Here’s a graphic that shows what institutional investors believe to be the biggest potential risks to investment returns in 2015.
Seventeen percent of institutional investors are most worried about geopolitical risks. Meanwhile, 13 percent and 12 percent of investors, respectively, think slow growth in Europe and China pose the biggest risk to their 2015 returns.
Chart credit: Natixis “Under Pressure” report
An audit of the Dallas Police and Fire Pension System has revealed that the fund overvalued a number of risky real estate investments, including a vineyard in California and luxury homes in Hawaii.
The fund invests heavily in real estate but suffered $96 million in real estate losses in 2013 [Read the Pension360 coverage here].
From the Dallas Morning News:
After a year of wrangling and delay, an independent review of the $3.3 billion fund has confirmed what many suspected: accounting problems.
The review, which focused on the fund’s real estate holdings in 2013, estimates that it overvalued some properties by tens of millions of dollars.
The new appraisals and the city’s push for an audit came after The Dallas Morning News flagged problems with the fund’s accounting. The News reported in early 2013 that the fund valued many of its real estate ventures by what it had invested, rather than by appraisals or other methods. This was contrary to widely accepted standards.
“This report shows we need better governance and more transparency into our pension fund so we can address issues as they come up — not years after the damage has been done,” said Mayor Pro Tem Tennell Atkins, reading from a statement at a news conference he called Tuesday.
The specific findings:
[The review] found that $772 million in assets were at risk of being overvalued “because the valuation approaches or methods … appear to have been improperly applied and/or inconsistent with commonly accepted valuation practice.”
From this pool, Deloitte selected nine large assets that the fund had valued collectively at $585 million. The firm estimated the actual value of these assets instead to be between $507 million and $559 million.
Overvaluing assets on a fund’s books can create a falsely optimistic picture of its overall health, leaving police, firefighters and taxpayers on the hook for the future.
Fund officials, in a statement released Tuesday by their public relations firm, called the overvaluation flagged by Deloitte “financially immaterial when measured against DPFP’s entire investment portfolio.”
The Dallas fund allocated nearly 50 percent of its assets towards real estate investments as of 2012.
Photo by thinkpanama via Flickr CC License
A coalition of 150 investors – including pension funds from around the world – are calling on oil giants BP and Shell to provide greater transparency regarding the risks that climate change poses to their business models.
More from Chief Investment Officer:
The coalition, which includes pension funds from the UK, US, and Northern Europe, has submitted a resolution to BP outlining the articles they expect it to reveal. These resolutions can be voted upon by all shareholders in the companies. A similar resolution was submitted to Shell last month.
The resolutions include: Stress-testing their business models against the requirement to limit global warming to 2ºC, as agreed by governments at the UN Climate Change Conference in 2010; Reforming their bonus systems so they no longer reward climate-harming activities; Committing to reduce emissions and invest in renewable energy; Disclosing how their public policy plans align with climate change mitigation and risk.
Catherine Howarth, the CEO of ShareAction that helped to coordinate the demands, welcomed the support from the investors. Some 13 UK public sector pensions committed to the project, with three of the Swedish AP funds joining the campaign.
“Millions of pension savers worldwide will want their pension funds to vote in support, demonstrating true commitment to protecting their members from the risks of climate change,” said Howarth. “These resolutions put the global investment community to the test on climate change.”
The move comes as large international investors are considering the risk climate change poses to their portfolio.
Read more coverage on pension funds’ engagement with fossil fuel companies here.
Photo by penagate via Flickr CC
JP Morgan and several pension funds have reached a settlement in a class action lawsuit filed against the bank.
The lawsuit stems from investment losses sustained from mortgage-backed securities sold to investors, which, the lawsuit claims, were “far riskier than represented”.
Under the settlement, JP Morgan will pay $500 million to investors, including the Public Employees’ Retirement System of Mississippi.
From Chief Investment Officer:
JP Morgan and a group of pension funds have reached a preliminary, $500 million agreement to settle a mortgage-backed securities lawsuit, according to court filings and the Wall Street Journal.
The pension funds, including the New Jersey Carpenters Health fund and Public Employees’ Retirement System of Mississippi, represent a class of investors who purchased securities they allege were “far riskier than represented, not of the ‘best quality’ and not equivalent to other investments with the same credit ratings.”
Bear Stearns issued the nearly $18 billion worth of mortgage-backed securities in question. JP Morgan, now the world’s largest banking corporation, bought the foundering firm for $10 per share in March 2008, as the financial crisis sharply escalated.
On Thursday, lawyers for the pension funds filed a letter with the presiding New York judge indicating a preliminary settlement had been reached.
“Following extensive negotiations,” the letter stated, “the parties have reached agreement and executed a binding term sheet containing the material terms of the settlement.”
All parties have a deadline of Feb. 2 to give the court a detailed outline of the settlement.
Photo by Sarath Kuchi via Flickr CC License
The UK’s British Coal Staff Superannuation Scheme has filed a lawsuit against consultant Towers Watson for investment losses stemming from allegedly “negligent investment consulting advice”.
These types of lawsuits – a pension fund suing their consultant or investment manager – are rare. Christian Toms, a lawyer who worked with a Dutch pension fund that sued its investment firm (Goldman Sachs) in 2012, explains why these situations are so rare.
From the Tally:
Why are these kinds of legal actions, where pension funds sue their investment consultants or fund managers, so rare?
Pension funds tend to look at legal actions in a different way to hedge funds or investment banks. They are very cautious about spending a lot of their members’ money pursuing something that’s not a ‘safe bet’. For this reason, the cases we see tend already to have a lot of meat to them – a clear failure to invest in a particular way that was promised, or a complex investment that was not right for the client.
Does the argument that investment is always risky, and investors should be aware they can lose their money, make these cases inherently harder to bring?
One of the big issues is this ‘hindsight’ argument. The focus of a legal case always has to be on what was going on at the time. Did the investment manager do enough due diligence on the investment? Did they properly understand the risks, and what the clients’ risk profile was? Would a reasonable manager have done what the investment firm did in this case?
This is particularly relevant for pension funds as they are not necessarily the most aggressive investors in the world, and if they end up in a riskier structure or a more complex investment than was necessary, that could give you grounds for an argument.
Toms also talks about the possibility that we could see more of these lawsuits:
Fiduciary management is a growth area in the industry. Could this lead to more disputes of this kind?
We are seeing this more and more. Consultants are taking on more asset management responsibilities. But even if they aren’t, there may still be grounds – a duty of care in relation to the advice given, perhaps. Was the advice appropriate?
In the Towers Watson/British Coal case, if they were specifically asked to implement a currency hedging strategy, it may be a question of what was appropriate. What was the need at the time and what did they do? Was what they did what a reasonable manager would do?
Generally, with pension funds, I’d say it would do all of them a benefit to more closely scrutinize their investment firms when something has gone wrong, rather than just saying ‘oh well, that’s life, it’s unfortunate, let’s fire the asset manager and move on’.
Read the full interview here.
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The end of 2014 was a busy period for Japan’s Government Pension Investment Fund (GPIF). The fund overhauled its asset allocation and will be putting 50 percent of its assets in equities while cutting its bond holdings.
In a related move, the fund will be looking for a new crop of money managers to handle investment duties, and the GPIF is willing to shell out more money for better talent.
Businessweek reports that the GPIF could begin recruiting managers officially next month. From Businessweek:
Japan’s Government Pension Investment Fund may use a private seminar next month to inform potential job applicants as part of its efforts to recruit professional money managers to the world’s largest investor of retirement savings.
Yasuhiro Yonezawa, chairman of the investment committee at the $1.1 trillion fund, is expected to discuss GPIF’s reforms and the qualifications it wants from future staff, said Nobukiyo Akiyama, an executive at Kotora Co., a Japanese executive search firm that’s organizing the Feb. 13 event.
GPIF is seeking to hire experienced investors as it shifts to riskier assets from bonds in anticipation of faster inflation under Prime Minister Shinzo Abe. Hiromichi Mizuno, a former partner of London-based private-equity firm Coller Capital Ltd., became its first chief investment officer this month.
“The fund will have to obtain professionals that have know-how and skills for private equity, venture capital and real-estate investments following the reform, besides back-office staff,” Akiyama, manager of the chief executive officer’s office at the Tokyo-based executive search firm, said in an interview yesterday. “That’s a very specialized area.”
Kotora, which has 20,000 job seekers registered with the firm, plans to invite 80 individual and corporate clients from the asset-management industry to the seminar, which will be held in Tokyo, Akiyama said.
[…]
The pension fund won flexibility last year to pay higher salaries to attract investment staff instead of government officials.
The GPIF plans to hire about 40 new managers, according to Businessweek.
The fund manages $1.1 trillion in assets and is the largest pension fund in the world.
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At one time, pensions were seen as the safest, most secure stream of retirement income. But the security of pension benefits is no longer rock-solid. That raises the question: do pensions give retirees a false sense of retirement security?
Economist Allison Schrager explores the idea:
Until recently, a pension benefit seemed as good as money in the bank. Companies or governments set aside money for employees’ retirements; the sponsors were on the hook for funding the promised benefits appropriately. In recent years, it has become clear that most pension plans are falling short, but accrued benefits normally aren’t cut unless the plan, or employer, is on the verge of bankruptcy—high-profile examples include airline and steel companies. Public pension benefits appear even safer, because they are guaranteed by state constitutions.
By comparison, 401(k) and other defined contribution plans seem much less reliable. They require employees to decide, individually, to set aside money for retirement and to invest it appropriately over the course of 30 or so years. Research suggests that people are remarkably bad at both: About 20 percent of eligible employees don’t participate in their 401(k) plan. Those who do save too little, and many choose investments that underperform the market, charge high investment fees, or both.
It turns out that pension plan sponsors, and the politicians who oversee them, are just as fallible as workaday employees. We all prefer to spend more today and deal with the future when it comes. Pension plans have done this for years by promising generous benefits without a clear plan to pay for them. When pressed, they may simply raise their performance expectations or choose more risky investments in search of higher returns. Neither is a legitimate solution. In theory, regulators should keep pension plan sponsors in check. In practice, the rules regulators must enforce tend to indulge, or even encourage, risky behavior.
Because pension plans seem so dependable, workers do in fact depend on them and save less outside their plans. According to the 2013 Survey of Consumer Finances, people between ages 55 and 65 with pensions have, on average, $60,000 in financial assets. Households with other kinds of retirement savings accounts have $160,000. It’s true that defined benefit pensions are worth more than the difference, but not if the benefit is cut.
As the new legislation makes clear, pension plans can kick the can down the road for only so long. Defined contribution plans have their problems, but a tremendous effort has been made to educate workers about the importance of participating. (Even if the education campaign has been the product of asset managers who make money when more people participate, it’s still valuable.) Almost half of 401(k) plans now automatically enroll employees, which has increased participation and encouraged investment in low-cost index funds. And now it looks like a generous 401(k) plan with sensible, low-cost investment options may turn out to be less risky than a poorly managed pension plan, not least of all because workers know exactly what the risks are.
Read the entire column here.
Photo by http://401kcalculator.org via Flickr CC License
This week, two Canadian pension funds — the Ontario Teachers’ Pension Plan Board and the Public Sector Pension Investment Board – teamed up with Spanish bank Banco Santandar S.A. to manage a $2 billion portfolio of renewable energy assets.
Leo Kolivakis of the Pension Pulse blog weighed in on the clean energy bet in a post on Wednesday. The post is re-published below.
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Originally published at Pension Pulse
This is a big deal and I expect to see more deals like this in the future as more European banks shed private assets to meet regulatory capital requirements. In doing so, they will looking to partner up with global pension and sovereign wealth funds that have very long-term investment horizons.
The Spaniards are global leaders in infrastructure projects (Germans and French are also top global infrastructure investors led by giants like HOCHTIEF and VINCI). When it comes to renewable energy, Spain is the first country to rely on wind as top energy source:
Spain is the first country in the world to draw a plurality of its power from wind energy for an entire year, according to new reports by the country’s energy regulator and wind energy advocacy group Spanish Wind Energy Association (AEE).
Wind accounted for 20.9 percent of the country’s energy last year — more than any other enough to power about 15.5 million households, with nuclear coming in a very close second at 20.8 percent. Wind energy usage was up over 13 percent from the year before, according to the report.
The news is being hailed by environmental advocates as a sign that Spain, and perhaps the rest of the world, is ready for a future based on renewables. But the record comes at the end of a very rocky year for Spain’s renewable energy sector, which was destabilized by subsidy cutbacks and arguments over how much the government should regulate renewable energy companies.
Despite the flaws in Spain’s system, the numbers are promising for green energy fans. The renewable push brought down Spain’s greenhouse gas emissions by 23 percent, according to another industry report from Red Electric Espana (REE).
Spain also has one of the largest solar industries in the world, with solar power accounting for almost 2,000 megawatts in 2012. That’s more than many countries but still just a fraction of the energy produced by wind in Spain. In 2013, solar power accounted for 3.1 percent of Spain’s energy, according to the AEE report.
By contrast, the U.S. produced only 9 percent of its energy with renewable sources last year, and wind accounted for only 15 percent of that.
But as the world reaches for more renewables, Spain’s record-breaking year is also a cautionary tale.
Going into 2014, it’s unclear how wind will survive steep government cutbacks.
At the moment, Spain heavily subsidizes its renewable energy sector, which costs billions of dollars in a country still in the depths of a financial crisis. When the country tried to raise individual rates for renewables, people complained bitterly and the government backed off, leaving the country with a nearly $35 billion renewable energy deficit.
The idea that renewables can’t survive without heavy subsidies might be cooling off the market in Spain and elsewhere, bringing the future of renewable growth into question. Global investment in renewable energy slipped 12 percent last year, despite the fact that the European Union and the UN have set ambitious energy goals for the next decade.
It remains unclear how the world will meet those goals given the spending-averse climate of most Western governments, but there’s no doubt they’ll be looking to Spain in 2014 to see if it can be done without going broke.
Indeed, over the summer, Spain’s government dealt a death blow to renewable energy:
In the latest move to draw down Spain’s energy sector debt, Madrid unveiled a new clean energy bill this week that will cap earnings on power plants as well as introduce retroactive actions, earning a quick rebuke from the country’s already ailing renewable sector. According to a Bloomberg report, clean energy “generators will earn a rate of return of about 7.5 percent over their lifetimes,” adding that the rate may be revised every three years and is based on “the average interest of a 10-year sovereign bond plus 3 percentage points.” The new plan will be retroactively applied to programs active from July 2013.
The new plan was presented by Spain’s Industry Minister Jose Manuel Soria as a necessary evolution of the country’s renewable energy subsidy system, which he said would have gone bankrupt if no changes were made. Since taking over the country’s leadership in 2011, the right-leaning Partido Popular has continued to expand on earlier efforts to chip away at the country’s renewable energy support programs, which many critics have called unsustainable. Once hailed as one of Spain’s most viable sectors for strong growth, renewable energy has suffered under a steady restructuring of government support programs.
In addition to slowing the country’s solar and wind growth, the restructuring garnered legal action on the part of both international investors and domestic trade organizations, the latter of which has appealed to the European Commission for some level of protection from tariff and agreement reductions. Early cuts resulted in legal action against Madrid from over a dozen investment funds with stakes in the country’s solar market, adding to the unease of foreign investors.
I can tell you the cash strapped Greek government did the exact same thing on solar projects in Greece. One of the biggest risks in infrastructure projects is regulatory risk as these governments can change regulations at a moment’s notice, severely impacting the projected revenues.
What are the other risks with infrastructure projects? Currency risk and illiquidity risk as these are very long-term projects, typically with a much longer investment horizon than private equity or real estate.
But both PSP and Ontario Teachers’ are aware of these risks and still went ahead with this investments which meets their objective of finding investments that match their long-term liabilities. The Caisse has also been buying wind farms but I am wondering whether they’re blowing billions in the wind.
Interestingly, this is the second major deal between PSP and OTPP this year. In November, I wrote about how they are nearing a $7 billion deal for Canadian satellite company Telesat Holdings Inc.
And on last week, Bloomberg reported that Riverbed Technology (RVBD), under pressure from activist investor Elliott Management Corp., agreed to be acquired for about $3.6 billion by private-equity firm Thoma Bravo and Teacher’s Private Capital.
In fact, Ontario Teachers’ has been very busy completing all sorts of private market deals lately, all outside of Canada, which is smart.
Photo by penagate via Flickr CC
New York Governor Andrew Cuomo on Thursday vetoed a bill that aimed to raise the percentage of assets New York City and state pension funds could allocate towards hedge funds and private equity.
From Bloomberg:
Governor Andrew Cuomo vetoed a bill that would have allowed New York state, city and teachers pension funds to allocate a larger percentage of their investments to hedge funds, private equity and international bonds.
The measure approved by lawmakers in June would have increased the cap on such investments to 30 percent from 25 percent for New York City’s five retirement plans, the fund for state and local workers outside the city, and the teachers pension. The funds have combined assets valued at $445 billion.
“The existing statutory limits on the investment of public pension funds are carefully designed to achieve the appropriate balance between promoting growth and limiting risk,” Cuomo said in a message attached to the veto. “This bill would undermine that balance by potentially exposing hard-earned pension savings to the increased risk and higher fees frequently associated with the class of investment assets permissible under this bill.”
[…]
A memo attached to the New York bill said raising the allotment for hedge funds and other investments is necessary for flexibility to meet targeted annual returns. A swing in the value of the funds’ publicly traded stocks can push the pensions “dangerously close” to the investment cap, the memo said. The change would also better enable the funds’ advisers and trustees to “tactically manage the investments to take advantage of market trends, react to market shocks and potentially costly rebalances or unwinds at inopportune times,” it said.
New York City Comptroller Scott Stringer supported the bill.
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It was revealed last week that CalPERS has plans to review its private equity benchmarks. The pension giant’s staff says the benchmark is too aggressive – in their words, the current system “creates unintended active risk for the program”.
Pension360 last week published the take of Naked Capitalism’s Yves Smith on the situation. Here’s the analysis of pension investment analyst Leo Kolivakis, publisher of Pension Pulse, who takes a different stance.
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By Leo Kolivakis [Originally published on Pension Pulse]
I was contacted in January 2013 by Réal Desrochers, their head of private equity who I know well, to discuss this issue. Réal wanted to hire me as an external consultant to review their benchmark relative to their peer group and industry best practices.
Unfortunately, I am not a registered investment advisor with the SEC which made it impossible for CalPERS to hire me. I did however provide my thoughts to Réal along with some perspectives on PE benchmarks and told him unequivocally that CalPERS current benchmark is very high, especially relative to its peers, making it almost impossible to beat without taking serious risks.
Almost two years later, we now find out that CalPERS is looking to change its private equity benchmark to better reflect the risks of the underlying portfolio. Yves Smith of Naked Capitalism, aka Susan Webber, came out swinging (again!) stating CalPERS is lowering its private equity benchmark to justify its crappy performance.
There are things I agree with but her lengthy and often vitriolic ramblings just annoy the hell out of me. She didn’t bother to mention how Réal Desrochers inherited a mess in private equity and still has to revamp that portfolio.
More importantly, she never invested a dime in private equity and quite frankly is far from being an authority on PE benchmarks. Moreover, she is completely biased against CalPERS and allows this to cloud her objectivity. Also, her dispersion argument is flimsy at best.
Let me be fully transparent and state that neither Réal Desrochers nor CalPERS ever paid me a dime for my blog even though I asked them to contribute. I am actually quite disappointed with Réal who seems to only contact me when it suits his needs but I am still able to maintain my objectivity.
I remember having a conversation with Leo de Bever, CEO at AIMCo, on this topic a while ago. We discussed the opportunity cost of investing in private markets is investing in public markets. So the correct benchmark should reflect this, along with a premium for illiquidity risk and leverage. Leo even told me “while you will underperform over any given year, you should outperform over the long-run.”
I agreed with his views and yet AIMCo uses a simple benchmark of MSCI All Country World Net Total Return Index as their private equity benchmark (page 33 of AIMCo’s Annual Report). When I confronted Leo about this, he shrugged it off saying “over the long-run it works out fine.” Grant Marsden, AIMCo’s former head of risk who is now head of risk at ADIA, had other thoughts but it shows you that even smart people don’t always get private market benchmarks right.
And AIMCo is one of the better ones. At least they publish all their private market benchmarks and I can tell you the benchmarks they use for their inflation-sensitive investments are better than what most of their peers use.
Now, my biggest beef with CalPERS changing their private equity benchmark is timing. If we are about to head into a period of low returns for public equities, then you should have some premium over public market investments. The exact level of that premium is left open for debate and I don’t rely on academic studies for setting it. But there needs to be some illiquidity premium attached to private equity, real estate and other private market investments.
Finally, I note the Caisse’s private equity also underperformed its benchmark in 2013 but handily outperformed it over the last four years. In its 2013 Annual Report, the Caisse states the private equity portfolio underperformed last year because “50% of its benchmark is based on an equity index that recorded strong gains in 2013″ (page 39) but it fails to provide what exactly this benchmark is on page 42.
Also, in my comment going over PSP’s FY 2014 results, I noted the following:
Over last four fiscal years, the bulk of the value added that PSP generated over its (benchmark) Policy Portfolio has come from two asset classes: private equity and real estate. The former gained 16.9% vs 13.7% benchmark return while the latter gained 12.6% vs 5.9% benchmark over the last four fiscal years. That last point is critically important because it explains the excess return over the Policy Portfolio from active management on page 16 during the last ten and four fiscal years (click on image).
But you might ask what are the benchmarks for these Private Market asset classes? The answer is provided on page 18 (click on image).
What troubles me is that it has been over six years since I wrote my comment on alternative investments and bogus benchmarks, exposing their ridiculously low benchmark for real estate (CPI + 500 basis points). André Collin, PSP’s former head of real estate, implemented this silly benchmark, took all sorts of risk in opportunistic real estate, made millions in compensation and then joined Lone Star, a private real estate fund that he invested billions with while at the Caisse and PSP and is now the president of that fund.
And yet the Auditor General of Canada turned a blind eye to all this shady activity and worse still, PSP’s board of directors has failed to fix the benchmarks in all Private Market asset classes to reflect the real risks of their underlying portfolio.
All this to say that private equity, real estate, infrastructure and timberland benchmarks are all over the map at the biggest best known pension funds across the world. There are specific reasons for this but it’s incredibly annoying and frustrating for supervisors and stakeholders trying to make sense of which is the appropriate benchmark to use for private market investments, one that truly reflects the risks of the underlying investments (you will get all sorts of “expert opinions” on this subject).
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