrol formula later widely adopted for local police and firefighters.

As the stock market boomed in the late 1990s, the CalPERS investment fund, expected to pay two-thirds of future pensions, bulged with a surplus and a funding level that reached 136 percent.

So, while sharply increasing pensions, the CalPERS board also contributed to later funding problems by sharply reducing state contributions from $1.2 billion in 1997 to $159 million in 1999 and $156 million in 2000.

Much of the $602 million state worker rate increase next fiscal year is for phasing in the third and final year of a rate increase, $266.7 million, to cover a longer average life span now expected for retirees.

The “normal progression” of debt payments added $176.4 million and “investment experience” $89.5 million. Payroll growth of 6 percent in the previous year, instead of 3 percent, added $109.4 million due to new hires and other factors.

All of the $602 million rate increase, if approved by the CalPERS board next week, would be paid by state employers. Usually, only the state, not the employee, pays for increased pension costs, particularly investment shortfalls that cause most of the debt.

But Brown’s pension reform that took effect three years ago is making a small but noticeable change.

Workers hired after Jan. 1, 2013, receive lower pensions, requiring them to work several years longer to receive the same benefit as workers hired before the reform. In the list of changes resulting in the $602 million state increase next year, lower pensions for new hires are a $33 million reduction.

State workers typically pay a CalPERS rate ranging from about 6 percent of pay to 11.5 percent, depending on the job and bargaining by labor unions. The new employer rates range from 26.1 percent of pay for miscellaneous workers to 48.7 percent of pay for the Highway Patrol.

Under the pension reform, some state workers (most are excluded) are expected to pay half of the “normal” cost, the estimated cost of the pension earned during a year by a worker, excluding debt from previous years.

Because of an increase in the normal cost, employees hired under the reform by the Legislature, California State University, and the judicial branch would get a small rate increase next year, up from 6 percent of pay to 6.75 percent.

State savings from these and other increases in worker rates must be used to pay down the pension debt. So, even though the state payment under the new CalPERS rate is $5.35 billion, the savings from higher worker rates boosts the payment to $5.462 billion.

CalPERS divested from tobacco-related assets in 2001.

But the topic re-surfaced last week, when a consultant report estimated the pension fund had missed out on $3 billion in investment gains during the 15 years CalPERS had been tobacco-free.

The report has trustees weighing whether to get back into tobacco. But Phil Angelides – former California State Treasurer and one-time Chairman of the Financial Crisis Inquiry Commission – says the pension fund should stay tobacco-free.

Angelides writes on the Huffington Post:

A 2015 report by Wilshire Associates, a consulting firm hired by CalPERS, claimed that CalPERS had foregone about $2 to $3 billion in investment earnings as a result of its decision to divest from tobacco. Yet, this analysis was deficient because it failed to examine whether and how CalPERS could have made investments with an acceptable risk return profile to replace its tobacco investments, which represented only about one-third of one percent of its investment portfolio at the time of divestment. Given the universe of investment options, there is no question that suitable investments to replace tobacco were and are available.

The same arguments raised against tobacco divestment were raised against divestment from companies doing business in South Africa during the brutal apartheid era and from companies aiding the genocide in Darfur. Make no mistake about it: the world of big finance and big business will continue to fight against divestment by institutional investors to close off any consideration of unethical or damaging corporate conduct in the making of investments, lest those considerations begin to curtail loathsome activities that produce big profits and big bonuses at the expense of the larger society.

As the nation’s largest public pension fund, CalPERS has a particular responsibility to continually strive to invest in ways that not only unequivocally meet its fiduciary obligations, but also strengthen our economy and society. That notion should hardly be considered novel. After all, as a society, we have an expectation that corporations should not only be profitable, but also should produce products of quality and conduct themselves well. Indeed, the ideal business enterprise is one that excels on both fronts. We value the real estate development firm that builds profitable, quality projects that enrich our communities. We respect the successful technology company that creates value for shareholders and innovations for the future. Why should we hold investors of capital — including CalPERS, the nation’s flagship pension fund — to a lesser standard?

Read the full piece here.

Last January, the Institutional Limited Partners Association unveiled a fee-reporting template that aims to improve transparency and disclosure around private equity investments.

Now, two-dozen pension funds are requiring general partners to use the template. But very few general partners are on board with the movement.

From Pensions & Investments:

Since the template’s creation in January, 42 limited partners have endorsed the form, which details fees, expenses and carried interest, up from 21 at its introduction. About half of those limited partners require its use in some way, said Jennifer Choi, Washington-based managing director of industry affairs at the Institutional Limited Partners Association, which created the form.

Such standardization helps board members as well as participants make comparisons between general partners, as opposed to wading through an undecipherable data dump, sources said.

“The key point here is getting people to coalesce around a single approach, a single standard,” said Ms. Choi. “Most (general partners) supply these figures, but (each) in a different fashion. … It could be in financial reports, in footnotes, in capital calls.

[…]

While pension funds have begun embracing the ILPA template, private equity managers have not endorsed it at the same pace. Ms. Choi said only two managers, TPG Group and The Carlyle Group, have publicly endorsed the use of the template.

“Some (GPs) have legitimate concerns,” Ms. Choi said. “Is it going to be this detailed template plus other templates that LPs have created on their own? That’s a very legitimate concern.”

“Not all GPs are created equal,” Ms. Choi said. “The back-office reporting functions required to do this, smaller firms might not be technologically capable of doing this. LPs are cognizant of that and are willing to work in a timeline that works for both sides.”

Ms. Choi said she expects most large GPs by 2017 should be able to use the template, but she wouldn’t hazard a guess as to how many firms would or what size they would be.

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

Edward Krudy of Reuters reports, ‘Let them sell their summer homes': NYC pension dumps hedge funds:

New York City’s largest public pension is exiting all hedge fund investments in the latest sign that the $4 trillion public pension sector is losing patience with these often secretive portfolios at a time of poor performance and high fees.

The board of the New York City Employees Retirement System (NYCERS) voted to leave blue chip firms such as Brevan Howard and D.E. Shaw after their consultants said they can reach their targeted investment returns with less risky funds.

The move by the fund, which had $51.2 billion in assets as of Jan. 31, follows a similar actions by the California Public Employees’ Retirement System (Calpers), the nation’s largest public pension fund, and public pensions in Illinois.

“Hedges have underperformed, costing us millions,” New York City’s Public Advocate Letitia James told board members in prepared remarks. “Let them sell their summer homes and jets, and return those fees to their investors.”

The move is a blow to the $3 trillion hedge fund industry where managers like to have pensions as investors because they leave their money in for longer than individuals, sending a signal of stability to other investors.

Hedge fund returns have been lackluster for some time. The average fund lost about 1 percent last year when the stock market was flat, prompting institutional investors to leave.

Research firm eVestment said investors overall pulled $19.8 billion from hedge funds in January, marking the biggest monthly outflow since 2009.

Performance at some of the funds with which New York City invested was far worse. Luxor Capital Group, a long-time favorite with many pensions, lost an average 18.3 percent a year for the last two years.

New York city’s public pension system has five separate pension funds with individual governing structures. The system has total assets of $154 billion, with about $3 billion invested in hedge funds as of Jan. 31.

NYCERS had $1.7 billion invested in hedge funds at the end of the second quarter 2015, according to its financial report. That amounted to 2.8 percent of total assets and was the smallest portion of its ‘alternative investments’ portfolio, which included $8.1 billion in private equity.

Unaudited data from the city Comptroller’s office showed NYCERS’ hedge fund exposure was $1.4 billion as of Jan. 31.

Comptroller Scott Stringer, a trustee, said eliminating hedge funds would a help NYCERS construct a “responsible portfolio that meets our long-term investment objectives”.

NYCERS paid nearly $40 million in fees to hedge funds during its 2015 financial year, while its hedge fund portfolio returned 3.89 percent over the year, according to its financial report.

“Hedge funds are charging exorbitant fees for high-risk and opaque investments,” said James.

Public pensions started to invest heavily in hedge funds after the financial crisis in 2008-2009 to diversify their assets. A CEM Benchmarking survey of public pensions with a total of $2.4 trillion in assets found 5.2 percent of assets were invested in hedge funds in 2014, compared to 1 percent a decade earlier.

Martin Braun of Bloomberg also reports, NYC Pension Votes to Scrap $1.5 Billion Hedge Fund Portfolio:

New York City’s pension for civil employees voted to exit its $1.5 billion portfolio of hedge funds and shift the money to other assets, deciding that the loosely regulated investment pools didn’t perform well enough to justify the high fees.

The action Thursday by the trustees of the $51 billion Employees Retirement System, known as NYCERS, may signal a growing willingness among public pensions to pull their money from the investment vehicles, whose highly paid managers have become a political lightning rod and have frequently failed to outperform. In September 2014, California’s Public Employees’ Retirement System, the largest U.S. pension, divested its $4 billion portfolio saying it cost too much and was too small to affect its overall returns.

NYCERS invested with hedge funds “with the belief that these would add value to the performance – both by increased returns and decreasing risk by providing downside protection,” New York City Public Advocate Tish James said in a statement. “I have seen little evidence of either.”

The New York fund’s decision will remove assets from firms including D.E. Shaw & Co., Brevan Howard Asset Management, and Perry Capital. Last year, NYCERS’s hedge fund portfolio lost 1.88 percent, lagging both the Standard & Poor’s 500 Index and the Barclays U.S. Aggregate Bond Index. Three-year returns were 2.83 percent.

Todd Fogarty, a spokesman for D.E. Shaw, Max Hilton, a spokesman for Brevan Howard and Mike Geller, a spokesman for Perry Capital, didn’t immediately return e-mails and phone calls seeking comment.

Hedge funds eked out returns of about 0.6 percent in 2015, when the S&P 500 slipped 0.7 percent, according to data compiled by Bloomberg. That was the first time the funds had outperformed the index since 2008 as share prices rallied.

NYCERS’s hedge fund investments were subject to intense political scrutiny. Last year, New York Mayor Bill de Blasio referred to funds that bought Puerto Rico’s bonds as ”predators” because they demanded cuts in spending and services to ensure they’re paid in full. Two of NYCERS hedge fund managers held some of Puerto Rico’s $70 billion debt. Hedge fund managers have also come under fire for supporting charter schools, which are privately run but funded with taxpayer money.

Hedge funds still manage money for New York City’s pensions for firefighters and police officers. The city’s teachers’ and education administrators don’t invest with hedge funds.

Reading these articles just reinforces my thinking that it’s a requiem for hedge funds in the sense that institutional investors are increasingly frustrated of paying big fees for lousy performance which tracks or underperforms stocks (it’s all beta, where’s the alpha??).

I’ve long argued that U.S. public pensions should have followed CalPERS and nuked their hedge fund programs. They have no business whatsoever investing in hedge funds as they lack the internal expertise to understand the risks of these investments and end up listening to their useless investment consultants that shove them in the hottest brand name hedge funds they should be avoiding.

How many U.S. public pensions invested with Bill Ackman’s Pershing Square at the wrong time and are now stuck praying shares of Valeant Pharmaceuticals (VRX) are somehow going to magically recover to hit new record highs (keep dreaming, if lucky shares will bounce from these levels but the downtrend is far from over. The only good news for Valeant is it’s everyone’s favorite whipping boy and Bill Miller thinks it can double from these levels. Others think it’s going to zero.).

And it’s not just Pershing Square that’s experiencing difficulties. Lone Pine Capital’s Lone Cypress fund lost 8 percent during the first quarter as bets on Valeant Pharmaceuticals and Energy Transfer/Williams Companies tumbled. A few well-known activist hedge funds got clobbered investing in SandRidge Energy. Extreme volatility in Q1 hit premiere hedge funds like Citadel, Millennium, Blackstone’s Senfina. Even Ray Dalio’s Pure Alpha fund is down almost 7% so far this year, which goes to show you how tough it is out there.

In fact, in early April, Zero Hedge published a list of the best and worst hedge funds so far this year noting “the bulk of the marquee names continue to substantially underperfom the broader market, with Tiger, Pershing Square, Glenview and Trian standing out” (click on image):

Many institutional investors are worried about the bonfire of the hedge funds. If these titans of finance are unable to cope with ultra low rates for years or the new negative normal, how are delusional U.S. public pensions, many of which are already doomed, going to deliver on their bogey of 6%, 7% or 8%?

Almost five years ago, I warned “what if 8% turns out to be 0%?” but nobody was paying attention, lapping up the nonsense Wall Street was feeding them on a big bad bond meltdown (I’m still waiting for it to happen).

Nowadays, everyone is accustomed to ZIRP and NIRP but pension fund fiduciaries should think long and hard of what this means for their alternative investments. If you’re paying 2 & 20 in a deflationary world to any hedge fund or even private equity fund, you’re nuts! Period.

I’ve long argued that hedge fund fees need to come down significantly and I openly questioned why pension funds and sovereign wealth funds pay management fees to a hedge fund or private equity fund managing multi-billions.

It’s one thing to give a startup hedge fund a management fee to get up and running but once they are performing well and gathering billions, why keep paying them any management fee? Let them live and die by their performance alone (Do the math: If Bridgewater manages roughly $150 billion and collects a 2% or even 1.5% management fee no matter how well it performs, that is a huge chunk of change for radical transparency nonsense!).

“But everybody is invested with Bridgewater, it’s a no-brainer!” Really? I think a lot of pension fund managers need to start grilling their hedge fund managers instead of falling in love with them and regretting it later on. If you’re paying huge fees to a brand name hedge fund which is down 6%,8%,10%  or more in one quarter and you’re not sure why, you’re in big trouble.

What else? I also think it’s high time to start thinking outside the box and maybe start investing with smaller hedge funds that have much better alignment of interests. Earlier this week, we learned former Paulson & Co. partner Samantha Greenberg received a $130 million commitment in seed money from the alternative investment manager Ramius LLC for her new hedge fund, Margate Capital. I don’t know her but she obviously has the pedigree and it’s worth tracking her fund.

Sure, investing in small hedge funds carries its own risks and isn’t really scalable but I believe the time is right to put in place a program that seeds or invests in some startup hedge funds. Don’t blindly jump on the big brand name funds, a lot of them are nothing more than glorified asset gatherers charging alpha fees for leveraged beta.