CPPIB Gains 11.8% in Fiscal 2017

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

Jacqueline Nelson of the Globe and Mail reports, CPPIB posts strong gains as push to increase investment diversity continues:

Canada Pension Plan Investment Board posted strong investment gains in its fiscal 2017 year as the fund continues to retool its approach to risk and increase the diversity of its investments.

CPPIB, the largest pension fund in the country and manager of the Canada Pension Plan’s portfolio, said that buoyant equity markets provided a boost last year that helped the fund reach net investment gains of 11.8 per cent in its fiscal 2017 year, which ended March 31. During that period, total assets climbed to $316.7-billion compared with $278.9-billion at the same time last year.

The increase in CPPIB’s assets through the year came from $33.5-billion in net income after all costs and $4.3-billion in net Canada Pension Plan contributions.

Mark Machin, chief executive officer of CPPIB, said the fund is still finding plenty of pockets of investment opportunities, even as valuations have climbed in many asset classes outside the public markets.

“While infrastructure may be really highly priced, and private equity in the U.S. might be really highly priced, and core real estate might be really highly priced – we have teams and capabilities to find the other opportunities,” he said in a press event to discuss the fund’s results.

It has been one year since CPPIB announced the leadership change that Mr. Machin would replace outgoing CEO Mark Wiseman.

Since then, the fund has moved to further extend the range of investments the fund makes, both by asset class and geography. CPPIB did 182 global transactions in 2017, a figure that has been climbing in the last few years. Of those transactions, 19 were worth more than $500-million.

Mr. Machin said this has been one of the most active years for the fund because investment teams are getting more developed and the investment fund is growing.

CPPIB’s thematic investing team, for example, bought a stake in the parent company of river and ocean cruise operator Viking Cruises, while the fund’s private investment team acquired specialty insurance company Ascot Underwriting Holdings Ltd.

The portion of the fund’s investment activities now taking place outside of the country also continued to tick up in the past year, and 83.5 per cent of the fund’s total assets are now located beyond Canada.

Ed Cass, CPPIB’s chief investment strategist, said that diversification in geography and asset class is the “one free lunch in financial markets” that the fund gets. This year, the return profile of private assets lagged public equities, but the fund believes that infrastructure, real estate, private credit and other alternative investment classes will help improve investment results over the long term.

Still, CPPIB is highly exposed to Canada, given the country’s overall contributions to the global economy, says Mr. Machin. “But we’re comfortable being massively overweight Canada because it is our home turf and we really understand it,” he said.

CPPIB reported a 10-year annualized return of 5.1 per cent after factoring in inflation, which exceeds the standard set by Canada’s Chief Actuary.

Barbara Shecter of the Financial Post also reports, CPPIB reaps almost 12% investment return as opportunities beckon in the U.S.:

The CPP Fund, which houses investments for the Canada Pension Plan, rose to $316.7 billion at the end of March on the back of an 11.8-per-cent net annual investment return.

The $37.8-billion increase in assets consisted of $33.5 billion in net income after all CPPIB-related costs, and $4.3 billion in net Canada Pension Plan contributions.

Despite the double-digit results for fiscal 2017 — which far outstripped a 3.4-per-cent return a year earlier — soaring stock markets caused the investment fund to underperform the 14.9-per-cent return of its benchmark reference portfolio, a passive portfolio of public market indexes.

“Given our deliberate choice to build a prudently diversified portfolio beyond just public equities and bonds, we expect to see swings in performance relative to this benchmark, either positive or negative, in any single year,” said Mark Machin, chief executive of the Canada Pension Plan Investment Board, which invests funds not needed to pay current benefits of the Canada Pension Plan.

“Over the longer term, the investment portfolio has outperformed the Reference Portfolio over both the past five- and 10-year periods,” Machin said, noting that the investment portfolio is being built to be “resilient during periods of economic stress” and to add value over the long term.

Four investment departments completed 182 global transactions in fiscal 2017, which Machin said was among the fund’s busiest years. Nineteen of those investments were more than $500 million.

Current stock market volatility and political uncertainty could create opportunities for the fund in the coming year, Machin said, adding that CPPIB continues to hunt for alternative investments such as infrastructure and real estate, despite high prices caused by stiff competition.

While being outbid by other investors in many instances, CPPIB has found success in emerging markets and complex situations that draw fewer bidders, he said. But he added that there would be more opportunities in the United States if U.S. policymakers are able to advance their agenda to increase investment in infrastructure.

“If the U.S. comes on stream, that would be really interesting, because it’s such a massive market and there are pools of capital that are getting ready to invest in it,” Machin said. “If policy (makers) in the U.S. got their act together … that would produce a good home for a lot of capital.”

He declined to weigh in on what current controversies surrounding President Donald Trump will mean in terms of the likelihood of investment-friendly policies on taxes and infrastructure being adopted. But he told the Financial Post he is optimistic there will be “interesting, sizable” investment opportunities in the “not-too-distant” future.”

“It’s a bipartisan view that the U.S. needs … more investment in infrastructure,” Machin said, adding that Canada’s largest pension would be interested in everything from roads, to airports, to energy transmission.

“We would find it interesting and I think other people would as well. At the moment there is much more demand than supply.”

Machin and CPPIB’s chief investment strategist Ed Cass said they would like to find a way to make more infrastructure investments in Canada, even if it means divesting Canadian stocks or other investments here in order to rebalance the fund’s portfolio.

However, details of how such investments would work under the federal government’s new Infrastructure Bank still need to be worked out, they said. Among the challenges is that many of the projects rolled out are expected to be new “greenfield” infrastructure, which carries more risk than the operating assets CPPIB prefers.

“All other things being equal, we prefer to invest in Canada. We understand it better than anywhere else,” Machin said. “It is our home turf.”

On infrastructure, David Paddon of The Canadian Press reports, Canadian infrastructure deals scarce but would be welcome: CPPIB chief executive:

Officials from the country’s largest pension fund said Thursday they’d welcome the opportunity to invest in Canadian infrastructure but there’s been a limited supply of suitable assets available to purchase.

“If the opportunities were there, we’d love to look at them. We’d love to invest in them. It’s just a scarcity of opportunities,” said Mark Machin, CEO of the Canada Pension Plan Investment Board.

He said the CPPIB is constantly on the hunt for purchases around the world but finds itself frequently outbid by rivals when infrastructure comes on the market.

“That’s terrific for governments. It’s terrific for sellers. But when you’re competing to buy, it’s really razor-sharp pricing,” Machin said.

“So we’ve been quite cautious on where we’ve added assets.”

Machin and CPPIB chief investment strategist Ed Cass said they’d prefer to invest in late-stage infrastructure projects or completed projects rather than “green field” developments that need to be approved and built before they generate cash flow.

Cass said that the new federal infrastructure bank, which is being created by the Trudeau government, will be able to “package” opportunities for late-stage investors after going through the early stages.

But Machin said that CPPIB faces no political pressure to invest in Canada, or the infrastructure bank, because the fund has a clear mandate to maximize investment returns and operates at an arms length from all levels of government.

“We’re shielded from anything along those lines,” Machin said.

His comments were made as CPPIB, created in 1999, announced that 2016-17 marked one of its best years for investment returns in a decade. As of March 31, when CPPIB’s financial year ends, it had $316.7 billion in assets — up $37.8 billion from a year before through a combination of market gains and new funds.

That trails only the $45.5 million increase in 2014-15, the biggest in the past 10 years.

For 2016-17, the fund realized a gross return of 12.2 per cent or 11.8 per cent in net return after all costs. For the 10-year period, CPPIB’s annualized gross return was 6.7 per cent or 5.1 per cent on a net basis.

And Matt Scuffham of Reuters also reports, Canada Pension Plan says it’s losing out on infrastructure deals:

The Canada Pension Plan Investment Board (CPPIB), one of the world’s biggest infrastructure investors, is regularly losing out in bidding wars for such assets, its chief executive said, as investors seek alternatives to low-yielding government bonds.

The CPPIB is one of the world’s biggest investors in infrastructure such as roads, bridges and tunnels but its CEO Mark Machin said high valuations were making it harder to do deals in the current environment.

“We are consistently outbid for assets around the world because they are really priced almost to perfection and there’s an enormous amount of capital chasing infrastructure, particularly in developed markets,” Machin told reporters after the fund reported results for its last fiscal year on Thursday.

The CPPIB did acquire a 33 percent stake in Pacific National, one of the largest providers of rail freight services in Australia, for about A$1.7 billion ($1.3 billion) last year but was generally less active in the infrastructure space than it has been in previous years.

Machin said there could be opportunities in the United States if U.S. President Donald Trump proceeds with a $1 trillion infrastructure plan.

“If the U.S. comes on stream that would be really interesting because it’s such a massive market. There are pools of capital that are getting ready to invest in it. If policy (makers) in the U.S. got their act together that would produce a good home for a lot of capital looking for that type of opportunity,” he said.

The fund, which manages Canada’s national pension fund and invests on behalf of 20 million Canadians, reported a net return of 11.8 percent on its investments last year, helped by its strategy of diversifying across asset classes and geographies.

The performance represented a significant improvement on the year before, when the fund achieved a net return of 3.4 percent.

The CPPIB said it ended its fiscal year on March 31 with net assets of C$316.7 billion ($232.2 billion), compared with C$278.9 billion a year ago, one of the largest yearly increases in assets since it was created 20 years ago.

CPPIB put out a press release, CPP Fund Totals $316.7 Billion at 2017 Fiscal Year-End:

The CPP Fund ended its fiscal year on March 31, 2017 with net assets of $316.7 billion compared to $278.9 billion at the end of fiscal 2016. The $37.8 billion increase in assets for the year consisted of $33.5 billion in net income after all CPPIB costs and $4.3 billion in net Canada Pension Plan (CPP) contributions. The portfolio delivered a gross investment return of 12.2% for fiscal 2017, or 11.8% net of all costs.

“This was a strong year for the CPP Fund as we achieved one of the largest yearly increases in assets since the inception of CPPIB,” said Mark Machin, President & Chief Executive Officer, Canada Pension Plan Investment Board (CPPIB). “As always, we continue to focus on longer-term performance. Year-by-year results will swing, but it is noteworthy that our 11.8% five-year return mirrors our annual return. We believe this is a strong indicator of our ability to generate steady, sustainable returns for generations of beneficiaries to come.”

In fiscal 2017, CPPIB continued to prudently execute its long-term investment strategy to diversify the CPP Fund across multiple asset classes and geographies. Through four investment departments, the organization completed 182 global transactions.

“The composition of our highly diversified long-term portfolio continues to position us well, allowing us to take advantage of the strong performance of global stock markets this year, amid significant global geopolitical developments,” said Mr. Machin. “Our diverse investment programs generated strong earnings, while fixed income investments remained relatively flat.”

In the 10-year period up to and including fiscal 2017, CPPIB has now contributed $146.1 billion in cumulative net income to the Fund after all CPPIB costs. Since CPPIB’s inception in 1999, it has contributed $194.1 billion. For the five-year period, the net nominal return was 11.8%, contributing $129.6 billion in cumulative net income to the Fund after all CPPIB costs.

Five and 10-Year Returns
(for the year ending March 31, 2017)

“We are building a portfolio capable of delivering superior performance over multiple generations to help ensure the long-term sustainability of the CPP,” said Mr. Machin. “We remain disciplined in doing this, investing only in assets that we believe will collectively deliver superior risk-adjusted returns over time. Our portfolio is designed to withstand short-term market uncertainty.”

Long-Term Sustainability

CPPIB’s 10-year annualized net nominal rate of return of 6.7%, or 5.1% on a net real rate of return basis, was above the Chief Actuary’s assumption over this same period. The real rate of return is reported net of all CPPIB costs to be consistent with the Chief Actuary’s approach.

In the most recent triennial review released in September 2016, the Chief Actuary of Canada reaffirmed that, as at December 31, 2015, the CPP remains sustainable at the current contribution rate of 9.9% throughout the forward-looking 75-year period covered by his report. The Chief Actuary’s projections are based on the assumption that the Fund’s prospective real rate of return, which takes into account the impact of inflation, will average 3.9% over 75 years.

The Chief Actuary’s report also indicates that CPP contributions are expected to exceed annual benefit payments until 2021, after which a small portion of the investment income from CPPIB will be needed to help pay pensions. In addition, the report confirmed that the Fund’s performance was well ahead of projections for the 2013-2015 period as investment income was 248% or $70 billion higher than anticipated.

The CPP’s multi-generational funding and liabilities give rise to an exceptionally long investment horizon. To meet long-term investment objectives, CPPIB continues to build a portfolio designed to generate and maximize long-term returns at an appropriate risk level. Accordingly, long-term investment returns are a more appropriate measure of CPPIB’s performance than returns in any given quarter or single fiscal year.

Relative Performance Against the Reference Portfolio

CPPIB also measures its performance against a market-based benchmark, the Reference Portfolio, representing a passive portfolio of public market indexes that reflect the level of long-term total risk that we believe is appropriate for the Fund.

To provide a clearer view of CPPIB’s performance given our long-term horizon, we track cumulative value-added returns since the April 1, 2006 inception of the benchmark Reference Portfolio. Cumulative value-added over the past 11 years totals $8.9 billion, after all CPPIB costs.

In fiscal 2017, the Reference Portfolio’s return of 14.9% outperformed the Investment Portfolio’s net return of 11.8% by 3.1% The Reference Portfolio return was $8.2 billion above the Investment Portfolio’s return, after deducting all costs from the Investment Portfolio and CPPIB’s operations. Over the five- and 10-year periods, the Investment Portfolio continued to outperform the Reference Portfolio by $5.6 billion and $6.7 billion, respectively, after all CPPIB costs.

“When public markets soar, as they generally did this year, we expect the public equity-based Reference Portfolio benchmark to perform exceptionally well,” said Mr. Machin. “Over the longer term, the Investment Portfolio has outperformed the Reference Portfolio over both the past five- and 10-year periods. Given our deliberate choice to build a prudently diversified portfolio beyond just public equities and bonds, we expect to see swings in performance relative to this benchmark, either positive or negative, in any single year. Our investment portfolio is designed to deliver value-building growth and be resilient during periods of economic stress while adding value over the long term.”

Total Costs

This fiscal year reflected a decline in the operating expense ratio for the second year in a row, as well as a slowdown in the growth of CPPIB’s operating expenses. We are committed to maintaining cost discipline in the years ahead. Approximately 32% of our personnel expenses are denominated in foreign currencies and that percentage is expected to increase in the coming years as we continue to hire specialized talent and skills where most of our investing activities occur.

To generate the $33.5 billion of net income from operations after all costs, CPPIB incurred total costs of $2,834 million for fiscal 2017, compared to $2,643 million in total costs for the previous year. CPPIB total costs for fiscal 2017 consisted of $923 million, or 31.3 basis points, of operating expenses; $987 million in management fees and $477 million in performance fees paid to external managers; and $447 million of transaction costs. CPPIB reports on these distinct cost categories, as each is materially different in purpose, substance and variability. We report the investment management fees and transaction costs we incur by asset class and report the net investment income our programs generate after deducting these fees and costs. We then report on total Fund performance net of these fees and costs, as well as CPPIB’s overall operating expenses.

Investment management fees increased due in part to the continued growth in the level of commitments and the average level of assets with external managers, and the year-over-year growth in the performance fees paid. Notably, performance fees reflect the strong performance of our external managers.

Transaction costs marginally increased by $10 million compared to the prior year. This year, we completed 19 global transactions valued at over $500 million, in addition to other transactions assessed across the investment groups. Transaction costs vary from year to year as they are directly correlated to the number, size and complexity of our investing activities in any given period.

Portfolio Performance by Asset Class

Portfolio performance by asset class is included in the table below. A more detailed breakdown of performance by investment department is included in the CPPIB Annual Report for fiscal 2017, which is available at www.cppib.com.

Asset Mix

We continued to diversify the portfolio by the return-risk characteristics of various assets and countries during fiscal 2017. Canadian assets represented 16.5% of the portfolio, and totalled $52.2 billion. Assets outside of Canada represented 83.5% of the portfolio, and totalled $264.7 billion.

Investment Highlights

Highlights for the year included:

Public Market Investments

  • Invested an additional C$400 million for a 1.4% stake in Kotak Mahindra Bank (Kotak). Kotak is a leading private-sector bank holding company in India, with additional lines of business in life insurance, brokerage and asset management. To date, CPPIB has invested a total of C$1.2 billion, representing a 6.3% ownership stake in the company.
  • Invested US$280 million in convertible preferred equity securities of a parent company of Advanced Disposal Services, Inc. (Advanced Disposal), which converted to approximately 20% common equity of Advanced Disposal upon its initial public offering. Based in Ponte Vedra, Florida, Advanced Disposal is the fourth largest solid waste company in the U.S. with operations across 16 states and the Bahamas.
  • Invested A$300 million for a 9.9% ownership in Qube Holdings Limited (Qube), the largest integrated provider of import-export logistics services in Australia. The investment helped fund Qube’s share of the purchase of Asciano Limited, which was acquired by a consortium of global investors including CPPIB.

Investment Partnerships

  • Invested US$137 million in Daesung Industrial Gases Co., Ltd. (Daesung) for an 18% ownership stake, alongside MBK Partners. Headquartered in Seoul, Daesung is the leading industrial gas producer in South Korea servicing a diversified blue-chip customer base with a resilient business model supported by long-term contracts.
  • Acquired a 3.3% direct ownership interest in Bharti Infratel Limited for US$300 million, as part of the purchase of a 10.3% stake alongside funds advised by KKR, from India’s Bharti Airtel Limited. Bharti Infratel deploys, owns and manages telecom towers and communication structures for various mobile operators, and is India’s leading player.
  • Announced a combined investment of US$500 million with TPG Capital for a 17% stake in MISA Investments Limited, the parent company of Viking Cruises. TPG Capital and CPPIB each invested US$250 million to support and accelerate Viking Cruises’ growth initiatives and strengthen the company’s balance sheet. Viking Cruises is a leading provider of worldwide river and ocean cruises, operating more than 60 cruise vessels based in 44 countries.

Private Investments

  • Acquired an approximate 48% stake in GlobalLogic Inc., a global leader in digital product development services, from funds advised by Apax Partners LLP. Based in San Jose, California, GlobalLogic helps clients build innovative digital products to enhance customer engagement, user experience and service capabilities.
  • Acquired 100% of Ascot Underwriting Holdings Ltd. and certain related entities (Ascot), together with Ascot’s management, for a total consideration of US$1.1 billion. Based in London, England, Ascot is a Lloyd’s of London syndicate and a global specialty insurance underwriter with expertise spanning multiple lines of businesses, including property, energy, cargo, casualty and reinsurance.
  • Invested additional equity into Teine Energy Ltd. (Teine) to support Teine’s acquisition of the Southwest Saskatchewan oil-weighted assets of Penn West Petroleum Ltd. for a cash consideration of C$975 million. Since 2010, CPPIB has invested approximately C$1.3 billion in Teine and holds approximately 90% of the company on a fully diluted basis.

Real Assets

  • Acquired three U.S. student housing portfolios for approximately US$1.6 billion through a joint venture entity owned by CPPIB, GIC and The Scion Group LLC (Scion). CPPIB and GIC each own a 45% interest in these portfolios and Scion owns the remaining 10%. The joint venture’s well-diversified US$2.9 billion national portfolio now comprises 48 student housing communities in 36 top-tier university markets, totalling 32,192 beds.
  • Entered into two agreements to invest alongside Ivanhoé Cambridge and LOGOS, an Australian-based real estate logistics specialist, to develop and acquire modern logistics facilities in Singapore and Indonesia. In Singapore, CPPIB will initially commit S$200 million for an approximate 48% stake in the LOGOS Singapore Logistics Venture. CPPIB will also initially commit US$100 million in equity for an approximate 48% stake in LOGOS Indonesia Logistics Venture.
  • Acquired a 50% interest in a portfolio of high-quality office properties in downtown Toronto and Calgary at a gross purchase price of C$1.175 billion from Oxford Properties Group, which will retain the remaining 50% interest. The 4.2-million-square-foot portfolio includes seven office buildings with a broad mix of tenants. The transaction brings the total size of the jointly owned Oxford-CPPIB office portfolio to over 12 million square feet.
  • Acquired a 33% stake in Pacific National for approximately A$1.7 billion, as part of the consortium that acquired Asciano Limited. Pacific National is one of the largest providers of rail freight services in Australia.

Investment highlights following the year end include:

  • Signed an agreement alongside Baring Private Equity Asia to acquire all the outstanding shares of, and to privatize, Nord Anglia Education, Inc. (Nord Anglia) for US$4.3 billion, including the 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. The transaction is subject to shareholder approval and customary closing conditions.
  • Signed a definitive agreement to acquire Ascend Learning LLC (Ascend), a leading provider of educational content, software and analytics solutions, in partnership with private equity funds managed by Blackstone and Ascend management. The transaction is subject to customary regulatory approvals and customary closing conditions.
  • Formed a strategic investment platform with The Phoenix Mills Limited (PML) to develop, own and operate retail-led mixed-use developments across India. CPPIB will initially own 30% in the platform, known as Island Star Mall Developers Pvt. Ltd., a PML subsidiary, which owns Phoenix MarketCity Bangalore, for an equity investment of approximately C$149 million. CPPIB’s total commitment to the platform is up to approximately C$330 million, which will increase CPPIB’s stake in the platform up to 49%.

Assets Dispositions

  • Signed an agreement to sell CPPIB’s 25% stake in AWAS, a Dublin-based aircraft lessor, to Dubai Aerospace Enterprise. The sale was made alongside Terra Firma. CPPIB had been an investor in AWAS since 2006.
  • Sold CPPIB’s 45% ownership interest in 1221 Avenue of the Americas, a Midtown Manhattan office property. Net proceeds to CPPIB from the sale were approximately US$950 million. CPPIB acquired the ownership interest in 2010.
  • An affiliate of CPPIB Credit Investments Inc. sold a 16% equity stake in Antares Holdings (Antares) to a private investment fund managed by Northleaf Capital Partners (Northleaf). Northleaf and Antares are forming a broader strategic relationship, which will include developing separately managed accounts and other investment solutions designed specifically for Canadian asset managers, institutional investors and private clients.

Corporate Highlights

  • Welcomed the appointments of three new members to CPPIB’s Board of Directors for three-year terms:
  •  Jackson Tai, appointed in June 2016 as our first non-resident Director, also serves on the       boards of various publicly listed companies, including HSBC Holdings PLC, Eli Lilly & Company and MasterCard Incorporated.
  • Ashleigh Everett, appointed in February 2017, who is President, Corporate Secretary and Director of Royal Canadian Securities Limited and has served on a number of publicly listed companies.
  • John Montalbano, appointed in February 2017, also serves on a number of corporate boards, including Canalyst Financial Modeling Corporation, Wize Monkey Inc. and Eupraxia Pharmaceuticals Inc.
  • Signed a Memorandum of Understanding with the National Development and Reform Commission of the People’s Republic of China to offer CPPIB’s expertise in assisting Chinese policy-makers as they address the challenges of China’s aging population, including pension reform and the promotion of investment in the domestic senior care industry by global investors. Related to this agreement, CPPIB launched the Chinese edition of “Fixing the Future: How Canada’s Usually Fractious Governments Worked Together to Rescue the Canada Pension Plan”.
  • CPPIB Capital Inc. (CPPIB Capital), a wholly owned subsidiary of CPPIB, completed two international debt offerings, comprising three-year term notes totalling US$2 billion, and five-year term notes totalling US$2 billion. CPPIB utilizes a conservative amount of short- and medium-term debt as one of several tools to manage our investment operations. Debt issuance gives CPPIB flexibility to fund investments that may not match our contribution cycle. Net proceeds from the private placement will be used by CPPIB for general corporate purposes.

About Canada Pension Plan Investment Board

Canada Pension Plan Investment Board (CPPIB) is a professional investment management organization that invests the funds not needed by the Canada Pension Plan (CPP) to pay current benefits on behalf of 20 million contributors and beneficiaries. In order to build a diversified portfolio of CPP assets, CPPIB invests in public equities, private equities, real estate, infrastructure and fixed income instruments. Headquartered in Toronto, with offices in Hong Kong, London, Luxembourg, Mumbai, New York City, São Paulo and Sydney, CPPIB is governed and managed independently of the Canada Pension Plan and at arm’s length from governments. At March 31, 2017, the CPP Fund totalled $316.7 billion. For more information about CPPIB, please visit www.cppib.com or follow us on LinkedIn or Twitter.

CPPIB also put out its FY 2017 Annual Report which you should read very carefully here.

In order to understand how CPPIB’s portfolio has shifted over the years, have a look at this image showing the historical comparison of the investment portfolio (click on image):

At the very beginning back in 2000, CPPIB’s portfolio was almost all Canadian bonds and a tiny bit in Canadian equities and now it’s made up of roughly 22% fixed income, 23% real assets, and the rest of it mostly in US and international public and private equities.

In order for CPPIB to invest in private markets all over the world, it needs to find the right partners and hire “boots on the ground” to nurture these relationships and to invest directly where warranted (like infrastructure).

On page 26 of the 2017 Annual Report, there is an interesting discussion on CPPIB’s shift in Reference Portfolio to attain its future funding objectives given the CPP is a partially, not a fully funded plan:

Based on very long-term projections, the Chief Actuary estimates that contributions will finance 65–70% of future Base CPP benefits. Investment returns will finance 30–35%. In other words, contributions will be almost twice as important as investment returns in sustaining future CPP benefits.

This is very different than most fully funded defined benefit pension plans, which are much more dependent on investment returns to finance the larger share of long-term benefits and hence generallymore risk-averse than the CPP Fund needs to be. The funding structure of the CPP means that:

  • Short-term volatility in returns has much less impact on the CPP’s sustainability and minimum required contributions than for conventionally funded plans.
  • A truly long-term perspective can be taken, in which the expected higher returns from undertaking a higher but still prudent investment risk profile tends to increasingly offset the impact of higher short-term volatility as the time horizon lengthens. In fact, it eventually reduces overall risk to the CPP.

Given these key factors, in fiscal 2014, the Board and Management of CPPIB concluded that the risk level of the Fund could and should be increased over time, with a corresponding increase in expected long-term returns. They approved a gradual increase to the equivalent risk level of a portfolio of 85% global equities and 15% Canadian governments’ bonds (click on image)

This shift in the Reference Portfolio makes it that much harder to beat when markets are soaring but over the long term, CPPIB has managed to add considerable value-added with its diversification strategy across public and private markets all over the world.

I explain the above to relate it to this part of CPPIB’s press release:

In fiscal 2017, the Reference Portfolio’s return of 14.9% outperformed the Investment Portfolio’s net return of 11.8% by 3.1%. The Reference Portfolio return was $8.2 billion above the Investment Portfolio’s return, after deducting all costs from the Investment Portfolio and CPPIB’s operations. Over the five- and 10-year periods, the Investment Portfolio continued to outperform the Reference Portfolio by $5.6 billion and $6.7 billion, respectively, after all CPPIB costs.

“When public markets soar, as they generally did this year, we expect the public equity-based Reference Portfolio benchmark to perform exceptionally well,” said Mr. Machin. “Over the longer term, the Investment Portfolio has outperformed the Reference Portfolio over both the past five- and 10-year periods. Given our deliberate choice to build a prudently diversified portfolio beyond just public equities and bonds, we expect to see swings in performance relative to this benchmark, either positive or negative, in any single year. Our investment portfolio is designed to deliver value-building growth and be resilient during periods of economic stress while adding value over the long term.”

This is why I keep stressing you need to evaluate CPPIB’s performance over the last five and ten years, not in any given year. What counts at these large pensions is long-term performance, and here CPPIB has clearly been delivering exceptional results.

In terms of results, one thing I would have liked to have seen is an in-depth discussion on performance attribution on currency hedging — or in the case of CPPIB, non-hedging (CPPIB wisely doesn’t hedge currency exposure).

Go back to read my comment on CPPIB’s FY 2016 results where I stated this:

[..] as stated in the press release above, currency swings matter a lot because CPPIB doesn’t hedge its foreign currency exposure (click on image):

We can debate the merits of not hedging F/X risk but we can’t debate the fact that on any given year, CPPIB will either enjoy bigger gains from foreign currency exposure or suffer F/X losses if the loonie rallies relative to other currencies (for those that hedge currency risk, it’s the exact opposite).

Now, as I was writing this comment and got this far late Thursday afternoon, CPPIB’s CEO Mark Machin called me to go over the results. He was boarding a plane and didn’t have a lot of time to spare so I began by asking him about how currency swings helped boost performance in fiscal 2017.

Mark said that while last year currency swings had a material impact on performance, in fiscal 2017, currency swings were “relatively neutral”.

Mark also told me that the percentage of liquid equities in the portfolio is now 35%, which is another reason why CPPIB will underperform its Reference Portfolio when global stocks are soaring in any given year (78% of the Reference Portfolio is liquid global equities).

More importantly, Mark Machin wanted me to flag page 122 of the 2017 Annual Report where there is a discussion on CPPIB’s value at risk (VaR) and how much the Fund can potentially lose in any given year if a crisis occurs (click on image and read carefully):

Basically, VaR estimates how much a set of investments might lose, given normal market conditions, in a set time period such as a day. It is valid under normal market conditions and does not specifically consider losses arising from severe market events. It also assumes that historical market data is a sound basis for estimating potential future losses.

Market VaR calculated by CPP Investment Board is estimated using a historical simulation method, evaluated at a 90% confidence level and scaled to a one-year holding period. Under these assumptions, CPPIB can lose 12% in any given year.

To complement the VaR measures CPP Investment Board examines the potential impact of exceptional but plausible adverse market events. Stress scenarios are based upon either forward-looking predictive views on events of imminent concern, such as the Brexit, or designed to mimic market moves from periods of historical distress, such as the Global Financial Crisis. A committee with representatives from each investment department meets regularly to identify probable market disruptions and to review underlying assumptions adopted in quantifying the impact of the specific stress scenario. Results are used to detect vulnerabilities in the portfolio and presented to senior management and the Board to affirm overall risk appetite.

I think Mark wanted to stress this point because while it’s nice to see CPPIB gain 11.8% in fiscal 2017, it’s well within the risk forecasts to see the Fund experience a 12% or worse drawdown if markets tumble next year.

And as I stressed in a recent comment, CPPIB is preparing for landing, taking a much more defensive approach in its overall portfolio in terms of public and private markets.

What else did I discuss with Mark Machin? I told him I saw his former colleague who is now running PSP Investments, André Bourbonnais, on Bloomberg Markets discussing how valuations in private markets are high and how PSP is selling some real estate holdings (see below).

Mark agreed, telling me everyone is competing for the same private assets, “outbidding CPPIB”, but he prefers to stay disciplined. I asked him where they’re finding opportunities and he told me by having the right partners and diversifying geographically, they are able to find some well-priced deals. He added: “If there is a crisis, CPPIB stands ready to capitalize on market dislocations.”

Lastly, below I embedded a summary of the compensation of the senior executives at CPPIB (click on image from page 83 of the Annual Report):

As you can see, Mark Machin is the highest paid pension CEO in Canada (and the world). But given the level of responsibility he has at the helm of Canada’s largest pension fund, and the long-term results CPPIB has delivered, and the fact he left Goldman Sachs a while ago to join CPPIB, I can assure you his total compensation is fair and well within reason for the position he holds.

On a personal level, I’ve only met Mark once in Montreal last Fall and found him to be extremely nice, very sharp and I’m happy he is leading CPPIB now. He also has a very experienced team of senior executives helping him manage assets and risks at CPPIB and very qualified and dedicated employees across the organization.

New Jersey’s Big Pension Gamble?

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

SNJ Today reports, Underfunded Public Pension Plans Could Hit the Lottery:

Governor Chris Christie is moving forward with his plan to dedicate the state’s lottery revenues to New Jersey’s woefully underfunded public worker pension plans.

The Treasury Department unveiled legislation that the Christie administration wants lawmakers to introduce and approve.

State officials say the plan would immediately reduce unfunded obligations by $13.5 billion for the state’s separate pension funds for teachers, public employees, police, and firefighters.

The state says that would raise the funded ratio of the retirement system from 45 percent to 59 percent.

Democratic Assembly Speaker Vincent Prieto says he continues to question whether it’s an effective plan or a gimmick, but adds that he will review the proposal.

Officials say nothing would change for current state lottery customers.

And Samantha Marcus of NJ Advance Media reports, What you need to know about Christie plan to slash N.J. pension debt with lottery cash:

Gov. Chris Christie’s administration on Thursday released long-awaited details of its proposal to use state lottery proceeds to boost the government worker pension fund.

In a briefing with reporters, the state treasurer emphasized the impact of the proposal, saying it said would take some of the burden off the state budget to come up with more and more money each year and will do more for improve the shaky pension fund than merely contributing the full amount recommended by actuaries.

The strategy is to inject a $13.5 billion asset into the pension fund and give it a guaranteed source of revenue for the next 30 years.

Here’s what you need to know:

How does it work?

Broadly, New Jersey’s lottery will become an asset of the pension fund, just like all of the fund’s stocks, bonds and other investments.

The state hired an outside consultant to determine the value of the fund, and it came back with $13.5 billion. That would immediately slash the state’s pension debt. Treasurer Ford Scudder said the valuation will be updated regularly.

Over the next 30 years, the revenue generated from ticket sales would add $37 billion to the pension fund. The lottery would revert to the state budget after those 30 years.

Who benefits?

While there are seven pension funds, only three are considered eligible. These are the Teachers’ Pension and Annuity Fund, the Public Employees’ Retirement System and the Police and Firemen’s Retirement System.

Under the state Constitution, lottery proceeds must be spent on education and state institutions. These three pension funds qualify, as teacher pensions “constitute state aid for education,” and some members of PERS and PFRS work at state institutions or public universities, according to the governor’s proposed legislation.

But they wouldn’t split it evenly.

The asset would be allocated based on a fund’s share of the liabilities, share of the unfunded liabilities and share of total members.

The teachers’ pension fund is the recipient of about 78 percent. While PERS would receive 21 percent and police and fire, a little more than 1 percent.

What will the impact be on the pension funds?

Overall, the state’s unfunded liabilities — the gap between how much money it has and how much it needs to pay future benefits — will drop from $49 billion to $36.5 billion. The total system will go from 44.7 percent funded to 58.9 percent funded.

The effect on the three pension funds will vary.

TPAF would improve from 47 percent funded to 63.9 percent.

The state portion of PERS would boost from 37.8 percent to 49.6 percent funded.

And the state side of PFRS would increase from 41.2 percent to 44.5 percent.

Both PERS and PFRS receive contributions from the state and local government employers.

What does this mean for the lottery?

Not much, according to the state treasurer.

“There will be absolutely no change in the operations of the lottery. If you like to buy lottery tickets, you’ll notice no difference. If you’re a vendor that sells lottery tickets, you’ll notice no difference … the lottery director will remain in charge of the lottery … the lottery will remain a division of the treasury. It will still be overseen by the state lottery commission,” he said.

According to the draft legislation, the director of investment will join the State Lottery Commission.

“The only thing that will change is rather than net proceeds coming to the general fund, they’ll be going in a new common pension fund.”

Where do lottery revenues go now?

They flow into the state budget. Under the state Constitution, lottery income must be spent on state institutions and state aid for education.

It is expected to bring in $965 million this year, helping fund higher education programs, psychiatric hospitals, centers for people with developmental disabilities and homes for disabled soldiers.

Scudder said those programs won’t be left behind. Once the lottery revenue is rerouted to the pension system, they will be funded out of the state budget.

How, when resources are already stretched thin? That’s more complicated.

Once the lottery is deposited in the pension system, it would dramatically decrease the unfunded liabilities, or debt. That would, in turn, eventually reduce the amount of money that needs to be budgeted for the pension contribution.

It’s like a credit card. Your minimum payment is based on how much you owe. The higher your balance gets, the higher your minimum payment gets. But if you pay down your balance, your minimum monthly payment should drop.

In the state’s case, that will free up some money to do other things, like pay for those programs.

According to an analysis provided by the state, the state budget will be able to absorb those costs without any impact for five years. From 2023 to 2029, there will be a hit of about $160 million to $235 million a year.

Where will the ticket proceeds go?

Proceeds from ticket sales can be used to pay out monthly benefits or invest along with the pension system’s other assets.

The lottery’s monthly cash flows will make it easier for the pension fund to pay benefits without having to sell off investments, Scudder said.

I want to first thank Suzanne Bishopric for bringing this to my attention. It has been two years since I discussed New Jersey’s pension war and three years since I discussed how that state’s pension is GASBing for air.

In my opinion, this latest attempt to shore up its chronically underfunded state pensions by using lottery proceeds is a desperate move which will only kick the can further down the road. It will help at the margin, especially for the state teachers’ pension fund, but it’s doing nothing to address serious structural flaws that continue to hamper the state’s pensions.

Worse still, lotteries are a form of regressive taxation, so here you’ll have New Jersey’s poor and working poor buying lottery tickets to fund chronically underfunded state pensions and the cuts in social programs will mostly affect them.

Sure, if the funded status of these chronically underfunded state pensions improves, it will free up money in the state budget to spend on other programs but the truth is there will be cuts to social programs to fund these pensions, and those projections from 2023 to 2029 look awfully optimistic.

And if something goes wrong, and invariably something always goes wrong, that’s it for New Jersey’s pensions, this last attempt to shore them up using state lottery proceeds will be the final straw.

“Ok Leo, so what would be your solution?” My solution would be to amalgamate these state pensions into one large state pension, adopt better governance to remove any political interference, implement a risk-sharing model, hike the contribution rates and lower the benefits for a period of five to ten years, and introduce a special property tax which is progressive, not regressive, for the same time period and make sure these tax revenues are earmarked only for these state pensions.

But Gov. Chris Christie decided to go for the politically expedient and in my opinion, dangerous route of using state lottery proceeds as the cash cow to fund chronically underfunded state pensions.

Why not? US politicians are like all other politicians, their first goal is to be reelected, so they will keep kicking that can down the road until there are no more cans left to kick.

Chris Christie Unveils Plan to Fund NJ Pensions Through Lottery Cash; Democrats Balk

New Jersey Gov. Chris Christie last week unveiled a plan that would use lottery proceeds to pay down the state’s mounting pension obligations.

The plan would make the state lottery an asset of the pension fund, generating an estimated $37 billion over the next 30 years, according to the state Treasury.

However, some lawmakers — particularly Democrats — balked at the proposal, calling it a distraction and an excuse for Christie to continue to short the pension fund’s annual required contribution. Christie will be shorting the pension system roughly $2.5 billion in required contributions in 2018, according to the state budget.

Additionally, the lottery is essentially a regressive tax — meaning the state’s poor/working class families who are playing the lottery would now be a source of funding for the pension fund.

More from NJ Spotlight:

On paper, the pension system would benefit for the next 30 years by having the Lottery – which generates nearly $1 billion in annual revenue and was recently valued at $13.5 billion – effectively transferred onto its balance sheet.

That shift would create a new and dedicated source of revenue for the pension system. In fact, the Christie administration expects the Lottery transfer will improve the state pension system’s overall funded ratio from a disastrous 45 percent to near 60 percent.

The fiscal maneuver should also have little immediate impact on the state budget because it will reduce an unfunded pension liability that right now measures close to $50 billion, and that figure is used by actuaries each year to determine how much the state should be putting into the pension system out of the budget to help maintain its solvency.

The view of Democrats, via NJ Spotlight:

Phil Murphy, Democratic frontrunner for his party’s gubernatorial nomination, compared it to the boardwalk-arcade game Whac-A-Mole during a gubernatorial debate that was held in Newark last week.

“That’s what this is,” said Murphy, a former Goldman Sachs executive. “You’re going to pile down some source of funding over here, and you’re going to expose another source of expense required over there.”

Democratic hopeful Jim Johnson, a lawyer and former U.S. Treasury official from Montclair, dismissed the scheme as a gimmick intended to distract from Christie’s decision to once again short the full payment.

Other lawmakers and union leaders have not taken positions on the bill.

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 LKolivakis@gmail.com).

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 Calpensions.com.

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 dot.com (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 LKolivakis@gmail.com.