Pension360

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

Kirk Falconer of PE Hub Network reports, OPTrust punches above its weight with private equity strategy:

OPTrust has greatly expanded its private equity program, deploying a strategy that gives the mid-sized pension fund access to opportunities usually available only to larger institutions.

OPTrust, which invests on behalf of OPSEU Pension Plan, the retirement system for about 90,000 Ontario public employees, this week reported a net return of 6 percent for 2016. Net assets grew to more than $19 billion from $18.4 billion in 2015.

Overall numbers were boosted by a strong performance in the PE portfolio. PE investments returned a net 20.6 percent last year, up from 14.4 percent in 2015.

These results cap a major five-year increase in OPTrust’s PE allocation. At the end of 2016, the portfolio held nearly $1.6 billion in assets, more than triple the amount in 2012. Private equity’s share of total assets rose in this period to 9 percent from 4 percent. OPTrust’s notional target is 15 percent.

OPTrust Managing Director Sandra Bosela, who heads the global PE group, told Buyouts that most of the growth owes to a strategic shift favouring direct deals and co-investments.

Prior to 2012, the main focus of OPTrust’s PE portfolio was funds and secondaries, with direct activity accounting for 20 percent of assets, Bosela noted. By 2016, the direct share was 48 percent.

Bosela, formerly a general partner with 15 years of experience, joined OPTrust Private Markets Group in 2012 to develop the PE strategy and ramp up direct investing. She says the result is an ability to “punch above our weight.”

“I’m pleased with the progress,” Bosela said. “Our strategy has been designed to carve out a niche that leverages our size and includes more direct, actively managed investments. It has opened doors for us and created access to deal flow that’s typically available only to our much larger peers.”

Deals plus funds

OPTrust is targeting a 50:50 balance between the portfolio’s direct and fund sides, Bosela said. That’s because many of the best opportunities for co-underwriting deals come from a core group of fund partners.

Opportunities are also sourced with “like-minded partners,” Bosela said. They include a range of market players, such as PE firms, strategic investors, financial players and business owners.

Drawing on these sources, OPTrust has increased both the pace and range of its mid-market buyouts and other PE transactions in North America, Europe and developed Asia.

Disclosed examples include OPTrust’s 2014 investments alongside Altas Partners in St. George’s University, a Grenada medical school, and alongside CDCM in Skybus, an Australian airport transit service.

Over 2014-2015 it also joined Imperial Capital Group in backing U.S. home-alarm monitor Ackerman Security Systems and Canadian dental network Dental Corp.
John Groenewegen, Partner, Osler, Hoskin & Harcourt LLP.

In-house resources

OPTrust’s experience may provide a model to some other small and mid-sized pension funds looking to expand their PE allocations.

John Groenewegen, a partner at law firm Osler, Hoskin & Harcourt, says OPTrust’s private equity program has “put them in a position they would not otherwise be in.”

Groenewegen, who advises pension-fund clients, says a central factor in OPTrust’s approach is in-house resources that include “professional deal-makers.”

“OPTrust has invested in the right funds, and an experienced team has ensured it can act quickly and make decisions quickly,” he said. “That’s key to being a good deal partner, to being invited back.”

Bosela agrees, noting that OPTrust’s ability to be “a value-adding partner, one that can execute shoulder-to-shoulder, even on complex transactions” is essential to its direct investing. “We’re not the big elephant in the room,” she says. “We must offer something other than our money.”

Not standing still

OPTrust aims to place more capital in the months ahead, Bosela said. She is mindful, however, of an “overheated” market environment, fuelled by high values and “heightened levels of dry powder.”

Market frothiness has reinforced a disciplined, selective focus to investments, Bosela said. OPTrust also will give more emphasis to private debt and long-term equities to help balance the portfolio and reduce volatility.

Bosela says OPTrust is not “standing still” with the PE program, but will instead continue to add to its capabilities. For example, it is exploring “proactive origination,” intended to accelerate independent sourcing of direct opportunities.

OPTrust PMG has a team of 18 located in offices in Toronto, London and Sydney, Australia. Overseeing nearly $4 billion in assets, it is co-led by Bosela and Gavin Ingram, a managing director and head of the global infrastructure group.

I recently covered how OPTrust is changing the conversation, emphasizing its funded status first and foremost instead of its annual results.

In that comment, I covered a conversation with OPTrust’s President and CEO, Hugh O’Reilly, and its CIO, James Davis, where we spoke at length about the funded status and shift in investment philosophy.

When I went over some of their private market investments, I noted the following:

In private equity, they invest and co-invest with funds but as James told me, “they’re not looking to fill buckets” and will use liquid markets to fulfill their allocation to illiquids if they’re not fully invested.

In infrastructure, they have done extremely well by investing primarily directly through co-sponsored deals with their strategic partners. Their focus is on the mid-market, with cheque sizes of $100M to $150M and where there is less competition.

After reading the article above, I noted the following on LinkedIn (click on image):

If you can’t read it, here it is again:

Agreed, Sandra Bosela has done a great job expanding co-investments at OPTrust. As far as “proactive origination”, that gets tricky because a) it’s hard to source great deals and b) you don’t want to compete with your GPs because they will end up seeing you as a competitor and cut you out of co-investment opportunities. Still, Mrs. Bosela should be commended for her work at OPTrust and she has the right game plan and strategic thinking.

The truth is OPTrust is punching above its weight in private equity and other activities but just like everyone else, there are limits to what Canada’s mighty PE investors can do in terms of “proactive origination” in direct private equity deals.

Most direct investing at Canada’s large pensions is done via co-investment opportunities the general partners (GPs) offer their limited partners (LPs, ie. pensions and other institutional investors).

Even though LPs pay big fees for comingled funds, co-investments have little or no fees but they require expertise from the pension staff that needs to quickly evaluate these larger transactions before investing in them.

In fact, John Groenewegen alluded to this: “OPTrust has invested in the right funds, and an experienced team has ensured it can act quickly and make decisions quickly,” he said. “That’s key to being a good deal partner, to being invited back.”

And Bosela is right, OPTrust’s ability to be “a value-adding partner, one that can execute shoulder-to-shoulder, even on complex transactions” is essential to its direct investing. “We’re not the big elephant in the room,” she says. “We must offer something other than our money.”

In order to expand your co-investments to lower the overall fees you pay in private equity, you need to a) invest in the right funds and b) have an experienced team to quickly evaluate co-investment opportunities.

It sounds easy and straightforward but it isn’t. If your pension fund doesn’t have the right governance to attract and retain qualified staff, you can forget all about expanding direct investments in private equity by gaining access to more co-investment opportunities.

So, first you need to choose the right funds and second you need to have very qualified people on your team to evaluate co-investment opportunities relatively quickly.

And judging by the outstanding long-term returns, Bosela and her team are good at both. She’s also right to fret about the current conditions in private equity which I alluded to on Friday when I discussed why there’s no luck in Alpha Land:

[…] it’s not just hedge funds. The same thing is going on in private equity where there’s a mountain of dry powder and the market return differential over public markets is narrowing:

Private equity firms had as much as $1.47 trillion in funds available to invest at the end of 2016, and debt capital was also readily available to bolster their investments. Still, a situation of rising asset prices, together with fierce competition for these assets in an environment overcast with a possibility of an upcoming recession that could drive down prices, made it difficult to close deals, according to an annual global private equity report from Bain & Company. These firms are cautious about whether today’s deals will bring them to their targeted returns. Banks are also wary of financing big deals.

According to Hugh MacArthur, head of global private equity with the Boston management consulting firm, “Capital superabundance and the tide of recent exits drove dry powder to yet another record high in 2016. Shadow capital in the form of co-investment and co-sponsorship could add another 15% to 20% to that number. While caution about interest rates remains, there is a general expectation that debt will remain affordable. As a result, deals won’t be getting any cheaper.”

Investors continued to show interest in private equity in 2016, and these firms raised $589 billion globally, just 2% shy of the 2015 total. One 2016 trend to note is the rise in “megabuyout” funds that raised more than $5 billion each, with 11 such funds raising a total of $90 billion. These funds appear particularly appealing to institutional investors who want to deploy large amounts of money into private equity, the management consulting firm reports.

And an overall decline in the net asset values of buyout firms, as their distributions to investors outpaced their new investments plus the value of their existing holdings, meant that some investors found themselves short of their targeted private equity allocation. For instance, the Washington State Investment Board pension fund found its private equity allocation down to 21% in 2016, from 26% in 2012. This created a positive environment for private equity fundraising in 2016, but the industry is apprehensive that this strong pace cannot last for too long, as a recession and a stalling stock market, for instance, could upset the strong dynamics.

The buyout market started off slow in 2016, as the Chinese stock market bust, declining oil prices and the uncertainty regarding Brexit in Europe all had an impact. In North America, the market did not recover momentum and the total number of deals for the year was down 24%, with deal value off 16%. In Europe, there was a more moderate drop off.

Bain finds that there is a potential for almost 800 public companies to be taken private in buyouts, but expects a much lower level of actual public-to-private buyouts going by historical activity. While returns on private equity buyouts continue to outshine the returns on public markets, the gap is closing, as it is getting harder for private equity to find outsize returns on undervalued assets in today’s more benign economic environment.

Private equity investors have also settled into longer holding periods of about five years for their investments, and this state of affairs is likely to endure for the near term. Historically, these firms have held on to assets for three to five years, but this period was pushed up in the aftermath of the financial crisis as firms had to nurse their assets over a slow recovery period, the management consulting firm reports.

In fact, deals that private equity firms were able to quickly flip over, holding onto them for less than three years, made up a mere 18% of private equity buyouts in 2016, compared to a 44% share in 2008.

No doubt, these are treacherous times for private equity and there is a misalignment of interests there too. Just ask CalPERS, it’s experiencing a PE disaster even if it’s been completely misconstrued in the popular blog naked capitalism.

I recently had a chance to talk to Réal Desrochers, the head of CalPERS’s PE program, and he told me he was concerned about the wall of money coming into private equity from super large sovereign wealth funds, many of which aren’t staffed adequately but just write “huge cheques” to private equity funds (and hedge funds).

It’s a recipe for disaster and it all reminds me of what Tom Barrack said in October 2005 when he cashed out before the crisis hit:

“There’s too much money chasing too few good deals, with too much debt and too few brains.” The amateurs are going to get trampled, he explains, taking seasoned horsemen, who should get off the turf, down with them. Says Barrack: “That’s why I’m getting out.”

Every large and small  institutional investor playing the cheque writing game should post this quote in their office along with my favorite market quote by Gary Shilling often attributed to Keynes: “The market can stay irrational longer than you can stay solvent.”

As far as private debt, it’s an increasingly popular asset class among Canada’s large pensions, including PSP which is “playing catch-up” to its large peers in this activity.

I will end it there and just say that it’s refreshing to see how OPTrust is punching above its weight in private equity and other activities. It’s not always size that matters, you can differentiate yourself in other ways as long as the governance is right.

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 paper issued by Stanford graduates seven years ago helped shift public focus to what critics call a “hidden” pension debt. Now a paper issued by UC Berkeley’s Haas Institute last month argues that full pension funding is not needed and may even be harmful.

The Stanford paper came after record losses in crucial investment funds expected to pay two-thirds of future pension costs. Whether investment earnings forecasts used to offset or “discount” future pension debt are too optimistic became a key part of pension debate.

It’s not clear at this point, needless to say, that the UC paper will mark another turning point in the debate. But pension funding has not recovered from the huge investment losses nearly a decade ago, despite a lengthy bull market that has nearly tripled the Dow index.

The California Public Employees Retirement System, only 63 percent funded last month, fears investment losses in another big market downturn could be crippling. Even a prolonged stagnant or slumping market could erode the management outlook.

It seems possible (who knows how likely) that in the years ahead there may be a growing movement, out of necessity, to accept or rationalize low pension funding as normal, reducing the pressure for employer rate increases that are already at an all-time high.

Seven years ago, the Stanford graduate student paper contending that California’s three big public pension funds had a shortfall of $500 billion, not the reported $55.4 billion, drew national media attention.

A New York Times story called it a “hidden shortfall.” A Washington Post editorial said it’s “more evidence that state governments are not leveling with their citizens about the costs of pensions for public employees.”

The Stanford study, using the principles of financial economics, discounted future pension obligations using risk-free bonds, not government accounting rules that allow pension funds to use earnings forecasts for stocks and other higher-yielding investments.

Responding to economic forecasts, not accounting theory, pension funds have lowered their forecasts. CalPERS and CalSTRS recently dropped their discount rates from 7.5 percent to 7 percent, increasing the need for more employer rate increases to fill the funding gap.

Far from signaling that low funding is becoming acceptable, Gov. Brown told Bloomberg news early this month he thinks CalPERS, which covers half of all state and local government employees, will “probably” lower its earnings forecast again.

“All that imposes greater costs on local and state government,” Brown told Bloomberg. “The pressure will mount.”

The UC paper issued last month, “Funding Public Pensions: Is full funding a misguided goal?” by Tom Sgouros, did not get major media attention. A quick internet search finds articles in The Week, The Fiscal Times, and the American Retirement Association news.

Sgouros argues that the Governmental Accounting Standards Board goal of full funding is needed for private-sector pensions but not for pensions offered by state and local governments, which are unlikely to go out of business.

The paper examines the problems created by the accounting rules in eight different categories, including actuarial and political. The conclusion is that the rules result in the “waste” of government funds that could be used for basic services.

A pension plan is “mutual insurance” for a group, not an attempt at “intergenerational equity” in which those who receive the services of government employees pay for their pensions, instead of pushing the cost to future generations.

Under the right conditions, the paper argues, a pension system with much less than full funding can pay benefits indefinitely: “Unless the combination of funding level and demographhics creates a liquidity crisis, there is always room to ‘kick the can’ further.”

A cautionary example of extreme full funding is a federal law in 2006 requiring the U.S. Postal Service to estimate pension and retiree health care liabilities 75 years in advance. By 2015 the USPS had put aside $335 billion and was 83 percent funded over 75 years.

But building a “breathtaking” retirement fund resulted in major operating losses, said the paper, that “shorted new capital investment and service expansions and left the service open to persistent charges that it is an an obsolete money-loser.”

The example in the paper of how pension funds that reach “full funding” tend to raise pensions and cut employer contributions is the California State Teachers Retirement System around 2000, as described in a Legislative Analyst’s Office report.

The UC paper said accounting rules “have been a convenient club to wield against public employee unions,” enabling claims that poor pension funding shows “the public has been duped into obligations it cannot afford.”

The author argues that many union leaders have weakened their own position by demanding full funding of pensions and viewing suggested cost-cutting reforms as an attack on benefits.

The paper quotes a source of support mentioned by other skeptics of the need for fully funding pensions, a report by the Congressional Government Accountability Office in 2008.

“Many experts and officials to whom we spoke consider a funded ratio of 80 percent to be sufficient for public plans for a couple of reasons,” said the GAO report.

“First, it is unlikely that public entities will go out of business or cease operations as can happen with private sector employers, and state and local governments can spread the costs of unfunded liabilities over a period of up to 30 years under current GASB standards.”

Girard Miller, debunking 12 pension myths, said in a 2012 Governing magazine column the view that 80 percent funding is healthy comes from anonymous GAO and Pew sources and a federal requirement that private pensions take action when funding falls below 80 percent.

Miller said pension funds should be 125 percent funded at the market peak. Based on equity losses in 14 recessions since 1926, a pension plan 100 percent funded at the end of a business expansion is likely to lose 20 percentof its value during an average recession.

“A plan funded at 80 percent going into a recession will likely find itself funded at 65 percent at the cyclical trough — and that’s a toxic recipe calling for huge increases in employer contributions to thereafter pay off the unfunded liabilities,” Miller said.

Now CalPERS is about 65 percent funded and phasing in the fourth in a decade-long series of rate increases ending in 2024. Getting back to 80 percent funding has been mentioned at the last two monthly CalPERS board meetings.

As a five-year strategic plan was adopted in February, board member Dana Hollinger suggested that a goal of 75 to 80 percent funding in five years would be more “attainable” and “realistic” than the goal that was aproved: 100 percent with acceptable risk, beyond five years.

Last week, Al Darby of the Retired Public Employees Association urged the board to reverse a short-term shift last September to lower-yielding investments expected to reduce the risk of funding dropping below 50 percent, another of the goals adopted in February.

“Restoring public equity allocation to pre-2016 levels would contribute a lot to reaching the 80 percent funding status that we are all hoping to restore,” Darby said.

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

Geoff Cutmore and Nyshka Chandran of CNBC report, Canada Pension Plan looks to raise its bet on China:

China’s gradual market liberalization may be good news for Canadian pensioners.

Canada Pension Plan Investment Board (CPPIB), the country’s largest pension fund, currently has 4 percent of its portfolio in the mainland — a figure that president and CEO Mark Machin said is too low for a globally diversified portfolio such as his.

But he plans to increase that share as the world’s second-largest economy opens itself up.

“We want to significantly increase our investment here over the long term,” he said, explaining that his fund is “substantially” underweight relative to GDP, but not necessarily relative to available market cap.

Last month, the People’s Bank of China allowed foreign investors to hedge bond positions in the foreign exchange derivatives market — a move that many strategists deemed significant to overall market reform.

“China is now by many measures the third-biggest bond market in the world at around $7 trillion, so allowing that to be more accessible to capital is yet another aspect of making this a more investable place,” Machin told CNBC at the China Development Forum in Beijing.

“We’re value investors and we’re super long term. We like to say a quarter for us is 25 years, not three months,” Machin said. “We don’t necessarily need our money back for immediate use, so I think we’re seen as relatively friendly capital, and therefore our access is reasonably good here.”

CPPIB is particularly big on Chinese e-commerce and despite the dominance of giants such as Alibaba and Tencent, Machin said he believes the sector remains exciting.

Below those large behemoths is an ecosystem of start-ups, Machin explained: “The ecosystem around these large companies is part of the secret source of innovation in this country…China’s been very thoughtful about creating the ingredients of innovation, which is creating more opportunities for all types of companies, whether it’s e-commerce or others, to bloom.”

As a long-term investor in a fast-changing market, it’s key for CPPIB to speedily identify early-stage trends, he continued.

“It now takes very little money to develop a company given the amount of cloud computing capacity…you can get a company some market for very little money, very very quickly and have a very disruptive impact.”

Last week I discussed why the Caisse and CPPIB are investing in Asian warehouses in Singapore and Indonesia noting the following:

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

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

As a burgeoning middle class develops in China and Southeast Asia and their service economy picks up, it will present long-term growth opportunities in many areas, especially e-commerce.

Let me remind you in public markets, CPPIB made a huge windfall off the Alibaba IPO a few years ago but that decision didn’t happen overnight. It took years and boots on the ground to nurture that investment.

The article above quotes CPPIB’s CEO Mark Machin as stating: “China’s been very thoughtful about creating the ingredients of innovation, which is creating more opportunities for all types of companies, whether it’s e-commerce or others, to bloom.”

I will trust Mark’s judgment on this but my own personal money is all invested in US stocks and I think it will only be invested in US stocks for the rest of my life, especially if the new Canadian federal budget announces higher taxes on capital gains and dividends. In my opinion, there is no other country that competes with the US when it comes to real innovation.

And let’s not forget, China is a communist country experimenting with “controlled capitalism”. This means capital isn’t allocated efficiently across various sectors and there is way too much government interference at all levels of the economy.

What the Chinese have managed to do is create a massive overinvestment bubble which  threatens economic growth there. In fact, the OECD recently warned that China should urgently address rising levels of corporate debt to contain financial risks as it tries rebalance the nation’s economy:

Beijing should also step up efforts to retire “zombie” state firms in ailing industries to help channel funds to more efficient sectors and enhance the contribution of innovation in the economy, the organisation said its latest survey of China’s economy.

“Orderly rebalancing requires addressing corporate over-leveraging, overcapacity in real estate and heavy industries and debt-financed overinvestment in asset markets,” the report said.

It forecast China’s economy would grow 6.5 per cent this year and 6.3 per cent in 2018.

The report warned of mounting financial risks as enterprises are heavily indebted, while housing prices have become “bubbly”.

Corporate debt is estimated at 175 per cent of GDP, among the highest in emerging economies, climbing from under 100 per cent of GDP at the end of 2008, the report said.

“Soaring property prices in the largest cities and leveraged investment in asset markets magnify vulnerability and the risk of disorderly defaults,” it said. “Excessive leverage and mounting debt in the corporate sector compound financial stability problems, even though a number of tax cuts are being implemented to reduce the burden on enterprises.

Alvaro Santos Pereira, director of the country studies division at the OECD’s economics department, said at a briefing on the report: “Although the risks are rising, the firepower in the Chinese government is big enough and if there’s a problem, it’s able to sort it out.”

The report called for better and more timely fiscal data releases and to expand funding in health and education. Monetary policy should rely more on market-oriented tools and less on targeted government policy, it said.

China is trying to boost the services sector and encourage greater innovation in the economy, partly through promoting greater entrepreneurship and the commercial use of the internet.

Official data shows more than 100,000 new firms were registered each day last year in China, but the report said there were too many unviable firms and the progress on scrapping zombie state-run companies was modest.

It cited a research report published last year saying that nearly half of steel mills and half of developers were making losses, but could still obtain loans. Zombie companies, mainly state-owned enterprises in industries plagued by excess capacity, have aggravated credit misallocation and dragged down productivity, the report said.

The State-owned Asset Supervision and Administration Commission said last year it aimed to close 345 zombie firms in the coming three years. The report said the number was “rather modest” given that the commission controls about 40,000 companies.

It added that the government should remove implicit guarantees to state firms as a way to stop corporate debt from piling up and that bankruptcy laws should be improved to help phase out zombie state firms.

China is increasing spending on research and development, but innovation does not significantly contribute to growth, the report said. Despite the soaring number of patents, “only a small share are genuine inventions”. The utilisation rate of university patents is only about five per cent compared to 27 per cent in Japan.

“Only a fraction of Chinese patents are registered in the United States, the European Union and Japan and Chinese researchers are weakly linked to global networks,” the report said. Margit Molnar, chief China economist and lead author of the report, added: “The internet should be faster and cheaper.”

The report suggested government support for innovation should extend to more sectors rather than strategically important projects and high-tech industries.

The OECD has 35 member countries, with China a strategic partner.

The organisation has a stringent set of criteria for membership based on data transparency and other factors including oil reserve levels.

The attraction of membership for China has waned as it favours involvement with other international organisations, including the International Money Fund and the G20 group of industrialised nations.

“The OECD is no longer a rich men’s club. It is important the OECD is becoming more and more global because the world has been changing dramatically over the past years,” said Pereira. “China is looking at the OECD, hopefully, with increasing interest.”

He added the organisation had close cooperation with the Chinese authorities. “We welcome that,” he said.

As you can see, even though China is still “officially” growing at a 6.5% clip, most of this growth is increasingly financed by debt to support thousands of zombie companies that should be shut down.

Also, innovation in China is not a meaningful contributor to economic growth because the Chinese don’t excel in innovation and have very few patents on any genuine inventions.

Having said this, China has managed its growth admirably thus far and we can debate whether a country like China can thrive on laissez-faire American capitalism (I personally don’t think so, not that there has been much laissez-faire capitalism going on in the US either).

In my last comment on the $3 trillion shift in investing, I stated the following:

Given my views on the reflation chimera and the risks of a US dollar crisis developing this year, I would be actively shorting emerging markets (EEM), Chinese (FXI), Industrials (XLI), Metal & Mining (XME), Energy (XLE)  and Financial (XLF) shares on any strength here (book your profits while you still can). The only sector I trade now, and it’s very volatile, is biotech (XBI) but technology (XLK) is also doing well, for now.

I still maintain that if you want to sleep well, buy US long bonds (TLT) and thank me later this year. In this deflationary environment, bonds remain the ultimate diversifier.

Now,  this morning I read that Asian shares are at 21-month highs and the US dollar is soft on Fed views which are less hawkish than previously anticipated.

Great, so am I wrong on my macro call? Nope, I am rarely wrong on my macro calls but the story I’m describing won’t hit us till the second half of the year and perhaps even in the last quarter of the year.

Yes, Chinese (FXI) shares have been breaking out on the weekly chart, propelling emerging market (EEM) shares higher too (click on images):

 

These are bullish weekly breakouts that augur well for these shares in the short run, but given my global deflation view, I wouldn’t be investing here and I’m pretty sure once global leading indicators start heading south, these markets are in big trouble (keep shorting them on any strength).

What does this have to do with CPPIB raising its stakes in China over the long term? Nothing except I would be more like PSP and remain very cautious on emerging markets including China over the near term. If there is a massive downturn in China, then reevaluate and go in and raise your stakes.

Having said this, I realize that CPPIB is a super long term investor and doesn’t need to perfectly time its entry in public and private markets, but all this bullishness on China at this particular time makes me very nervous.

Still, CPPIB is helping China fix its pension future  (they need all the help they can get) and it has developed solid relationships there, including high level government relationships it can leverage off of to make smart investments over the long run.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CPPIB put out this press release to announce the deal:

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

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

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

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

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

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

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

Ivanhoé Cambridge put out this press release on the deal:

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

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

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

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

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

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

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

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

About LOGOS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Narvaez is actually one of the luckier ones in 707.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Narvaez is actually one of the luckier ones in 707.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Caisse and benchmark portfolio returns

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

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

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

RETURNS BY ASSET CLASS

HIGHLIGHTS OF THE ACCOMPLISHMENTS

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

Bonds: performance in corporate credit stands out

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

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

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

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

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

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

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

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

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

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

Impact in Québec: a focus on the private sector

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

Growth and globalization

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

Impactful projects

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

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

Innovation and the next generation

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

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

FINANCIAL REPORTING

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

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

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

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

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

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

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

The press release states:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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