Pension360

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

Vipal Monga and Heather Gillers of the Wall Street Journal report, Dow 20000 Won’t Wipe Away Pension Problems:

The 2016 surge in stocks and bond yields is a rare positive for U.S. company and public pensions. But it doesn’t solve their problems.

In November large corporate retirement plans gained back $116 billion needed to pay out future benefits largely because of dramatic market movements following Donald Trump’s Nov. 8 election win, according to consulting firm Mercer Investment Consulting LLC.

The S&P 500 soared and long-term interest rates rose, boosting asset values and lowering liabilities for pensions at 1,500 of the largest U.S. companies. The present-day value of future obligations owed by companies falls when interest rates rise.

Even with November’s gains, corporate pensions were left with a $414 billion funding deficit, $10 billion larger than it was at the end of last year, according to Mercer. Funding deficits occur when the value of assets in pension plans don’t equal the projected future payments to retirees.

“It’s been good, but not great,” said Michael Moran, pension strategist at Goldman Sachs Asset Management. “Things are better than where we were a month ago, but it’s still too early to declare victory.”

That tempered reaction indicates the magnitude of the funding gap faced by managers of retirement assets across the U.S. Pensions still haven’t recovered from the chronic deficits created by the financial crisis and perpetuated by low interest rates.

The largest corporate-pension funds lost more than $300 billion during the 2008 downturn, according to consulting firm Milliman Inc., and that loss wiped out the previous five years of gains.

Pension deficits are a big deal for companies, because firms must close funding gaps with cash they could use for other purposes. Companies such as General Motors Co., International Paper Co., and CSX Corp. have all borrowed money this year to pump funds into their pension plans.

Companies in the S&P 1500 have contributed $550 billion into their pension plans between 2008 and Nov. 30 of this year, according to Mercer. Even with those contributions, their funded status was 81.3% as of Nov. 30.

Although pension-funding levels fluctuate during the year, most companies lock in their pension obligations at the end of the year for accounting purposes. November’s run-up, if it continues into December, could help lessen the burden of what had earlier been shaping up to be a big drag on 2016 financial results.

Funding holes are a trickier problem for funds that manage the pension assets of public workers because market rallies don’t automatically help close the gap.

Public-pension liabilities have grown significantly over the past decade, with the 30 largest plans tracked by the Public Plans Database showing a net pension debt of $585 billion in 2014, compared with $186 billion in 2005.

Almost all public retirement systems engage in an accounting practice known as “smoothing” returns, meaning it takes time to fully recognize investment earnings that exceed expectations. That approach limits how much the funding status will improve this year even if strong stock markets help the plans earn a return above their targets.

“All we know is that interest rates have popped up a little bit and equity prices have run up over the last three weeks,” said Alan Perry, an actuary with Milliman. “How that’s going to filter into the ingredients that go into forecasting long-term returns, it’s too early to tell.”

The largest public pension in the U.S., California Public Employees’ Retirement System, is debating whether to lower its expected rate of return—currently 7.5%.

The fund, known by its acronym Calpers, absorbed substantial losses during the last recession and currently has just 68% of assets needed to pay for future obligations. It earned 0.6% on its investments in the fiscal year ended June 30, well short of its annual goal.

“It’s too early to tell whether this [recent improvement] is something that’s going to be sustained,” said California State Controller Betty T. Yee, who serves on Calpers’s board.

This is a good article which explains why big gains in the stock market and the backup in yields aren’t going to make a dent in America’s ongoing pension crisis.

First, let me split US private pensions apart from US public pensions. Unlike the latter, the former aren’t delusional when it comes to discounting their future liabilities. In particular, they don’t use rosy investment assumptions to discount future liabilities but actual AAA corporate bond yields which have declined a lot as government bond yields hit record lows.

Some think using market rates artificially inflates pension deficits at America’s corporate defined-benefit plans and there is some truth to this argument. But one thing is for sure, if reported corporate pension deficits are higher than they should be at private corporations, US public pension deficits are woefully under-reported using a silly and delusional approach which discounts future liabilities using a pension rate-of-return fantasy.

Now, it’s in US corporations’ best interests to over-report their pension deficits just like it’s in the best interests of US public plans to under-report them. How so? Aren’t pension deficits a noose around the neck of US corporations?

Yes, they are which is why they are trying to offload the risk onto employees and get rid of defined-benefit plans altogether for any new employees. What concerns me is that they are shifting everyone into defined-contribution plans which will only ensure more pension poverty down the road. That is the brutal truth on DC pensions, they aren’t real pensions employees can count on.

Interestingly, in an email exchange, Jim Leech, the former president of the Ontario Teachers’ Pension Plan, agreed with Bob Baldwin’s comments on Canada’s great pension debate and added this:

“My recollection is that the Tories were lobbied hard for this after New Brunswick succeeded in its reform and reluctantly introduced the TB concept. I say reluctantly because they were more interested in promoting their group DC plan – forget the name (it was PRPPs).

So drafting was in works by civil servants before Liberals won. The Canada Post labour strife put back on front burner as TB is most helpful answer there but unions are fighting tooth and nail. Liberals likely thought there would be no outcry as there was none when Tories announced originally.

Still amazed that GM/Unifor went straight to DC instead of adopting TB.”

What Jim is referring to is that sponsors are shifting employees into defined-contribution plans without first assessing the merits of target or variable-benefit plans.

Of course, TB plans are not DB plans and this is something that employees should be made aware of and something Bob Baldwin explained further when I asked him where he considers various plans (like OTPP, HOOPP, OMERS, etc.) fall in the spectrum:

“I would reserve the term Target Benefit for plans in which all accrued benefits (i.e. accrued benefits of active members, retirees and deferred vested benefits) are subject to adjustment based on the financial status of the plan. Aside from the New Brunswick’s shared risk plans, the best examples of this type of plan are the union initiated multi-employer plans. I would describe OTPP and HOOPP as plans that are largely but not purely DB. They are not purely DB because they have shifted some financial risk from the contribution rate to the benefits.

The fact that you asked the question is important to me. It speaks to the reality that pension design is more like a spectrum of choice rather than a binary choice between DB and DC or even a three way choice among DB, DC and TB. There are any number of ways that financial risk can be allocated. Unfortunately, when the reality that confronts us is a spectrum, the language we will choose to describe it will almost always be more categorical than the reality itself. That’s why in my earlier email urged paying more attention to how risk is allocated and less to the labels we use.”

I agree with Bob Baldwin and might add that even though OTPP and HOOPP are fully or even over-funded, not every public pension plan can do what they’re doing either because they don’t have the governance or because their investment policies don’t allow them to take the leverage that these two venerable Canadian pension plans take.

Also, while I like their use of adjusting inflation protection partially or fully to get their respective  plans back to fully-funded status, former actuary Malcolm Hamilton made a good point to me yesterday that in a low inflation world, adjusting for inflation protection becomes a lot harder and less effective (God forbid we go into deflation, then there will be no choice but to raise contributions, cut benefits or increase taxes).

As far as US public plans, they truly need a miracle. Every day I read articles about horror stories at Dallas, Chicago, San Diego, and elsewhere in the United States.

I highly recommend every state plan follows CalPERS and gets real on future returns but I recognize this will have ripple effects on the US economy and deter from growth over a long period.

The problem is ignoring the elephant in the room and waiting for disaster to strike (another financial crisis) will only make the problem that much worse in the future and really deter from US growth.

President-elect Trump is meeting with tech executives today. I think that is great as America needs to tackle its productivity problem, but something tells me he should also meet with leaders of US pension plans to discuss how pensions can make America great again.

One thing is for sure, Dow 20,000 or even 50,000 under Trump isn’t going to solve America’s pension ills or make a dent in America’s ongoing retirement crisis. And if we get another financial crisis, deflation, Dow 5,000 and zero or negative rates for a very long time, all pensions are screwed, especially US public pensions.

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

Richard Ferguson of the Australian reports, CPPIB acquires 50pc stake in AMP Capital-managed NZ portfolio:

North American investor Canada Pension Plan Investment Board has acquired a half-stake in an AMP Capital-managed portfolio of New Zealand properties for $NZ580 million ($557m).

CPPIB bought the 50 per cent interest in the New Zealand properties from another ­Canadian fund investor, PSP ­Investments, which will keep a half-stake in the suite of prime office and retail assets.

The portfolio of 13 buildings is worth $NZ1.1 billion in total and is located primarily in Wellington and Auckland.

Yesterday’s move was CPPIB’s first investment in New Zealand and saw the fund expand its $C38.4bn ($39bn) worth of global real estate investments.

CPPIB head of Asian real estate investments Jimmy Phua said the Canadian pension fund was attracted to New Zealand’s strong population growth and buoyant tourism sector.

“With this acquisition, we are able to gain a meaningful presence in the New Zealand commercial real estate market, partnering alongside PSP Investments, who is a like-minded, long-term partner,” he said.

CPPIB is partnered with AMP Capital in several Australian ventures and said the firm would continue to manage the New Zealand portfolio. “This is a rare opportunity to acquire a ­diversified portfolio that includes top-tier office and retail properties in New Zealand,” he said.

The AMP-managed property portfolio includes the Botany Town Centre and the Manukau Supa Centre in Auckland.

It also holds the 13-level St Pauls Square office building in Wellington, which is undergoing a $38 million refurbishment, ­before the New Zealand government moves in after signing a 15-year lease.

AMP Capital head of real estate investments Chris Judd said there had been talks about the expansion of the New Zealand property portfolio.

“Ultimately we will be looking at more acquisitions in the near future but right now I’m ­focused on investment performance,” he said.

CPPIB put out this press release going over the deal:

Canada Pension Plan Investment Board (CPPIB) announced today that it has signed an agreement to acquire a 50% interest in a diversified portfolio of prime office and retail properties in New Zealand from the Public Sector Pension Investment Board (PSP Investments). The 50% interest is valued at NZ$580 million (C$545 million) with an equity investment of NZ$230 million (C$216 million) subject to customary closing adjustments. PSP Investments will continue to hold the remaining 50% interest. The portfolio will continue to be managed by AMP Capital, an existing partner of CPPIB in Australia.‎

The portfolio comprises a mix of 13 well-located office properties and high-quality shopping centres totalling approximately 268,000 square metres (2.9 million square feet). Located primarily in Auckland and Wellington, the properties are situated within the central business districts and growing metropolitan markets.

“This is a rare opportunity to acquire a diversified portfolio that includes top-tier office and retail properties in New Zealand, a market with continuing population and tourism growth,” said ‎Jimmy Phua, Managing Director, Head of Real Estate Investments – Asia, CPPIB. “With this acquisition, we are able to gain a meaningful presence in the New Zealand commercial real estate market, partnering alongside PSP Investments, who is a like-minded, long-term partner and extending our relationship with AMP Capital.”

The transaction is expected to close following customary closing conditions and regulatory approvals.

At September 30, 2016, CPPIB’s investments in global real estate totalled C$38.4 billion.

I don’t know much about New Zealand except that it’s a beautiful country and boasts the best rugby team in the world, the All Blacks.

From what I’ve read, New Zealand’s political stability is in stark contrast to Australia’s shakes and shifts and the country’s economy is being labeled “the miracle economy“.

Why did CPPIB buy this real estate portfolio? To diversify its real estate holdings in Asia and New Zealand, just like Australia, is a stable country with a strong economy which will benefit over the long term as Asian emerging markets grow.

It is also worth noting that the Kiwi-CAD cross rate is fairly stable and one Canadian dollar equals about 1.06 New Zealand dollars, so currency risk isn’t as big of a deal here (unless you get a Brexit type of event in New Zealand which seems highly unlikely).

Why is PSP selling part of its real estate holdings in New Zealand? Why not? It wants to lock in profits and focus its attention elsewhere. It’s not selling out, still has a big stake, and now has a great long-term investor alongside it to manage these assets.

Don’t forget, in Canada, it’s all a big giant pension club. Everyone knows each other. André Bourbonnais, PSP’s CEO, used to work at CPPIB and knows Mark Machin, CPPIB’s CEO, very well. Neil Cunningham, PSP’s Senior Vice President and Global Head of Real Estate Investments, knows Graeme Eadie, CPPIB’s Senior Managing Director & Global Head of Real Assets.

There is a lot of communication between the senior managers of Canada’s large pensions so if someone is looking to unload something or buy something, they will talk to each other first to see if they can strike a deal. It could be that CPPIB’s real estate partner in Australia, AMP Capital, approached them with this particular deal but I am certain there were high level discussions between senior representatives at these funds.

Anyway, that isn’t a bad thing, especially between PSP and CPPIB, two of the largest Canadian Crown corporations with very similar liquidity profiles and a lot of money to invest across public and private markets all around the world. In my opinion, they should be partnering up on more deals.

[Note: One area where they are not similar is in the way they benchmark their respective policy portfolios and in particular, the way they benchmark real estate assets. This is a deficiency on PSP’s part which I’ve discussed plenty of times on this blog, like when I covered PSP’s fiscal 2016 results. Neil Cunningham and his team are doing an outstanding job managing PSP’s real estate portfolio, but it sure helps that their benchmark doesn’t reflect the risks they take and is easy to beat.]

In other real estate news, Pooja Sarkar of India’s Economic Times reports, CPPIB to invest in India’s largest realty deal:

In the largest deal brewing up in the commercial real estate space in India, Canada Pension Plan Investment Board ( CPPIB) is leading the negotiation to acquire private equity firm Everstone Group’s industrial and logistics real estate development platform, IndoSpace, as part of private real estate investment (REIT), said two people familiar with the development.

The entire deal is pegged at Rs 15,000 crore making it the largest commercial real estate transaction in the country, they added.

“The deal has been structured in two parts, in the first phase, CPPIB will acquire the ready development space of nearly 10 million sft for nearly Rs 4000 crore,” said the first person mentioned above.

“Indospace is developing another 30 million sft across the country which will be developed and added to this portfolio and the payouts will be linked to that. Everstone will continue to manage these assets even after the full sale process,” the second person added.

IndoSpace is a joint venture between Everstone Group and US-based Realterm. Everstone is a private equity and real estate firm that focuses on India and South-East Asia, with over $3.3 billion of assets under management. Realterm is an industrial real estate firm that manages approximately $2.5 billion of assets across 300 operating and development properties in North America, Europe and India.

Sources add that Everstone has hired Citi bank to run the sale process.

Reits are entities that own rent-generating real estate assets and offer investors regular income streams and long-term capital appreciation.

With this sale, this would be the first successful Reit offering from the Indian subcontinent.

“The talks were on with three serious contender but final negotiations are underway with CPPIB and it would be the largest investment by Canadian pension fund in India to date,” the first person added.

CPPIB and Everstone both declined to comment for the story.

The deal is expected to be signed by January end with CPPIB head expected to visit India two weeks late and discuss the transaction, said another person involved in the matter.

This is a good deal as India is one of the emerging markets that many analysts feel has great prospects ahead even if there will be problems along the way, like its unprecedented assault on cash.

The point with all these private market deals is that CPPIB, PSP and other large Canadian pensions are setting up teams in these regions and finding the right partners to make these long-term strategic investments which will benefit their funds and their beneficiaries.

Below, Canada Pension Plan Investment Board Chief Executive Officer Mark Machin says he was among the minority of investors who accurately foresaw Donald Trump’s march to the White House:

In an interview on BNN, Machin said his doubts in the polls indicating a Hillary Clinton victory began growing in late 2015.

“I had personally predicted a Trump win for the past year; I thought the margin of error was very, very tight in the polls … and it could quite easily swing in Trump’s direction,” he said.

Machin said investors can easily assess scheduled political events like the U.S. election and the U.K. referendum, but are no better at accurately predicting the outcome than the polls.

“Markets are not great at judging the outcomes because market participants don’t really have any better insight than anybody else on what the politics and public opinion is going to be,” he said. “They’re also not that great at judging what the reaction will be after the event as well, and that was classically the case in … the U.S. election.”

Watch the entire interview below or click here if it doesn’t load below. He discusses CPPIB’s investments and how they are positioning their portfolio to achieve the long-term actuarial target rate-of-return. He also discusses why CPPIB’s governance is the key to its long-term success.

I met Mark Machin a few months ago when he was in Montreal and think he’s very nice, very smart and a very capable leader.

Pension giant CalPERS has sued business magnate Barry Diller over IAC/InterActive’s plan to implement a dual class stock structure, which the pension fund opposes because it could take power away from public stockholders.

More from the Wall Street Journal:

The California Public Employees’ Retirement System has sued Barry Diller over his Internet company IAC/InterActiveCorp’s plan to create Class C shares.

The suit filed in the Delaware Court of Chancery also names the company’s board.

Calpers alleges that “granting dynastic control in response to implicit threats from a controlling shareholder” is a breach of the board’s fiduciary duty.

[…]

Mr. Diller has said the formation of the new class of nonvoting common shares would be helpful in issuing stock for acquisitions and equity awards without diluting the voting power of existing stockholders.

Calpers, the U.S.’s largest public pension fund, has been a longtime critic of dual-class stock structures, arguing they can hurt the interests of public stockholders.

The Canada Pension Plan Investment Board (CPPIB) has purchased a 50 percent stake in a portfolio of office buildings and shopping centers in New Zealand for $417 million, according to the pension fund.

The portfolio was previously owned by Canadian pension peer PSP Investments; after the deal, PSP and the CPPIB each own a 50 percent stake.

More from DealStreetAsia:

Connecticut Gov. Dannel Malloy and a group of unions struck a deal last week that will spread the state’s pension contributions over a longer period of time, thus lowering the short-term cost of those payments.

The deal still needs approval from the legislature; but if they don’t vote on the matter within 30 days of the next legislative session (which begins Jan. 4), the proposal becomes law.

The deal also lowers the assumed rate of return of the state’s pension fund to 6.9 percent from 8 percent.

More from the Wall Street Journal:

Mr. Malloy, a Democrat, said that without the agreement, the state’s pension payments could balloon from about $1.5 billion a year to $6.65 billion in 2032.

The deal means that state pension payments will now peak at $2.4 billion in 2032.

[…]

Under the Connecticut agreement, annual pension payments would be more affordable because the state would pay smaller annual pension payments but over a longer period. The state was supposed to pay off much of its pension obligations by 2032. This deal pushes that date to 2046.

Union leaders said they agreed to the deal because it didn’t make changes to retirement benefits or contributions.

The state’s annual pension payments were supposed to fall to only a few hundred million dollars a year after 2032 and then would rise again. Now, with the new deal, the state will pay more than $1.5 billion annually through the 2040s.

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

A new labor contract negotiated by the leaders of a 95,000-member California worker union has a pay raise that, an opposition group said last week, is more than offset by medical costs and Gov. Brown’s push to have workers begin paying toward their retiree health care.

Most California workers contribute 5 to 11 percent of their pay toward their CalPERS pensions, while most state employers contribute 27 percent of pay. The Highway patrol has the highest employer contribution, 50 percent of pay, and an employee rate of 11.5 percent of pay.

But only state employers have been paying for retiree health care during its rapid growth. Until recently, state workers have not paid for a remarkably generous retiree health plan that actually pays more of their health care premium when they retire.

While on the job, the state pays 80 percent of the health care premium for most state workers and their dependents. When most retire, the state pays 100 percent of the average individual premium and 90 percent for dependents, which last year was $1,605 a month.

How did what Brown has called an “anomaly” happen?

Some trace it to a cost-cutting move more than two decades ago by the administration of former Gov. Pete Wilson. Active workers were required to begin paying some of the cost of their health care. No change was made for retiree health care.

At about the same time, legislation by former Assemblyman Dave Elder, D-Long Beach (AB 1104 in 1991) created a fund in the state treasurer’s office to begin “prefunding” state worker retire health care.

Annual payments from the state and workers could go into an investment fund to help cut the long-term cost of retiree health care. Investment earnings are expected to pay two-thirds of the cost of California Public Employees Retirement system pensions.

Prefunding retiree health care also would improve “intergenerational equity,” the fairness principle that public services should be paid for by those that receive them not passed on to future taxpayers. (See previous post: “How pensions pass the buck to future generations”)

But lawmakers had other priorities, and they chose not to put money in the state worker retiree health care fund created by the Elder legislation. Pay-as-you-go state worker retiree health care would go on to become one of the fastest-growing state budget costs.

The state paid $458 million in 2001 (0.6 percent of the general fund) for state worker retiree health care and this fiscal year is expected to pay $2 billion (1.7 percent of the general fund), according to the Finance department. The state payment for CalPERS pensions is $5.4 billion.

Now pay-as-you-go state worker retiree health care, unaided by investment earnings, has created a long-term debt for state worker retiree health care that is larger than the debt for state worker pensions.

The estimated debt or “unfunded liability” for retiree health care promised state workers was $74.1 billion as of June 30, 2015, according to a report issued by state Controller Betty Yee last January.

The unfunded liability for pensions promised state workers was $49.6 billion as of June 30, 2015, according to the CalPERS annual valuation of state worker pension plans issued last April.

Meanwhile, retiree health care from private-sector employers is declining. The number of large private firms (200 or more employees) offering any level of retiree health care fell from 66 percent in 1988 to 28 percent in 2013, a Kaiser report said, and this year dropped to 24 percent.

For government employees, retiree health care from employers is not a given, particularly for teachers who, unlike most state workers, do not receive federal Social Security in addition to their state pensions.

A California State Teachers Retirement System survey in 2011-12 found 11 percent of teachers had no employer retiree health care, 49 percent had some retiree premium support until age 65 and Medicare eligibility, and 29 percent had lifetime employer health care support.

“Postretirement premium support varies by hire date and is decreasing,” said the CalSTRS study.

The tentative contract negotiated with SEIU Local 1000 would be, if approved by members, a big step toward the cost-cutting state worker retiree health care reform Brown announced in January last year.

The administration already has new contracts with several smaller unions that include the retiree health care reforms. Prefunding began in 2010 with the Highway Patrol contributing 0.5 percent of pay, now 2 percent until 2018.

One part of Brown’s plan opposed by unions was rejected by the Legislature last year. An optional low-cost health plan with a high deductible would have taken less from the paycheck, but more from the pocket before insurance begins paying medical expenses.

A key part of the plan is negotiating contracts with prefunding that require workers to pay half of the “normal cost” of retiree health care, the estimated cost of retiree health care earned during a year excluding debt from previous years.

Controller Yee said in her January report that fully prefunding retiree health care and cutting the debt from $74.1 billion to $48.4 billion would have cost $3.99 billion last fiscal year, doubling the pay-as-you-go tab.

For new hires, Brown’s plan requires five more years of service to become eligible for retiree health care. Current workers are eligible for 50 percent coverage after 10 years on the job, increasing to 100 percent after 20 years. The new thresholds are 15 and 25 years.

Retiree health care for new hires is capped at the premium support level they received while on the job, eventually ending the “anomaly” of health coverage increasing on retirement, regarded by some as an incentive for early retirement.

While announcing his state worker retiree health care reform last year, Brown pointed to a chart showing that if no action is taken the debt by 2047-48 grows to $300 billion, but under his plan the debt by 2044-45 drops to zero.

“This is a long-term liability that would only get bigger without taking action,” Joe DeAnda, a spokesman for Brown’s Human Resources department said last week, when asked if the retiree health care reform is still on track to cut the debt as planned.

“Starting to prefund retiree health care, along with the other measures we’ve incorporated into labor contracts during the latest round of bargaining, will eliminate this unfunded liability over the next three decades,” he said.

Brown’s plan asked CalPERS to “increase efforts to ensure” retirees eligible for Medicare at age 65 are switching to lower-cost supplemental plans. Most state workers can retire at age 50. But their pension formula, along with annual service credit, continues to increase until age 63 if they stay on the job.

About 69 percent of retirees are in a Medicare supplemental plan, a CalPERS spokeswoman said last week, and 31 percent are in basic health plans, some ineligible for Medicare for a variety of reasons including age.

A Legislative Analyst’s Office report on state worker retirement health benefits in March last year suggested that the Legislature consider offering new hires an alternative to the current plan, perhaps higher pay and contributions to a retiree health insurance plan.

The Analyst said, among other things, the governor’s plan could “require some employees to pay for benefits they will never receive.” Some state workers may leave before serving the 10 or 15 years needed for minimum retiree health care.

Another potential problem, said the Analyst, is that bargaining to begin prefunding retiree health care may require offsetting pay raises, as happened when Brown negotiated pension cuts for new hires four years ago.

A $1 pay raise for the typical state worker increases state costs by about $1.34 due to Social Security, Medicare, and pensions. The Analyst said a dollar-for-dollar offset, or even 75 cents per dollar, could cost the state more than paying all of the prefunding cost without a worker share.

There “arguably is some ambiguity” about whether state worker retiree is a “contractual obligation” protected from cuts, said the Analyst. (The state Supreme Court has agreed to hear an appeal of a ruling that allows cuts in the pension offered at hire.)

The website of a dissident group said the SEIU Local 1000 president, Yvonne Walker, will “continue to misrepresent the facts regarding retiree healthcare costs as not a protected right.”

The tentative contract has an 11.5 percent pay raise (4 percent in 2017, 4 percent in 2018, and 3.5 percent in 2019) and will take 3.5 percent from paychecks for retiree health care (1.2 percent in 2018, 1.1 percent in 2019, and 1.2 percent in 2020).

“When members factor in the increased out-of-pocket expenses of pre-funding retirement healthcare and increased CalPERS medical costs this is not a raise,” said the website of the dissident group, WeAreLocal1000.

After contract negotiations that began in April stalled, the union announced that it would strike on Dec. 5. The agreement with the Brown administration was announced two days before the strike date.

“Our tentative agreement achieves many of the goals we identified as priorities in four areas: improvements in compensation, professional development, working conditions, and health and safety,” Walker said on the SEIU Local 1000 website. “At the same time, we protected the hard-earned rights we won during previous negotiations.”

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

Frank McGuire of Newsmax Finance reports, Former Fed Adviser: ‘Some Miracle’ Needed to Defuse $1.3 Trillion Pensions Time Bomb:

America will need “some miracle” to survive the looming economic disaster of $1.3 trillion worth of underfunded government pensions, a former Federal Reserve adviser has warned.

“The average state pension in the last fiscal year returned something south of 1%. You cannot fill that gap with a bulldozer, impossible,” Danielle DiMartino Booth told Real Vision TV.

The median state pension had 74.5 percent of assets needed to meet promised benefits, down from 75.6 percent the prior year. The decline followed two years of gains. The shortfall for states overall was $1.1 trillion in 2015 and has continued to grow.

“Anyone who knows their compounding tables knows you don’t make that up. You don’t get that back unless you get some miracle,” Business Insider quoted the president of Money Strong as saying.

“The baby boomers are no longer an actuarial theory,” she said. “They’re a reality. The checks are being written.”

Pressure on governments to increase pension contributions has mounted because of investment losses during the recession that ended in 2009, benefit increases, rising retirements and flat or declining public payrolls that have cut the number of workers paying in. U.S. state and local government pensions logged median increases of 3.4 percent for the 12 months ended June 30, 2015, according to data from Wilshire Associates.

State and local pensions count on annual gains of 7 percent to 8 percent to pay retirement benefits for teachers, police officers and other civil employees. The funds are being forced to re-evaluate projected investment gains that determine how much money taxpayers need to put into them, given the recent run of lackluster returns.

And while many aging Americans have accepted the “new reality” that they would be retiring at 70 instead of 65, any additional extension won’t be welcome. “They’re turning 71. And the physiological decision to stay in the workforce won’t work for much longer. And that means that these pensions are going to come under tremendous amounts of pressure,” she said.

“And the idea that we can escape what’s to come, given demographically what we’re staring at is naive at best. And it’s reckless at worst,” DiMartino Booth said. “And when you throw private equity and all of the dry powder that they have — that they’re sitting on — still waiting to deploy on pensions’ behalf, at really egregious valuations, yeah, it’s hard to sleep at night,” she said.

DiMartino Booth cited Dallas as an example of the pensions crisis, where returns for the $2.27 billion Police and Fire Pension System have suffered due to risky investments in real estate.

“We’re seeing this surge of people trying to retire early and take the money. Because they see it’s not going to be there. And if that dynamic and that belief spreads– forget all the other problems,” DiMartino Booth said. “The pension fund — underfunding is Ground Zero.”

DiMartino Booth warned of public violence if her pensions predictions come to fruition. Large pension shortfalls may lead to cuts in services as governments face pressure to pump more cash into the retirement systems.

“This is where the smile comes off my face. We are an angry country. We’re an angry world. The wealth effect is dead. The inequality divide is unlike anything we’ve seen since the years that preceded the Great Depression,” she said.

To be sure, New Jersey became the state with the worst-funded public pension system in the U.S. in 2015, followed closely by Kentucky and Illinois, Bloomberg recently reported.

The Garden State had $135.7 billion less than it needs to cover all the benefits that have been promised, a $22.6 billion increase over the prior year, according to data compiled by Bloomberg. Illinois’s unfunded pension liabilities rose to $119.1 billion from $111.5 billion.

The two were among states whose retirement systems slipped further behind as rock-bottom bond yields and lackluster stock-market gains caused investment returns to fall short of targets.

Danielle DiMartino Booth, president of Money Strong, is one smart lady. I’ve heard her speak a few times on CNBC and she understands Fed policy and the economy.

In this interview, she highlights a lot of the issues I’ve been warning of for years, namely, state pensions are delusional, reality will hit them all hard which effectively means higher contributions, lower benefits, higher property taxes and a slower economy as baby boomers retire with little to no savings.

I’ve also been warning my readers that the global pension crisis isn’t getting better, it’s deflationary and it will exacerbate rising inequality which is itself very deflationary.

I discussed all this in my recent comment on CalPERS getting real on future returns:

So, CalPERS is getting real on future returns? It’s about time. I’ve long argued that US public pensions are delusional when it comes to their investment return assumptions and that if they used the discount rates most Canadian public pensions use, they’d be insolvent.

And J.J. Jelincic is right, taking too little risk in public equities is walking away from upside but he’s not being completely honest because when a mature pension plan with negative cash flows the size of CalPERS is underfunded, taking more risk in public equities can also spell doom because it introduces a lot more volatility in the asset mix (ie. downside risk).

When it comes to pensions, it’s not just about taking more risk, it’s about taking smarter risks, it’s about delivering high risk-adjusted returns over the long run to minimize the volatility in contribution risk.

Sure, CalPERS can allocate 60% of its portfolio to MSCI global stocks and hope for the best but can it then live through the volatility or worse still, a prolonged recession and bear market?

This too has huge implications because pension plans are path dependent which means the starting point matters and if the plan is underfunded or severely underfunded, taking more risk can put it in a deeper hole, one that it might never get out of.

…

The main reason why US public pensions don’t like lowering their return assumptions is because it effectively means public sector workers and state and local governments will need to contribute more to shore up these pensions. And this isn’t always feasible, which means property taxes might need to rise too to shore up these public pensions.

This is why I keep stating the pension crisis is deflationary. The shift from defined-benefit to defined-contribution plans shifts the retirement risk entirely on to employees which will eventually succumb to pension poverty once they outlive their meager savings (forcing higher social welfare costs for governments) and public sector pension deficits will only be met by lowering return assumptions, hiking the contributions, cutting benefits or raising property taxes, all of which take money out of the system and impact aggregate demand in a negative way.

This is why it’s a huge deal if CalPERS goes ahead and lowers its investment return assumptions. The ripple effects will be felt throughout the economy especially if other US public pensions follow suit.

The point is CalPERS is a mature plan with negative cash flows and it’s underfunded so it needs to get real on its return assumptions as do plenty of other US state pensions that are in the same or much worse situation (most are far worse).

Now, to be fair, the situation isn’t dire as the article above states the median state pension has had 74.5 percent of assets needed to meet promised benefits, down from 75.6 percent the prior year. Typically any figure close to 80% is considered fine to pension actuaries who smooth things out over a long period.

But as DiMartino Booth correctly points out, the structural headwinds pensions face, driven primarily by demographics but other factors too, are unlike anything in the past and looking ahead, the environment is very grim for US state pensions.

Maybe the Trump reflation rally will continue for the next four years and interest rates will normalize at 5-6% — the best scenario for pensions. But if I were advising US state pensions, I’d say this is a pipe dream scenario and they are all better off getting real on future returns, just like CalPERS is currently doing.

Defusing America’s pensions time bomb will require some serious structural reforms to the governance of these plans and adopting a shared-risk model so that the risk of these plans doesn’t just fall on sponsors and taxpayers. Beneficiaries need to accept that when times are tough, their benefits will necessarily be lower until these plans get back to fully funded status.

The aggregate funding ratio of the country’s largest corporate pension plans climbed significantly in November, jumping 3 percentage points from 77.2 percent to 80.3 percent.

Funding-wise, it was easily the best month of 2016 for corporate pensions.

More from Milliman:

In November, the funded status for these pension plans experienced its largest increase of the year, improving by $71 billion, primarily due to interest rate gains that reduced the deficit for the Milliman 100 plans to $340 billion. The funded ratio for these plans climbed sharply, increasing three percentage points from 77.2% to 80.3%.

“While plan sponsors are pleased with the third straight month of funded status improvement, all eyes are on interest rates as we near the December 30^th measurement date,” said Zorast Wadia, co-author of the Milliman 100 PFI, “Discount rates have climbed 66 basis points since their record low in August, now the question is whether we’ll see interest rates climb above 4% by year’s end.”

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.63% by the end of 2017 and 5.23% by the end of 2018) and asset gains (11.2% annual returns), the funded ratio would climb to 93% by the end of 2017 and 106% by the end of 2018.  Under a pessimistic forecast (3.33% discount rate at the end of 2017 and 2.73% by the end of 2018 and 3.2% annual returns), the funded ratio would decline to 73% by the end of 2017 and 66% by the end of 2018.

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

Dylan Cox of Pitchbook reports, Size doesn’t matter in PE fund performance over the long term:

Despite the dueling claims that smaller PE fund managers lack sophistication or sufficient scale, or that larger fund managers lack the nimbleness, operational focus and expertise necessary to improve portfolio companies, returns across different fund sizes are relatively uniform in the long term. 10-year horizon IRRs for PE funds of any size bucket are all between 10% and 11%.

When comparing returns on a horizon basis, it’s important to remember that the data is indicative of market conditions over time, and not the returns of any one vintage. For example, a lower IRR across the industry between the five- and 10-year horizon is not indicative of a loss of alpha-generating capacity after the five-year mark, but rather a reflection of the stretched hold periods and asset write-offs that plagued many PE portfolios during the recession. Similarly, the three-year horizon IRR is the highest we observe, due to the fact that these investments were made before the recent run-up in valuations and have been subsequently marked as such—even though many of these returns have yet to be fully realized through an exit.

Interestingly, funds with less than $250 million in AUM have underperformed the rest of the asset class on a one- and three-year horizon. This is at least partially due to the aforementioned run-up in valuations which stemmed from cash-heavy corporate balance sheets that went looking for inorganic growth through strategic acquisitions—a strategy that often doesn’t reach the lower middle market (LMM) of PE. Only in the last few months have valuations started to rise in the LMM and below, as PE firms of all stripes increasingly look for value plays through add-ons and smaller portfolio companies.

Note: This column was previously published in The Lead Left.

For more data and analysis into PE fund performance, download our new Benchmarking Report.

Let me first thank Ken Akoundi of Investor DNA for bringing this up to my attention. You can subscribe to Ken’s distribution list where he sends a daily email with links to various articles covering industry news here.

As far as this study, I would be careful interpreting aggregate data on PE funds and note that previous studies have shown that there is performance persistence in the private equity industry.

Yesterday I covered why big hedge funds are getting bigger or risk going home. You should read that comment because a lot of what I wrote there is driving the same bifurcation between small and large PE funds in the industry.

Importantly, big institutions looking for scale are not going to waste their time performing due diligence on several small PE funds which may or may not perform better than their larger rivals. They will go to the large brand name private equity funds that everybody knows well because they will be able to invest and co-invest (where they pay no fees) large sums with them.

And just like big hedge funds are dropping their fees, big PE funds are dropping their fees but locking in their investors for a longer period, effectively emulating Warren Buffet’s approach. I discussed why they are doing this last year in this comment.

These are treacherous times for private equity and big institutional investors are taking note, demanding a lot more from their PE partners and making sure private equity’s diminishing returns and misalignment of interests don’t impact their long-term performance.

Still, large PE funds are generating huge returns, embracing the quick flip and reorienting their internal strategies to adapt to a tough environment.

In Canada, there is a big push by pensions to go direct in private equity, foregoing funds altogether. Dasha Afanasieva of Reuters reports, Canada’s OMERS private equity arm makes first European sale:

Ontario’s municipal workers pension fund has sold a majority stake in marine-services company V.Group to buyout firm Advent International in the first sale by the Canadian fund’s private equity arm in Europe.

Pension funds and other institutional investors are a growing force in direct private investment as they seek to bypass investing in traditional buyout funds and boost returns against a backdrop of low global interest rates.

As part of the shift to more direct investment, the Ontario Municipal Employees Retirement System (OMERS) set up a private equity team (OPE) and now has about $10-billion invested.

It started a London operation in 2009 and two years later it bought V.Group, which manages more than 1,000 vessels and employs more than 3,000 people, from Exponent Private Equity for an enterprise value of $520-million (U.S.).

Mark Redman, global head of private equity at OMERS Private Markets, said the V.Group sale was its fourth successful exit worldwide this year and vindicated the fund’s strategy. He said no more private equity sales were in the works for now.

“I am delighted that we have demonstrated ultimate proof of concept with this exit and am confident the global team shall continue to generate the long-term, stable returns necessary to meet the OMERS pension promise,” he said.

OMERS, which has about $80-billion (Canadian) of assets under management, still allocates some $2-billion Canadian dollars through private equity funds, but OPE expects this to decline further as it focuses more on direct investments.

OPE declined to disclose how much Advent paid for 51 per cent of V.Group. OPE will remain a minority investor.

OPE targets investments in companies with enterprise values of $200-million to $1.5-billion with a geographical focus is on Canada, the United States and Europe, with a particular emphasis on Britain.

As pension funds increasingly focus on direct private investments, traditional private equity houses are in turn setting up funds which hold onto companies for longer and target potentially lower returns.

Bankers say this broad trend in the private equity industry has led to higher valuations as the fundraising pool has grown bigger than ever.

Advent has a $13-billion (U.S.) fund for equity investments outside Latin America of between $100-million and $1-billion.

The sale announced on Monday followed bolt on acquisitions of Bibby Ship Management and Selandia Ship Management Group by V.Group.

Goldman Sachs acted as financial advisers to the shipping services company; Weil acted as legal counsel and EY as financial diligence advisers.

Now, a couple of comments. 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).

Hope you enjoyed this comment, please remember to subscribe or donate to PensionPulse via PayPal on the top right-hand side to support my effort in bringing you the every latest insights on pensions and investments [good time to remind all of you this blog takes a lot of work and it requires your ongoing support.]