Pension360

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

The Ontario Teachers’ Federation put out a press release, Surplus funds will further restore inflation protection for retired teachers:

The Ontario Teachers’ Federation (OTF) and the Ontario Government, joint sponsors of the $171.4 billion Ontario Teachers’ Pension Plan (Teachers’), will use a portion of the $13.2 billion surplus in the Plan (as of January 1, 2016) to partially restore inflation protection for teachers who retired after 2009.

“Conditional inflation protection has proven to be an effective tool for managing Plan deficits and now, for the third year in a row, the sponsors will use some of the surplus to partially restore indexing that pensioners lost in recent years,” said OTF President Mike Foulds. “The remainder of the surplus will be kept in reserve to provide benefit and contribution rate stability against future funding challenges such as low interest rates and increasing longevity, both of which increase the Plan’s liabilities.”

Pensioners who retired after 2009 will receive a one-time increase in January 2017 to restore their pensions to the levels they would have been at, had full inflation protection been provided each year since they retired. They will also receive a slightly higher inflation increase next year for the portion of their pensions earned after 2009. Cost-of-living increases for this portion of pension credit will equal 90% of the annual increase in the Consumer Price Index (CPI), up from the current level of 70%. Pension credits earned before 2010 remain fully inflation-protected.

Pensioners who retired before 2010 are unaffected by these latest changes because pension credits earned before 2010 receive full inflation protection. Working members are also unaffected because annual inflation adjustments are determined after retirement.

Last March, Teachers’ reported its third surplus in a decade. A preliminary funding valuation showed that the Plan was 107% funded at the beginning of 2016, based on current benefits and contribution rates.

About Teachers’

With $171.4 billion in net assets as of December 31, 2015, the Ontario Teachers’ Pension Plan is the largest single-profession pension plan in Canada. An independent organization, it invests the pension fund’s assets and administers the defined benefit pensions of 316,000 active and retired teachers in Ontario.

About OTF

The Ontario Teachers’ Federation is the advocate for the teaching profession in Ontario and for its 160,000 teachers. OTF members are full-time, part-time and occasional teachers in all publicly funded schools in the province – elementary, secondary, public, Catholic and francophone.

On Monday, I went over a recent conversation with HOOPP’s Jim Keohane where we discussed markets and I brought up an article he had written with Hugh O’Reilly, President and CEO of OPTrust, which discusses funded status as a better measure of a pension fund’s success.

In that comment,  I stated the following:

No doubt, you need to pay your investment officers properly, especially in private markets like private equity, real estate, and infrastructure which require unique skills sets, but the message that Jim Keohane and Hugh O’Reilly are conveying is equally important, pensions need to focus first and foremost on their funded status, not taking huge risks to beat their policy portfolio benchmark.

The nuance here is that you can’t blindly compare the performance of one pension plan to another without first understanding how their liabilities are determined and what their funded status is.

For example, Ontario Teachers and HOOPP are widely regarded as two of the best pension plans in Canada, if not the world. They both use extremely low discount rates (HOOPP’s is 5.3% and Teachers’ is just below 5% because it’s a more mature plan and its members are older) to determine their liabilities, especially relative to US pensions which use expected returns of 7% or 8% to determine their liabilities (if US pensions used the discount rate HOOPP and Ontario Teachers use, they’d be insolvent).

In 2015, Ontario Teachers returned 13% as growth in its private market assets really kicked in while HOOPP which is more heavily weighted in fixed income than all of its larger Canadian peers only gained 5.1% last year.

A novice might look at the huge outperformance of Ontario Teachers as proof that it’s a better managed plan than HOOPP but this is committing a fatal error, looking first at performance, ignoring the funded status.

Well, it turns out that HOOPP’s funded position improved last year as it stood at 122%, compared to 115% in 2014, placing it in the top position of DB plans when you use funded status as the only real measure of success (less contribution risk relative to other DB plans). And unlike others, HOOPP manages almost all its assets internally and has the lowest operating costs in the pension industry (it’s 30 basis points).

Now, to be fair, Ontario Teachers’ is a much larger pension plan and it too is now fully funded and does a lot of the things HOOPP does in terms of internal absolute return arbitrage strategies and using leverage wisely to juice its returns, but the point I’m making is if you’re looking at the health of a plan, you should focus on funded status, not just performance.

Yes, the two go hand in hand as a pension that consistently underperforms its benchmark will also experience big deficits but it’s not true that a pension plan that consistently outperforms its benchmark will enjoy fully or super-funded status.

Why? Because as I keep hammering on my blog, pensions are all about managing assets AND liabilities. If you’re only looking at the asset side of the balance sheet without understanding what’s driving liabilities, your plan runs the risk of being underfunded no matter how well it performs.

Now, to be fair, I should also point out that unlike Ontario Teachers and HOOPP, most of Canada’s large pension funds (like bcIMC, the Caisse, CPPIB and PSP) are NOT pension plans managing assets and liabilities. They are pension funds managing assets to beat their actuarial target rate of return which is set by their stakeholders who know their liabilities.

Also, unlike many other pension plans, HOOPP, Ontario Teachers and a few other Ontario pensions (like OPTrust and CAAT) have adopted a risk-sharing model which basically states the members and the plan sponsor share the risk of the plan if a deficit occurs. This effectively means that when a deficit persists, members can face a hike in contributions or a reduction in benefits.

In a follow-up comment going over the executive shakeup at CPPIB, I clarified something:

I also want to stress something else, when I compare Ontario Teachers’ to HOOPP, it’s not to claim one is way better than the other. Both of these pension plans are regarded as the best plans in the world so comparing them is like comparing Wayne Gretzky to Mario Lemieux. They also have some key differences in size and maturity of their plans which makes a direct comparison difficult, if not impossible.

The point I’m trying to make, however, is anyone looking to be part of a great defined-benefit plan would love to be a member of HOOPP or Ontario Teachers and I don’t blame them.

As far as CPPIB, I trust Mark Wiseman’s judgment which is why I trust that Mark Machin and his new senior executives are all more than qualified to take over and deliver on the fund’s long term objectives during the next phase which will be far more challenging in a ZIRP and NIRP world.

So the next time you hear some reporter lament about a big shakeup at CPPIB, please refer them to this comment and tell them to relax and stop spreading misleading information.

Ever notice how reporters love reporting BAD news? I guess it sells more newspapers but it’s equally important to report GOOD news.

And this latest decision to use a portion of the surplus funds to restore inflation protection for Ontario teachers who retired after 2009 is great news.

When I went over Ontario Teachers’ 2015 results, I actually spoke to Ron Mock, Teachers’ CEO, about what they are going to do with surplus funds.

I told him it’s best to save the surplus for a rainy day. He agreed but he also told me that this decision is up the Ontario Teachers’ Federation and Ontario’s government and that OTPP can only make recommendations.

I guess everyone got a little something in this decision and they wisely only used a portion of the surplus (what percentage is confidential) to restore inflation protection to teachers who retired after 2009.

Of course, to even contemplate restoring inflation protection, pension plans need a surplus to begin with, and most pension plans are struggling with deficits and can only dream of achieving the funded status of an Ontario Teachers or a HOOPP.

This decision also highlights something else I’ve been discussing, the importance of implementing a shared-risk model so beneficiaries and plans sponsors equally share the contribution risk of the plan if a deficit occurs and enjoy benefits (like lower contribution rate or full inflation protection) when the plan has a surplus.

It’s not rocket science folks. You need good governance, a shared-risk model, an independent and qualified board overseeing qualified investment officers who can deliver outstanding results over the long term and get compensated properly for delivering these stellar returns.

This is why I firmly believe the solution to any retirement crisis centers around large, well-governed defined-benefit plans. If you aren’t convinced, just look at the success of HOOPP and Ontario Teachers’ Pension Plan. The proof is in the pudding, it’s right there staring all of us in the face.

Ontario’s teachers and healthcare workers are very lucky to have their retirement managed by world class pension plans. Unfortunately, too many Canadians don’t have this luxury and fall through the cracks after they retire with little or no savings.

This is why I kept pounding the table to enhance the CPP so more Canadians can retire in dignity and security but a lot more needs to be done.

I’ll give you some examples. Some people don’t contribute directly to the Canada Pension Plan and if they manage to save for retirement, they can only opt for mutual funds that can only invest in public markets and charge huge fees. Why shouldn’t they be able to invest their hard earned savings in the CPP so their retirement can be managed by the CPPIB which invests directly in public and private markets all over the world?

What else? The Registered Disability Savings Plan (RDSP) is a Canada-wide registered matched savings plan specific for people with disabilities. It’s a fantastic plan for people with disabilities and parents who care for children with disabilities. Again, why not offer these people the chance to invest in the CPP so their disability savings can be managed by the CPPIB?

[Note: Of course, the financial services industry wouldn’t be to happy competing with CPPIB or any of Canada’s large, well governed pensions.]

In my last comment going over the 2016 Delivering Alpha conference,  I stated the following:

What are long-term investors like pensions suppose to do? Well, they can read the wise insights of Jim Keohane, Leo de Bever and others on my blog but I have to tell you, there’s no magic bullet in a low growth environment where ultra low and negative rates are here to stay.

I’ve long warned all investors to prepare for lower returns and think it’s going to get harder and harder for large hedge funds and private equity funds to deliver alpha in a ZIRP and NIRP world.

In this environment, I believe large, well-governed defined-benefit pensions with a long-term focus have a structural advantage over traditional and alternative active managers who are pressured to deliver returns on a short-term basis.

So, if you’re retirement savings are being managed by a HOOPP, OTPP, CPPIB, Caisse, PSP, OMERS, bcIMC, AIMCo, OPTrust, and other large, well-governed pensions, you’re very lucky. For the rest of you, try to save a nickel for retirement and prepare for pension poverty.

Jerry Brown on Thursday signed a law requiring California’s public pension funds to disclose fees and carried interest paid to alternative asset managers.

The new law appears to make very few people happy on any side.

As we’ve written previously, advocates of disclosure say the law doesn’t go far enough and was gutted in backroom meetings. Meanwhile, some public pension officials have publicly worried the law would make it difficult to do business with asset managers.

From ai-cio:

The new law, which affects commitments to private equity, venture capital, hedge funds, and absolute return funds, will apply to investments made on or after January 1, 2017.

“California taxpayers and pension beneficiaries will now get to go behind the curtain to view the previously hidden fees and charges paid to Wall Street firms,” said State Treasurer John Chiang, who sponsored the bill.

Public pensions based in California—including the California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS)—will be required to “undertake reasonable efforts” to obtain and disclose fee information, as well as the gross and net rate of return of alternative investment vehicles, at least once annually at a meeting open to the public.

As for the watering down of the original bill, Naked Capitalism’s Yves Smith writes:

AB 2833 has gaping holes that will allow general partners to structure related party payments to escape reporting. The bill, which you can read here, has a very long and complicated definition of what constitutes a related party. It is inferior to shorter and more comprehensive definitions in earlier drafts.

[…]

AB 2833’s definition of “portfolio company” allows payment to be routed through other entities. The definition of “portfolio company” is more obviously deficient than that of “related party” and again allows the bill to be circumvented:

“Portfolio companies” means individual portfolio investments made by the alternative investment vehicle.

Huh? What does “individual portfolio investments” mean? This language does not map onto legal entities or contractual relationships. But by saying “individual,” that would appear to set up the argument that the portfolio company is only “individual” meaning the senior-most legal entity that owns fund assets. But private equity funds seldom invest directly in a portfolio company. For tax and other reasons, there are often “blocker” legal vehicles and other legal entities that sit between the private equity fund and the investee business. It thus appears that general partners could launder the former portfolio company fees through legal vehicles that sit above the portfolio company. For instance, Portfolio Company contracts with Intermediate Co. which has a mirror contract with the general partner or a related party.

Reporting is at far too high a level of abstraction to allow for verification or cross-checks. Another major flaw in the bill is that it fails to report fees quarterly, as the unhappy 13 major trustees had called for, and is nowhere near granular enough to allow them to map the fees back to either portfolio company activities or limited partnership agreements. It simply calls for an aggregate of fees and costs, reported on a pro-rata basis for the fund and also by the portfolio companies.

Bear in mind that the previous version of the bill required that all related party transactions be reported. The current version calls only for providing each CA public fund with its pro rata share of those fees.

At Pension360, we like to keep tabs on strides in pension system transparency.

This week, all of Ohio’s pension funds joined the state’s “online checkbook” — making Ohio the first state where all of its pension funds have put its finances online for public perusing.

More from the Columbus Dispatch:

Representatives from Ohio’s five statewide public pension funds joined Ohio Treasurer Josh Mandel on Tuesday in announcing the financial information is now available at OhioCheckbook.com, the state’s online checkbook site.

The agencies are the Ohio Public Employees Retirement System, State Teachers Retirement System, School Employees Retirement System, Ohio Highway Patrol Retirement System and Ohio Police and Fire Pension Funds. They cover more than 132,000 individual transactions totaling in excess of $720 million in recent years.

“A pension system that is responsible for the stewardship of member and employer contributions must always operate in full view of the public,” said Karen Carraher, director of the Public Employees Retirement System, largest of the five.

The teachers system, covering nearly 500,000 active, inactive and retired teachers, is “pleased to partner with the treasurer’s office on this transparency initiative to include STRS Ohio’s administrative expenses on the Ohio Checkbook,” said Executive Director Michael Nehf.

Mandel, who started the online checkbook almost two years ago, said his idea is to “create an army of citizen watchdogs who are empowered to hold public officials accountable.”

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

Barbara Shecter of the National Post reports, Mark Jenkins is leaving CPPIB, triggering executive shakeup at pension manager:

Mark Jenkins, global head of private investments at Canada Pension Plan Investment Board, is leaving the pension management organization, triggering an executive shakeup just three months after Mark Machin took over for outgoing chief executive Mark Wiseman.

Jenkins, who joined CPIB in 2008, is leaving on Sept. 16 to take a senior leadership role at The Carlyle Group.

Shane Feeney, who was head of direct private equity for CPPIB, will take over as global head of private investments. Ryan Selwood, who led the organization’s direct private equity activities in Europe, becomes head of direct private equity.

CPPIB also announced that Graeme Eadie, who was head of real estate investments, will now oversee both that department and the infrastructure and agriculture groups at the pension management organization that invests and manages assets on behalf of the Canada Pension Plan.

The CPP Fund was valued at $287.3 billion as of June 30.

Wiseman left CPPIB in June, about four years into an expected five to seven-year run as chief executive, to take a senior role at Blackrock, the world’s largest asset manager. The move surprised many observers, particularly in light of the much longer transition time when Wiseman took over from his CPPIB predecessor David Denison.

The pension organization’s board conducted an internal and external search for Wiseman’s replacement, settling on Machin, a 49-year-old British citizen who had joined CPPIB just four years earlier to oversee international investment activities. Machin was a 20-year veteran of Goldman Sachs, including six years running Goldman’s investment banking division in Asia. In mid-June, he became the first non-Canadian to lead CPPIB.

Jenkins, who graduated from Queen’s University in Ontario, also worked at Goldman Sachs before joining CPPIB, putting in more than 10 years in senior positions within the investment bank’s fixed income and financing groups in New York. He could not be reached for comment, but a source said his new job is expected to involve the debt markets, which was an area of focus earlier in his career.

CPPIB has kept deals moving through the pipeline despite the internal changes. On Monday, the Canadian pension organization teamed up with private equity player TPG Capital to invest US$500 million for a 17 per cent stake in MISA Investments Limited, the parent company of Viking Cruises.

Viking Cruises runs river and ocean cruises, operating more than 61 vessels based in 44 countries.

Scott Deveau and Devin Banerjee of Bloomberg also report, Carlyle Hires Jenkins to Head Global Credit From Canada Pension:

Mark Jenkins is joining Carlyle Group LP as head of global credit, exiting the Canada Pension Plan Investment Board amid a shakeup of the country’s largest pension fund.

Jenkins will oversee most of the Carlyle unit previously run by Mitch Petrick. He will also become a member of Carlyle’s management committee, the Washington-based asset manager said in a statement Monday. He’ll start later this month and be based in New York.

Jenkins’s departure comes less than four months after Toronto-based Canada Pension announced Mark Machin would take over as chief executive officer, replacing Mark Wiseman, who left to become a senior managing director at BlackRock Inc.

Canada Pension will create a new investment unit called Real Assets that will combine real estate investments, infrastructure and agriculture groups under one umbrella to be lead by Graeme Eadie, the fund said in a statement. Eadie has been with Canada Pension since 2005, most recently serving as global head of real estate.

Jenkins, who was global head of private investments and leaves on Sept. 16, will be replaced by Shane Feeney, the pension fund’s current head of direct private equity who has been with Canada Pension since 2010. Feeney will be replaced by Ryan Selwood, the pension fund said.

‘Bench Strength’

“These appointments demonstrate the deep bench strength and investment expertise we have developed at CPPIB,” said Machin. “Graeme, Shane and Ryan have been instrumental in a number of our major transactions and will no doubt continue to provide superb leadership in their new roles.”

Carlyle has been reviewing its global market strategies unit, which houses the firm’s credit and hedge funds, after the division’s leader Petrick left in May. Since then, Carlyle has sold one if its hedge funds, Emerging Sovereign Group, and continued to transition another, Carlyle Commodity Management, toward new investment strategies.

The firm’s credit funds manage loans, structure credit, private debt, energy credit and distressed debt.

“Our credit business is broad and deep with tremendous growth potential,” Bill Conway and David Rubenstein, Carlyle’s co-CEOs, said in the firm’s statement. “Mark is an experienced and proven investment leader who will help take our firm to a new level of success.”

Canada Pension oversees the retirement savings of 19 million Canadians with C$287.3 billion ($219.4 billion) in assets under management.

Carlyle manages $176 billion in private equity holdings, credit assets, real estate and hedge funds. The firm was founded in 1987 by Conway, Rubenstein and Chairman Dan D’Aniello.

Matt Jarzemsky of the Wall Street Journal also reports, Carlyle Taps Pension Fund Executive to Run Credit Investing Operations:

LP hired a senior executive from Canada’s biggest pension fund to oversee debt investing, part of the asset manager’s effort to regroup from setbacks in its credit and hedge funds business.

Washington, D.C.-based Carlyle tapped Mark Jenkins, most recently head of global private investments at Canada Pension Plan Investment Board, for the newly created position, according to a statement.

The hire follows a series of setbacks in Carlyle’s global market strategies arm, which encompasses much of the firm’s investing outside of private equity and real estate. Like its peers, the firm has expanded beyond its roots in corporate buyouts over the years, seeking to diversify, boost assets and appeal to shareholders following its 2012 initial public offering.

Global market strategies has been a sore spot for Carlyle, largely because of struggles at its hedge funds Claren Road Asset Management, Vermillion Asset Management LLC and Emerging Sovereign Group LLC. In May, Mitch Petrick stepped down from a role running the $34.7 billion business. Carlyle tasked longtime private-equity executive Kewsong Lee to rebuild it and has said it is reviewing options to improve the unit’s performance.

Overall, global market strategies’ funds have fallen in four-straight quarters, including a 12% decline the first three months of the year.

Mr. Jenkins is focused on the unit’s credit investing, which includes energy lending, providing capital to mid-sized companies and bets on distressed debt.

Credit is an “established, profitable business” for Carlyle, Mr. Lee said in an interview. “Mark’s hiring makes a strategic statement that we are committed to investing in and growing the credit platform.”

Carlyle has been active in collateralized loan obligations, distressed investing and other areas of credit over the years. It may seek to build on its nascent debt business in Europe or providing bonds and loans to small companies or those with atypical capital needs.

During his eight years at CPPIB, he built the pension fund’s direct-lending business and oversaw its $12 billion acquisition of General Electric Co. ’s private-equity lending business, Antares Capital. Before that, Mr. Jenkins co-led Barclays PLC’s leveraged-finance business in New York and worked in Goldman Sachs Group Inc.’s finance and fixed-income departments.

CPPIB, like other Canadian pensions, takes stakes in funds managed by Carlyle and other firms but also directly invests in companies and other assets. In recent years, the pension has invested in department-store chain Neiman Marcus Group, retailer 99 Cents Only Stores and health-care information technology company IMS Health Inc.

CPPIB promoted managing director Shane Feeney to global head of private investments, succeeding Mr. Jenkins, according to a statement.

Lastly, FINalternatives reports, Carlyle Strengthens Executive Team With Jenkins, Sokoloff Hires:

Global alternative asset giant Carlyle Group has made two additions to its senior management team.

Mark Jenkins, former global head of private placements for the Canada Pension Plan Investment Board (CPPIB), has joined the firm as head of global credit, while it has also brought former Jefferies global head of financial sponsors Adam Sokoloff aboard as an executive in its private equity group.

Jenkins will be based in New York and will start at Carlyle by the end of September, the company said in a statement. During his eight years with CPPIB, he built and oversaw the principal credit investments group, the multi-strategy credit investment platform at CPPIB, led the acquisition of Antares Capital and the expansion of CPPIB’s middle-market direct lending efforts. Prior to CPPIB, he was co-head of leveraged finance origination and execution for Barclays Capital and worked for 11 years at Goldman Sachs & Co.

Sokoloff, meanwhile, joins Carlyle’s private equity efforts after a 14-year stint at Jefferies, where he was global head of the bank’s financial sponsor advisory business. He will be tasked with finding deals for the company’s mid-market funds, according to a Bloomberg article citing an email Sokoloff wrote to clients and friends on Monday.

Sokoloff left New York-based Jefferies in March after the firm merged its junk-rated loans and business into a joint venture with MassMutual Finance Group. Sokoloff was replaced by U.S. sponsors co-head Jeffery Greenip.

Carlyle raised $2.4 billion for its second middle-market equity group in February, according to Bloomberg. The buyout vehicle aims to make control investments of $20 million-$200 million in middle-market businesses.

Carlyle manages $176 billion in private equity holdings, credit assets, real estate and hedge funds across 127 funds and 164 fund of funds vehicles as of June 30, 2016. The firm was founded in 1987 by David Rubenstein, Bill Conway and Dan D’Aniello.

You can read more articles on Mark Jenkins leaving CPPIB here.

So, why is Mark Jenkins leaving CPPIB and more importantly, will CPPIB survive this latest high profile departure?

First, let me address the second question and calm a lot of nervous reporters contacting me worried that CPPIB is going down the drain after the departure of Mark Wiseman and now the departure of Mark Jenkins, global head of private investments.

There is no question in my mind — none whatsoever — that CPPIB can survive not just the departure of a Wiseman or Jenkins but even a Machin. In fact, in the Bloomberg article above, CPPIB’s CEO Mark Machin stressed there is “deep bench strength and investment expertise” in this organization. Mark Wiseman told me the exact same thing after the announcement he is leaving CPPIB a few months ago.

Reporters love making a big stink about these executive shakeups but if you’ve been around Canada’s pension industry long enough, you’ll know it’s all part of the game, especially when a new CEO takes over.

Sometimes new CEOs make minor changes to the executive ranks and sometimes they make drastic changes. Personally, I hate it when they make drastic changes to place their “own people” in key positions because it’s not only costly (ie., huge severance packages for letting go of senior investment officers for reasons other than performance) but it also disrupts the culture of the organization, typically in a negative way.

But I’m not a CEO of a major Canadian pension fund so to be fair, it’s easy for me to make these judgment calls from the outside looking in and to be sure, often there are valid and good reasons to shake things up at the executive ranks (like getting rid of people who aren’t on the same page as you when it comes to the culture of the organization).

Now, let’s go over why Mark Jenkins left CPPIB to join the Carlyle Group. I have never met or spoken to Jenkins so here I’m going to speculate a bit and if I’m off, please be my guest and contact me to let me know.

I personally think Jenkins was disappointed he wasn’t named CEO after Mark Wiseman stepped down to join Blackrock. He probably contacted a global executive search firm to let them know he’s looking to move from CPPIB or more likely, he directly contacted senior executives at the Carlyle Group which is one of several private equity relationships at CPPIB (see the entire list of CPPIB’s private equity partners here).

[Note: Another possibility is Jenkins advised Mark Machin and CPPIB’s board before accepting this offer but that’s not the way things typically go down.]

You have to keep in mind that people like Mark Wiseman and Mark Jenkins are not like you and me. Yes, there is no question they’re exceptionally bright, hard workers with tons of great experience (and in the case of Jenkins, he has the coveted “Goldman pedigree”), but they also have a Rolodex of the who’s who in the GP and LP world.

I underlined LP world for a reason. Blackrock and Carlyle didn’t hire Wiseman and Jenkins for their brains and experience, they’re bringing to the table something far more valuable, key contacts which consist of the top sovereign wealth and global pension funds of the world. And in the asset management business, it’s all about garnering ever more assets so you can collect more fees.

This is especially true for a large alternatives shop like Carlyle which has been struggling lately and losing business to rivals like Blackstone, a powerhouse in alternatives which seems to be closing funds faster than it can open them. It also didn’t help that Carlyle’s venture into hedge funds has been an abysmal failure.

The point I’m trying to make here is it’s one thing having Mark Wiseman or Mark Jenkins meet with your established or prospective limited partners and another having Joe Schmoe even if they have a solid pedigree. Why? Because a Mark Wiseman or a Mark Jenkins can better understand the needs of their clients as they sat in their chairs.

What else can I share with you? I’ll admit when I last spoke with Mark Wiseman, I too was a bit surprised Mark Jenkins wasn’t selected to replace him. I didn’t know of Mark Machin but Mark told me that “Mark (Machin) was his right-hand who built CPPIB’s Asian investments” and understood better than anyone the objectives of the organization and where it needs to go after he leaves (aka, he probably highly recommended Machin to CPPIB’s board of directors and they fully agreed with him).

One last governance note. I’m a little uncomfortable watching senior executives leaving Canada’s large pensions to join private sector funds. It’s great for them to have opportunities others can only dream of but let’s call a spade a spade, it’s a huge governance faux pas, especially if they are directly responsible for investing billions in these funds.

[Note: US public pension funds have tight governance rules barring investment officers from joining a fund they directly invested with for a period of three or five years. Again, this is governance 101.]

Also, after Mark Machin was appointed CPPIB’s new CEO, Leo de Bever, AIMCo’s former CEO, appeared on BNN saying he’s worried Canada’s large pensions are going to become the breeding ground for private funds looking to snatch talent away.

Leo and I spoke last night after I wrote my comment on my conversation with HOOPP’s Jim Keohane. Leo told me that HOOPP was the “first large Canadian pension to hedge against a decline in interest rates” and obviously being first mover on that front really helped HOOPP achieve its enviable super-funded status.

Also, please note I’m not a reporter, I don’t tape my conversations, and I’m not always the best short note taker. I try to do my best when covering pensions and investments, and sometimes I get it right but sometimes I don’t.

Jim Keohane sent me a nice email this morning thanking me for writing the comment on HOOPP and shared this: “I might have worded things slightly differently, but I think you captured the spirit of what we talked about quite well.”

I thank Jim and beefed up my last comment on our conversation so you can all better understand the key measure of success at any pension. Leo de Bever told me the problem with using funded status is that US pensions use expected return to discount their future liabilities and that “7% or 8% discount rate is way too high” (again, if they used Ontario Teachers’ or HOOPP’s discount rate, they’d be insolvent).

I also want to stress something else, when I compare Ontario Teachers’ to HOOPP, it’s not to claim one is way better than the other. Both of these pension plans are regarded as the best plans in the world so comparing them is like comparing Wayne Gretzky to Mario Lemieux. They also have some key differences in size and maturity of their plans which makes a direct comparison difficult, if not impossible.

The point I’m trying to make, however, is anyone looking to be part of a great defined-benefit plan would love to be a member of HOOPP or Ontario Teachers and I don’t blame them.

As far as CPPIB, I trust Mark Wiseman’s judgment which is why I trust that Mark Machin and his new senior executives are all more than qualified to take over and deliver on the fund’s long term objectives during the next phase which will be far more challenging in a ZIRP and NIRP world.

So the next time you hear some reporter lament about a big shakeup at CPPIB, please refer them to this comment and tell them to relax and stop spreading misleading information.

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

On Friday, I had a chance to talk to Jim Keohane, President and CEO of the Healthcare of Ontario Pension Plan (HOOPP). Before I get to to that discussion, you should all read an article Jim and Hugh O’Reilly, President and CEO of OpTrust, wrote for the Globe and Mail back in February, Looking for a better measure of a pension fund’s success:

The world of business is one where people like to quantify and measure things. This drive has led to the old saw: “If it can’t be measured, it can’t be managed,” and, like all sayings, it has its portion of truth. However, our desire to measure progress can also leave us vulnerable to certain pitfalls.

Too often, we head down the path of holding up metrics as accurate barometers of success because they represent things that are easy to understand, quantify and report. This then raises questions for any business. Are we are on the right track? Are we truly doing the right things for success, not just for this quarter or year, but for the long term? And, most important, are we measuring the right things?

For example, if you were in the business of cutting paths through a forest, you might take measurements of how straight your paths were and how quickly you were progressing. But those measurements would be completely meaningless if you were cutting a path through the wrong forest.

This is a bit of what goes on in the pension-fund industry. Many pension funds view themselves as asset managers, and their metrics for gauging success focus on how the asset side of their balance sheet has done in comparison with public market benchmarks. There is some validity to this approach at a micro level, but in terms of measuring organizational success, it is akin to measuring results in the wrong forest.

Canada’s large public-sector pension plans have garnered considerable acclaim as investors on the world stage. But it’s a misnomer to call us asset managers. We are pension-delivery organizations. The nature of the product we deliver to our members means our goals are fundamentally different from organizations that are simply looking to accumulate and grow capital. We are investing to deliver a specific outcome, which is to make the pension payments to our members that they are expecting.

Despite this, people inside and outside the industry have historically looked to a measure that is short-term, easy to report and easy to understand: annual investment returns.

Each year, when the results come out, people sift through the numbers like fortune tellers trying to discern the future from tea leaves. But it’s all sleight of hand, a showy distraction from the real action. Annual investment returns are just one part of the complex business of running a pension plan. Ultimately, to be successful in delivering pensions to our members, the assets have to outperform the liabilities (which are the current and future pension payments owed to our members). We measure this by looking at a plan’s funded ratio. If a plan’s current assets are equal or greater than the present value of current and future pension payments, it is fully funded and has achieved success.

Positive investment returns are generally a good indication of success, but not always. There are scenarios in which investment returns have been positive and the funded ratio has declined, and conversely times when investment returns are negative yet the funded ratio improved.

Our own industry has been as guilty as anyone else in trumpeting annual returns. In a world in which so many people are in a pension rat race to accumulate the biggest pot of money before they retire, it feels normal to celebrate when we’ve been able to make our assets perform faster, higher and stronger. However, if we are honest with ourselves, it’s not the business we’re in. Does this mean that returns don’t matter? Not at all. What it does mean is that as pension plans, our investment approach must be inextricably linked to the goal of keeping the plan fully funded.

Growing and maintaining our funding surplus over time to ensure we can deliver pension benefits to our members leads to very different decision-making, particularly when it comes to risk management, and the nature and mix of assets that we hold in the investment portfolio.

For members, the true value of a defined-benefit (DB) pension plan is certainty at a stage of life when there is little runway to accumulate more. Beyond the dollars that will one day be paid, we give members the confidence that they can count on their pension to be there when they retire and that their contributions will remain as stable as possible during their working years.

When creating certainty is the true goal, taking undue risk with members’ futures for the sake of a few hundred extra basis points in a given year makes no sense at all. That is why both of our organizations have adopted an approach that puts funding first, one in which we balance the need to generate returns with the need to effectively manage risk.

When viewed from this perspective, being good, better or best will not be assessed on the basis of a given year’s investment return. Instead, we will measure success by the plan’s funded status. This measure of success also means that plans will be focused on putting the interests of plan members first in the decision-making process. In so doing, we will be putting stock in another old saw: “If it isn’t measured, it doesn’t matter.”

This is a great article which nicely covers the importance of a pension plan’s funded status as the true measure of long-term success.

Interestingly, over the weekend, Suzanne Bishopric forwarded me a Vox Eu comment on measuring institutional investor performance which argues that the skill set of institutional investment officers is critically important in producing meaningful outperformance in private equity and that institutional investors could improve returns by paying their investment officers more, by letting them share the upside, and by monitoring them better.

No doubt, you need to pay your investment officers properly, especially in private markets like private equity, real estate, and infrastructure which require unique skills sets, but the message that Jim Keohane and Hugh O’Reilly are conveying is equally important, pensions need to focus first and foremost on their funded status, not taking huge risks to beat their policy portfolio benchmark.

The nuance here is that you can’t blindly compare the performance of one pension plan to another without first understanding how their liabilities are determined and what their funded status is.

For example, Ontario Teachers and HOOPP are widely regarded as two of the best pension plans in Canada, if not the world. They both use extremely low discount rates (HOOPP’s is 5.3% and Teachers’ is just below 5% because it’s a more mature plan and its members are older) to determine their liabilities, especially relative to US pensions which use expected returns of 7% or 8% to determine their liabilities (if US pensions used the discount rate HOOPP and Ontario Teachers use, they’d be insolvent).

In 2015, Ontario Teachers returned 13% as growth in its private market assets really kicked in while HOOPP which is more heavily weighted in fixed income than all of its larger Canadian peers only gained 5.1% last year.

A novice might look at the huge outperformance of Ontario Teachers as proof that it’s a better managed plan than HOOPP but this is committing a fatal error, looking first at performance, ignoring the funded status.

Well, it turns out that HOOPP’s funded position improved last year as it stood at 122%, compared to 115% in 2014, placing it in the top position of DB plans when you use funded status as the only real measure of success (less contribution risk relative to other DB plans). And unlike others, HOOPP manages almost all its assets internally and has the lowest operating costs in the pension industry (it’s 30 basis points).

Now, to be fair, Ontario Teachers’ is a much larger pension plan and it too is now fully funded and does a lot of the things HOOPP does in terms of internal absolute return arbitrage strategies and using leverage wisely to juice its returns, but the point I’m making is if you’re looking at the health of a plan, you should focus on funded status, not just performance.

Yes, the two go hand in hand as a pension that consistently underperforms its benchmark will also experience big deficits but it’s not true that a pension plan that consistently outperforms its benchmark will enjoy fully or super-funded status.

Why? Because as I keep hammering on my blog, pensions are all about managing assets AND liabilities. If you’re only looking at the asset side of the balance sheet without understanding what’s driving liabilities, your plan runs the risk of being underfunded no matter how well it performs.

Now, to be fair, I should also point out that unlike Ontario Teachers and HOOPP, most of Canada’s large pension funds (like bcIMC, the Caisse, CPPIB and PSP) are NOT pension plans mnaging assets and liabilities. They are pension funds managing assets to beat their actuarial target rate of return which is set by their stakeholders who know their liabilities.

Also, unlike many other pension plans, HOOPP, Ontario Teachers and a few other Ontario pensions (like OpTrust and CAAT) have adopted a risk-sharing model which basically states the members and the plan sponsor share the risk of the plan if a deficit occurs. This effectively means that when a deficit persists, members can face a hike in contributions or a reduction in benefits.

It’s also important to understand that HOOPP didn’t achieve its super-funded status fortuitously. It went though a deep reflection after the tech crash when it was underfunded and Jim Keohane who was then the CIO went to Denmark to understand how ATP was closely managing its assets and liabilities.

That was a huge moment for Jim Keohane and former CEO John Crocker because the entire culture and focus at HOOPP shifted to managing assets and liabilities a lot more closely. That effectively meant HOOPP started immunizing its portfolio, hedging interest rate risk, long before other DB pensions even thought of it and increased its allocation to fixed income assets, effectively derisking its plan and managing its assets and liabilities more closely.

[Note: In a phone conversation, Leo de Bever, AIMCo’s former CEO, told me that “HOOPP started hedging interest rate risk long before others, including Ontario Teachers.” He also told me at one point, Teachers’ had 25% allocated to real return bonds.]

The timing of that decision proved to be critical as HOOPP now enjoys a funded status that most other DB pension plans can only dream of. I wish my father and his physician friends had access to a HOOPP long ago because that would have made their retirement a lot smoother.

[Note: HOOPP is a private plan which manages pensions of Ontario’s healthcare workers but not Ontario physicians. I’m sure if doctors in Ontario had a choice they too would prefer to fork over their retirement savings to HOOPP than some mutual fund in their RRSP and enjoy a real DB, not DC pension.]

The above rant that was my preamble to my conversation with Jim Keohane on Friday. I also got to LinkIn to Hugh O’Reilly and exchanged messages with him but I will have to cover changes at OpTrust another day when I talk with him and his CIO, James Davis.

I’ve said it before and I’ll say it again, Jim Keohane is one of the smartest and nicest pension fund leaders I’ve ever had the pleasure of meeting. They’re all nice but Jim really takes the time to talk to me and explain things in clear terms. I am very fortunate to have access to him and others when covering pensions and investments.

So what did we talk about? We covered a lot  of topics which I will summarize below. Please take the time to read his insights and any errors are entirely mine and will be edited if needed (I will ask Jim to review my entire comment):

• On Fed policy and buying bonds with negative yields: Jim thinks the Fed is in a bad corner and needs to raise rates in order to have ammunition to combat the next recession. He didn’t say whether he thinks the Fed will raise in September or December but he did say with rates at zero, policy will be more constrained when the next crisis hits. More importantly, he told me that HOOPP will never buy bonds with negative yields. “It just doesn’t make sense. Many institutions are forced to which distorts the market but if you think about it, why buy a bond where you know with certainty you’re payoff is negative?” (Leo de Bever thinks the return on risk in bonds will be low to negative in the coming years).
• On real estate over fixed income: That discussion led to an interesting discussion on bonds. I told him that I view bonds as the ultimate diversifier in a deflationary world and can’t take seriously all this talk of a bubble in bonds or cracks in the bond market. Jim explained to me it’s not a matter of bubbles in the bond market, which he doesn’t believe in either, but rather long term investing. “Why hold bonds over the next 15 years? Bonds are a hedge against a decline in rates but rates have already declined significantly.”Okay, fair enough but if not bonds, then what? He told me he prefers real estate with cap rates at 5-6% over bonds over the next 15 years. “Even if you take a big 20% hit on asset values, you will still come out of ahead just on the differential of rates” (I thought to myself true provided of course we are not entering a prolonged period of debt deflation).
• On the risk of deflation or inflation: Jim didn’t tell me whether he thinks deflation will prevail over inflation but he did tell me that real return bonds are very cheap. “The breakeven trade (spread between nominal and real return bond yield) is at historically cheap levels. Market is calling for long term inflation of 1.3% and bonds are pricing in a depression” (all true but I wouldn’t ignore the bond market’s ominous warning).
• On HOOPP’s real estate investments: We talked about Brexit and how cheap the pound is which makes it cheaper for Canada’s large pensions to invest in the UK. Jim told me that HOOPP invested in UK real estate which is basically a large warehouse and port for technology driven firms like Amazon. “You have them in North America but not in Europe and these are great projects with solid tenants. We are even building one for BM in Sweden.”
• Of course, I had to ask why wouldn’t an Amazon or other tech giants invest its mountain of cash in such real estate projects? Jim told me it’s all about return on investment: “Why tie up their capital in a project yielding 6% or 7% per year when they can earn 12% focusing on other projects? The same goes for banks, why buy real estate when they can put your capital at work and earn more elsewhere?” Excellent point.
• On the benefits of greenfield real estate: In December, HOOPP will be moving from 1 Toronto Street to 1 York Street. The new offices will be just a few blocks from its current location. What is interesting about this building is that it was a greenfield project. In fact, 1 York Street is a new 800,000 square foot, 35-storey, LEED Platinum office development in Toronto’s South Core which already has solid tenants. Jim told me “the cost of construction is cheaper than buying a building and even though it took five years to build, it’s well worth it.” He added: “New buildings are significantly more energy efficient which means HOOPP will collect more rent per square foot and the tenants will benefit from less common costs.” Still, he admitted “there is a big time lag in greenfield real estate projects and it takes expertise to do it right.”
• On Vancouver real estate: Jim told me that article about Canadian pensions unloading Vancouver real estate was way overdone and misleading. “Yes we sold one project but are building an ever bigger project a few blocks down which will be a shopping center with condos. No reporter bothered to contact us so we can explain our real estate projects in Vancouver.”
• On pricey infrastructure: I noted that HOOPP is a “big laggard” in terms of infrastructure relative to its larger Canadian peers but this didn’t seem to phase Jim one bit. “If you look at OMERS Borealis, they have a great infrastructure portfolio but they were first movers. That is great for their members but they haven’t done as many big infrastructure investments in the last few years because deals are a lot pricier as competition is fierce.” I asked whether he still thought pensions are taking on too much illiquidity risk and he said “yes, no doubt about it.”
• On the stock market: We talked about stocks and sectors. Jim told me he thinks many banks are cheap, “selling at book value” and that they are still positive on the energy sector. Given my views on deflation (terrible for financials) and the US dollar, I bit my tongue but also understand his long term view.
• On emerging markets: Jim told me that emerging markets are “ok from a price perspective but vulnerable if global liquidity is weak.” Again, given my views on the US dollar and deflation, I would steer clear of emerging markets until a much better buying opportunity presents itself, say if anothert EM crisis erupts.
• On the big risks that keep him up at night: He told me: “With low rates, there’s a lot of risk out there. Valuations are stretched and there’s nothing cheap out there.
• On HOOPP’s S&P volatility trade: In 2012, HOOPP gained a whopping 17% as everything kicked in, including their liability driven investments and long term option strategy which was basically selling 10-year vol when the S&P was at 1000. I asked him if they are buying long term vol at these levels but he told me “it’s priced high”. He also made an excellent point that “10-year vol swaps are NOT 10-year vol options” and “many investors entering these 10-year vol swap trades are going to get killed.”

Finally, it is worth noting that HOOPP is on track for another stellar year, which doesn’t surprise me as I stated this on my blog a couple of months ago. Given their high allocation to fixed income (44%), it’s not surprising that they will deliver outstanding results (bonds are performing well so far this year).

And what if the bond market cracks and rates shoot up? Jim had an answer for that too: “It’s all about assets vs liabilities. If rates go up, our liabilities will decline significantly, so even if we get hit on fixed income, we will still maintain our fully-funded status.”

Smart guy, real smart and super nice. Jim Keohane reminds me a lot of Ron Mock, another nice guy who really knows his stuff. It’s hardly surprising these two pension plans are the envy of the world.

On that note, please forgive my tardy comment, I’ve been battling an ear infection (swimmer’s ear is very painful) and have been visiting our super hospital frequently (looks like antibiotics are kicking in). If there are any errors or additional information, I will edit this comment.
Once again, I thank Jim Keohane for graciously offering his time and wise insights. There are many reasons why HOOPP is one of the best pension plans in the world, and if you ask me, the number one reason is its amazing leader.

Only 28 percent of small businesses offer their employees a 401(k) plan, according to a report from SurePayroll.

Forty-two percent of small business owners surveyed said they don’t see the value in a 401(k) plan; 35 percent say the fees are too high.

More from PlanSponsor:

Only 28% of small businesses offer a 401(k), with 6% planning to add one soon. This runs counter to the 34.4% who say that a 401(k) plan is the primary way they will save for retirement, followed by earnings from their business (24.7%), a traditional or Roth individual retirement account (13.7%), real estate investments (not including their home—9.3%), and stocks, bonds and cash outside of a retirement account (8.9%).

Among the small businesses that are offering a 401(k), only 5% say they are doing so to attract new employees, and only 6% value the tax breaks.

“There needs to be more education for small business owners about the tax benefits and the long-term growth potential of investing in a 401(k) plan,” says SurePayroll General Manager Andy Roe. “The fees really are minimal when you consider the benefits to you and your employees. The plans available today make it very easy to manage, and your payroll provider can help guide you. It’s a growth opportunity for business owners.”

One of the top investment staffers at the Canada Pension Plan Investment Board is moving to Carlyle Group.

CPPIB made several new appointments following the move.

More on the Carlyle move from the Wall Street Journal:

Carlyle Group LP hired a senior executive from Canada’s biggest pension fund to oversee debt investing, part of the asset manager’s effort to regroup from setbacks in its credit and hedge funds business.

Washington, D.C.-based Carlyle tapped Mark Jenkins, most recently head of global private investments at Canada Pension Plan Investment Board, for the newly created position, according to a statement.

Global market strategies has been a sore spot for Carlyle, largely because of struggles at its hedge funds Claren Road Asset Management, Vermillion Asset Management LLC and Emerging Sovereign Group LLC. In May, Mitch Petrick stepped down from a role running the $34.7 billion business. Carlyle tasked longtime private-equity executive Kewsong Lee to rebuild it and has said it is reviewing options to improve the unit’s performance.

Mr. Jenkins is focused on the unit’s credit investing, which includes energy lending, providing capital to mid-sized companies and bets on distressed debt.

[…]

During his eight years at CPPIB, he built the pension fund’s direct-lending business and oversaw its $12 billion acquisition of General Electric Co. ’s private-equity lending business, Antares Capital. Before that, Mr. Jenkins co-led Barclays PLC’s leveraged-finance business in New York and worked in Goldman Sachs Group Inc. ’s finance and fixed-income departments.

And the other moves at the CPPIB, from a press release:

--  Graeme Eadie is appointed Senior Managing Director & Global Head of Real
    Assets, a new investment department that brings together the Real Estate
    Investments department with our existing Infrastructure and Agriculture
    groups. This change will create a better alignment with our Strategic
    Portfolio. Mr. Eadie has been with CPPIB since 2005, and was most
    recently Senior Managing Director & Global Head of Real Estate
    Investments. 
    
--  Shane Feeney is appointed Senior Managing Director & Global Head of
    Private Investments. Mr. Feeney will also join CPPIB's Senior Management
    Team. In this role, Mr. Feeney will be responsible for CPPIB's private
    investment activities and will report to Mark Machin. Mr. Feeney was
    most recently Managing Director, Head of Direct Private Equity for
    CPPIB. He joined CPPIB in 2010 and has 18 years of private equity
    experience. Before joining CPPIB, he was a partner and founding member
    of Hermes Fund Managers Limited's direct private equity business. He had
    also previously been an Associate Director with Morgan Grenfell Private
    Equity in London.  
    
--  Ryan Selwood is appointed Managing Director, Head of Direct Private
    Equity, and will be responsible for overseeing co-sponsorships and other
    direct private equity transactions. Mr. Selwood was most recently a
    Managing Director in the Direct Private Equity group and lead for
    CPPIB's financial institutions investing initiative. Mr. Selwood
    previously led CPPIB's direct private equity activities in Europe. Prior
    to joining CPPIB in 2006, Mr. Selwood was a Vice-President at Merrill
    Lynch & Co. in the Financial Institutions Group in the Investment
    Banking Division in New York.

The board of the New York City Employees’ Retirement System voted this week to explore the possibility of divesting from private prisons.

City Comptroller Scott Stringer said he’d propose the same resolution at the city’s other four pension funds, as well.

More from Politico:

The city’s five pension funds, which hold a cumulative $154 billion in assets, altogether have an estimated $20 million worth of holdings in private prisons, and NYCERS, which holds roughly $51.2 billion in assets, has private prison holdings worth roughly $6 million.

“Prisons should not be profitable at the expense of humane conditions and safety,” said John Adler, the Director of the Mayor’s Office of Pensions and Investments and chair of the NYCERS Board, in an emailed statement.

“If NYCERS can responsibly divest from corporations that run private prisons, the City is eager to do its part in working to eliminate private prisons,” Adler said.

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

Tito Boeri, Pietro Garibaldi, Espen Moen wrote a comment for Vox EU, CEPR’s policy portal, Increases in the retirement age and labour demand for youth (h/t, Suzanne Bishopric):

Most European countries have experienced a dramatic increase in youth unemployment since the beginning of the Great Recession in April 2008. For the Eurozone as a whole, employment for people aged between 15 and 24 fell by almost 17% in six years. In southern Europe, the smallest decline was 34% in Italy, and the largest was 57% in Spain. Other age groups suffered less: 3% for the Eurozone as a whole and, for all older age groups in all countries, between one-third and one-sixth of the employment decline for young workers.

In the Eurozone as a whole, employment for people in the 55-65 age group increased by approximately 10%. Demographic factors do not account for these changes. Both employment levels and employment rates moved in opposite directions for young and senior workers (Figure 1).

The strong increase of youth unemployment was predicted by the research on contractual dualism (Saint-Paul 1993, Boeri 2011). This predicts that youth unemployment will respond more strongly to cyclical fluctuations in countries with strict employment protection in permanent contracts and ‘fire-at-will’ for temporary contract workers (Boeri et al 2015). Boeri and Garibaldi (2007) predicted that immediate declines in youth unemployment after two-tier labour market reforms, even under slow growth scenarios, would be followed by youth disemployment when macroeconomic conditions deteriorate. Research on contractual dualism, however, does not explain why employment rates have diverged for young and old.

Figure 1. Employment rate for young and old workers in the EU15

Portugal in 2007, Spain in 2011, Greece in various stages between 2010 and 2016, and Italy in 2011 all increased the retirement age during the recession. So is the decline in youth employment related to changes in the retirement rules? Research on retirement is typically focused on the supply side. As a result, it ignores trade-offs between young and old workers on the demand side. Vestad (2013) used administrative data to estimate the impact of an early retirement programme on youth employment in Norway, but there is little other research on this topic.

The economics of pension reform and labour demand

The economics of a pension reform and labour demand is more subtle than a simple exogenous shift in labour supply. Most of the individuals involved are already employed and cannot be easily fired. Under a pension reform forcing firms to retain older workers, there are two effects at work.

• First, there is a negative scale effect, due to decreasing returns to scale. The reform forces some of the older workers to stay employed rather than retire. This tends to increase output, but with decreasing marginal returns to scale in production, the marginal product of young workers falls and so does youth hiring.
• Second, there is an effect that depends on the degree of complementarity between young and old workers: the stronger the complementarity, the more likely that the reform could positively affect youth employment.

Which one of the two effects – the scale or the substitution effect – prevails is ultimately an empirical matter.

Italy and the Monti Fornero reform

Italy provides an excellent case study of whether unexpected increases in retirement age can have adverse effects on youth employment. In the middle of a recession, labour markets are typically driven by the demand side. In Italy, employment rates for the 15-24 and 55-64 age groups were almost the same in 2005 (Figure 2). Ten years afterwards, the employment rate for the 55-64 age group was 45%, while the youth employment rate was approximately 12%. In this period, the normal retirement age increased, and the minimum contribution requirement for access to early retirement tightened. In December 2011, the Monti Fornero reform increased the retirement age by up to five years for some categories of workers. We use this policy experiment to estimate the impact of increases in retirement age on youth labour demand.

Figure 2. Employment rate for young and old workers in Italy

We had access to a dataset on Italian firms before and after the reform compiled by the Italian social security administration (INPS). We looked at whether a sudden and unexpected increase in the contributory and age requirements for retirement, which forced firms to keep workers previously entitled to pensions to stay in the payroll, affected labour demand for young workers. We identified the population hit by the changes in retirement rules in each firm, and looked at the dynamics of net hiring in the same firms.

The results are clear. Before and after the reform, firms that were more exposed to the mandatory increase in the retirement age significantly reduced youth hiring compared to those who were less exposed to the reforms. We cannot rule out that the latter firms may have increased their hiring as a result of the reform, due to general equilibrium effects. Nevertheless, we argue that the reform was likely to reduce the labour market prospects of young workers.

We estimate that five workers locked in for one year mean the firm hires approximately one less young person. Firms with more than 15 employees lost 160,000 youth jobs in this period. Of these, 36,000 can be attributed to the reform. We performed robustness checks including rolling regressions across the size distribution, propensity score matching, and a falsification test on the pre-reform years.

Policy implications

Cautiously, we make two points.

Reducing the generosity of pensions in the middle of the European sovereign debt crisis was probably inevitable, despite the severe recession that southern European economies experienced. But this tightening could have been done by reducing pensions for workers who were retiring before the normal retirement age. This would have allowed firms to encourage the least productive older workers to retire. With hindsight (as well as the evidence above), much more should have been done by European policymakers to help and sustain young workers who were about to enter the labour market. The equilibrium for young and old workers in the southern European labour market was not what these policies set out to achieve. We risk a lost generation in Europe.

Also, the retirement age should be as flexible as possible. As far as Italy is concerned, the long-run defined contribution system is viable and sustainable. A system like this, though, has a prolonged transition phase. During the medium-run adjustment to the new system, policy should seriously attempt to increase actuarially neutral flexibility in retirement. From the perspective of broader fiscal coordination, our results suggest that short-sighted fiscal rules that force sudden increases in retirement age during major downturns may backfire. They may cause a prolonged and almost total freeze on new hires, particularly when older workers are locked in by the increase in the retirement age.

Fiscal rules should better focus on fiscal sustainability in the long run. A 2005 reform of the Stability and Growth Pact attempted this, but in words, not in practice. It stated that a short-run deterioration in the budget deficit could be tolerated if, at the same time, a government reduces its long-run liabilities. In practice, however, this principle can only be enforced by explicitly including in the pact any efforts that reduce the hidden liabilities associated with social security entitlements, the most important long-run liabilities in our ageing societies.

This means that a citizen could be given some freedom to retire when he or she wants, provided the size of the pension reflects age and life expectancy. More pensions could be paid under downturns without affecting long-term liabilities, because the additional pensions for early retirees would be lower than those paid to people who retiring later. Therefore this system could be budget-neutral and operate as an automatic stabiliser. A pact that allows for sustainable flexibility in retirement would also help countries facing the huge demographic shock that is associated with the current refugee crisis.

References

Boeri, T. (2011) “Institutional reform and dualism”, Handbook of Labor Economics 4b ed. D. Card and O. Ashenfelter. Elsevier.

Boeri, T. and Garibaldi P. (2007) “Two Tier Reforms of Employment Protection: a Honeymoon Effect?” The Economic Journal 117 (521), F357-F385

Boeri, T., Garibaldi, P. and E. R. Moen (2015) “Graded security from theory to practice”, VoxEU.org, 12 June.

Boeri, T. Garibaldi, P. and E. R. Moen (2016) “A Clash of Generations? “Increase in Retirement Age and Labor Demand for Youth”, CEPR Discussion Paper 11422 and WorkInps Paper 1.

Saint Paul, G. (1993) “On the Political Economy of Labor Market Flexibility”, NBER Macroeconomic Annual 151-192

Vestad, O. L. (2013) “Early Retirement and Youth Employment in Norway”, Statistic Norway.

The theme this week is the global pension crunch which is why I covered developments in China, Chile, Brazil and now looking more closely at the Eurozone’s pension woes.

Today’s comment happens to coincide with the ECB’s monetary policy decision (more on that below) and this was done purposely to demonstrate why Mario Draghi’s worst nightmare is far from over.

Regular readers of my blog will recall that I called checkmate for Europe’s pensions back in March and basically haven’t changed my mind on the dismal prospects and huge challenges Eurozone’s pensions have to contend with.

As far as the findings of the academics above, I’m hardly impressed. They are basically arguing that increasing the retirement age in Greece, Italy, Portugal and Spain after the Great Recession exacerbated youth unemployment in southern Europe and we risk seeing a lost generation in Europe because of these retirement reforms.

Being good academics, the authors claim they “performed robustness checks including rolling regressions across the size distribution, propensity score matching, and a falsification test on the pre-reform years.”

It all sounds so legitimate and “robust”. Unfortunately, it’s mostly academic nonsense and the primary reason why I stopped reading a lot of academic literature on economics.

Do you want to know the real reason why youth unemployment is soaring in Greece and southern Europe?  It’s not because they followed the rest of the developed world and increased the retirement age. It’s because of archaic labor laws that basically protect powerful interest groups and virtually make it impossible to introduce real labor market competition in these countries.

I am going to talk about Greece because I know what that country extremely well. Very bright Greeks, mostly Greeks living outside Greece (and some living there), know exactly what Greece needs in terms of meaningful reforms.

Much has been made lately about how the IMF screwed up with Greece — and to be sure, it did — but little attention is being placed on how successive Greek governments refuse to implement much needed reforms to finally break the bloated public sector which is crippling their economy.

Let me be clear, I have nothing against a well managed and strong public sector but any country that experiences a sovereign debt crisis and keeps expanding its public sector is doomed to fail.

And let me take it a step further and state this: any country that relies on the primacy of its public sector is doomed to fail. I don’t care if it’s Greece, Italy, Spain, Portugal, France or even Canada, a thriving public sector at the expense of a dwindling private sector is a recipe for disaster.

I mention this because in Greece, it’s business as usual as Prime Minister Alexis Tsipras recently announced plans to overhaul the Constitution in order to hire 20,000 civil servants.

You read that right, bankrupt Greece wants to increase its bloated public sector after it went through a major sovereign debt restructuring.

Not surprisingly, Greece is facing another bailout standoff with its creditors amid reports that Eurozone countries will refuse to release additional funds to it this month.

None of this surprises those of us who know Greek politicians all too well. They are crooked, crony liars who will do anything, and I mean anything, to stay in power which is why even in the face of disaster, they succumb to the demands of powerful public sector unions.

The biggest tragedy inflicted upon Greece over the last forty years was this insane expansion of its public sector to epic proportions. It all started with Andreas Papandreou but each successive Greek government since then caught on to the game of handing out goodies to public sector unions to ensure their hold on power.

That’s why I can’t take any Greek politician seriously, whether it’s Yanis Varoufakis peddling his memoirs on Europe’s crisis or even George Papaconstantinou, another former finance minister who rightly notes in his memoirs that it’s game over for Greece.

[Note: My biggest beef with Varoufakis is not that he’s a shameless self-promoter looking to sell his books. In fact, I highly recommend you read his best book, The Global Minotaur. My biggest beef with him is that he’s a master of half truths and was never able to admit that Greece’s bloated public sector was crippling its economy and continues to do so till this day.]

What does all this have to do with Europe’s lost generation and the Eurozone’s pension policy? Europe is a huge structural mess and no matter what the ECB does, it’s losing its battle against deflation.

And while Nobel laureates like Joe Stiglitz discuss the real issues in the Eurozone and how to solve them, I personally believe this fragile union is living on borrowed time and the real issue is how to stop European and Asian deflation from ravaging the global economy.

This is why I can’t take clowns warning of a bond bubble seriously. What world do they live in? Do they not realize how Brexit was Europe’s Minsky moment and the increasingly likely disintegration of the Eurozone will drive US Treasury yields to uncharted territory?

I don’t know, maybe there’s something I’m missing, but from a macro perspective I’m more worried than ever that the global deflation tsunami is gaining steam and unless there is a massive and coordinated fiscal response (by implementing major infrastructure projects all over the world), it’s going to wreak havoc on the global economy for decades (I think it’s already too late).

And when that happens, we’re not going to be talking about Europe’s lost generation, we’re going to be fretting over the entire world’s lost generation.