Pension360

A Willis Towers Watson official last week indicated the consulting giant will soon require asset managers to provide data on the gender composition of their employees.

There have been numerous studies in recent years that indicate gender diversity is linked to better financial performance.

From IPE:

Willis Towers Watson will require fund managers to provide data about the gender composition across their workforce, a move that responds to evidence that more women in the workforce improves financial performance.

The plan was mentioned by Luba Nikulina, global head of manager research at Willis Towers Watson, at an MSCI event on the subject of women in finance in London last week. She spoke of “hardwiring this into the process of allocating money”.

“If asset owners add their voice it will help to move things forward,” she added.

She was responding to a comment from a representative of a local authority pension fund about asset owners wanting better data on gender representation in roles below board level.

[…]

Linda-Eling Lee, global head of ESG research at MSCI, highlighted three possible connections between female representation in the workforce and financial performance benefits.

These benefits could stem from women being “better suited to today’s economy”, Lee suggested, from a greater diversity of thinking, or “human capital arbitrage”.

The latter is the idea that, given the barriers they face, “the women who end up at the top are extraordinary so the performance edge may erode as the pipeline to the top opens up”.

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

Jonathan Rochford, portfolio manager at Narrow Road Capital, wrote a guest comment for ValueWalk, The Dallas Pension Fiasco Is Just the Beginning (h/t, Jim Leech):

The recent blow-up of the Dallas Police and Fire Pension System was entirely predictable. Whilst it is tempting to blame unusual circumstances for the recent lock-up of redemptions and likely substantial reductions to pensions for those still in the fund, many other American pension funds are heading down the same road. The combination of overpriced financial markets, inadequate contributions and overly generous pension promises mean dozens of US local and state government pension plans will end up in the same situation. The simple maths and political factors at play mean what happened at GM, Chrysler, Detroit and now Dallas will happen nationwide in the coming decade. So, what’s happened in Dallas and why will it happen elsewhere?

The Dallas pension scheme has been underfunded for many years with the situation accelerating recently. As the table below shows, as at 1 January 2016 the pension plan had $2.68 billion of assets (AVA) against $5.95 billion of liabilities (AAL), making the funding ratio (AVA/AAL) a mere 45.1%. Despite equity markets recovering strongly over the last seven years, the value of the assets has fallen at the same time as the value of the liabilities has grown rapidly. The story of how such a seemingly odd outcome could occur dates back to decisions made long before the financial crisis (click on image).

Source: Dallas Police and Fire Pension System

In the late 1990’s, returns in financial markets had been strong for years leading many to believe that exceptional returns would continue. In this environment, the board that ran the Dallas plan decided that more generous pension terms could be offered to employees and that these could be funded by the higher expected returns without needing greater contributions from the Dallas municipality and its taxpayers. Exceptionally generous terms were introduced including the now notorious DROP accounts and inflated assumptions for cost of living adjustments (COLA). These changes meant that pension liabilities were guaranteed to skyrocket in future years, whilst there was no guarantee that investment returns and inflation levels would also be high. Dallas police and fire personnel were being offered the equivalent of a free lunch and they took full advantage.

In the 2000’s the pension plan made some unusual investment decisions. A disproportionate amount of plan assets were invested in illiquid and exotic alternative investments. When the financial crisis struck these assets didn’t decline as much as the assets of other pension plans. However, this was merely a deferral of the inevitable write downs which came in the last two years after a change in management.

Dallas Pension – Recent Events

Throughout 2016 the pension board, the municipality and the State government bickered over who was responsible and who should pay to fix the mess. The State government blamed the municipality for the poor investment decisions. The municipality blamed the State government for creating a system that it could not control but was supposed to be responsible for. It also blamed the pension board for the overly generous changes they implemented. The pension board recognised the huge problem but offered only minor concessions arguing that plan participants were entitled to be paid in full in all circumstances. They asked the municipality for a one-off addition of $1.1 billion, equivalent to almost one year’s general fund revenue for the municipality.

As the funding ratio plummeted during 2016, plan participants became concerned that their generous pension entitlements might not be met. In other pension plans the employer might increase its contributions when these circumstances occurred, but in Dallas the municipality was already paying close to the legislative maximum. Police officers with high balances retired in record numbers, pulling out $500 million in four months in late 2016. Those who withdrew received 100% of what was owed, with those remaining seeing their position as measured by the funding ratio deteriorate further.

In November, when faced with $154 million of redemption requests and dwindling liquid assets, the pension board suspended redemptions. The funding ratio is now estimated to be around 36% with assets forecast to be exhausted in a decade. Litigation has begun with some plan participants suing to see their redemption requests honoured. The municipality has indicated it wants to claw back some of the generous benefits accrued since the changes in the 1990’s, though this is likely to only impact those who didn’t redeemed. The State has begun a criminal investigation. Everyone is looking to blame someone else, but not everyone has accepted that drastic pension cuts are inevitable.

Dallas Pension – The Interplay of Political Decisions and Financial Reality

The factors that led to Dallas pension fiasco are all too common. Politicians and their administrations often make decisions that are politically beneficial without taking into account financial reality. A generous pension scheme keeps workers and their unions onside, helping the politicians win re-election. However, the bill for the generosity is deferred beyond the current political generation, with unrealistic assumptions of future returns enabling the problem to be obscured. As financial markets tend to go up the escalator and down the elevator it is not until a market crash that the unrealistic return assumptions are exposed and the funding ratio collapses.

This is when a second political reality kicks in. In the case of Dallas, there are just under 10,000 participants in the pension plan compared to 1.258 million residents in the municipality. Plan participants therefore make up less than 1% of the population. If the Dallas municipality chose to fully fund the Dallas pension plan it would be require an enormous increase in taxes from the entire population in order to fund overly generous pensions for a very small minority of the population. For current politicians, it is far easier to blame the previous politicians and the pension board for the mess and see pensions for a select group cut by half or more than it is to sell a massive tax increase.

The legal position remains murky and it will take some time to clear up. The municipality is paying 37.5% of employee benefits into the pension plan, the maximum amount required by state law. Without a change in state legislation, it seems likely that the Dallas pension plan will have to bear almost all of the financial pain through pension reductions. If state legislation was changed to increase the burden on the municipality years of litigation could ensue with the potential for the municipality to declare bankruptcy as a strategic response. The appointment of an administrator during bankruptcy could see services reduced and/or taxes increased, but pension cuts would be all but a certainty.

Dallas Pension Isn’t the First and Won’t be the Last

It’s tempting to see the generous pension structure and bad investment decisions in Dallas as making it a special case. Detroit was seen by many as a special case when it went into bankruptcy in 2013 as it had seen its population fall by 25% in a decade. This depopulation left a smaller population base trying to fund the debt and pensions obligations incurred when the population was much larger. Growing debt and pension obligations are signs of what is to come for many local and state governments who have been living beyond their means for decades.

As well as building up pension obligations many US governments have been accruing explicit debt. The two are intertwined, with some governments issuing debt to make payments into their pension plans, often to close the underfunding gap. This is very much a short-term measure, as whether it is pension contributions or debt repayments both will either require high taxes and/or lower spending on government services in the future in order for these payments to be met.

Pew Charitable Trusts research estimates a $1.5 trillion pension funding gap for the states alone, with Kentucky, New Jersey, Illinois, Pennsylvania and California going backwards at a rapid rate. Using a wider range of fiscal health measures the Mercatus Center has the five worst states as Kentucky, Illinois, New Jersey, Massachusetts and Connecticut. The table below shows the five state pension plans in Illinois, with an average funded ratio of just 37.6% (click on image).

Dallas Pension Source: Illinois Commission on Government Forecasting and Accountability

For cities, Chicago is likely to be the next Detroit with the city and its school system both showing signs of financial distress. Chicago is trying to stem the bleeding with a grab bag of tax and other revenue increases but in the long term this makes the overall position worse.

Default is Almost Inevitable as the Weak get Weaker

The problem for Chicago and others trying to pay their debt and pension obligations by raising taxes is that this makes them unattractive destinations for businesses and workers. Growth covers many sins, as growth creates more jobs and drags more people into the area. This increases the tax base and lessens the burden from previous commitments on those already there. Well managed, low tax jurisdictions benefit from a positive feedback loop.

For states and municipalities in decline, their best taxpayers are the first to leave when the tax burden increases. Young college educated workers with professional jobs generate substantial income and sales tax revenue but require little in the way of education and healthcare expenditure. This cohort has many options for work elsewhere and can easily relocate. Chicago and Illinois are bleeding people, with the flight of millionaires particularly detrimental on revenues.

Those who own property are caught in a catch 22; property taxes and declining population have pushed property prices down, potentially creating negative equity. But staying means a bigger drain on the household budget as property taxes are the most efficient way to raise revenue and therefore become the tax increased the most. If too many people leave property prices plummet as they have in Detroit, making it even more difficult to collect property taxes as these are typically calculated as a percentage of the property valuation. Bankruptcy becomes inevitable as a poorer and older population base that remains simply cannot support the debt and pension obligations incurred when the population base was larger and wealthier.

Dallas Pension – Will be Reduced, but Bondholders Will Fare Worst

The playbook from the Detroit bankruptcy is likely to be used repeatedly in the coming decade. When a bankruptcy occurs and an administrator is appointed a very clear order of priority emerges. Firstly, services must be provided otherwise voters/taxpayers will leave or revolt. There may need to be cuts to balance the budget but if there is no police force, water or waste collection the city will cease to function.

Secondly, pensions will be reduced to match the available assets quarantined to meet pension obligations and the ability of the budget to provide some contribution. If the budget doesn’t have capacity or the legal obligation to contribute more to pension funding, pensioners should expect their payments to be cut to something like the funding percentage. For Dallas and the Dallas pension plans in Illinois this means payments cut by more than half.

Third in line are financial debtors. Bondholders and lenders don’t vote and they are seen as a bunch of faceless wealthy individuals and institutions who mostly reside out of state. They effectively rank behind pensioners, who are people who predominantly reside in the state and who vote, even though the two groups technically might rank equally. This makes state and local government debt a great candidate for a CDS short as the recovery rate for unsecured debt is usually awful in the event of default.

Dallas Pension Canary In Coal Mine? The Next Crisis Will Trigger an Avalanche

At the risk of being labelled a Meredith Whitney style boy who cried wolf I expect that the next financial crisis will trigger a wholesale revaluation of the creditworthiness of US state and local government debt. I have no crystal ball for when this will happen, but it is almost certain that the next decade will contain another substantial decline in asset prices. This will impact state and local governments and their pension obligations in two major ways.

Firstly, asset prices will fall causing underfunded pensions to become even more obviously insolvent. Most US defined benefit pension funds are using 7.50% – 8.00% as their future return assumption. Using a 7.50% return assumption for a 60/40 stock/bond portfolio, with ten year US treasuries at 2.50%, implies equities will return 10.8% every year going forward. In a low growth, low inflation environment this might be achievable for several years, but an eventual market crash will destroy any outperformance from the good years. The continued use of such high return assumptions is unrealistic and is being used to kick the can further down the road. The largest US public pension fund, Calpers, has recognised this and is reducing its return expectations from 7.50% to 7.00% over three years. This still implies a 10% return on equities for a 60/40 portfolio.

Secondly, downturns cause a reassessment of all types of debt with the highest risk and most unsustainable debt unable to be renewed. State and local governments with a history of increasing indebtedness and no realistic plan for reducing their debts may become unable to borrow at any price. This will force them to seek bankruptcy or an equivalent restructuring process. Once this happens for one mainland state (Illinois looks likely to be the first) lenders will dramatically reprice the possibility that it could happen elsewhere. Those who think states cannot file for bankruptcy should watch the process occurring in Puerto Rico, it will be repeated elsewhere. Barring a federal bailout, an overly indebted state or territory has no alternative other than to default on its debts. Raising taxes or cutting services will see the city or state depopulated. Politicians and voters are strongly incentivised to default.

Dallas Pension – Conclusion

Chronic budget deficits, growing indebtedness, excessive pension return assumptions and pension underfunding all set the stage for a wave of state and local government pension and debt defaults in the coming decade. As Detroit has shown this century, once an area loses its competitiveness its financial viability spirals downward. As taxes increase and services are cut the wealthiest and highest income earners leave slashing government revenues and increasing the burden on the older and poorer population that remains.

The next substantial fall in asset prices will sharpen the focus on budget deficits and pension underfunding, with the most indebted and underfunded states likely to find they are unable to rollover their debts at any price. Remaining residents will be negatively impacted, pensioners will see their payments slashed and bondholders will recover little, if any, of their debt. As there is virtually no political will to take action to avoid these problems investors should position their portfolios in expectation that these events will happen.

Written by Jonathan Rochford for Narrow Road Capital on January 17, 2017. Comments and criticisms are welcomed and can be sent to info@narrowroadcapital.com

Disclosure

This article has been prepared for educational purposes and is in no way meant to be a substitute for professional and tailored financial advice. It contains information derived and sourced from a broad list of third parties, and has been prepared on the basis that this third party information is accurate. This article expresses the views of the author at a point in time, and such views may change in the future with no obligation on Narrow Road Capital or the author to publicly update these views. Narrow Road Capital advises on and invests in a wide range of securities, including securities linked to the performance of various companies and financial institutions.

This is an excellent comment on why all roads lead to Dallas when it comes to chronically underfunded US public pensions with poor governance. I thank Jim leech for bringing it to my attention.

US state and local public pension plans need a miracle to get out of the hole they are in. Detroit was a basket case but Dallas and Chicago are not far behind. This particular case of the Dallas Police and Fire Pension once again demonstrates how public plans with little or no governance are a disaster waiting to happen.

The key passage from above is this one:

The combination of overpriced financial markets, inadequate contributions and overly generous pension promises mean dozens of US local and state government pension plans will end up in the same situation. The simple maths and political factors at play mean what happened at GM, Chrysler, Detroit and now Dallas will happen nationwide in the coming decade. So, what’s happened in Dallas and why will it happen elsewhere?

The simple math just doesn’t add up when you combine chronically underfunded public pensions with overly generous pension promises. You can promise pensioners the world but when the money runs out and you’re unable to raise property or sales taxes to fund gross incompetence and negligence, the only option left is to drastically reduce pension benefits.

If you don’t believe me, ask Greek pensioners. For years they were living under the delusion that their public pensions are well managed and that their pension payments are sacred, untouchable, good as gold. When the money ran out, they got a rude awakening as their pension benefits were slashed by 50, 60, 70% or more.

Pensions are all about managing assets and liabilities. If liabilities soar while assets plummet, there simply is no choice but to raise contributions and/or cut benefits. This is especially true if pensions are chronically underfunded. The math is simple and any rational person looking at the situation objectively would come to the same conclusion.

In response to dire pension calculus, state and local governments are trying to raise taxes and emit pension obligation bonds. These are feeble attempts to solve deep structural problems that can only be addressed properly through major reforms on pension governance and introducing some form of a shared risk model to make sure these pensions are sustainable over the long run.

Do all roads lead to Dallas? You bet, to Dallas, Chicago, Detroit and Greece, but so many people are living in Bubble Land that they simply can’t see the global pension storm is gathering steam and will soon threaten public finances everywhere, especially in areas where chronic pension deficits abound.

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

Jacqueline Nelson of the Globe and Mail reports, Teachers eyes new tack after 25 years:

Ontario Teachers’ Pension Plan first began to lead the Canadian pension funds’ shift from sleepy, passive investors to globe-trotting deal makers 25 years ago.

What Teachers started in 1991 with a few million dollars and its first direct private equity investment has grown into a multibillion-dollar private-capital group active around the world. Others have followed, with new funds specializing in buyouts and turnarounds emerging and more institutional investors seeking to boost their exposure to alternative investments.

Now wrapping up a landmark year, Teachers Private Capital is giving more thought to selling some investments into the hot market.

“We’ve probably been more focused on taking advantage of where prices are today and lightening up on some of our holdings than we have been on adding new companies to our portfolio,” says Jane Rowe, head of Teachers Private Capital division, from headquarters perched in northern Toronto.

Ms. Rowe is taking stock of a private-equity portfolio representing 16 per cent of Teachers’ total assets – $28.4-billion as of the end of 2015, the most recent figure available. When the Ontario Teachers’ Pension Plan was made independent in 1990, it was just a pile of non-marketable Province of Ontario debentures. Over time, Teachers Private Capital bought up a quirky range of international businesses such as a British lottery, seniors’ housing facilities, mattress companies and snack foods. In its next act, Ms. Rowe says Teachers Private Capital will further refine how it sets itself apart from – and partners with – its global competitiors.

It has been a profitable run for the country’s largest single-profession pension plan. After factoring in asset management, internal and carried interest costs, the group has generated a 20.2-per-cent internal rate of return for the schoolteachers of Ontario since its inception.

Over time, Teachers Private Capital has sent less money to private-equity firms to invest on its behalf, building a team that can do more direct investments that now make up about three-quarters of its holdings. In many cases, the private equity funds that it does invest in have also become co-investment partners on other deals.

There were some hard lessons along the way. A massive $35-billion leveraged buyout bid for Bell Canada Enterprises (now BCE Inc.) that Teachers led in 2007 might have been the world’s largest at the time, but instead fizzled out 18 months later. And the group’s very first private-equity investment of a 25-per-cent stake in the White Rose Crafts and Nursery Sales Ltd. store chain was a major bust.

“We lost all our money within six months – that’s the folklore,” says Ms. Rowe of that investment. “But shortly thereafter – about two years later – we did our investment into Maple Leaf Sports & Entertainment. And that’s one we held for 17 years,” she says. Teachers’ sold its stake to Canadian telecom giants in 2012 for $1.32-billion.

Twenty years ago, Teachers was already being recognized as a potentially significant source of capital for Canadian mergers and takeovers. But the then-$35-billion pension fund was limited in its investments by the depth of Canada’s capital markets, because federal pension laws capped foreign investments at no more than 20 per cent of the total fund.

While finding its footing in the Canadian private-investment world, Teachers private-capital team encountered criticisms that it didn’t have the knowledge and experience needed to influence corporate management and boards when it took large stakes in companies, or led hostile bids.

Two decades later, Teachers Private Capital has proven its ability to turn companies around at home and abroad – it built up investments in North America, Europe, Asia, Africa and South America and now has about 70 investment professionals. But the group is being tested in other ways. Keeping the international team focused, engaged and committed to Teachers is the challenge Ms. Rowe thinks about most. “I’m always worried somebody’s going to poach them or steal them,” she says.

There’s also a lot more competition out there for Teachers, not only from other Canadian pension funds that have developed their own robust private-equity investment arms, but from investors around the world. The amount of available money piling up with private equity fund managers, called dry powder by industry insiders, hit a record $839-billion (U.S.) globally in September, 2016, according to research firm Preqin. That has grown from a little more than $500-billion a decade ago.

Teachers’ private equity team feels the pressure to prove they can outperform stock indexes that can be bought and managed without the same expense. “You can do that in part through leverage, but really what we kind of say is fundamentally you need to find sectors that you hope are going to outperform GDP over an extended period of time,” Ms. Rowe said.

That’s why Teachers toasted its quarter-century with a $1.03-billion (Canadian) deal for wine-producer Constellation Brands Inc. this fall, giving the pension plan a cellar full of top wine brands such as Kim Crawford and Jackson-Triggs. Teachers’ estimates that Canadian wine consumption is growing at about 4 per cent to 5 per cent annually, compared to a couple of per cent for Canadian GDP.

This deal also recalls Teachers’ earlier investments. In the 1990s, the pension plan took a 23-per-cent stake in wine producer Vincor International Inc. for $13-million – a much smaller cheque size than would turn its head today. Teachers later helped the business leap to the public markets. Vincor was then acquired by Constellation Brands about 10 years ago. Now, it’s returning to the Teachers stable.

The fund does more direct investing than it used to, which has made its relationships with other private-equity investors more important.

“The further you go in geography from home, the more you should probably have a smart friend at the table as you are doing those transactions,” Ms. Rowe said. “If an opportunity came in, for argument’s sake, for Colombia or Korea, you know, I’d be kind of saying what makes a Teachers’ here at Yonge and Finch the go-to provider of capital there?”

As Teachers built its reputation as an investor among other international private equity heavyweights, it has also relied on its wholesome brand. Everyone has been to school and can relate to paying the pensions of hard-working teachers. It’s a tougher sell for private equity firms, which are perceived as making money purely to fatten the pockets of their top brass, Ms. Rowe says. “It’s easier to make why we do our investing resonate.”

Ontario Teachers’ Private Capital is a success story. Under the watch of Jim Leech, the former CEO, it really took off and blossomed. Jim was the person who hired Mark Wiseman to develop Teachers’ private equity fund and co-investment program before he moved on to head CPPIB.

And under the watch of Jane Rowe, the current head of Teachers’ Private Capital and likely next president of Ontario Teachers’, direct investments have continued to be the focus as they try to contain costs and get more bang out of their private equity buck.

But these are treacherous times for private equity, there are serious and legitimate concerns about diminishing returns and misalignment of interests.

Against this backdrop, Canada’s new masters of the universe are focusing their attention on other asset classes, like infrastructure where they can invest huge sums directly, foregoing any fees whatsoever to third party funds.

Still, private equity is an important asset class and will remain an important asset class as Canada’s large pensions push further into private markets in their constant search for alpha. What this means is that all these large pensions will continue to develop their fund and co-investment programs to try to gain access to larger deals where they effectively pay no fees.

Go back to read my recent comment on whether size matters for PE fund performance. There I discuss the push from OMERS and others to invest more directly in private equity but I also tempered my enthusiasm on direct PE investments noting the following:

While I welcome OPE’s success in going direct, OMERS still needs to invest in private equity funds. And some of Canada’s largest pensions, like CPPIB, will never go direct in private equity because they don’t feel like they can compete with top funds in this space.

[Note: It might help if OPE reports the IRR of their direct operations, net of all expenses relative to the IRR of their fund investments, net of all fees so their stakeholders can understand the pros and cons of going direct in private equity. Here you need to look at a long period.]

There is a lot of misinformation when it comes to Canadian pensions ‘going direct’ in private equity. Yes, they have a much longer investment horizon than traditional funds which is a competitive advantage, but PE funds are adapting and going longer too and in the end, it will be very hard, if not impossible, for any Canadian pension to compete with top PE funds.

I am not saying there aren’t qualified people doing wonderful work investing directly in PE at Canada’s large pensions, but the fact is it will be hard for them to match the performance of top PE funds, even after fees and expenses are taken into account.

Who knows, maybe OPE will prove me wrong, but this is a tough environment for private equity and I’m not sure going direct in this asset class is a wise long-term strategy (unlike infrastructure, where most of Canada’s large pensions are investing directly).

When I talk about direct investments above, it’s purely direct, which means the teams source their own deals and help transform operations at a private company they acquired. I think this is a hard space to compete against giants like Apax, Blackstone, Carlyle, KKR, TPG  and others.

It’s much easier for Canada’s large pensions to invest in funds and then invest directly through co-investments (where they pay no fees) on bigger deals or when a large private equity fund sells them a big stake in a private company, like the Apax-CPPIB deal on GlobalLogic I covered in my last comment.

The key point is this, Ontario Teachers, CPPIB, OMERS, PSP, bcIMC, AIMCo, the Caisse and other large Canadian pensions will never be able to compete head on with premiere global private equity funds for two reasons. First, they can’t compete on compensation and second they will never get the first phone call from investment bankers or strategics (companies looking to sell a business unit) when there is a great deal on the table.

It’s just never going to happen, ever. This doesn’t mean that Jane Rowe, Mark Redman, Jim Pittman, Ryan Selwood or other private equity professionals at Canada’s large pensions aren’t good at what they do. They are damn good at what they do but even they will tell you what I’m telling you is 100% accurate, not in their wildest dreams can they effectively compete with PE giants, even over a very long investment horizon.

When it comes to private equity, there is a symbiotic relationship between Canada’s large pensions and large private equity global funds. They need each other to thrive and make the necessary returns they require to justify a 10 or 15% allocation to private equity. Sure, Canada’s large pensions are doing more and more direct investments, mostly through co-investments with large PE funds they invest in and pay big fees to. But this notion that Ontario Teachers’ Private Capital or any other private equity group at Canada’s large pensions will move entirely into direct investments effectively competing with top private equity funds on big deals is pure fantasy. And it’s a dangerous notion because it’s not in the best interests of their beneficiaries and stakeholders.

Just to underscore this point, Ontario Teachers’ recently announced a great deal with Redbird Partners to invest in Dallas-based Compass Datacenters:

RedBird Capital Partners (“RedBird”) and Ontario Teachers’ Pension Plan (“Ontario Teachers’”) today announced an investment in Compass Datacenters, LLC (“Compass” or the “Company”) in partnership with the Company’s management team, which includes Founder and CEO Chris Crosby. The existing management team will continue to lead the business and execute the Company’s growth strategy, which is supported by long-term, flexible capital from Compass’s new investment partners. Financial terms of the transaction were not disclosed.

“The next major wave of growth in the data center industry will be driven by the need for dedicated data centers that address technology trends including large-scale Internet of Things deployments, edge computing strategies that reduce latency, rapid delivery of new applications, and more,” said Chris Crosby. “I couldn’t be happier about welcoming RedBird and Ontario Teachers’ to our team, as it provides Compass with the financial resources to fund the next phase of our growth with partners who have deep domain expertise in the industry. We will continue serving as a trusted, behind-the-scenes provider to large-scale users in this multi-billion market which is experiencing impressive double-digit growth.”

Based in Dallas, Texas, Compass is a leading wholesale data center developer, specializing in customized build-to-order solutions for enterprise, cloud computing, and service provider customers. Compass focuses on solving customer needs through its patented architecture, scalable design, low cost of ownership model, and overall speed to market. Compass’s solutions also enable customers to locate their dedicated facilities anywhere. This functionality provides customers with the degree of geographic flexibility necessary as the Internet of Things (IoT) and large rich packet applications (such as video and augmented reality) require data centers to be located closer to end users. Compass CEO Chris Crosby was a founding member of the second-largest data center company in the world and leads a team that has collectively built over $3 billion of data centers globally and operated more than six million square feet of space.

“Compass’s unique solutions align perfectly with the way data center needs are evolving for large cloud/SaaS providers, corporate customers and service providers, and this investment gives Compass significant resources to take advantage of market opportunities,” said Robert Covington, Partner of RedBird Capital. “Compass now has the ability to develop larger, multi-phase projects for customers, as well as to invest in the acquisition of real estate in markets that support customer needs. Compass is one of the great stories in the data center industry, and we are proud to be part of the team’s growth strategy.”

“This investment enables Compass to significantly advance its growth plan, maintain its focus on innovative customer solutions and continue to leverage the experience and knowledge of its talented management team,” said Jane Rowe, Senior Managing Director, Private Capital, Ontario Teachers’. “We recognized that Compass is a leader in its market segment and, through this partnership, is very well positioned to serve as the trusted data center partner for even more customers whose evolving technology needs can be met by the facilities that Compass designs and builds.”

DH Capital served as exclusive financial advisor to Compass Datacenters on the transaction.

The recent deals of Ontario Teachers’ investing in Compass Datacenters and CPPIB buying a big stake in GlobalLogic underscore the need to have great private equity partners all around the world. They also show you where these two mega pensions see growth in the IT sector going forward.

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

Indulai PM and Jochelle Mendonca of India’s Economic Times report, Apax Partners sells 48% of GlobalLogic to CPPIB in $1.5 billion deal:

Apax Partners has sold half its 96% stake in GlobalLogic, an IT outsourcing firm founded by four IT Titans, to Canada’s CPP Investment Board.

The financial terms weren’t disclosed, but people in the know said the transaction valued the digital products development company at $1.5 billion (Rs 10,235 crore). That means a big payday for Apax, as the private equity firm will end up making more than three times money on a four-year-old investment.

Apax acquired GlobalLogic in 2013 for $420 million from a clutch of financial investors, including a PE fund managed by Goldman Sachs, Westbridge, New Atlantic Ventures and Sequoia. It will continue to own 48% of the US-based firm, with the management team holding the rest, the people said. Both CPPIB and Apax will become co owners of the company.

The transaction would be one of the biggest private equity exits in the technology sector post Capgemini’s $4 billion acquisition of Nadasdaq-listed iGate, which was also backed by Apax Partners.

Ryan Selwood, managing director and head of direct private equity at CPPIB, called it a “compelling opportunity” for the Canadian pension fund. “GlobalLogic’s market-leading position, exceptional track record and deep customer relationships will enable it to continue capitalising on technology megatrends,” he said.

“GlobalLogic has seen significant returns from early investments in customer focus and in building differentiated capabilities to drive digital transformation for a number of large customers,” said Rohan Haldea, partner at Apax Partners.

Founded by Rajul Garg, Sanjay Singh, Manoj Agarwala and Tarun Upadhyay, San Jose, California-based GlobalLogic has its core operations in India. The company was initially founded as Induslogic in 2000, with headquarters in Vienna, Virginia and had a delivery centre in Noida.

It provides product development services, including experience design, product engineering, content engineering, and labs. It specializes in big data and analytics, cloud, design, DevOps, embedded, Internet of Things, mobile, and security practices.

“In the past three years with Apax, we’ve enjoyed a 20%+ compound annual growth rate, consistently outperforming the broader product engineering services market,” said GlobalLogic Chief Executive Shashank Samant.

GlobalLogic is one of the larger players in the outsourced engineering research and development industry. The company is forecast to post around $450 million in fiscal 2017 revenue, with a 20% operating margin. It has more than 11,000 employees and delivery centres, called ToyFactories, in India, the US, Eastern Europe and Argentina.

Engineering R&D services have been growing faster than regular IT services, though over a smaller base. The sector has seen some consolidation, with over 15 niche players having been acquired over the last two years.

GlobalLogic was also looking at potential acquisitions, and could consider at bolting niche consulting firms in the future. India’s technology sector has matured and has more challenges to face, but analysts believe growth can still be achieved with the right business mix and people.

“Despite having a cautious outlook on growth/margins and the overall Indian IT space currently, we still maintain our view that if the business mix is right, the proposition is right and execution is right — the IT services industry still has growth left,” Nomura Securities analysts Ashwin Mehta and Rishit Parikh wrote in a note in September.

Apax, which started investing in India 10 years ago, has invested $1.5 billion across half a dozen companies, but has already returned $2.3 billion cash to its investors, even though it has yet to exit some of its portfolio companies. The performance makes it one of the most successful global private equity funds in India. The UK-based investment firm, which manages $20 billion globally, has invested predominantly in the technology space. Apax backed iGate to acquire India’s Patni Computer Systems in 2011 for roughly $1 billion and sold it off to Capegemini four years, making a nearly fourfold return.

It also made bets in the healthcare and financial services space in the country. It acquired an 11% stake in Apollo Hospitals in 2007 for $100 million, which it sold off in 2013 making a 3.5-time return. The PE fund has a Rs 500 crore exposure to the Murugappa Group’s Cholamandalam Investment & Finance Co.

Someone from the Street.com contacted me on Friday to give my thoughts on this deal. I said it was a great deal for all parties involved and referred her to Mark Machin and Ryan Selwood at CPPIB.

First, Apax the private equity giant which acquired GlobalLogic in 2013 for $420 million made more than three times its money in a little over three years. That is a great return for Apax and its private equity clients which are pretty much the who’s who in the pension and sovereign wealth fund world.

Second, CPPIB through its fund and co-investment program just got a big stake in one of the fastest growing companies in a very hot industry. The way it works is like this. CPPIB invests billions in private equity, exclusively through funds like Apax which it pays hefty fees to. But it also gets to co-invest alongside them in some big deals (paying no fees) or gets first dibs when these private equity funds sell part of their stakes in their portfolio of companies. It wasn’t by accident that Apax approached CPPIB to sell them half their stake in GlobalLogic.

On co-investments, CPPIB pays no fees but when it acquires a stake in a private company which is part of the private equity portfolio through its fund investments, it pays a premium to the general partner, in this case, Apax. Now, if GlobalLogic continues to grow at a healthy clip, CPPIB will turn around in three years and exit this investment via an IPO in public markets and make multiples on its investments, boosting its returns in private equity (Apax will also make a killing in the process).

What does GlobalLogic gain? In addition to Apax, it gains a strategic long-term partner/ owner with tentacles around the world that will provide solid long-term strategic advice to its management and if needed, patient capital to fund new projects.

It’s through co-investments and private equity deals like this that CPPIB and other large Canadian pensions are able to juice their private equity returns. These gains benefit their beneficiaries but it also allows senior pension fund managers to reap big gains relative to their private equity benchmarks to collect big bonuses in their own personal compensation.

I had a discussion with someone in public markets yesterday who told me flat out “they should strip away these co-investments and big deals from CPPIB’s private equity returns”, adding “it’s not like they sourced them, they get them just because they are big and are able to invest huge sums in private equity giants like Apax.”

True but if you are Ryan Selwood at CPPIB, you can argue that you work hard to invest in Apax and cut deals like GlobalLogic so you deserve to reap the rewards of such deals. Nobody forced Apax to sell its stake to CPPIB, negotiations happened at the highest levels and it is an excellent deal all around.

The Globe and Mail had a big report on CPPIB’s appetite for risk, which isn’t anything new. CPPIB has comparative advantages over many other large investors and it will use these advantages to make strategic long-term investments at the right time (click on image):

It’s not about taking on more risk, it’s about taking on smarter risk. What CPPIB is doing makes great sense and you don’t need a PhD in finance to understand it.

The key thing to understand is that in a raging bull market, CPPIB will typically underperform its peers and many other public funds but when a bear market develops, it will use its competitive advantages to get to work and make strategic long-term acquisitions across public and private markets all over the world, and these investments will benefit the CPP Fund over the long run.

Again, it’s not rocket science, it’s understanding their long-term competitive advantages and capitalizing on them at the right time by taking very smart long-term risks.

The U.S. Supreme Court said Friday it will review an appeal by CalPERS that seeks to revive a lawsuit brought by the pension fund against Lehman Brothers.

CalPERS lost $300 million when the bank went bankrupt, and has only recovered about $118 million from other lawsuits.

Details from SFGate:

[CalPERS’] suit against other underwriters and financial institutions, whom it accused of misrepresentations in the investment offerings, was dismissed by federal courts in New York, where all Lehman-related cases were transferred. The courts said the three-year legal deadline for filing securities lawsuits had started to run in July 2007, when the bank made its first securities offering, so CalPERS’ February 2011 suit was too late.

CalPERS argued that the deadline should have been suspended when it joined the class-action suit, which was filed before the three-year deadline. The Supreme Court had ruled nearly 43 years ago that plaintiffs who take part in a class action can be allowed more time to file their own suits, but hasn’t yet decided whether such an extension applies to securities cases.

The justices indicated they would resolve that issue when they announced Friday that they had granted review of CalPERS’ appeal. The court has only eight members, following the death of Justice Antonin Scalia in February, so it may wait until the term that starts in October before hearing the case.

A month after his arrest, the head of Korea’s National Pension Service was indicted by prosecutors on Monday.

Moon Hyung-pyo was indicted on charges of perjury and abuse of authority. The charges are the result of an ongoing investigation into whether Mr. Moon illegally pushed the pension fund’s board to vote in favor of a merger of two Samsung affiliates.

More from the Wall Street Journal:

South Korean prosecutors on Monday indicted the head of the country’s National Pension Service, as investigators tightened their focus on a 2015 merger of two Samsung affiliates that has pulled the Samsung conglomerate’s heir apparent into a wide-ranging political corruption scandal.

[…]

Prosecutors late last month arrested Mr. Moon for allegedly illegally ordering the fund, the world’s third largest, to vote in favor of a controversial $8 billion merger of the Samsung affiliates in 2015. NPS, which held an 11% stake in Samsung C&T at the time, had the deciding vote in the deal, which strengthened the control of Samsung heir Lee Jae-yong over Samsung Electronics Co., the crown jewel of South Korea’s largest conglomerate.

The merger was opposed by proxy-advisory firms as well as by U.S. activist hedge fund Elliott Management Corp.

Kansas Gov. Sam Brownback budget proposal would achieve short-term savings by decelerating the state’s pension payment schedule, pushing full funding back by 10 years and raising long-term costs by $6 billion, according to retirement system officials.

The budget would also cancel the repayment of $97 million that lawmakers shifted out of the pension system in 2016.

Officials from the Kansas Public Employees Retirement System this week briefed lawmakers on the long-term consequences of the Gov.’s plan.

From the Kansas City Star:

Alan Conroy, the executive director of the Kansas Public Employees Retirement System, on Thursday briefed the Senate budget committee on the long-term impact of the governor’s budget proposal.

Brownback wants to slow down the state’s pension payment schedule to save money as the state faces a budget shortfall. Conroy compared that to refinancing the mortgage on your house.

“If you don’t pay it now, you’re going to pay more later and over a longer period of time,” he said.

KPERS has an $8.5 billion unfunded liability. If the state keeps its current payment schedule, it would pay that off by 2033. Brownback’s budget proposal would delay that by 10 years, which Conroy said would increase the long-term pension costs by $6.5 billion through 2043.

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

Bruce Einhorn and Heejin Kim of Bloomberg report, A Scandal at Korea’s Retirement Giant:

With 546 trillion won ($456.5 billion) in assets, South Korea’s public National Pension Service is the world’s third-largest pension fund, behind Japan’s and Norway’s. It’s also become a part of the widening scandal surrounding impeached President Park Geun-hye.

On Dec. 31, a Seoul court issued a warrant for the arrest of Moon Hyung-pyo, chairman of the NPS. He was suspected of having pressured the fund, when he was a government minister, to support the controversial merger of two Samsung Group-affiliated companies. Moon’s lawyer said the chairman denied the allegations, according to reports in Korean media. Authorities also want to know whether Samsung made donations to benefit a confidante of the president in exchange for help getting NPS support. Jay Y. Lee, Samsung’s heir apparent and de facto leader, was summoned to be questioned as a suspect on Jan. 12. Both Samsung and Lee have denied wrongdoing. The NPS has said it supported the deal based on investment considerations.

Established in 1988, the NPS is Korea’s main public retirement plan and a major investor in the country’s blue-chip companies, owning 9 percent of Samsung Electronics, 8 percent of Hyundai Motor, 10.3 percent of LG Display, and large stakes in other prominent companies. Its potential influence as a shareholder makes it a natural target for pressure from politicians seeking favors from the corporations in its portfolio. The scandal has “created huge risks to the integrity and legitimacy of the NPS,” says Katharine Moon, a political science professor at Wellesley College.

As the fallout from Park’s impeachment spreads, some lawmakers are looking into reforming the pension service. The alleged use of the fund’s investment clout to advance politicians’ agendas “can bring doubts on Korea’s capital markets overall,” says Chae Yibai, a National Assembly member from the opposition People’s Party. “We need to discuss the matter of the independence of the investment management unit from the control of the government, like overseas pension funds,” he says.

Despite its size, the NPS often takes a passive approach in its relations with the chaebol, the family-run conglomerates that dominate Korea’s economy and have close ties with local politicians, says Woojin Kim, an associate professor of finance at Seoul National University. The fund’s management structure contributes to its low-key approach. The NPS has three decision-making bodies to provide public input into investment decisions, but “none of them is formed of members with knowledge of asset management or pension funds,” says Kim Sang-Jo, a professor of international trade at Hansung University in Seoul. Instead, officials from business lobbies, labor unions, and civic groups dominate the committees, and “they have little power or interest in decision-making on important issues at NPS,” says Kim.

The NPS has occasionally taken a more active role, particularly when the government has the lead on an issue. In early 2016 the fund announced plans to blacklist companies that didn’t follow Park’s directive to raise their dividend payouts, part of her effort to get chaebol to reduce their cash hoards and return money to shareholders through dividends or to workers via wage increases.

The NPS has recently felt some pain from a government-dictated relocation of its headquarters to Jeonju, a sleepy provincial capital about 125 miles south of Seoul. During her campaign for president in 2012, Park pledged to help redevelop the southwestern city. More than 30 fund managers, including about 20 in charge of overseas investment, have left the fund rather than relocate, according to the NPS.

By focusing public attention on the tangled relationships among the government, the fund, and business, the turmoil may ultimately help the NPS achieve one stated goal: to invest more outside Korea. “The Korean stock market is going to be too small for them,” says Michael Na, a Korea strategist with Nomura. “More and more of the money will go overseas.” Foreign investments account for less than 150 trillion won, about 27 percent of its total assets, but the NPS wants to expand its foreign portfolio to more than 300 trillion won by 2021. This year it plans to increase international holdings by about 25 trillion won, of which 10 trillion will go to alternative investments such as private equity or bank loans. The NPS in July picked BlackRock and Grosvenor Capital Management to manage as much as $1 billion in hedge fund investments. As for local stocks, the fund “will cautiously approach investing in domestic markets for this year,” spokeswoman Chi Young Hye says.

Moving beyond Korean equities wouldn’t only reduce the risk of political meddling but would also potentially improve investment performance, says Moon of Wellesley. That will be essential as NPS fund managers face the task of supporting Korea’s aging population. “They know the math,” she says. “There will have to be a push to diversify and decrease the overinvesting in a small number of companies.”

The bottom line: Korea’s public retirement plan is a major shareholder in the country’s most important companies, and its chairman has been arrested.

So, what else is new, a scandal at a large national pension fund with paltry governance? How shocking!

Sorry, I’m still in a crabby mood and recovering from the flu with off and on low grade fever but I decided to write on this because it’s just another example of a large pension fund — in this case, the third largest in the world — where lack of proper governance leads to political interference and corruption.

South Korea’s National Pension Service should first and foremost get its governance right. It should relocate its headquarters back to Seoul (nobody worth anything will want to live in Jeonju) and hire a top-notch consulting firm like McKinsey or Boston Consulting Group to make a series of recommendations on how it can bolster its governance, adopting Canadian pension governance standards.

In Canada, there is is a clear separation of pension investments and governments. Instead, most have an independent qualified board overseeing the operations at these pensions where decisions of where and how to invest are made solely by senior pension fund managers that are paid extremely well to run these organizations.

Is it perfect? No, it isn’t and there is always room to improve on governance, but it’s a lot better than having your national pension fund run by a bunch of corrupt cronies who are looking to line their pockets.

The thing that gets me is the part of Korea’s NPS allocating a billion dollars to hedge funds and picking BlackRock and Grosvenor Capital Management.

On Wednesday, Bloomberg reported that BlackRock’s main quantitative hedge-fund strategies were on track to post big losses:

At least three of the quant strategies used by BlackRock’s global hedge fund platform have suffered losses greater than 10 percent in the year through November, according to the client update, a copy of which was seen by Bloomberg. That compares with an average return of 3.6 percent for quant funds, Hedge Fund Research Inc.’s directional quant index shows.

In September, Mark Wiseman, the former head of the Canada Pension Plan Investment Board, was brought in to run the group and no doubt use his huge Rolodex to garner new assets.

But things aren’t going well for this group. I don’t know what exactly is going on at Blackrock’s SAE team but it’s losing top talent and investors. Larry Fink, BlackRock’s CEO, is right to feel frustrated with the group’s poor showing.

[Note: Too many quants with PhDs all doing factor-based models are getting killed. BlackRock needs to really understand why these strategies are unable to perform and if it can’t get to the bottom of it, shut these operations down until it has clear answers to explain their poor performance to investors.]

As far as Grosvenor Capital, it’s a well known fund of funds which invests across hedge funds and other alternative funds. It has a solid reputation but again, why is NPS investing in any hedge funds before it gets its governance right? That just doesn’t make sense to me.

I think Korea’s NPS should be revamped and the first order of business is to drastically improve its governance. Forget hedge funds, private equity funds, infrastructure, real estate or foreign investments. Get the governance right first, implement fraud detection and whistleblower policies, use top-notch consultants and forensic accounting firms to beef up internal compliance and then worry about investing in hedge funds!

By the way, those of you looking to invest in a great macro hedge fund, Bloomberg reports Chris Rokos’s hedge fund rose about 20 percent in 2016, its first full year of trading, to become one of the world’s best-performing money pools betting on economic trends, according to people with knowledge of the matter.

In my opinion, Rokos is a superstar macro manager, one of the very best in the world. Brevan Howard has never been the same without him and he really performed exceptionally well last year which wasn’t an easy year for most hedge funds in general and macro funds in particular (just ask Mr. Soros who lost a cool billion after Trump was elected; Rokos one-upped him last year).

New classes of lawmakers in several states are making their priorities clear as new legislative sessions begin; and altering pension benefits appears to be on the docket in Michigan and South Carolina.

In Michigan, the GOP majority has plans to close the state’s Teachers Retirement System to new hires, and instead shuffle those workers into a 401(k)-style plan.

But they might have trouble doing so, because Gov. Rick Snyder isn’t on board. From Detroit News:

Michigan’s Republican-led Legislature could be on a crash course with GOP Gov. Rick Snyder over plans to eliminate teacher pensions for new hires.

[…]

The incoming speaker has a powerful ally in the upper chamber, where Meekhof led a recent lame-duck push for legislation that would have closed Michigan’s teacher pension system to new hires and instead limited offerings to 401(k)-style retirement plans.

The legislation stalled out in late December amid opposition from the Snyder administration, which said the transition could cost the state $25 billion over the next 30 years.

The legislation was not a “cost-effective approach” to pension reform, said Snyder spokeswoman Anna Heaton, adding the governor is “open to working with the Legislature on this issue and reviewing the data again.”

Meanwhile in South Carolina, lawmakers are already drafting a bill that would increase contributions for workers and public-sector employers, and reduce the retirement system’s assumed rate of return.

From the Independent Mail:

A panel of S.C. House and Senate members kicked off the legislative session Tuesday by working to draft a bill to fix the state’s ailing system.

To begin addressing that $20 billion gap, lawmakers agreed Tuesday to include in a bill: