Canada’s Pensions to the Rescue?

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

Theophilos Argitis and Kristine Owram of Bloomberg report, Home Capital Is a Minor Meltdown That’s Left a Major Mark on Canada:

The story Canada has been telling itself about its economy is starting to sound like wishful thinking.

It’s too early for the meltdown at Home Capital Group Inc. to show up in the data — and, with just 1 percent of the national market, the mortgage lender may be too small to do so anyway. But it’s already had a big impact on how investors and analysts are weighing the country’s weaknesses against its strengths.

[Note: Home Capital accounts for only 1 percent of the national market but is much more present in the Greater Toronto Area, and this is where the concern lies.]

Boom-times in Vancouver and Toronto look increasingly like the spillovers from debt-fueled housing bubbles, the kind that wrought havoc in so many Western countries last decade. A banking system long considered among the world’s soundest got hit by a Moody’s downgrade this week. The government has touted a transition away from commodity-dependence and toward hi-tech smarts; Canadians are waking up to the possibility that their economy got hooked on real-estate instead.

None of that is to say that Canada has become a basket case overnight, of course. Still, expectations that it’ll grow faster than developed-world peers this year — as forecast by the Bank of Canada — may be unsustainable, according to Craig Fehr, Canadian investment strategist at money-manager Edward Jones & Co.

“Every time I see estimates for 2 plus percent GDP growth this year I just think they’re far too rosy,” he said. “It’s a function of the imbalances that exist in the economy.”

Housing is exhibit no. 1. Estimates of its direct contribution to the economy exceed 20 percent (click on image).

The figure is much higher when secondary effects are included, from lawyer fees to higher government revenue to increased retail spending driven by homeowners’ inflated sense of their own wealth, as house prices in some regions shot up more than 20 percent a year. Consumer spending as a share of gross domestic product is hovering around the highest since possibly as far back as the 1960s.

“The question is just how will the economy look as that ceases to contribute quite so forcefully,” said Eric Lascelles, chief economist at RBC Global Asset Management Inc. “All bubbles come to an end. I think it could be an interesting year or two ahead.”

Both home-ownership and consumption are being financed by record levels of household debt. Canada’s traditional remedy for commodity busts involved scraping together enough foreign financing to cushion the initial blow, then depreciating the currency to stoke manufacturing and exports.

This time, after the oil crash of 2014, there’s little sign of an industrial revival. There has been plenty of overseas borrowing: External debt was about 60 percent of GDP a decade ago; now, at C$2.3 trillion, it’s larger than the economy. But much of it has been channeled to households.

As a result, they’re “indebted to a level that is unprecedented,” said Michael Emory, chief executive officer of Allied Properties Real Estate Investment Trust, who describes that as the economy’s biggest concern. “Canadian consumers historically have been very prudent with the levels of debt they bear,” he said.

Not anymore (click on image).

Moody’s Investors Service cited the private-debt burden when it cut ratings on the country’s six biggest banks, expressing concern about asset quality.

That backdrop makes the Home Capital crisis more threatening than it otherwise might have been. A run on deposits, even at a small lender, sparks concern about contagion. Default levels across the system remain low, but could rise if the economy slows and financial conditions tighten.

Which they likely will, according to David Rosenberg, chief economist at Gluskin Sheff & Associates Inc. in Toronto, who expects credit growth to tail off. “That alone will probably cause the Bank of Canada to keep interest rates that much lower for longer,” he said.

Investors looking for the drama of a full-blown financial crash may be disappointed.

Even while downgrading Canadian banks, Moody’s acknowledged that they “maintain strong buffers in terms of capital and liquidity.” Regulators keep a relatively tight grip on the system.

And history shows that, when forced to confront problems, the industry tends to circle the wagons. Home Capital’s troubles, for example, have prompted other lenders to step up to limit the fallout. MCAP Corp. agreed to pick up C$1.5 billion in mortgages and renewals from its rival, according to the Globe and Mail. Investment funds at Canadian Imperial Bank of Commerce are buying Home Capital’s equity.

All has that contributed to a rally in the shares this week. They’re still trading at less than half the level of a month ago, and plunged again at the market’s opening on Friday after company management said on a conference call that there’s no immediate prospect of additional asset sales.

Canada’s wider financial markets have been lackluster rather than dismal. The loonie is down 1.9 percent this year, the most among 16 major currencies tracked by Bloomberg. The main stock gauge has underperformed other developed countries, but it’s still up 1.7 percent.

So investors aren’t exactly flashing warning signals. Still, they’re finding more things to worry about than was the case a month ago.

When the U.S. housing bubble collapsed, it triggered first a financial crisis and then a recession. In the event of a replay north of the border, Canada might avoid the first pitfall, if its banks are as sound as everyone says. That doesn’t mean its economy won’t get hurt in the fallout.

On Friday, Matt Scuffham of Reuters reports, Home Capital shares fall after flagging going concern issues:

Shares in Home Capital Group Inc (HCG.TO) fell as much as 20 percent in early trading on Friday after the lender said uncertainty around future funding had cast doubt about whether it could continue as a going concern.

Shares in Canada’s biggest non-bank lender hit a low of C$8.70 in early deals before recovering to trade down 11 percent at C$9.60.

Home Capital issued first-quarter results after the market closed on Thursday, alongside which it stated that: “Management believes that material uncertainty exists regarding the company’s future funding capabilities as a result of reputational concerns that may cast significant doubt upon the company’s ability to continue as a going concern.”

Depositors have withdrawn nearly 94 percent of funds from Home Capital’s high-interest savings accounts since March 27, when the company terminated the employment of former Chief Executive Martin Reid.

The withdrawals accelerated after April 19, when Canada’s biggest securities regulator, the Ontario Securities Commission, accused Home Capital of making misleading statements to investors about its mortgage underwriting business.

Home Capital relies on deposits from savers to fund its lending to borrowers, such as self-employed workers or newcomers to Canada, who may not meet the strict criteria of the country’s biggest banks.

Reuters reported on Thursday that Home Capital was in talks to divest about C$2 billion in assets to help pay down a high-interest loan, according to people familiar with the situation.

The lender needs to raise funds to help repay a C$2 billion loan from Healthcare of Ontario Pension Plan (HOOPP), which provided the high-interest line of credit last month, charging interest of 10 percent on outstanding balances. Home Capital has so far drawn down C$1.4 billion from the facility but is hoping to secure alternative funding on more favorable terms.

In a conference call with investors on Friday, Chief Financial Officer Robert Morton confirmed the company is considering selling assets to enable it to refinance quicker and pay off the emergency loan provided by HOOPP.

[Note: Boyd Erman of Longview Communications reached out to me and provided a transcript of the conference call which shows it wasn’t Robert Morton but a director, Robert J. Blowes, who said this.]

“Given the cost of the C$2 billion credit line repayment of amounts, repayment of the amounts drawn under this facility in a timely fashion is an essential part of management’s plans. This may necessitate asset dispositions,” he said.

Home Capital disclosed data on Friday that showed the rate of withdrawals by depositors was slowing, a day after the company raised doubts about its ability to continue as a going concern.

At this writing, late Friday morning, shares of Home Capital Group (HCG.TO) are down roughly 12% but enjoyed a hell of a run this week, doubling from the lows before falling back, and this on much higher than normal volume (click on image):

While some see this as a ‘classic contrarian opportunity’, I’m on record stating I wouldn’t touch these shares with a ten-foot pole given the uncertainty surrounding the fate of the company. But I also said that you shouldn’t be surprised to see them bounce every time some potentially good news story leaks and shorts sellers cover.

Ten days ago, Reuters reported that buyout firms Apollo Global Management, Blackstone Group, and Centerbridge Partners LP are among potential suitors studying bids for Canada’s biggest alternative mortgage lender. According to the article, Brookfield Asset Management and Fairfax Financial Holdings are also among other firms interested in buying Home Capital.

On Thursday, John Tilak and Matt Scuffham of Reuters reported, Home Capital plans $2 billion in asset sales to ease loan burden:

Home Capital Group, Canada’s biggest non-bank lender, is in talks to divest about C$2 billion in assets to help pay down a high-interest loan and delay a potential sale of the entire company, according to people familiar with the situation.

The company wants to sell all or part of its commercial mortgage portfolio, its consumer finance business and a small portion of its traditional residential mortgage portfolio to raise the $2 billion, the people said.

U.S. buyout firms Cerberus Capital Management L.P., Fortress Investment Group LLC and Apollo Global Management LLC are among those in active talks with Home Capital about buying some of its assets, the people said, declining to be named as the matter is not public.

Home Capital and Cerberus declined comment. Fortress and Apollo did not respond to requests for comment.

Toronto-based Home Capital expects the proceeds of the sales to help repay a $2 billion loan from Healthcare of Ontario Pension Plan, which provided a high-interest line of credit last month, the people said. Home Capital has said it plans to secure a loan on more favorable terms.

Caisse de depot et placement du Quebec, as well as other pension funds and some private equity firms, are in talks with Home Capital about providing an alternative loan, the people said.

Caisse did not immediately respond to a request for comment.

Depositors have withdrawn more than 90 per cent of funds from Home Capital’s high-interest savings accounts since March 27, when the company terminated the employment of former Chief Executive Martin Reid.

The withdrawals accelerated after April 19, when Canada’s biggest securities regulator, the Ontario Securities Commission, accused Home Capital of making misleading statements to investors about its mortgage underwriting business. The company has said the accusations are without merit.

The pace of decline of withdrawals has slowed down, recent data shows..

The sale of assets, if successful, is likely to delay the sale of the entire company, the people said.

Home Capital’s commercial mortgage business, which includes both residential and non-residential mortgages targeting higher-quality borrowers, may be worth about C$2 billion, the people said.

The consumer finance business includes secured and unsecured credit cards and could be worth about C$400 million, the people said. Home Capital could also sell as much as C$1 billion in single-family residential mortgages, the people said.

Reuters reported last week that buyout firms Apollo and Blackstone Group LP are among potential suitors studying bids for Home Capital.

On Friday morning, Matt Scuffham of Reuters confirmed Home Capital eyes disposals to address funding issues, stating this in his article:

Reuters reported on Thursday that Home Capital was in talks to divest about C$2 billion in assets to help pay down a high-interest loan, according to people familiar with the situation.

The lender needs to raise funds to help repay a C$2 billion loan from Healthcare of Ontario Pension Plan (HOOPP), which provided the high-interest line of credit last month, charging interest of 10 percent on outstanding balances. Home Capital has so far drawn down C$1.4 billion from the facility but is hoping to secure alternative funding on more favorable terms.

In a conference call with investors on Friday, Chief Financial Officer Robert Morton confirmed the company is considering selling assets to enable it to refinance quicker and pay off the emergency loan provided by HOOPP, which he said would significantly impact the company’s performance in 2017.

[Note: Boyd Erman of Longview Communications reached out to me and provided a transcript of the conference call which shows it wasn’t Robert Morton but a director, Robert J. Blowes, who said this.]

“Given the cost of the C$2 billion credit line repayment of amounts, repayment of the amounts drawn under this facility in a timely fashion is an essential part of management’s plans. This may necessitate asset dispositions,” he said.

Alan Hibben, a former Royal Bank of Canada executive who was brought in a week ago to bolster Home Capital’s board, replacing company founder Gerald Soloway, fielded many of the questions on the call, which was the first time Home Capital executives have spoken publicly since the withdrawal of deposits sparked concerns over the lender’s liquidity.

Hibben said he “fundamentally believed in the funding model of Home Capital and the role that it played in the market”.

“This company has faced a crisis in confidence and liquidity but a number of steps have been taken to address both our governance and near-term liquidity issues, which will provide a platform which we can build on to assess our strategic alternatives,” he said.

Hibben said he was taking on a grater role, alongside management, to address a “wide range of potential funding sources and strategic transactions”.

He added, however, that he did not expect deals in the coming weeks.

“We have some breathing room so that we can address medium and longer-term issues in a thoughtful way. I don’t expect there to be any new, significant, transactions within the next days and weeks,” he said.

Home Capital disclosed data on Friday that showed the rate of withdrawals by depositors was slowing, a day after the company raised doubts about its ability to continue as a going concern.

Alan Hibben wasn’t the only person Home Capital brought in to shore up its board. Earlier this week, the company announced that pension heavyweights Claude Lamoureux, Ontario Teacher’s former CEO (featured in the image at the top), and Paul Haggis, the former CEO of OMERS are joining Home Capital’s Board along with Sharon Sallows.

I don’t know if traders and investors picked up on that, but in my opinion, the addition of these credible board members had a lot to do with the rally in Home Capital’s shares this week, along with the news of interest from top buyout funds, the Caisse and other pensions.

All this got me thinking if Canada’s big pensions are behind the move to save Home Capital to limit contagion risks to the Canadian financial system.

It sounds crazy but think about it, Canada’s big pensions have a material interest in making sure the big banks don’t suffer significantly from Home Capital’s woes.

First, we had HOOPP giving the company a big loan with hefty terms and now we have interest from top buyout funds, the Caisse and “other pensions”, and well-known former CEOs of big Canadian pensions being nominated to Home Capital’s Board (soon after Jim Keohane stepped down).

If I didn’t know any better, it sounds like Canada’s big pensions are all colluding to save Home Capital Group to limit contagion risk to the Canadian financial system.

And that’s my weekend conspiracy theory. Buy Home Capital’s shares at your own risk. I’m still kicking myself for not holding my nose and buying Valeant Pharmaceuticals (VRX) for a quick trade earlier this week. Oh well, could have, should have, didn’t and that trade has sailed!

As far as Canadian banks, I don’t like them for a lot of reasons, and they have nothing to do with Home Capital’s problems. I see the US economy slowing down considerably in the second half of the year and we could have a perfect storm hitting the Canadian economy — US and global slowdown, lower oil prices and the bursting of the housing bubble — all of which don’t bode well for Canada’s big banks.

Add to this intensifying deflationary headwinds which will cap any increases in rates, and you understand why I don’t like financials in general, although I’m particularly worried about Canada’s big banks.

In fact, I was looking at the weekly chart of CIBC (CM), one the big six banks that’s most exposed to a downturn in housing, and it’s been hit very badly recently (click on image):

The thing with Canadian banks is every time they dip hard, Canada’s big pensions come in to buy them, but I wouldn’t rush to buy any dip here, there could be another crisis on its way, which will give investors the opportunity to buy at a lower price.

That’s all from me, hope you enjoyed reading this comment. As always, these are my views and have nothing to do with Canada’s pension giants. Do your own due diligence before buying and selling anything. I’m just providing you with my two cents.

Also, please remember to kindly donate and/ or subscribe to this blog on the right-hand side under my picture. I accept all donations and thank those of you who take the time to contribute (I’ve heard PayPal is frustrating but it should be simple, if you encounter problems, email me at

Asset Management Still Inflicted By Lack of Diversity As Emerging Managers Fight For Small Piece Of Pie: Report

Investment management is well known to be dominated by white males.

But it’s still startling to see what a small percentage of assets (1.1%) are managed by firms run by women or minorities, according to a new report authored by Harvard Business School and Bella Research Group’s Josh Lerner.

The stark number comes even as public pension funds create mandates to invest in emerging managers.

And the issue isn’t performance, because academic evidence suggests emerging managers perform just as well as white-male-run investment funds.

More on the study’s findings, from Chief Investment Officer:

They found that women-owned mutual funds control just 0.9% of assets under management, while minority-owned mutual funds control just 0.3% of assets. Among real estate funds, women-owned companies control just 0.3% of assets and minority-owned firms hold 1.5% of assets.

In the hedge fund industry, firms owned by women and minorities hold less than 1% of all assets, Lerner found. In private equity, the figure is less than 5%.

“Despite the potential economic and social benefits of utilizing diverse asset managers, the industry is afflicted by a lack of diversity,” Lerner wrote in his report.


“We highlight the need for data sources with comprehensive and detailed reporting of diverse ownership and diverse management,” Lerner wrote. “This demographic information is most notably absent in the PE and real estate spaces. Creating a publicly available, non-proprietary database with this information should be a top priority for the investment community.”


Photo by Satya via Flickr CC License

Ron Mock on Canada’s Infrastructure Needs?

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

Ron Mock, Ontario Teachers’ president and CEO was in Montreal briefly last week following the Milken Institute Conference in Los Angeles to discuss “The Real Infrastructure Questions for Canada” at The International Finance Club of Montreal.

You can read the entire speech here.  In his speech, Ron covered seven questions:

  1. What is our longer-term vision for major-project infrastructure strategy in Canada?
  2. Why should we care?
  3. What are our priorities?
  4. How should we fund these projects?
  5. What are the impediments to execution?
  6. Have other countries figured this out?
  7. Does the public support private capital investments in large infrastructure projects?

Take the time to read the entire speech here, it’s quite short and makes the critical points below:

  • On the first question: “I can’t say strongly enough that this is not about the financing. It is about having the projects with ongoing funding plans, guided by the vision that will lead us to success. My belief is that this vision remains a work in progress and when it is crystallized it will propel us forward.”
  • On the second question: Yes, we should all care, Ron is right, “we can’t afford not to. For the sake of productivity, global competitiveness and jobs.” I would also add for the sake of our environment.
  • On the third question: Ties into the vision for infrastructure. Not investing in infrastructure will lead to more congested roads, ports, airports and impede the flow of goods and services and limit the advancement of technology hubs like the one between Toronto, Kitchener and Waterloo.
  • On the fourth question: Even though Canada invests quite a bit of its GDP on infrastructure (18%), it’s not enough to meet the growing needs of investing far more ($62 billion per year till 2030 to support economic growth). Governments need capital and institutional investors trying to meet their long-dated liabilities are looking for good infrastructure projects to invest in. Moreover, on top of capital, Ontario Teachers [and other large Canadian investors] has a long history of investing in this sector and has the right partners which bring critical knowledge on managing these projects efficiently.
  • On the fifth question: The major impediments to investing in infrastructure in Canada are twofold: first, infrastructure assets are owned by three levels of government and none of them is ready to cede control and second and more importantly, “the political reality of an election cycle, which is far shorter than the time frame needed to deliver an infrastructure project from the ground up.” In this regard, all three levels of government will play a critical role, much more important than being a financing partner, in getting everyone on-side and moving in the same direction. Ron was clear on this” I believe the new infrastructure bank of Canada should be a bank on projects, not a bank of cash.”And these infrastructure projects require long-term sustainability in which partners can implement realistic user-pay rates and adjust them according to market conditions and offer a critical mass customers, have clarity around government policies and tax incentives, have a clear understanding of the need and role for regulators to protect the public’s interest, etc.
  • On the sixth question: Ron cites examples in Australia, the UK, Belgium and Denmark to make his point that some countries have figured out how the “right governance, structure and  projects” create a “win-win” situation for everyone.
  • On the last question: Ron was clear: “In order to be successful as a country, if we want to pursue this model, we are going to have to find ways to clearly demonstrate the benefits, and to gain the public trust.” Canada has many right things to make this model successful but the devil is in the details and “in an environment where our productivity is declining as our
    demography ages, I hope it won’t take a crisis for us to be forced to finally sort out those details.”

I agree and hope they do get the details right on Canada’s new infrastructure bank, government policy, the projects and a lot more.

Again, take the time to read the entire speech here, it covers the points above in more detail.

Dallas Pension Bill Clears House

Legislation was unanimously passed by the Texas House of Representatives on Thursday that would require significantly larger pension contributions from Dallas to its severely underfunded pension system.

Additionally, the bill would require higher contributions from workers while also slashing benefits.

The legislation is aimed at improving the funding of the Dallas Police and Fire pension fund, one of the most dangerously underfunded plans in the country.

But officials have disagreed on a solution, and this bill also has its detractors.

More from the Dallas Business Journal:

The city paid $118.5 million in contributions to the pension in the last fiscal year, and the bill would require $151 million from the city by 2018. Rawlings has asked for a floor to be extended for the city for seven years before having to pitch in 34.5 percent of employee pay each year. Rawlings has also asked for more city oversight of the pension’s decisions.

There is still the chance for possible tweaks as the proposal makes its way to the next chamber. Rawlings and other city council members have said that some services may have to be cut to make the higher payments, but he indicated he would stop short of going further.

The bill would also nearly double the contributions from current pension members by $1.2 billion over the next 30 years, while also cutting benefits by $1.4 billion, according to pension officials.

The bill heads to the state Senate.

CPPIB Retreats From Farmland?

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

John Tilak and Matt Scuffham of Reuters report, Canada’s CPPIB pension fund plans farmland retreat:

Canada Pension Plan Investment Board (CPPIB) has decided against making further investments in farmland and is open to selling its existing portfolio after reviewing the operations, people familiar with the matter told Reuters this week, a shift in strategy after some local farmers voiced concerns.

CPPIB began buying farmland in North America in 2012 and has since purchased about 120,000 acres in the United States and a similar amount in Canada. The country’s biggest public pension fund purchased 115,000 acres of Saskatchewan farmland from Assiniboia Farmland LP in 2013 for C$128 million ($95 million)and had intended to invest another C$500 million in Canadian farmland over a five-year period.

However, its plans met with a backlash from some local farmers who believed they would be squeezed out of buying land themselves and feared rising rents if the CPPIB pursued its mandate to maximize returns for Canada’s pensioners.

Those concerns eventually prompted the Saskatchewan government to ban some institutional investors from buying farmland in the province, whose plains usually grow more wheat than Argentina, thwarting CPPIB’s plans for expansion.

CPPIB, a late entrant to farmland business, declined to comment specifically on the changes, but the fund’s global head of public affairs, Michel Leduc, said:

“We assess performance of each investment program with that in mind as well as fit within our total portfolio approach, contribution to diversification and desired return-risk profile.”

CPPIB, which had C$298 billion ($219.62 billion) under management at the end of 2016, oversees the national pension fund on behalf of 20 million Canadians.

The fund’s move stands to be good news for some farmers and not so good for others. Those who want to expand the size of their farms are winners because they have one less tough bidder to compete against, but those hoping to sell the farm and retire may find fewer buyers.

Although CPPIB continued to buy farmland in the United States, plans to purchase farmland in Australia, New Zealand and Brazil also failed to materialize. Frustrated by the fund’s lack of progress, CPPIB Chief Executive Mark Machin recently ordered a review of the business led by its global head of real estate investments, Graham Eadie, the people told Reuters.

The sources spoke on condition of anonymity because the matter is confidential.

Eadie’s review concluded the business was not sufficiently scalable to justify further investment. As a result, CPPIB has decided not to acquire more farmland and is open to selling what it already has, the sources added.

It is not clear whether the fund is actively seeking buyers.

CPPIB’s decision comes as some large pension funds continue to look for opportunities in the sector. Wealth funds of Gulf Arab states have been buying farmland in developing nations to ensure food security. Recently, some of the Australian pension funds have started buying farmland after staying away as the local farms were often too small in value to be of interest to the A$2 trillion ($1.51 trillion) pension fund industry.

Global farmland investors range from pension plans like CPPIB to companies including Ontario-based Bonnefield and U.S.-based real estate investment trust Farmland Partners Inc.

The CPPIB has decided instead to focus on the processing, delivery and storage of agricultural products following last year’s acquisition of a 40 percent stake in Glencore Plc’s agricultural business for $2.5 billion.

As part of the changes, the fund has parted company with Angus Selby, who was based in London and had led the bank’s global investment strategy for agriculture and farmland for five years, the people added. The fund’s agriculture trading group was also laid off at the end of last year, one of the people said. Selby was not available for comment and CPPIB declined to comment.

Let me begin my comment by stating I agree with CPPIB’s decision to exit farmland. Graeme Eadie (not Graham Eadie), CPPIB’s Senior Managing Director & Global Head of Real Assets, is right, it’s not scalable and in my opinion, CPPIB is better off focusing on other private markets right now, like infrastructure, real estate, private equity and private debt.

A little over two years ago, I openly questioned whether farmland is a good fit for pensions, stating the following:

[…] the bubble in farmland is bursting and second, when it bursts and farmers walk away from their leases, it could potentially mean costly and lengthy court battles pitting landowners (ie. endowment funds and public pension funds like CPPIB and PSPIB which also invests in farmland) against farmers. That doesn’t look good at all for pensions.

All this to say, while it’s really cool following Harvard’s mighty endowment into timberland and farmland, when you come down to it, managing and operating farmland is a lot harder than it seems on paper and the risks are greatly under-appreciated. Add the potential of global deflation wreaking havoc on all private market investments and you understand why I’m skeptical that farmland is a good fit for pensions, even if they invest for the long, long run.

No doubt about it, the farm bubble burst, peaking around 2013 (click on image):

Glenn Kauth, editor of Benefits Canada, recently reported on navigating the complexities of investing in agriculture:

While a recommendation that the government reverse course on maintaining the retirement age at 65 was one of the headline suggestions to come out of the recent report from the federal advisory council on economic growth, a key focus was on four sectors the group felt have a high potential for growth in Canada. One of the four sectors was agriculture.

With US$26.1 billion in agricultural exports in 2015, Canada is already the world’s fifth-largest exporter in that sector, the report noted. The growth of the global middle class signals further growth potential, with worldwide demand expected to rise by 70 per cent by 2050. In his recent budget, Finance Minister Bill Morneau embraced the call to focus on agriculture. As part of the budget’s innovation and skills plan, the government is targeting a rise in exports in the agricultural and food category to $75 billion a year by 2025.

But while J.P. Gervais, vice-president and chief agricultural economist at Farm Credit Canada, says recent years “have been great” for agriculture in Canada, he notes predictions are for a decline of up to four per cent for farm cash receipts in 2016. The reasons, according to Gervais, include weather issues in some regions that have led to poor yields for certain crops. And while falling commodity prices have put a damper on the U.S. agricultural sector, Gervais says the decline of the Canadian dollar has helped to shield Canadian farmers from some of the pressures. “Anything but cereals is generally doing well,” he says, noting crops such as oilseeds and canola are doing better.

Focus on farmland

While Canadian agriculture shows some promise, institutional investors have been active on the global front, particularly when it comes to farmland. The activity started to pick up in 2012, when the Caisse de dépôt et placement du Québec and the British Columbia Investment Management Corp. both invested in an agricultural company launched by the U.S.-based Teachers Insurance and Annuity Association of America-College Retirement Equities Fund (TIAA-CREF). The company, TIAA-CREF Global Agriculture LLC, included $2 billion in commitments to invest in farmland in the United States, Australia and Brazil.

The move followed an investment in 2011 by the Alberta Investment Management Corp. in timberland assets owned by Australia’s Great Southern Plantations. The Alberta fund’s plan is to boost its investment in part by converting some of the land to a higher use, such as agriculture. More recent moves by Canadian plans include the Public Sector Pension Investment Board’s 2015 investment in cattle properties through Queensland-based Hewitt Cattle Australia.

Australia, in fact, seems to be a key focus for Canadian pension funds’ agricultural interests. In 2014, the Ontario Teachers’ Pension Plan invested in Aroona Farms, a grower of almonds that operates two properties in the states of Victoria and South Australia. The plan owns a 99 per cent stake in Aroona Farms.

“As part of our natural resources, we have an agriculture strategy,” said Bjarne Graven Larsen, executive vice-president and chief investment officer at the Teachers’ plan, during an announcement in March of the organization’s annual results for 2016. “And we like that a lot because it diversifies. It gives us, at least to some extent, exposure to inflation in food prices and land as well.”

While farm values have been on a long-term upswing, they’ve been on a recent downturn in one key market, the U.S. Midwest. The overall decline in U.S. farm values in 2016 was just 0.3 per cent, according to the U.S. Department of Agriculture. The declines were higher, however, in the midwestern states. Karen Dolenec, global head of real assets at Willis Towers Watson in London, England, notes Australia has generally been attractive for agricultural investments, while South America has good potential for boosting properties to higher uses.

When it comes to the merits of various crops, Dolenec emphasizes diversification. Options include investing in annual row crops that require planting every year, versus permanent ones, such as vineyards, orchards and nuts. Permanent crops, says Dolenec, can require higher upfront and ongoing investments but they do offer an investor the opportunity to add value.

At the Ontario Teachers’ plan, Graven Larsen says the focus is on slower-growing crops. “We like almond, avocado, something of the not-so-fast crop, so far,” he said last month.

How to invest is one of the key questions when it comes to deciding whether to acquire farmland as a landlord renting out the property to farmers or with more of an active role. For Canadian pension plans, the typical approach has been to be a landlord, as is the case with investments like the TIAA-CREF funds. But in Canada, a smaller player on the scene, Area One Farms Ltd., offers what president and chief executive officer Joelle Faulkner describes as a joint venture that’s “more like private equity in that we’re equity partners with the farmer.”

“They put in equity and we put in equity and they co-own,” says Faulkner, noting both owners share in the profits, with an extra portion going to the farmer for running the operation.

Investors get access to higher-quality land that often isn’t available on the open market, according to Faulkner. The idea, she adds, is to boost farm productivity. “We do upgrade about half of our portfolio.”

Faulkner expects Area One Farms, which started in 2012, to close the deal on its third fund soon and she says it’s now seeing some institutional interest. While it targets a return of 15 per cent to investors, Faulkner admits that’s largely on the capital appreciation side. The balance would be from a targeted three to five per cent from crop income.

On the other side, Justin Ourso, managing director and portfolio manager at TIAA Investments, says renting out farmland can be very “fixed income-like.” Investors, he notes, can remove themselves from the volatility of farming and avoid production risks.

The challenges

While rising farmland values are good news for investors already in the area, they can be a challenge for those looking to buy now, an issue Dolenec acknowledges is a concern but one she says is true of all real assets.

And then there are the legal difficulties. Many governments are protective about foreign investment in farmland. Saskatchewan, for example, prohibits foreigners and publicly traded entities from owning more than four hectares of land. According to Faulkner, the rules initially limited pension fund involvement in Saskatchewan farmland to the Canada Pension Plan Investment Board, which in 2013 acquired the assets of Assiniboia Farmland LP. The transaction, which involved a portfolio of more than 45,000 hectares of farmland, included an initial equity investment of about $120 million. The board then bought 12 more farms for $33.7 million.

While the board had been planning additional investments in Canadian farmland, the Saskatchewan government, amid concerns about the impact of inflated farm prices, put a halt to further purchases in 2015. Asked about the board’s investments in agriculture, spokesman Dan Madge declined to comment. “Agriculture isn’t something we’re focused on right now,” he told Benefits Canada.

Pension fund involvement is even more controversial in countries like Brazil. Canadian groups, including several unions and non-profit organizations, have taken investors like the Caisse and bcIMC to task for their involvement in Brazil through TIAA-CREF Global Agriculture LLC and demanded they refrain from further investments in its funds. The controversies centre on concerns about violence and land conflicts in areas where the fund has been acquiring farms.

Asked about the allegations, Ourso questions their accuracy and says the TIAA-CREF fund has worked to address the concerns. “We take those allegations quite seriously,” he says.

“We don’t believe that they are accurate.”

The actions the fund has taken include title searches to verify ownership for a minimum of 20 years and an assessment of legal, civil, tax or criminal matters related to the seller of the land. In Brazil, it reviews licences permitting land conversion to agriculture and satellite images to assess historical uses.

Devlin Kuyek, a researcher at Grain, a non-profiit organization that has criticized farmland investments by pension plans in Brazil, acknowledges that TIAA-CREF has made strides on disclosing the locations of its holdings in that country. The organization still has concerns about the acquisitions, however. “If TIAA is sincere about its intentions, then it should not be investing in any part of the world where there are land conflicts and ongoing processes of agrarian reform,” he says.

And beyond the legal and financial concerns is a more practical one. According to Dolenec, the fund offerings available to institutional investors remained limited, despite the interest in agriculture over the past decade.

“The range of offerings has really not grown as quickly as people expected,” she says.

But as Dolenec notes, there are other opportunities in agriculture besides farmland. Last year, for example, the CPPIB announced it was buying a 40 per cent stake in Glencore Agricultural Products, a global grains and oilseeds company whose operations include processing, storage, logistics and marketing.

As for farmland, the investment opportunities have typically been on the small side, Ontario Teachers’ Graven Larsen noted last month.

Climate change, he added, is another big consideration. “We will continue to focus on that area, but it’s not going to be huge,” he said in reference to agriculture.

“But it’s probably going to be larger than today.”

Nobody knows more about the challenges of investing in farmland than TIIA, one of the largest global investors in farmland.

Recently, protesters rallied outside TIAA’s New York offices to protest its farmland deals and TIAA’s investment services clients – 14,000 of them – and a broad coalition of international organizations requested last week that TIAA address material financial risks in how the firm’s manages its global agriculture investments:

TIAA is one of the largest global investors in farmland, with over 607,000 hectares under management in the U.S. and around the world. These farmland assets are worth about USD 8 billion. In aggregate, they represent about 1 percent of TIAA’s overall assets under management.

To mitigate this material financial risks, back in 2011, TIAA signed the Farmland Principles for responsible investing focusing on robust investment and sustainable management of farmland assets. Now this TIAA–CREF client–led coalition is requesting that TIAA demonstrate compliance with these principles in how they manage their assets under management.

This is because recent reports, described in The New York Times in 2015, claim that TIAA has promoted land speculation by investing hundreds of millions of dollars in Brazil’s cerrado wooded prairielands. These TIAA clients allege that the firm’s investments lead to land speculation in Brazil that contravenes Brazilian law restricting land ownership by foreign corporations.

Similarly, according to TIAA’s 2015 report Responsible Investing in Farmland, the firm owns 256,300 hectares of farmland in Brazil. Their clients are extremely concerned that reports of land grabbing and human rights violations in Brazil are systemic.

Beyond its direct land investments, as of March 20, 2017, TIAA has at least USD 170 million invested in SE Asian palm oil companies, some of who also represent similar material financial risks to TIAA and its clients.

As reported by Chain Reaction Research, Pepsico and TIAA face financial risks from agricultural investments and supply chains.

When you read these articles, you realize that investing in farmland isn’t clean and smooth, it’s fraught with all sorts of political, legal and financial risks.

Yes, on a smaller scale, Ontario Teachers’ CIO Graven Larsen is right, you can invest in some nice deals. I too like almonds, avocados, and walnuts, all are regular staples of my daily diet.

But investing in farmland on a much larger scale is fraught with all sorts of risks, so maybe a better approach is the private equity approach where you partner up with local experts and farmers who have an equity stake in the investment (like Area One Farms in Canada). Another approach is what CPPIB did with its massive Glencore deal.

All I know is I think CPPIB made a wise decision to retreat from farmland, especially now that it’s preparing for landing and taking a much more defensive stance, waiting for the right moment to pounce on opportunities as they arise in the future.

New York Pension Systems Outperform California

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

New York state pension systems are better funded than California state pension systems, currently take a smaller bite out of state and local government budgets, and still provide pension benefits well above the national average.

How do they do it?

Part of the answer seems to be that the New York systems, following state law, more quickly pay down the debt or “unfunded liability” mainly created when pension fund investments earn less than expected.

Investments are crucial, often expected to pay two-thirds of future pensions. To hit earnings targets critics say are too optimistic (7 percent for CalPERS and CalSTRS), half of investments usually are in the unpredictable stock market, with higher yields and larger losses.

Much of the pension funding debate in California has been about whether investment earnings can hit the target over the long run. The California-New York gap shows how quickly raising employer rates, when earnings fall below the target, can keep a lid on pension debt.

Last month, the Pew Charitable Trusts, using the most complete data available, reported the nationwide funding gap for state pensions two years ago was $1.1 trillion.

The New York state systems had 98 percent of the projected assets needed to pay future pension obligations in 2015, said the Pew report, and the California state systems had 74 percent.

“Large increases in state contributions prevented rapid growth in unfunded pensions following stock market losses created in part by the bursting of the (in the early 2000s) and housing (in 2008) bubbles,” said a Moody’s rating service report on New York state pensions last July.

The importance of continuing to make annual pension contributions large enough to pay down debt is getting more attention, driven in part by additional information reported under new government accounting rules.

Pew and Moody’s both have developed new benchmarks showing when employer-employee payments into the pension system are enough, if investment returns are exactly on target, to prevent debt from growing.

Using its “net amortization” benchmark, Pew said the combined pension contributions of the California Public Employees Retirement System and the California State Teachers Retirement System were 79 percent of the $18.9 billion needed to keep debt from growing.

While the California contribution in 2015 was under the benchmark, the New York State and Local Retirement System contributed 163 percent of the $3.7 billion needed to keep debt from growing.

Similarly, Moody’s reported last October that in 2015 California state pension contributions were 74.3 percent of its “tread water” benchmark needed to keep debt from growing, while New York state contributions were 120.8 percent.

“If all plan assumptions are met, including investment returns and demographic changes, a contribution equal to the tread water benchmark would result in a yearend NPL (Net Pension Liability) equal to its beginning of year value,” Moody’s said.

Moody’s makes an adjustment of pension debt by using a less optimistic earnings forecast to discount future pension debt. For California it’s 4.33 percent, for New York 4.54 percent.

The total adjusted net pension liability for all state pension systems was $1.25 trillion in fiscal 2015, said Moody’s. Using its method, half of the states are not contributing enough to halt debt growth, less than the 32 states with positive amortization under the Pew benchmark.

Eye-popping pension debt can be a slippery number, unintentionally changed by demographics or investment gains and losses, deliberately pushed further into the future by longer payment schedules or annual refinancing.

One benefit of rigorous debt payment, and a high funding level like New York’s, is a cushion against huge investment losses. CalPERS investments plunged from $260 billion to $160 billion during the 2008 financial crisi, dropping funding from 101 percent to 61 percent.

The CalPERS funding level was 64 percent in January. For several years, some CalPERS board members have been saying experts think dropping below 50 percent could be crippling, making a return to 100 percent funding very difficult.

CalSTRS was 64 percent funded last June. Last month, Nick Collier, a Milliman actuary, told the CalSTRS board: “I would say if you get below 50 percent, it’s really hard to recover. Maybe the number is a little bit higher than that. But I wouldn’t go below 50 percent.”

Pew said Illinois state funds in 2015 were 40 percent funded and Connecticut state funds 49 percent. Moody’s said: “If Illinois made at least a tread water contribution, its fixed costs would consume 33.5 percent of revenue, followed by Connecticut’s 30.6 percent.”

The New York State and Local Retirement System, like CalPERS and CalSTRS, has lowered its earnings forecast used to discount future pension obligations to an annual average of 7 percent.

The New York employer contribution rates for 2016, the same for state and local government, were 17.9 percent of pay for miscellaneous employees and 25.6 percent for police and firefighters, according to the NYSLRS annual financial report.

The CalPERS state rate for 2017 is 54.1 percent of pay for the Highway Patrol and 28.4 percent for miscellaneous. The average 2017 rate for local government police and firefighters is 40.6 percent of pay and 28.6 percent for miscellaneous.

An Urban Institute study of New York state pension costs last year said the average pension benefit was $31,300 in 2014, compared to the national average of $26,500. A half dozen states had higher average benefits than New York, including California at about $36,000.

Unlike a modest California reform for new hires, the Urban Institute said a New York reform in 2012 gives new hires a pension that, depending on how long they work, will only be 10 to 60 percent as large as the pensions of workers hired four decades ago.

New York has cut employer contributions when the pension fund had a surplus, like CalPERS. But a chart in the Urban Institute report shows that New York, twice in this century, more than doubled employer rates in just several years.

“After the 2000 collapse of the dot-com bubble and the 2008 financial crisis, the state passed ad hoc legislation easing plan funding rules and allowing public employers to make up funding shortfalls gradually over time instead of in a single year,” said the Urban Institute report.

Only a handful of the 717 employers in the New York State Teachers Retirement System opted to pay the rate increase gradually, Moody’s said. The NYSTRS employer contribution rate was 13.3 percent last year, down from 19.5 percent the previous year.

While CalSTRS was 64 percent funded last year, NYSTRS was 104 percent funded, according to its annual financial report. Under legislation three years ago, the CalSTRS employer rate for school districts is doubling in annual steps to 19.1 percent in 2020.

The CalPERS rate for non-teaching school employees is projected to be doubling to 27.3 percent of pay in 2023, further straining school budgets.

Unlike CalPERS and other California public pension systems, CalSTRS has lacked the power to raise employer contribution rates, needing legislation instead. For years CalSTRS officials pleaded with legislators: “Pay now or pay more later.”

So, here’s another way of looking at the gap between pension funding policy in New York and California. With a funding level of 64 percent in January, CalPERS has only kept pace with a pension system whose rates were frozen until recently.

A Caisse of Outrageous Compensation?

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

This is a bilingual comment so bear with me. La Presse Canadienne recently reported on the compensation of the Caisse’s senior managers, Combien ont gagné les patrons de la Caisse de dépôt et placement du Québec en 2016?:

Les six principaux dirigeants de la Caisse de dépôt et placement du Québec (CDPQ) se sont partagé près de 11 millions $ en rémunération totale l’an dernier, indique le rapport annuel de l’institution dévoilé mardi.

C’est un peu plus que les quelque 10,7 millions $ en salaires qui avaient été octroyés en 2015.

Son président et chef de la direction, Michael Sabia, a touché un total de 2,82 millions $, en hausse de 8,5 pour cent. Ce montant tient compte du versement d’une rémunération incitative différée de 1,12 million $. En 2013, M. Sabia avait choisi de différer 900 000 $, une somme qui a évolué en fonction de la performance de la Caisse sur trois ans, ce qui lui a permis de réaliser un rendement de 221 723 $.

L’an dernier, M. Sabia a décidé de différer 1,74 million $.

Celui qui était jusqu’à tout récemment premier vice-président et chef des placements, Roland Lescure, arrive au deuxième rang au chapitre du salaire global, avec 2,62 millions $, en hausse de 20 pour cent.

M. Lescure, qui a quitté ses fonctions au début du mois pour se joindre à la campagne du candidat à la présidentielle française Emmanuel Macron, a touché une somme différée de 987 739 $.

En 2016, la Caisse a affiché un rendement de 7,6 pour cent, soit 18,4 milliards $, dépassant son indice de référence fixé à 5,8 pour cent. Sur cinq ans, il s’agissait toutefois de la moins bonne performance annuelle du bas de laine des Québécois.

Sur cinq ans, le rendement de la CDPQ a été de 10,2 pour cent, soit 1,1 point de pourcentage de plus que son indice de référence.

Au total, les employés de l’investisseur institutionnel ont touché des primes de 59 millions $, en hausse de 21 pour cent par rapport à l’an dernier. La Caisse justifie cette progression par son rendement sur cinq ans ainsi qu’une “valeur ajoutée” de 12,3 milliards $ générée l’an dernier.

L’ensemble des employés ont choisi de différer jusqu’en 2019 une somme de 32 millions $.

Below, I translate the key takeaways:

  • According to the latest annual report which came out last Tuesday, the top six directors at the Caisse were compensated a total of $11 million in 2016, a bit more than the $10.7 million they received in total compensation in 2015.
  • Michael Sabia, the President and CEO, received a total of $2.82 million in 2016, up 8.5 per cent from the previous year. This amount includes the payment of a deferred incentive fee of $1.12 million. In 2013, Mr. Sabia chose to defer $900,000, a sum that evolved based on the Caisse’s performance over three years, resulting in a return of $221,723. Last year, Mr. Sabia decided to defer $1.74 million.
  • Roland Lescure who up until recently was the CIO of the Caisse, came in second in the overall compensation at $2.62 million, up 20 per cent from the previous year. Mr. Lescure, who left office earlier last month to join the campaign of French presidential candidate Emmanuel Macron, received a deferred sum of $987,739.
  • In 2016, the Caisse posted a return of 7.6 per cent, or $ 18.4 billion, exceeding its benchmark of 5.8 per cent. Over five years, however, it was the worst annual performance of the Fund. Over five years, the Caisse’s performance was 10.2 per cent, 1.1 percentage points more than its benchmark.
  • In total, the Caisse’s employees received $59 million in compensation in 2016, up 21 per cent from the previous year. The Caisse justifies this increase by its five-year return and a “value added” of $12.3 billion generated last year. All employees chose to defer a total of $32 million in compensation until 2019.

Now, let’s go over the main tables going over compensation, starting with table 41 on page 103 of the Caisse’s 2016 Annual Report (click on image):

In order to understand these figures, it’s important to carefully read the Report of the Human Resources Committee which begins on page 93 of the Annual Report. La Caisse’s employees receive total compensation based on four components:

  1. Base salary
  2. Incentive compensation
  3. Pension plan
  4. Benefits

I’d like to highlight passages from pages 97 and 98 of the Annual Report (click on image):


Below, I embed an extract from page 100 of the Caisse’s 2016 Annual Report discussing Michael Sabia’s compensation (click on image):

And below is figure 36 which goes over the performance components of the President and CEO’s total compensation (click on image):

Also worth mentioning some added information provided on Michael Sabia’s compensation:

  • The compensation and other employment conditions of the President and Chief Executive Officer are based on parameters set by the government after consultation with the Board of Directors.
  • In accordance with his request, Mr. Sabia has received no salary increase since he was appointed in 2009. In 2016, Mr. Sabia’s base salary remained unchanged at $500,000.
  • In 2016, Mr. Sabia received his deferred incentive compensation amount for 2013. The amount of this deferred incentive compensation totalled $1,121,723 and included the return credited since 2013.
  • When he was appointed in 2009, Mr. Sabia waived membership in any pension plan. He also waived any severance pay, regardless of the cause. Even so, given that membership in the basic pension plan is mandatory under the provisions of the Pension Plan of Management Personnel (under Retraite Québec rules), Mr. Sabia is obliged to be a member despite his waiver. In 2016, contributions to the mandatory basic plan represented an annual cost to la Caisse of $20,779.

What else is important to note in terms of compensation at the Caisse? As mentioned on page 99 of the Annual Report, under the incentive compensation program, executives must defer a minimum of 55% of their calculated incentive compensation into a co-investment account. Deferred incentive compensation for 2016 is presented in Table 42 below (click on image):

Tables 43 and 44 below provide the pension summary and severance for the president and five most highly compensated executives at the Caisse (click on images):


Table 45 below provides details of the reference markets used to reference the compensation of the president and five most highly executives of the Caisse (click on image):

Make sure you read the footnotes to these tables to understand how compensation is determined.

The reference markets used for the CEO and executive VPs and non-investment positions used for referencing compensation are provided in tables 37, 38, 39 and 40 below (click on images):



As you can see, I provided you with a thorough discussion on how exactly compensation is determined at the Caisse. The key points are that the incentive plan is based on five-year returns and a significant portion of incentive compensation for senior executives and for employees is deferred (at the end of each three-year period, the deferred amount, plus or minus the average return credited for the period, will be paid to each participant as a deferred incentive payment with restrictions).

[Note: Read my comment going over the Caisse’s 2016 results.]

Obviously, any layperson, teacher or public sector employee looking at these figures and reading articles in the Journal de Montréal will think the Caisse’s top executives are extremely well compensated.

And no doubt, they are, and total compensation has increased over the last few years but it’s based on long-term performance and added-value over a benchmark (over the last five years) and is in line with what the Caisse’s peer group doles out to its senior executives and investment professionals.

It’s been a while since I last went into a full discussion on compensation at Canada’s large public pension funds. Over two years ago, I discussed a list of the highest paid pension fund CEOs  but I need to do a more thorough job of going over compensation to explain in great detail how it’s determined and why it’s important in terms of attracting and retaining top talent to do a job that is arguably far more important and difficult than most people realize.

Michael Sabia is paid very well but he’s the President and CEO of the second largest pension fund in Canada, he and his senior executives have delivered on long-term performance targets and his job is arguably a lot more difficult than that of his peers because there is a political dimension to it which quite frankly is daunting at times (for example, he recently appeared in front of Quebec’s National Assembly to defend the Caisse’s investments in companies that are registered offshore, which by the way most funds that pensions invest in are registered in!).

As for the rest of the Caisse’s top executives, they too are paid well but in line with their peer group (and even below) and it’s important to understand they have huge responsibilities and very difficult objectives to achieve.

Lastly, one person who is missing from this list is Daniel Fournier, the Chairman and CEO of the Caisse’s real estate subsidiary, Ivanhoé Cambridge (click on image):

Mr. Fournier is also a member of the Board of Otéra Capital, a CDPQ’s subsidiary specialized in commercial real estate financing and for which he is responsible. He reports to his own board, not Michael Sabia.

There are no public reports going over compensation at Ivanhoé Cambridge but given that real estate is the most important asset class at the Caisse, and that long-term performance has been stellar in this asset class, I wouldn’t be surprised if Daniel Fournier gets paid even more than Michael Sabia (just a guess here but he has huge responsibilities).

Anyway, these are my comments on compensation at the Caisse. Just like in other large shops, the top executives make the most because they have the most responsibility.

This comment is to provide many of you with more details on how compensation is determined at Canada’s second largest pension fund and if you go over the annual reports of other large Canadian pensions, you will find a similar thorough discussion on compensation.

One thing I would like these big public pensions to provide is information on the median compensation of top executives relative to median compensation of the rest of the employees at these funds and how this ratio has varied over time.

Once again, if you have anything to add, feel free to email me at

CalPERS, CalSTRS Dislike Divestment As Dakota Access Pipeline Reignites Debate

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

A bill that began life as a requirement that CalPERS and CalSTRS divest holdings in Dakota Access Pipeline firms emerged from a legislative committee last week reborn — a requirement that the pension funds only report on their “engagement” with the firms.

The revised AB 20 by Assemblyman Ash Kalra, D-San Jose, reflects a new emphasis on what the two big state pension funds say is often a less costly and more effective alternative to divestment: remaining a shareholder with a “seat at the table” to advocate change.

Since the sale of investments in firms doing business with apartheid South Africa in 1986, all CalPERS divestments have resulted in a total loss of $7.9 billion, including transaction costs and foregone investment returns, Wilshire consultants estimated earlier this year.

The two state pension funds, still struggling to recover from huge investment losses a decade ago, are taking a harder look at a small wave of divestment bills proposed by legislators on a wide range of political issues.

Both pension funds recently were about 64 percent funded, CalPERS as of last January and CalSTRS last June. Most of their employer contribution rates are doubling over a decade or less, squeezing local government and school budgets.

Experts predict that investment earnings, expected to pay nearly two-thirds of future pension costs, will weaken after a long bull market. Both pension funds recently dropped their investment earnings forecast from an annual average of 7.5 percent to 7 percent.

The small wave of divestment bills followed Gov. Brown’s signature two years ago on a bill by Senate President Pro Tempore Kevin de Leon, D-Los Angeles, requiring divestment, if fiduciarily responsible, of thermal coal companies not transitioning to clean energy.

Last year three bills that failed passage required pension fund divestment of any holdings in securitized home rental properties, banned additional investments in firms that further the boycott of Israel, and prohibited investments in Turkey government bonds.

This year, in addition to the pipeline, there are divestment bills on firms building a Mexican border wall and Turkey government bonds and a bill requiring the two pension funds to consider financial climate risk in the management of their funds.

Critics say divestment limits investment opportunity, decreases diversification, burdens staff, and may limit returns, increase risk, and result only in a turnover of shares with little or no effect on the target.

A union-sponsored constitutional amendment (Proposition 162 in 1992), a response to a legislative “raid” on pension funds, made paying benefits the top pension board priority, up from equal standing with minimizing employer contributions and reasonable administrative costs.

“A retirement board’s duty to its participants and their beneficiaries shall take precedence over any other duty,” said the amendment. Arguably, the two state pension boards could legally decline to divest, citing net losses and their fiduciary duty to pensioners.

“The Legislature may by statute continue to prohibit certain investments by a retirement board where it is in the public interest to do so, and provided that the prohibition satisfies the standards of fiduciary care and loyalty required of a retirement board pursuant to this section,” said the amendment.

A revised investment policy adopted by the CalPERS board last week in a second reading drew opposition during public comment from RL Miller, president of Climate Hawks Vote and the elected chair of the California Democratic Party’s environmental caucus.

Miller said the divestment policy can be summed up as “no divestment ever.” The policy said divestment “appears to almost invariably harm investment performance” and often is a mere transfer of ownership that only results in a loss of influence on the company.

“This Policy, therefore, generally prohibits Divesting in response to Divestment Initiatives, but permits CalPERS to use constructive engagement, where consistent with fiduciary duties, to help Divestment Initiatives achieve their goals,” the policy said.

Despite hearing in February from dozens urging Dakota pipeline divestment, Miller said, the only CalPERS response was a letter urging Energy Transfer Partners to reroute the pipeline, then 90 percent complete and only weeks away from moving oil through Sioux sacred land.

And despite a Democratic Party resolution in 2015 urging the California Public Employees Retirement System and the California State Teachers Retirement System to divest fossil fuel, she said, two of the largest CalPERS holdings are in Exxon and Chevron.

“You are deliberately choosing to shun the single most effective tool in an engaged shareholder’s tool box, divestment,” Miller said at a CalPERS investment committee meeting. (See CalPERS video, remarks begin at 1:14)

State Controller Betty Yee, who sits on the CalPERS and CalSTRS boards, told Miller she thinks the policy encourages engagement but is not an outright ban on divestment, which should be considered on a case-by-case basis.

“We are fiduciaries of this fund,” Yee said. “Our sole focus is how we are going to pay the benefits that our public-sector workers and educators have earned during their career, and it’s becoming a tougher business to be in as you heard this morning.”

People listen when CalPERS (investments valued at $317.5 billion last week) speaks, Yee said, but it lacks clout to make change on its own and does much engagement with other large investors. She said some work is not reported in documents that might reveal strategy.

“But understand, we are not letting up on this,” Yee said. “We also see the risk, the huge risk that climate is going to place on this fund relative to the ability of companies to continue to create long-term value.”

The CalSTRS board discussed divestment early this month while taking an “oppose unless amended” position on three bills. A forum to help legislators better understand work already being done was mentioned as a way to slow the introduction of divestment bills.

CalPERS did not take a position on the divestment bills. Kalra said he was influenced by the CalPERS and CalSTRS advocacy of engagement as he told the Assembly public pension committee his Dakota pipeline measure was no longer a divestment bill.

A bill requiring divestment of companies that build President Trump’s Mexican border wall was rescheduled for a hearing in the Assembly committee on May 3, an author of AB 946, Assemblywoman Lorena Gonzalez Fletcher, D-San Diego, said in a news release.

The committee approved a bill requiring divestment of Turkey bonds for failure to recognize the Aremenian genocide. The author, Adrin Nazarian, D-Van Nuys, said AB 1597 would only take effect if the federal government acts first.

Today, the Senate pension committee is scheduled to hear a bill requiring the two pension funds to consider climate risk in fund management and to make annual reports of climate risk in their investment portfolios, SB 560 by Sen. Ben Allen, D-Santa Monica.

CPPIB Preparing For Landing?

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

Benefits Canada reports, CPPIB to sell Irish aircraft leasing company:

The Canada Pension Plan Investment Board and its co-investors have announced the sale of Dublin-based aircraft leasing company AWAS to Dubai Aerospace Enterprise Ltd.

The CPPIB first invested in the company with European private equity firm Terra Firma in 2006.

“We are pleased with the outcome of this transaction,” said Ryan Selwood, managing director and head of direct private equity at CPPIB. “We continue to believe that the aircraft leasing industry is a highly attractive market for CPPIB over the long term and look forward to exploring future opportunities to invest in the sector at scale, subject to market conditions.”

AWAS leases airplanes to 87 airline customers in more than 45 countries and has assets totalling about $10 billion as of last November. The company owns 214 aircraft with an average age of 5.8 years, and has also ordered 23 new aircraft.

In March 2015, AWAS sold 84 aircraft to Macquarie Group Ltd. Since then, it has continued to grow its business and portfolio.

The deal is subject to regulatory approval and is expected to close in the third quarter of 2017.

The Telegraph also reports, Guy Hands’ Terra Firma sells aircraft leasing investment to Dubai-based rival:

Private equity baron Guy Hands has sold an aircraft leasing business his hedge fund Terra Firma has co-owned for more than a decade.

The fund, alongside co-investors and the Canada Pension Plan Investment Board (CPPIB), has sold the Dublin-based aircraft lessor Awas to Dubai Aerospace Enterprise, the largest aircraft lessor in the Middle East. The terms were not disclosed.

Awas was formed in 2006 when Terra Firma and CPPIB bought the underlying business and later snapped up rival Pegasus in 2007. It now boasts $7.5bn of owned aircraft assets that it leases out to 87 airlines in more than 45 countries. Besides the 214 aircraft it owns, Awas also has 23 new ones on order.

At acquisition in 2006, Awas owned 154 Airbus and Boeing aircraft, with long-term leases and what the investors saw as good rental income.

Terra Firma said its decision to invest in the company was based on its view the aviation sector would grow rapidly, with the world fleet expected to double by 2034, and steady demand from airlines for leased aircraft.

International Airlines Group said in its recent results in February it had 32 additional leased aircraft compared to the same period last year partially due to fleet renewal with 13 less owned aircraft.

But some airlines are eyeing greater levels of ownership, with easyJet stating in its full-year results in November last year the size of its leased fleet had decreased by 6.4pc to 64 while its owned fleet rose by more than 10pc to 180 thanks to its recent purchase of 20 A320 aircraft.

Mr Hands, chairman and chief investment officer of Terra Firma, said it was “the right time for Terra Firma to realise maximum value for our investors”.

“Under our ownership, we have transformed the company to better reflect the fast-changing market that it serves,” he said.

“This has been achieved through an active aircraft acquisition and disposal strategy to optimise the business’ portfolio and align with its diverse customer base.”

The sale of the business comes just over two years after the company sold 84 aircraft to Macquarie Group, a transaction that Terra Firma said was a significant stage in preparing the business for sale.

Dubai Aerospace Enterprise was founded in 2006 and counts airlines such as Emirates, EVA Airways, easyJet, Wizz and EgyptAir among its customers.

Ryan Selwood, managing director, head of direct private equity, at CPPIB, said in spite of the sale it would look for other opportunities in the aircraft leasing space in the future.

Goldman Sachs is acting as financial advisor and Milbank as legal advisor to the seller. The deal is subject to regulatory approval and is expected to close in Q3 2017.

Anshuman Daga of Reuters also reports, Dubai Aerospace to buy aircraft lessor AWAS, catapults to top tier:

Government-controlled Dubai Aerospace Enterprise Ltd (DAE) is acquiring Dublin-based AWAS, the world’s tenth biggest aircraft lessor, in a deal that will add over 200 planes to its fleet and more than double the size of its current business.

AWAS is the latest asset to be sold in the rapidly consolidating global aircraft leasing industry whose top 50 lessors had a fleet value of $256 billion last year, according to consultancy Flightglobal. The sector is seeing increased investment from players in emerging markets such as China, which were also in the running for AWAS, sources said.

Reuters had reported in December citing sources that AWAS had been put up for sale in an auction that could value the lessor at $7 billion, including debt.

DAE, controlled by the government of Dubai, signed a definitive agreement to buy AWAS from British financier Guy Hands’ private equity firm Terra Firma Capital Partners and Canadian Pension Plan Investment Board (CPPIB), the companies said on Monday. They did not disclose financial terms of the deal.

DAE, which calls itself the largest aircraft lessor in the Middle East with a portfolio of 112 planes, said the combined company will have an owned, managed and committed fleet of 394 planes with a total value of over $14 billion. It will have more than 110 airline customers spread across 55 countries.

“This acquisition of AWAS is strategically compelling and propels DAE into a top 10 aircraft leasing platform,” DAE Managing Director Khalifa H. AlDaboos said in a statement.

“Our leasing business has been growing at a rapid clip and this acquisition will more than double the current size of our business…”he said.

Paid for in U.S. dollars, aircraft are comparatively easy to re-lease to various airline operators across the world.

AWAS has a fleet of 263 owned, managed and committed narrow and wide-body aircraft, including a pipeline of 23 new aircraft on order to be delivered before the end of 2018.

DAE said its transaction will be financed by the group’s internal resources and committed debt financing. The deal is subject to regulatory approvals and is expected to be completed in the third quarter of this year.

The latest sale marks the exit of Terra Firma and CPPIB from AWAS, in which they first put in money in 2006. In 2015, Macquarie Group bought about 90 planes from AWAS for $4 billion.

DAE was advised by Freshfields Bruckhaus Deringer LLP and Morgan Stanley & Co. LLC. DAE was also advised by KPMG and Latham and Watkins LLP. Goldman Sachs is acting as financial adviser and Milbank as legal adviser to the seller.

You can read CPPIB’s press release on this deal here. What do I think of this deal? It’s a great deal for all parties involved.

Let me provide you with some background. Back in March 2011, CPPIB spent $266 million to help fund an expansion of AWAS:

The Canada Pension Plan Investment Board has pledged to spend $266 million to help fund expansion at Dublin-based aircraft leasing firm AWAS.

AWAS has a fleet of over 200 commercial aircraft on lease to more than 90 customers in approximately 45 countries. It employs roughly 120 people worldwide, and has 110 aircraft on order from Airbus and Boeing.

CPPIB’s investment adds to the $347 million US that CPPIB has already directly invested in the company.

The investment is part of $529 million US in total that AWAS secured to fund its expansion plans Thursday. The other major partner is Terra Firma — which pledged an additional $246 million US — but other investors are also putting up $17 million US.

CPPIB already owns 16 per cent of AWAS and the investment will increase its stake to 25 per cent. Terra’s stake will increase to 60 per cent, and other investors will own the remaining 15 per cent. CPP’s stake could increase beyond 25 per cent because it has committed a further $200 million US that AWAS could draw on at a later date.

The aircraft leasing firm’s plan to grow comes at an opportune time, CPPIB management said in a release.

“We are delighted to help fund AWAS’ acquisition strategy at what we feel is an attractive point in the aviation cycle to invest,” said Andre Bourbonnais, senior vice-president for private investments at CPPIB.

“We see this as another affirmation of the value of our proven platform, growth strategy,” AWAS president Ray Sisson said of the deal.

The CPPIB invests surplus money from employer and employee contributions that aren’t required to pay current retirement benefits. It had $140.1 billion in assets at the end of December.

As you can see, CPPIB can also thank André Bourbonnais (and Mark Wiseman) for this deal which netted it a very handsome return (AWAS was bought for roughly $4 billion and reportedly sold for over $7 billion).

Interestingly, Mr. Bourbonnais is now the CEO of PSP Investments which launched its own aviation leasing platform back in 2015 (SKY Leasing) with industry veteran Richard Wiley (Jim Pittman who is now the head of private equity at bcIMC worked on that deal).

What does Dubai Aerospace Enterprise (DAE) get from this deal? It’s catapulted to a top tier global  aircraft leaser and will enjoy rental income for many more years ahead but will likely ride out some turbulence in the short run depending on how bad the next global economic downturn is (you can read more on giants of aircraft leasing here).

If you look at the latest press releases from CPPIB, you’ll see it has been very busy lately with mega private deals which I would characterize as more defensive in nature (this after I recently stated CPPIB is sounding the alarm on markets).

For example, along with Blackstone, it recently acquired Ascend Learning from private equity funds advised by Providence Equity Partners and Ontario Teachers’ Pension Plan.Ascend is a leading provider of educational content, software and analytics solutions.

Today CPPIB announced that it and funds affiliated with Baring Private Equity Asia (BPEA) announced their intention to purchase all outstanding shares of, and to privatize, Nord Anglia Education, Inc. (Nord Anglia), the world’s leading premium schools organization, for a purchase price of USD 4.3 billion, including repayment of debt:

  • Nord Anglia operates 43 leading private schools globally in 15 countries in China, Europe, Middle East, North America and South East Asia
  • Funds affiliated with BPEA are the majority shareholders of Nord Anglia and BPEA controls 67% of Nord Anglia’s issued and outstanding share capital

The transaction is subject to shareholder approval and customary closing conditions.

Keep in mind, this mega deal comes after another deal announced in March when CPPIB and Singapore’s GIC bet big on US college housing.

Why invest billions in private schools and higher education? It makes perfect sense from a long-term perspective. It’s a play on global wealth inequality and how rich foreigners will spend a lot of money sending their kids to private schools and US colleges.

But it’s also a play on the need for students from all socioeconomic backgrounds to invest in higher education to compete in an increasingly more competitive workplace where certain skills are highly coveted (interestingly, the Fed’s Kashkari thinks spending on education, not infrastructure, is the key to US economic growth).

Lastly, please take the time to read this recent interview with John Graham, Managing Director, Head of Principal Credit Investments at CPPIB. Graham discusses CPPIB’s approach in private credit investments, including which segments are most attractive in this space and how CPPIB is dealing with increased competition from other institutions getting into private debt markets.

Are State Pensions Failing to Deliver?

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

Rupert Hargreaves of ValueWalk reports, State Pension Funds Take On More Risk, Higher Fees For Worse Returns:

State and locally run retirement systems are increasingly turning to alternative and complex investments to help boost returns but these decisions may not be the best for all stakeholders involved, that’s according to a new report from The Pew Charitable Trusts.

The report, which is the latest in a series of reports from Pew on the topic, uses data from the 73 largest state-sponsored pension funds, which collectively have assets under management of over $2.8 trillion (about 95 percent of all state pension fund investments).

The use of alternative investment by pension funds varies widely across the industry. The use of alternative investments for the 73 largest public funds analyzed by Pew within its report varies from 0 to over 50% of fund portfolios. There are also vast differences in returns and returns reporting.

State Pension Funds Take On More Risk, Higher Fees For Worse Returns

For the 41 largest state funds that can be clearly compared against target returns—those reporting performance after accounting for management fees and on a fiscal year basis— the average annual target return in 2015 was 7.7 %. Actual annualized returns over ten years, however, averaged 6.6 % and ranged from 4.7 % to 8.1 % a year. Only one of the 41 (and two of all 73 funds) exceeded their target return in 2015.

At the same time, the majority of funds report on the basis of a fiscal year ending June 30 and include 10-year performance returns minus the fees paid to investment managers, although 12 funds report on a different period and more than a third provide ten year returns only “gross of fees.”

States also vary in whether they include performance-based fees for certain investments, known as carried interest, for private equity. States that disclose the cost of carried interest report higher fees than states that do not.

Over the past three decades, public pension funds have increasingly relied on more complex investments to reduce volatility and improve returns. A difference of just one percentage point in annual returns on the $3.6 trillion managed by the US pension industry equates to a $36 billion impact on pension assets.

However, while asset managers have been diversifying into assets such as real estate, hedge funds, and infrastructure in an attempt to reduce volatility and improve returns, Pew’s research shows US public pension plans’ exposure to financial market uncertainty has increased dramatically over the past 25 years. Between 1992 and 2015 the expected equity risk premium for public funds increased from less than 1% to more than 4%, as bond yields declined in the assumed rates of return remained relatively stable. What’s more, research shows that the asset allocation required to yield target returns today has more than twice as volatile as the allocations used 20 years ago as measured by the standard deviation of returns.

Given the fact that the majority of pension funds target a long-term return rate of 7% to 8%, with three only falling outside the range and given the current depressed interest rates available on fixed income securities, is easy to see why funds are investing in more complex instruments in an attempt to improve returns.

Indeed, Pew notes public pension funds more than doubled allocations to alternative investments between 2006 and 2014 with the average allocation rising from 11% of assets to 25% on assets. The higher expected return on these assets has allowed pension funds to keep return assumptions relatively constant.

But while managers have diversified in an attempt to improve returns, it seems exactly the opposite is happening. The shift to alternatives has coincided with a substantial increase in fees as well as uncertainty about future realized returns. State pension funds reported investment fees equal to approximately 0.34% of assets in 2014, up from an estimated 0.26% in 2006, which may seem like a small increase but in dollar terms, it equates to over $2 billion.

Pennsylvania’s state public pension funds are some of the highest fee payers in the industry with reported annual fees coming in at more than 0.8% of assets, or 0.9% when unreported carried interest for private equity is included. The dollar cost is $700 million per annum.

In total, the US state pension system paid $10 billion in fees during 2014 this figure includes unreported fees, such as unreported carried interest for private equity. Pew’s analysts estimate that these unreported fees could total over $4 billion annually on the $255 billion private equity assets held by state retirement systems.

Unfortunately, for all the additional risk being taken on, and fees being paid out, alternative investments and not helping state pension funds hit their return targets. 10-year total investment returns for the 41 funds Pew looked at reporting net of fees as of June 30, 2015, ranged from 4.7% to 8.1%, with an average yield of 6.6%. The average return target for these plans was 7.7%. Only one plan met or exceeded investment return targets over the ten-year period ending 2015.

You can click on the images below that accompanied this article:





Let me first thank Ken Akoundi of Investor DNA for bringing this report to my attention. For those of you who like keeping abreast on industry trends, I highly recommend you subscribe to Ken’s daily emails with links to investment and pension news. All you need to do is register here.

You can go over the overview of The Pew Charitable Trusts report here and read the entire report here.

Take the time to read this report, it’s excellent and very detailed in its analysis of state funds, highlighting key differences and interesting points on unreported fees and the success of shifting ever more assets into alternative investments like private equity, real estate and hedge funds.

A few things that struck me. First, it’s clear that state pensions are paying billions in hidden fees and something needs to change in terms of reporting these fees:

Comprehensive fee disclosure in annual financial reports is still uncommon, but a few other states have also adopted the practice. The South Carolina Retirement System (SCRS) collects detailed information on portfolio company fees, other fund-level fees, and accrued carried interest in addition to details provided by external managers’ standard invoices. Likewise, the Missouri State Employees’ Retirement System (MOSERS) is particularly thorough in collecting and reporting these fees, not only by asset class but also for each external manager. Both states reported performance fees of over 2 percent of private equity assets for fiscal 2014 in addition to about 1 percent in invoiced management fees.

If the relative size of traditionally unreported investment costs demonstrated by CalPERS, MOSERS, and the SCRS holds true for public pension plans generally, unreported fees could total over $4 billion annually on the $255 billion in private equity assets held by state retirement systems. That’s more than 40 percent over currently reported total investment expenses, which topped $10 billion in 2014. Policymakers, stakeholders, and the public need full disclosure on investment performance and fees to ensure that risks, returns, and costs are balanced to meet funds’ policy goals. Such assessments are unlikely when billions of dollars in fees are not reported.

I totally agree with that last part, we need a lot more fee transparency on all fees paid by asset class and each external manager. In fact, there should be a detailed breakdown of fees paid to brokers, advisors, lawyers, and pretty much all service providers at any public pension plan.

Moreover, it’s completely ridiculous that more than a third of state pensions only provide ten-year returns “gross of fees”. All public pensions should report all their returns net of all fees and costs because that represents the true cost of managing these assets.

Worse still, if you look at the state pensions that do report their ten-year returns gross of fees, you will see some well-known US pensions like CalSTRS and Mass PRIM (click on image):

It makes you wonder whether they have the appropriate systems to monitor all fees and costs or they are deliberately withholding this information because net of fees, the returns are a lot less over a ten-year period.

The Pew report also highlights mixed results among state pensions in terms of returns following a shift to alternative investment strategies:

Although no clear relationship exists between the use of alternatives and total fund performance, there are examples of top-performing funds with long-standing alternative investment programs. Conversely, funds with recent and rapid entries into alternative markets—including significant allocations to hedge funds—were among those with the weakest 10-year yields.

Among the funds with successful long-standing alternative investment programs, the report cites the Washington Department of Retirement Systems (WDRS):

For example, the Washington Department of Retirement Systems (WDRS) is among the highest-performing public funds and has had a private equities program since 1981, making it one of the earliest adopters of alternative investments. In 2014, the WDRS had 36.3 percent of total investments in alternative asset classes, including 22.3 percent in private equity, 12.4 percent in real estate, and 1.6 percent in other alternatives. Hedge funds were notably absent from the mix. The fund’s long-term experience with the complexities of alternatives is reflected in its performance metrics: The WDRS has one of the highest 10-year returns of plans examined here, at 7.6 percent in 2015, buoyed in large part by the performance of its private equity and real estate holdings.

Now, a few points here. Notice that almost all of the alternative investments at WDRS are in private equity (22.3%) and real estate (12.4%) and more importantly, they were early adopters of such investments and have relationships that go back decades? This means they really know their funds well and likely also do a lot of co-investments with their GPs (general partners or funds they invest in) to lower their overall fees.

Another success in shifting into alternatives was South Dakota’s Retirement System:

Similarly, the South Dakota Retirement System began its private equity and real estate programs in the mid-1990s and realized 10-year returns of over 8 percent in 2015. The fund held nearly 25 percent of assets in alternative investments in 2014, but lowered this to less than 20 percent in 2015, comparable to the 18.3 percent held in alternatives in 2006. The 2015 allocation includes over 10 percent in real estate, 8 percent in private equity, and 1 percent in hedge funds. The fund reports net since inception internal rates of return of 9 percent for private equity and 21.4 percent for real estate, in comparison to the S&P 500 index of 5.8 percent for the same period.

But most state plans have struggled shifting assets into alternatives:

Conversely, plans with more recent shifts into alternatives—especially those with significant investment in hedge funds—are among those that exhibit the lowest returns. For example, the three funds with the weakest 10-year performance among net fiscal year reporters—the Indiana Public Retirement System, the South Carolina Retirement System, and the Arizona Public Safety Personnel Retirement System—are also among the half dozen funds with the largest recent shifts to alternative investments. All three have increased their allocations to alternatives by more than 30 percentage points since 2006. Significantly, these funds also have hedge fund allocations above the median fund, and all three rank in the top quartile for reported fees.

For example, in contrast with the WDRS and South Dakota’s early diversification, South Carolina shifted into alternatives precipitously in 2007 when the state enacted legislation to establish a new retirement system investment commission and provide the needed statutory authority to invest in high-yield, diversified nontraditional assets. Within a year, over 31 percent of plan assets were invested in alternatives, and by 2014 those assets made up nearly 40 percent of the fund’s total.

As detailed in an independent audit, rapid diversification into alternative investments proved difficult for a newly founded, under-resourced investment commission: The South Carolina Retirement System’s 10-year return of only 5 percent in 2015 is among the lowest of the plans studied. Given the long-term, illiquid nature of these investments, correcting misjudgments or realigning investments made quickly during the commission’s first years may prove challenging.

Ah yes, I remember when South Carolina was going to throw in the towel on alts. Instead, it kept on going, praying for an alternatives miracle just like North Carolina.

But there are no miracles in alternative assets, just more complexity and higher fees and if not done properly, it’s a total disaster for the plan and its stakeholders.

The report also notes that many states have consistently achieved relatively high returns without a heavy reliance on alternatives:

The Oklahoma Teachers Retirement System (OTRS) stands out in terms of performance among state-sponsored pension funds. It ranked near the top percentile of all public funds in the United States with a 10-year return of 8.3 percent gross of fees in 2015. The OTRS holds 17 percent of its assets in alternatives—below the fund average of 25 percent—with the bulk of its investments in public equities (62 percent) and fixed income (20 percent). Diversifying within the equity portfolio, employing low-fee strategies, and cutting operating costs are explicitly part of the fund’s overall strategy.

The Oklahoma Public Employees Retirement System (OPERS) takes this approach even further, with 70.2 percent of its investments in equity and 29.5 percent in fixed income. The fund holds no alternative investments. OPERS’ investment philosophy is guided by the belief that a pension fund has the longest of investment horizons and, therefore, focuses on factors that affect long-term results. These factors include diversification within and across asset classes as the most effective tool for controlling risk, as well as the use of passive investment management. Still, the fund does employ active investment strategies in less efficient markets (click on image).


The report also highlighted the need for greater standardized reporting to increase transparency:

Public retirement systems’ financial reports are guided by GASB standards, in addition to those of the Government Finance Officers Association (GFOA) and the CFA Institute. Collectively, these guidelines are widely recognized as the minimum standards for responsible accounting and financial reporting practices. For example, both GASB and the CFA Institute require a minimum of 10 years of annual performance reporting; the CFA suggests that plans present more than 10 years of data. The GFOA recommends reporting annualized returns for the preceding 3- and 5-year periods as well.

However, funds apply these standards differently. And because the performance and costs of managing pension investments can significantly affect the long-term costs of providing retirement benefits to public workers, boosting transparency is essential.

In a recent brief on state pension investment reporting, Pew reviewed the disclosure practices of plans across the 50 states and highlighted the need for greater and more consistent transparency on alternative investments. State funds paid more than $10 billion in fees and investment expenses in 2014, their largest expenditure and one that has increased by about 30 percent over the past decade as allocation to alternatives has grown.

However, over one-third of the funds in the study report 10-year performance results before deducting the cost of investment management—referred to as “gross of fees reporting.”

But the biggest problem of all at most US state pensions is they’re delusional, stubbornly clinging on to their pension rate-of-return fantasy which will never materialize. They do this to keep contributions low to make their members and state governments happy but sooner or later, the chicken will come home to roost, and that’s when we all need to worry.

The other problem and I keep referring to this on my blog, is lack of proper governance, which effectively means there is way too much political interference at state pensions, making it extremely hard for them to attract and retain qualified candidates that can manage public, private and hedge fund assets internally, significantly lowering costs of running these state pensions (basically the much touted Canadian pension model).

There are powerful vested interests (ie. extremely wealthy, politically connected private equity and hedge fund managers) who want to maintain the status quo primarily because they are the main beneficiaries of this US pension model which increasingly relies on external managers to attain an unattainable bogey.

But after reading this report, you need to ask some hard questions as to whether this shift into alternatives, especially hedge funds, has benefitted US state pensions net of all the billions in fees being doled out.

“Ok Leo, but what’s the alternative? You yourself have pointed out there is a major beta bubble going on in markets and now that the next economic shoe is dropping and the Fed is considering to shrink its balance sheet, what are these state pensions suppose to do?”

Good question. First, every investor needs a reality check and to prepare for lower returns ahead. Second, if deflation is coming, it will decimate all pensions, especially chronically underfunded pensions. They need to mitigate downside risks as much as possible and in a deflationary environment, the truth is only good old US long bonds (TLT) are the ultimate diversifier.

But bond yields are low and headed lower, which effectively means pensions need to diversify and take intelligent risks to make their required rate-of-return. Here is where it gets tricky. There are intelligent ways to take on more risk while reducing overall volatility of your funded status (think HOOPP, Ontario Teachers’ and other large Canadian public pensions) and dumb ways to increase your risk which will only make your general partners very wealthy but not benefit your plan’s funded status in a significant and positive way (think of most US state pensions).

My only gripe with The Pew Charitable Trusts report is it doesn’t focus on funded status to tie in all other information they present in the report. Pensions are all about managing assets and liabilities and it would have made the report a lot better if they focused first and foremost on funded status of each state pension, not just returns and fees.

Still, take the time to read the entire report and you have to only hope that one day Pew will do the same report for Canada’s large public pensions and compare the results to their US counterparts.