Thursday, April 28, 2016

Is Soros Wrong About China?

Hema Parmar and Saijel Kishan of Bloomberg report, The Hedge Fund Manager Betting Soros Is Wrong About China:
Bob Bishop, who once ran investments for billionaire George Soros, is betting his former boss is wrong about China. The world’s second-biggest economy has had its hard landing and is on its way up, according to Bishop.

Rising infrastructure spending, steel production and demand for metal and heavy-duty trucks are signs of improvement for the nation’s industrial and manufacturing sectors, said Bishop, a former chief investment officer at Soros Fund Management who runs $2.2 billion hedge fund Impala Asset Management. Soros said last week that China resembles the U.S. in 2007-08, when credit markets froze and triggered a global recession, and that its banking system is increasingly unstable.

“China already had the crash,” Bishop said in an April 18 interview. “It bottomed at the end of 2015. It’s going to feel like a much better economy in China over the next two years than people seem to think it will be.”

Policy makers in China talked up growth and added stimulus this year to re-energize the economy. In March, the purchasing managers index ticked above 50, signaling expanding factory activity for the first time since June. A recovering China, which is a key importer of steel, copper, iron ore and other metals, bodes well for commodity prices. The price of iron ore rose 44 percent this year as of 1:45 p.m. Tuesday in New York, and copper was up more than 5 percent.

If copper reaches $3.25 a pound, which Bishop expects will occur in 2017, Freeport-McMoRan Inc., the largest publicly traded copper miner, could earn $3 a share, he said. Impala initiated a “modest” investment in the stock in the past month and a half, according to Bishop. It also took a position in miner First Quantum Minerals Ltd.

Commodity Stocks

The firm has boosted its investments in commodity stocks to about 20 percent of the Impala Fund from 4 percent at the start of this year, Bishop said.

"What people often miss on commodity stocks is that their earnings leverage and stock sensitivity to price movements in the underlying commodity is very high, more so than any other sectors in the market," Bishop said.

The Standard & Poor’s Global Natural Resources Net Total Return Index has rebounded almost 40 percent since Jan. 20, its low point this year, after a slide that began in mid-2014 as China’s economic growth slowed.

Bishop, who worked at Soros between 2002 and 2003, started New Canaan, Connecticut-based Impala in 2004. Its main equity fund, which manages about $1.5 billion, gained 7.7 percent in March, bringing returns for the year to 2 percent, according to a person familiar with the matter.

Bishop declined to comment on performance or on Soros’s views.

Warning Sign

China’s March credit-growth figures should be viewed as a warning sign, Soros said at an Asia Society event in New York on April 20. The broadest measure of new credit in the nation was 2.34 trillion yuan ($360 billion) last month, far exceeding the median forecast of 1.4 trillion yuan in a Bloomberg survey.

Soros, a former hedge fund manager who built a $24 billion fortune, in January called a hard landing in China “practically unavoidable.” Soros returned outside capital in 2011 and his firm now manages his own wealth. Hedge fund managers including Crispin Odey at London-based Odey Asset Management and Kyle Bass at Hayman Capital Management in Dallas have been wagering on a slowdown in China. Bass is said to be starting a fund to focus on China-related investments.

Bishop isn’t the only U.S. hedge fund manager who’s bullish on China. In March, Jordi Visser, head of investments at $1.4 billion Weiss Multi-Strategy Advisors, said China’s Shenzhen Composite Index will beat most global peers by the end of this year.

Bishop spent at least a decade focusing on commodities and other cyclical stocks at hedge funds Maverick Capital, Kingdon Capital and Julian Robertson’s Tiger Management.

Impala said in a March 31 investor memo obtained by Bloomberg that energy prices have bottomed, and that improving U.S. demographic and consumer trends, loosening mortgage availability and tight supply are creating an environment in which the homebuilding cycle will accelerate.
You have to hand it to Bob Bishop, so far this year he's been right on the money on China and commodity stocks. You can view his fund's latest stock holdings here as well as those of Jordi Visser's fund here (as of Q4 2015; Q1 updates coming in mid May).

Bishop isn't the only one who made money betting big on a global recovery. Carl Icahn has made a killing so far this year on some of his top holdings like Freeport McMoran (FCX), Chesapeake Energy (CHK) and Transocean (RIG). (Icahn also just announced he dumped his Apple shares back in February, another good move).

And if you think that's impressive, check out some of the moves in names like Cliff Natural Resources (CLF), Teck Resources (TCK), Baytex Energy (BTE), Seadrill (SDRL) and Olympic Steel (ZEUS). There are many energy and commodity stocks that have doubled, tripled, and even quintupled since bottoming in mid January and showing no signs whatsoever of slowing down.

In fact, have a look at the S&P Metals and Mining ETF (XME) and you'll get a feel at how big the moves have been (click on image, as of Wednesday's close):


Looking at individual companies, the moves have been even more violent to the upside (click on images, as of Wednesday's close):



What is driving this huge move into commodities and energy names? Traders will tell you they were were extremely oversold in mid January but the violent surge is beyond scary, it's as if all the algos went long and have been steadily adding on every dip. When you see moves this violent, it's definitely being driven by algorithmic/ quant trading and it can persist longer than you think.

Of course, fundamentalists will argue that the world is in much better shape than doomsayers think. And there are some top oil traders like Pierre Andurand who was shorting oil during the last two years now calling for a multiyear rally in crude prices.

Even after Doha, Andurand remains resolute, warning of rising Mideast tensions:
Pierre Andurand, the money manager who made 38 percent betting against oil in 2014, warned that signs of tension at a meeting of the world’s biggest producers this month in Doha point to increasing Middle East unrest that could eventually lead to supply disruptions.

The failure of oil ministers to reach an agreement at meetings in the Qatari capital “clearly revealed deep disagreement within the Kingdom and rising tensions between Saudi Arabia and Iran,” the manager wrote in a monthly letter to clients of his hedge fund, Andurand Capital Management. “As a result, we believe that the current escalation in Middle Eastern sectarian conflicts will likely result in more proxy wars that will eventually create more supply disruptions.”

Andurand’s firm has more than doubled to $1 billion in assets from $430 million about a year ago. His main fund rose 2.2 percent in March, bringing gains to 5.8 percent in the first quarter, according to the letter obtained by Bloomberg.

The fund manager said earlier this year that he thought oil prices had bottomed, ending a decline that began in June 2014. Andurand sees oil prices rallying to $60 to $70 a barrel by year-end, he reiterated in the letter, before they reach $85 in 2017.

Supply disruptions in the Middle East “would come at a time when the market is already rebalancing quickly which would add a large upside potential to our current crude oil price forecast,” Andurand wrote, adding that lower prices may have taken a long-lasting toll on production infrastructure.

“We continue to believe that we are only at the beginning of a structural multiyear rally in oil prices,” he said.
Rising oil prices have boosted commodity and emerging market currencies and fueled big moves in Energy (XLE), Oil Services (OIH) and Oil Exploration (XOP) stocks this year (click on images, as of Wednesday's close):




Now, a lot of equity fund managers underperforming this year, not to mention hedge fund managers getting obliterated, are all asking themselves the same question: Should I close my eyes, hold my nose and just buy these sectors, even after this huge move?

Any trader will tell you "YES! BUY THE BREAKOUT!" but if you're a money manager worried about downside risk, it's very hard to justify buying these breakouts after such an extraordinary non-stop run-up. Sure, the charts tell you to buy but your gut tells you hold on a second, is this rally sustainable, especially after such a hard run-up?

The problem again is these breakout moves are being driven by high frequency quants and algos, pushing prices up based on technical levels, making life miserable for ordinary fund managers trying to figure out whether these big moves are justified and sustainable.

Then there's Soros. Some think he's wrong on China, but others agree with him and think there are rising risks in that country. In fact, Australia's Super is now warning of Chinese bubble risks:
Australia’s largest industry super fund, the $90 billion Australian Super, has delivered a stark warning on the risks in the Chinese economy, warning that the country had a credit bubble which “looks pretty scary.”

“The China credit bubble could well be the biggest issue facing China in the next five years,” Australian Super’s chief investment officer, Mark Delaney, told a conference in Sydney today hosted by The Economist magazine.

“When you look at the data in countries that have had credit bubbles, the data is really poor and the policy response is uncertain,” he said.

He said it would be “a big deal for everybody” if China were to have a financial crisis in the next five years.

But he said “no one has a really good handle on it.”

He said Australian Super, which has had an office in Beijing for several years, had been looking at investing directly in China for some time, but it had held off because of the deteriorating economic outlook.

“China has been in a downturn for two years. Profit growth has been terrible and asset prices have been very expensive,” he said.

“It hasn’t been a very good cyclical environment to be involved in.”

But he said there was concern about the credit bubble in China, including growing levels of federal government and local government debt, as well as questions about the bad debt exposure of the country’s banks.

He said Chinese bank shares were only selling at single digit multiples of their returns “not because they don’t make a lot of money, but because people don’t trust their balance sheets.”

“No one really knows how this is going to be sorted out.”

Mr Delaney was speaking after the International Monetary Fund estimated that China may have as much as $US1.3 trillion in loans to borrowers who did not have enough income to meet their repayments.

It estimated that this could mean potential losses of as much as 7 per cent of China’s gross domestic product. In its latest Global Financial Stability Report, the IMF estimated that loans “potentially at risk” could reach as much as 15.5 per cent of total bank commercial lending – some three times the level reported by the Chinese bank regulator.

Mr Delaney said Chinese regulators cut back on credit growth in the past year but had now changed their tune and were now trying to stimulate credit.

His comments followed another bearish comment on the outlook for the Chinese economy by Credit Suisse regional economist, Dong Tao.

He said Australian businesses he had spoken to were “living on a different planet” in their view of the changing Chinese economy.

He said the heyday of Chinese investment in infrastructure, housing and its strong exports had ended.

“The golden age of stimulus of the economy by the Chinese government is over.”

But he said the next Chinese business cycle would be the Chinese consumption boom.

He said demand in China was changing from steel and cement to baby food, organic foods and cosmetics.

“Australia is well positioned to take advantage of Chinese demand but it is changing.”

He said the Chinese government should stop trying to produce economic growth levels of more than 6.5 per cent and be prepared to live with growth levels closer to 4 per cent.

He said adopting growth targets of around 4 per cent would be a lot more credible and “will save a lot of anxiety.”
When you think of China's big pension gamble and the commodity trading frenzy taking over there, you have to question how long this China bubble can go on and whether another Big Bang will clobber risk assets all around the world in the second half of the year.

Then there is Japan. The Bank of Japan stunned everyone on Thursday by keeping its policy steady and not surprisingly, the Nikkei tanked and yen soared. Keep your eyes glued on the yen and emerging market currencies as another Asian crisis could be on the horizon.

All this to say that while some are betting George Soros is wrong on China and the global recovery will continue unabated, I think Mr. Soros will get the last laugh and the Great Crash of 2016 that has thus far alluded us might still be in play.

Below, Bill Gross of Janus Capital Group talks about the Federal Reserve's decision to leave rates unchanged and gives insight into his global investment strategy. Gross also recommended a preferred bank share ETF (PFF) but that was cut out of this clip.

And Antonin Jullier, global head of equity trading strategy at Citi, discusses the market's reaction to the Bank of Japan's vote against further stimulus.

Also, Philipp Hildebrand, vice chairman at BlackRock, talks with Caroline Hyde about European banking profitability, the impact of post-crisis regulation on bank business models, and why he thinks a China derailment is the biggest risk to the global economy. He speaks on "Bloomberg Surveillance."

Fourth, Joshua Crabb, Old Mutual Global Investors head of Asian equities, discusses the outlook for China's economy with Bloomberg's Angie Lau on "First Up."

Lastly, Carl Icahn, Chairman of Icahn Enterprises, discusses his thoughts on the U.S. markets and the economy. He says "there will be a day of reckoning unless we get fiscal stimulus." Listen to his views and what he says about specific commodity stocks he owns.





Wednesday, April 27, 2016

Pensions Should Brace for Lower Rates?

Andy Blatchford of the Canadian Press reports, Pensions should brace for new normal of lower neutral interest rates:
Bank of Canada governor Stephen Poloz is recommending pension funds get ready for a new normal: neutral interest rates lower than they were before the financial crisis.

Poloz told a Wall Street audience Tuesday that the fate of neutral rates — the levels he said will prevail once the world economy recovers — remain unknown, but they will almost certainly be lower than previously thought.

The central banker made the comment during a question-and-answer period that followed his speech on global trade growth.

Among the reasons, Poloz pointed to the more-pessimistic outlook for potential long-term global growth. The forecast was lowered to 3.2 per cent from four per cent, he said.

"That downgrade means the neutral rate of interest will be lower for sure — for a very long time," said Poloz, who added it could go even lower if economic "headwinds" continue.

"Those in the pension business need to get used to it. They need to adapt to it."

Since the 2008 global financial crisis, pension funds around the world have had to contend with market uncertainty, feeble growth and record-low interest rates.

Pension funds use long-term interest rates to calculate their liabilities. The lower the rates, the more money plans need to have to ensure they will be able to pay future benefits.

A December report by the Organization for Economic Co-operation and Development said the conditions have "cast doubts on the ability of defined-contribution systems and annuity schemes to deliver adequate pensions."

To cushion the Canadian economy from the shock of lower commodity prices, Poloz lowered the central bank's key rate twice last year to 0.5 per cent — just above its historic low of 0.25.

Poloz linked the higher neutral interest rates of the past to the baby boom, which he described as a 50-year period of higher labour-force participation and better growth.

"Well, that's behind us," Poloz told the meeting of the Investment Industry Association of Canada and the Securities Industry and Financial Markets Association.

"We don't have numbers for all this, but you need to be scenario-testing those pension plans and the needs of your clients because the returns simply won't be there."

But with all the unpredictability Poloz said it remains possible current headwinds could convert into positive forces that would push interest rates back to "more-normal levels" seen prior to the crisis.

Earlier Tuesday, Poloz's speech touched on another aspect of the post-crisis world.

He told the crowd they shouldn't expect to see a return of the "rapid pace of trade growth" the world saw for the two decades before the crisis.

Poloz was optimistic, however, that the "striking weakness" in international trade wasn't a sign of a looming global recession.

He said the renewed slowdown in global exports is more likely a result of the fact that big opportunities to boost global trade have already been largely exploited.

As an example, he noted China could only join the World Trade Organization once.

Poloz expressed confidence that most of the trade slump will be reversed as the global economy recovers — even if it's a slow process.

"The weakness in trade we've seen is not a warning of an impending recession," said Poloz, a former president and CEO of Export Development Canada.

"Rather, I see it as a sign that trade has reached a new balance point in the global economy — and one that we have the ability to nudge forward."

He said there's still room to boost global trade through efficiency improvements to international supply chains, the signing of major treaties such as the Trans-Pacific Partnership and the creation of brand new companies.

Poloz's speech came a day after Export Development Canada downgraded its outlook for the growth of exports.

EDC chief economist Peter Hall predicted overall Canadian exports of goods and services to expand two per cent in 2016, down from a projection last fall of seven per cent.
Well, if President Trump takes over after President Obama, you can expect more protectionism and trade wars, which isn't good for global trade.

But Bank of Canada Governor Stephen Poloz is absolutely right, pensions need to brace for a new normal of lower neutral interest rates. I've long warned my readers that ultra low rates are here to stay and if global deflation sets in, the new negative normal will rule the day.

Thus far, Canada has managed to escape negative rates but this is mostly due to the rebound in oil prices. If, as some claim, oil doubles by year-end, you can expect the loonie to appreciate and the Bank of Canada might even hike rates (highly doubt it). On the other hand, if the Great Crash of 2016 materializes, oil will sink to new lows and the Bank of Canada will be forced to go negative.

Interestingly,  on Wednesday, the Australian dollar plunged almost 2 per cent after a lower-than-expected inflation print  and deflation fears put a rate cut back on the agenda for next week's Reserve Bank meeting. Keep an eye on the Aussie as it might portend the future of commodity prices, deflation and what will happen to the loonie.

You should also read Ted Carmichael's latest, Why Does the Bank of Canada Now Believe that Fiscal Stimulus Works?. I agree with him, all this talk of fiscal stimulus is way overblown and in my opinion, it's a smokescreen for what really lies behind the Bank of Canada's monetary policy: it's all about oil prices. And like it or not, the loonie is a petro currency, period.

[As an aside, Ted also shared this with me: "I'd be ok with the budget if they stuck with carefully thought out infrastructure with private sector and/or pension fund participation, but they have blown up the deficit with middle income transfers and operational spending."]

The rise in oil prices alleviates the terms of trade shock and if it continues, the Bank of Canada won't need to cut rates this year. It's that simple, no need to torture yourself trying to figure out the Bank of Canada's monetary policy, it's all about oil, not fiscal policy.

South of the border, the Fed will do a cautious dance to avoid volatility:
The Fed is expected to do a cautious dance when it releases its statement Wednesday, as it leaves the door open for a rate hike in June but is not signaling one.

After two days of meetings, the Fed will release a 2 p.m. statement Wednesday. The statement is not expected to be much changed from its last one, but Fed watchers say the nuances will be important. There is no press conference where Fed chair Janet Yellen can provide further clarification, so markets will have only the statement to respond to.

The Fed is expected to be dovish in its statement, but the bond market clearly has been fearing it will be a bit more hawkish, and yields have been rising. Market expectations are for the next rate hike to come early next year, but the Fed has said it expects two rate hikes before then, so there is tension around any statement it would make.

"I don't think they're going to tip their hand on the policy section of it. I think the hawkishness might come in their description of the economy, because credit spreads have come back and are no longer a worry. The stock market is no longer down 10 percent on the year. Even the G-20 was less concerned about the economic outlook for the world," said Chris Rupkey, chief financial economist at MUFG Union Bank.

But the U.S. economic data has been spotty, with more than a few misses recently. Durable goods was weaker than expected Tuesday, and first quarter GDP, expected Thursday, is predicted to be just barely positive.

Fed officials have also been sending mixed messages about rate hikes. For instance, Boston Fed President Eric Rosengren, viewed as a dove, has said the markets have it wrong and are not pricing in enough rate hikes.

"The problem is you've got disagreement. The gap has widened," said Diane Swonk, CEO of DS Economics. "You've got dissents. When you have dissents, you have volatility." Cleveland Federal Reserve President Loretta Mester is expected to join Kansas City Fed President Esther George in dissenting Wednesday, as they object to the Fed's lack of rate hikes.

"I don't think they can put the balance of risk back in, because they can't agree what the balance of risks are," said Swonk. "It just means continued uncertainty, continued uncertainty for the market."

Michael Arone, chief investment strategist at State Street Global Advisors, also said the Fed is unlikely to suggest that risks are balanced.

"If they tell you it's nearly balancing, that'll be a signal that June is on the table," said Arone, adding he does not expect to see that.

Arone said the Fed will want to leave options open. "I don't think this Fed, and Yellen in particular, likes to paint themselves into a corner," said Arone. "The statement will acknowledge that growth in the economy is modest. They haven't seen the flow through to inflation and they'll remain data dependent going forward."

He said he will be watching to see if Yellen's view is dominant in the statement. "My view is what Yellen did with her Economic Club of New York speech (March 29), she was saying: 'I'm the chairperson. This is my view. We're going to go slow and gradual.' At the time, other Fed officials were talking about how April was still on the table," Arone said. "I think what markets are going to be looking to see is if that remains the message or if we're back in this kind of limbo."

It will also be important to see if the Fed gives any nod to stability in international markets now that China has calmed some of the fears around its economy.

Besides the Fed, there is the trade deficit data at 8:30 a.m. EDT and pending home sales at 10 a.m. EDT. There is a 10:30 a.m. EDT government inventory data on oil and gasoline, and the Treasury auctions seven-year notes at 1 p.m. auction.

Earnings before the bell include Boeing, Comcast, GlaxoSmithKline, Mondelez, United Technologies, Anthem, Northrop Grumman, Dr Pepper Snapple, Nasdaq OMX, Nintendo, State Street, Tegna, Garmin, Six Flags and General Dynamics. After the bell, reports are expected from Facebook, PayPal, Marriott, SanDisk, Cheesecake Factory, La Quinta, Rent-A-Center, First Solar, Texas Instruments and Vertex Pharmaceuticals.
The only earnings that matter on Wednesday are those of Apple (AAPL). Its shares are down 7% at this writing as it feels the pain of the end of iPhone 6 cycle (they better come up with a great marketing campaign for iPhone 7 to bring the stock back over $120 this fall).

As far as the Fed, I don't expect any major surprises today but who knows how markets react if the statement turns out to be more hawkish than expected.

More interestingly, Jeffrey Gundlach, the reigning bond king, visited Toronto recently and spoke with Financial Post reporter Jonathan Ratner. Here is an edited version of their discussion which you all MUST read as Gundlach talks about why debt deflation is a real threat, why the Fed capitulated in March and why negative rates are 'horror' (read this interview carefully).

Lately, Gundlach has been legging into Treasuries which shows you he's not worried about any rout in the bond market.

So, if low rates are here to stay, how are pensions going to adapt? More hedge funds? Good luck with that strategy. More private equity, real estate and infrastructure? This seems to be the reigning strategy but pensions have to be careful taking on illiquidity risk, especially if global deflation sets in. And when it comes to private equity funds, they have to monitor fees and performance carefully and also realize real estate has its own set of challenges in this environment.

This is why in Canada, large public pensions are gearing up to bankroll domestic infrastructure, ignoring critics calling this the great Canadian pension heist. By investing directly in mature and greenfield infrastructure, Canada's large public pensions can put a lot of money to work in assets that offer stable, predictable long-term cash flows, essentially better matching assets with their long dated liabilities without paying huge fees to private equity funds and without taking currency or regulatory risks (still taking on huge illiquidity risk but they have a long horizon to do this).

Below, listen to the speech Bank of Canada Governor Stephen Poloz gave on Tuesday at the Investment Industry Association of Canada and Securities Industry and Financial Markets Association in New York.

I worked with Steve at BCA Research years ago and think very highly of him. Take the time to listen to this speech and the Q&A where he discusses what lower neutral rates mean for pensions.

Also, CNBC contributor Richard Fisher, Harvard University Economics Professor Martin Feldstein and CNBC's Steve Liesman look ahead to Wednesday's Fed meeting. A very interesting discussion (too bad CNBC didn't post all of it) where Fisher and Feldstein claim inflation pressures are picking up as service sector inflation keeps rising and this could spell trouble ahead. Too bad the bond market doesn't agree with either of them.

Lastly, Columbia University Professor of Economics and Nobel Laureate Joseph Stiglitz discusses the problem of extreme income inequality in the United States and the negative economic impact of monetary policy. He speaks on "Bloomberg Surveillance."

Like I said, I don't pity hedge fund managers but I do pity millions who will retire in pension poverty, unable to cope with the new normal of lower rates. Pensions and savers better prepare for lower returns ahead.



Tuesday, April 26, 2016

The Great Canadian Pension Heist?

Andrew Coyne of the National Post warns, Funding government projects through public pension plans a terrible idea:
The federal government, it is well known, is determined to spend $120 billion on infrastructure over the next 10 years. If traditional definitions of infrastructure are insufficient to get it to that sum, then by God it will come up with whole new definitions.

Ah, but whose money? From what source? The government would appear to have three alternatives. One, it can pay for it out of each year’s taxes. Two, it can borrow on private credit markets. Or three, it can finance capital projects like roads and bridges by charging the people who use them. Once these would have been known as user fees or road tolls; in the language of today’s technocrats, it’s called “asset monetization” or “asset recycling.”

Governments at every level and of every stripe have been showing increasing interest in this option, and with good reason. Pricing scarce resources encourages consumers to make more sparing use of them, while confining ambitious politicians and bureaucrats to providing services people actually want and are willing to pay for.

Moreover, by charging users where possible, scarce tax dollars are freed up to pay for the things that can only be paid for through taxes: public goods, like defence, policing and lighthouses.

Of course, if it is possible to charge users, it raises the question of whether the service need be provided, or at least financed, by the state at all. Rather than front the capital for a project themselves, governments can open it to private investors to finance, in return for some or all of the revenues expected to flow from it. As with user fees, this need not be limited to new ventures: “asset recycling” can also mean selling existing government enterprises — what used to be called “privatization.”

Again, there’s much to recommend this. If a project can be financed privately, it usually should, as this provides a truer measure of the cost of capital. (This point eludes many people: since the government has the best credit and pays the lowest interest rate, they ask, doesn’t it make sense to borrow on its account? But by that reasoning we should get the government to borrow on everybody’s behalf. If not, then it is privileging some investments over others, in the same way as if it were to directly subsidize them, and subject to the same critiques.)

The further removed from government, moreover, the less the chances of politicization. There’s a reason we set up Crown corporations at arm’s length from the government of the day, in the hopes of insulating them from politically-minded meddling.

Privatization simply takes that one step further. At the same time, a company in private hands can be regulated in a more disinterested fashion, without the inherent conflict of interest of a government, in effect, regulating itself. Last, experience teaches that when people own something directly, and have an interest in its value, they tend to take better care of it — whereas when the state owns something, no one does.

Yet government and private sector alike are too willing to blur this distinction. Rather than simply put a project out to private tender, with investors bearing all of the risk in return for all of the profit, public and private capital are frequently commingled. All too often, this means public risk for private profit.

That, alas, seems where we are headed — with an extra twist of malignancy. For, as the Canadian Press recently reported, the “private” investors the feds have their eyes on are in fact the country’s public pension plans, notably the Canada Pension Plan’s $283-billion investment fund and Quebec’s Caisse de dépot et placement — much as the Ontario government had earlier suggested it would use its planned provincial equivalent.

This is a truly terrible idea. On the one hand, it offers governments a way to finance their spending on the quiet, without subjecting their plans to the scrutiny of either the credit markets or Parliament. On the other hand, it opens pension funds to pressure to invest in ways that may not be in the best interest of pensioners, but rather of their political “partners.”

I know, I know: the public pension plans are independent of government, at arms’ length, and all that. But the history of the Caisse is rather less than reassuring in this regard, while the presence of the CEOs of both the Caisse and the CPP Investment Board on the Finance minister’s new economic advisory council does not quite scream independence.

Even more disquieting is the Caisse’s latest venture, a $5.5-billion light rail project in Montreal, of which the Caisse itself would put up a little more than half — with the remainder, it hopes, to come from the federal and provincial governments.

Is it too hard to imagine, in the negotiations to come, the governments in question suggesting a little quid pro quo: we’ll fund yours if you’ll fund ours?

Well now. If I lend you $100 and you lend me $100, are either of us $1 better off? Now suppose you and I are basically the same person, and you have some idea of the nonsense involved here. The pension plans will fund government infrastructure projects with the money they make on investments funded in part by governments out of the return on investments that were financed by the pension plans and so on ad infinitum.

A government that borrows from others acquires a liability, but a government that borrows from itself may be accounted a calamity.
Poor Andrew Coyne, he just doesn't get it. Before I rip into his idiotic comment, let's go over another equally idiotic comment by an economist called Martin Armstrong who put out a post, Asset Recycling – Robbing Pensions to Cover Govt. Costs:
We are facing a pension crisis, thanks to negative interest rates that have destroyed pension funds. Pension funds are a tempting pot of money that government cannot keep its hands out of. The federal government of Canada, for example, is looking to reduce the cost of government by shifting Canada’s mounting infrastructure costs to the private sector. They want to sell or lease stakes in major public assets such as highways, rail lines, and ports. In Canada, they hid a line in last month’s federal budget that revealed that the Liberals are considering making public assets available to non-government investors, such as public pension funds. They will sell the national infrastructure to pension funds, robbing them of the cash they have to fund themselves. This latest trick is being called “asset recycling,” which is simply a system designed to raise money for governments. This idea is surfacing in Europe as well as the United States, especially among cash-strapped states.

This is the other side of 2015.75; the peak in government (socialism). Everything from this point forward is a confirmation that these people are in crisis mode. They are rapidly destroying Western culture because they are simply crazy and the people who blindly vote for them are out of their minds. They are destroying the very fabric of society for they cannot see what they are doing nor where this all leads. Once they wipe out the security of the future, the government will crumble to dust to be swept away by history. We deserve what we blindly vote for.
Wow, "peak government socialism", "destroying the very fabric of society", and all this because our federal government had the foresight to approach Canada's big, boring public pension funds to invest in domestic infrastructure?

These comments are beyond idiotic. Forget about Martin Armstrong, he sounds like a total conspiratorial flake worried about the end of humanity as we know it (not surprised to see him publishing doom and gloom articles on Zero Hedge).

Let me focus on Andrew Coyne, the resident conservative commentator who also regularly appears on the CBC to discuss politics. People actually listen to Coyne, which makes him far more dangerous when he spreads complete rubbish like the article he penned above (to be fair, I prefer his political comments a lot more than his economic ones).

In my last comment on pensions bankrolling Canada's infrastructure, I praised the federal government's initiative of "asset recycling" and stated why it makes perfect sense for Canada's large pensions to invest in domestic infrastructure:
  • Federal, provincial and municipal governments are cash-strapped and they need funds to invest in infrastructure. Increasing taxes to do this is simply not a viable option when the economy is weak.
  • Unlike other investments, investing in infrastructure has huge long-term economic benefits to any country and infrastructure jobs pay well, which means there is an important multiplier effect to the overall economy from these jobs.
  • Pensions need yield. They can invest in public and private markets or in hedge funds. Increasingly, they're avoiding volatile public markets where bond yields are at historic lows and they're even starting to shun hedge funds which promise absolute returns but have failed to keep up with simple stock and bond indexes. 
  • Where are pensions turning to? Private equity, real estate and infrastructure. But unlike private equity, Canada's large pensions invest directly in infrastructure, avoiding hefty fees to general partners (GPs), and unlike real estate, the duration of infrastructure assets is a better match to the duration of their long dated liabilities which typically go out 75+ years. 
  • What else? infrastructure assets are highly scalable, meaning these large pensions can put a huge chunk of money to work in one infrastructure investment instead of many private equity or hedge funds which charge big fees and don't offer safe, predictable returns.
  • Most of Canada's large public pensions target an actuarial rate of 6.3% (nominal), so if Michael Sabia is right and infrastructure offers a stable, predictable and low-risk return of 7-9%, then why not invest directly in infrastructure? It makes perfect sense.
  • Canada's large public pensions are internationally renowned infrastructure investors, investing in airports, highways, ports, and other infrastructure investments all around the world. Their focus has mainly been in Britain and Australia where the rule of law is similar to the one in Canada. 
  • But if the federal government makes public infrastructure available to them here, either through long-term leases or outright sales, then why not invest in domestic projects, foregoing any currency risk or foreign regulatory risk? Again, it makes perfect sense, it's simple logic, not rocket science. 
  • Of course, if the federal government opens public infrastructure assets to Canada's large pensions, it has to do so for international mega pension and sovereign wealth funds too, introducing competition and leveling the playing field. 
  • Typically Canada's large pensions invest in mature infrastructure investments that have been operational for years and offer well-known cash flows, avoiding riskier greenfield projects with uncertain cash flow projections.
  • But the Caisse is dipping into greenfield projects here in Quebec. It can do so because it has hired an experienced team of infrastructure professionals with actual operational experience who have project management experience and have overseen previous greenfield projects.
I also stated the following:
No doubt, greenfield infrastructure projects carry bigger risks but they also offer bigger rewards down the road. Will everything go smoothly in this project? Of course not, there isn't one major greenfield infrastructure project that goes off without a hitch but the people working on this project have actual operational experience and a track record of delivering on such projects below budget (which isn't easy) easing my concerns about recouping operating and capital costs.

So, I would tell the media and critics to ease up and have faith in Macky Tall and his team at CDPQ Infra. They are all very experienced and highly ethical individuals who will deliver on this and other greenfield projects if they are asked to in the future. And trust me, there will be no Charboneau Commission on this project which is great news for Quebec's taxpayers.
Now, let's get back to Coyne's article. He states the following:
This is a truly terrible idea. On the one hand, it offers governments a way to finance their spending on the quiet, without subjecting their plans to the scrutiny of either the credit markets or Parliament. On the other hand, it opens pension funds to pressure to invest in ways that may not be in the best interest of pensioners, but rather of their political “partners.”
And follows up right away with this:
I know, I know: the public pension plans are independent of government, at arms’ length, and all that. But the history of the Caisse is rather less than reassuring in this regard, while the presence of the CEOs of both the Caisse and the CPP Investment Board on the Finance minister’s new economic advisory council does not quite scream independence.
First of all, it's arm's length, but leaving that typo aside, what is Coyne talking about? Canada's large public pensions have a fiduciary mandate to invest in the best interests of their beneficiaries by maximizing their return without taking undue risk. It is stipulated in the law governing their operations and it's part of their investment policy and philosophy.

Second, Canada's large public pensions operate at arm's length from the government precisely because they want to eliminate government interference in their investment process. Importantly, the federal government isn't forcing Canada's large public pensions to invest in infrastructure, it's consulting them to see if they can strike a mutually beneficial policy which will allow the government to deliver on its promise to invest in infrastructure and public pensions to meet their actuarial target rate of return by investing in domestic as opposed to foreign infrastructure (lest we forget their liabilities are in Canadian dollars and there is less regulatory risk investing in domestic infrastructure).

Here you have world class pension experts investing directly in infrastructure assets all around the world and Andrew Coyne thinks it's shady that Mark Wiseman and Michael Sabia are sitting on the Finance Minister's economic advisory council? If you ask me, our Finance Minister would be a fool if he didn't ask them and others (like Leo de Bever, AIMCo's former CEO and the godfather of investing in infrastructure) to sit on his advisory council.

In the height of the 2008 crisis, I was working as a senior economist at the Business Development Bank of Canada (BDC) and I clearly remember our team preparing that organization's former CEO, Jean-René Halde, for his Friday morning discussions with then Finance Minister Jim Flaherty. Other CEOs of major Crown corporations (like Steve Poloz the current Governor of the Bank of Canada who was the former CEO of Export Development Canada), were on that call too looking at ways to help banks provide credit and invest in small and medium sized enterprises. There was nothing shady about that, it was a very smart move on Flaherty's part.

Speaking of shady activity, I have more confidence in the people at the Caisse overseeing the $5.5 billion light rail project than I do with anyone working in the municipal, provincial or federal government in charge of our infrastructure assets. If you want to cut the risk of corruption, you are much better off having the tender offers go through CPDQ Infra than some government organization which isn't held accountable and doesn't have skin in the game.

That brings me to another topic. Canada's large public pensions aren't in the charity business, far from it. If they're investing in domestic infrastructure, it's because they see a fit to meet their long dated liabilities and make money off these investments. And let's be clear, they all want to make money taking the least risk possible because that is how they justify their hefty compensation.

The notion that any provincial or even the federal government is forcing public pensions to invest in infrastructure is not only ridiculous, it's downright laughable and shows complete ignorance on Coyne's part as to the governance at Canada's large public pensions and their investment mandate and incentive structure.

Andrew Coyne should stick to political commentaries. When it comes to public pensions and the economy, he's just as clueless as the hacks over at the Fraser Institute claiming CPP is too costly. It isn't, we should build on CPPIB's success.

By the way, if you want to see a really terrible idea, check out China's pension gamble. That is a perfect example of a country where there's no pension governance whatsoever (either you follow the government's instructions or your head is chopped off).

There's another bubble going on in China, a great ball of money rushing into commodities. Below, CNBC reports on how China just raised transaction costs to cool commodities frenzy. God help us!!

If I was Andrew Coyne, I'd be far more worried about Chinese speculating in the stock and commodities markets than Canada's large public pensions investing in domestic infrastructure. Then again, Coyne loves hearing himself speak even when he doesn't have a clue of what he's talking about.

Monday, April 25, 2016

Pensions Bankrolling Canada's Infrastructure?

Andy Blatchford of the Canadian Press reports, Liberal government to consider public pension funds to help bankroll mounting infrastructure costs:
The federal government has identified a potential source of cash to help pay for Canada’s mounting infrastructure costs — and it could involve leasing or selling stakes in major public assets such as highways, rail lines, and ports.

A line tucked into last month’s federal budget reveals the Liberals are considering making public assets available to non-government investors, like public pension funds.

The sentence mentions “asset recycling,” a system designed to raise money to help governments bankroll improvements to existing public infrastructure and, possibly, to build new projects.

For massive, deep-pocketed investors like pension funds, asset recycling offers access to reliable investments with predictable returns through revenue streams that could include user fees such as tolls.

“Where it is in the public interest, engage public pension plans and other innovative sources of funding — such as demand management initiatives and asset recycling — to increase the long-term affordability and sustainability of infrastructure in Canada,” reads the sentence in the new Liberal government’s first budget.

Asset recycling is gaining an increasing amount of international attention and one of the best-known, large-scale examples is found in Australia. The Australian government launched a plan to attract billions of dollars in capital by offering incentives to its states and territories that sell stakes in public assets.

Like the Australian example, experts believe monetizing Canadian public assets could generate much-needed funds for a country faced with significant infrastructure needs.

The Liberal budget paid considerable attention to infrastructure investment, which it sees as way to create jobs and boost long-term economic growth. The Liberals have committed more than $120 billion toward infrastructure over the next decade.

Proponents of asset recycling say enticing deep-pocketed investors to join can help governments avoid amassing debt or raising taxes.

“Asset recycling is a way to attract private-sector investment into activities that were formerly, exclusively, in the public realm,” said Michael Fenn, a former Ontario deputy minister and management consultant who specializes in the public sector.

“It’s something that we should pay a lot of attention to and I’m really pleased to see the federal government is looking seriously at it.”

Fenn serves as a board member for OMERS pension fund, which invests in public infrastructure around the world. He stressed he was not speaking on behalf of OMERS or its investments.

Two years ago, Fenn wrote a research paper for the Toronto-based Mowat Centre think-tank titled, Recycling Ontario’s Assets: A New Framework for Managing Public Finances.

In Canada, he said there have been a few examples that resemble asset recycling, including Ontario’s partnership with Teranet to manage its land registry system and the province’s more recent move to sell part of the Hydro One power company.

For the most part, Canada’s big pension funds have been focused on international infrastructure investments because few domestic opportunities have been of the magnitude for which they tend to look.

Australia’s asset-recycling model has been praised by influential Canadians such as Mark Wiseman, president and chief executive of the Canada Pension Plan Investment Board.

“With growing infrastructure deficits worldwide … we often reference this model with our own government and others as one to follow to (incentivize) and attract long-term capital,” Wiseman said in prepared remarks of a September speech in Sydney to the Canadian Australian Chamber of Commerce.

The massive CPP Fund had $282.6 billion worth of assets at the end of 2015. Wiseman’s speech noted more than 75 per cent of its investments were made outside Canada, including about $7 billion in Australia.

Last month, Wiseman was named to Finance Minister Bill Morneau’s economic advisory council, which is tasked with helping the government map out a long-term growth plan. The council also includes Michael Sabia, CEO of Quebec’s largest public pension fund, the Caisse de dépôt et placement du Québec.

In a prepared speech last month in Toronto, Sabia said financial institutions like pension plans have tremendous potential to drive growth through infrastructure investment. For the investor, Sabia said that infrastructure offers stable, predictable, low-risk returns of seven to nine per cent.

A spokeswoman for Morneau’s office was asked about Ottawa’s interest in asset recycling, but she referred back to the budget and said there was nothing new to add on the issue, for the moment.
Last year, I discussed this idea of opening Canada's infrastructure floodgates. Since then, the idea has taken off and there has been a vigorous push from Ottawa to court pensions on infrastructure.

Why does this initiative of "asset recycling" make sense? I've already mentioned my thoughts here but let me briefly make a much simpler case below:
  • Federal, provincial and municipal governments are cash-strapped and they need funds to invest in infrastructure. Increasing taxes to do this is simply not a viable option when the economy is weak.
  • Unlike other investments, investing in infrastructure has huge long-term economic benefits to any country and infrastructure jobs pay well, which means there is an important multiplier effect to the overall economy from these jobs.
  • Pensions need yield. They can invest in public and private markets or in hedge funds. Increasingly, they're avoiding volatile public markets where bond yields are at historic lows and they're even starting to shun hedge funds which promise absolute returns but have failed to keep up with simple stock and bond indexes. 
  • Where are pensions turning to? Private equity, real estate and infrastructure. But unlike private equity, Canada's large pensions invest directly in infrastructure, avoiding hefty fees to general partners (GPs), and unlike real estate, the duration of infrastructure assets is a better match to the duration of their long dated liabilities which typically go out 75+ years. 
  • What else? infrastructure assets are highly scalable, meaning these large pensions can put a huge chunk of money to work in one infrastructure investment instead of many private equity or hedge funds which charge big fees and don't offer safe, predictable returns.
  • Most of Canada's large public pensions target an actuarial rate of 6.3% (nominal), so if Michael Sabia is right and infrastructure offers a stable, predictable and low-risk return of 7-9%, then why not invest directly in infrastructure? It makes perfect sense.
  • Canada's large public pensions are internationally renowned infrastructure investors, investing in airports, highways, ports, and other infrastructure investments all around the world. Their focus has mainly been in Britain and Australia where the rule of law is similar to the one in Canada. 
  • But if the federal government makes public infrastructure available to them here, either through long-term leases or outright sales, then why not invest in domestic projects, foregoing any currency risk or foreign regulatory risk? Again, it makes perfect sense, it's simple logic, not rocket science. 
  • Of course, if the federal government opens public infrastructure assets to Canada's large pensions, it has to do so for international mega pension and sovereign wealth funds too, introducing competition and leveling the playing field. 
  • Typically Canada's large pensions invest in mature infrastructure investments that have been operational for years and offer well-known cash flows, avoiding riskier greenfield projects with uncertain cash flow projections.
  • But the Caisse is dipping into greenfield projects here in Quebec. It can do so because it has hired an experienced team of infrastructure professionals with actual operational experience who have project management experience and have overseen previous greenfield projects.
On this last point, the Caisse announced plans on Friday for its Réseau électrique métropolitain (REM), an integrated, world-class public transportation project. Jason Magder of the Montreal Gazette reports, Electric light-rail train network to span Montreal by 2020:
It will be the biggest transit project since the Montreal métro, but this one will be built and mostly funded by a pension fund.

The Caisse de dépôt et placement du Québec, the province’s pension fund manager, unveiled on Friday a light-rail network it intends to build, with the first stations coming online in 2020.

“Every time you take this train, you’ll be paying into your retirement,” said Michael Sabia, the CEO of the Caisse.

Answering decades of demands for an airport link from downtown, the $5.5-billion Réseau électrique métropolitain will be a vast network linking the South Shore, the West Island and Deux-Montagnes to both the airport and the downtown core.

“What we’re announcing today is the most important public transit project in Montreal in the last 50 years,” said Macky Tall, the president of CDPQ Infra, the Caisse’s infrastructure arm.

Leaving from Central Station, the 67-kilometre network will use the track running through the Mount Royal tunnel, taking over the Deux-Montagnes line — which already runs electric trains — from the Agence métropolitaine de transport. New tracks will be built over the new Champlain Bridge, and link to the South Shore, ending near the intersection of Highways 30 and 10 in Brossard. Two other dedicated tracks will be built, branching off from the Deux-Montagnes line, where Highway 13 meets Highway 40. One track will head to Trudeau airport, with a stop in the Technoparc in St-Laurent. Another will follow Highway 40 toward Ste-Anne-de-Bellevue. The existing Vaudreuil-Dorion train line won’t be affected by the project.

Light rail trains are smaller and carry fewer passengers, but the service will be more frequent than the current AMT service, Tall said.

This is not the pension manager’s first foray into public transit. The Caisse is one of the builders of the Canada Line, a train that links Vancouver’s airport to the downtown area and the suburb of Richmond. It was built in time for the 2010 Olympic Games.

However, Sabia admitted this project represents a much greater risk, since the Caisse is the principal investor and has to recoup both its capital investment and its operating costs. But he’s confident the Caisse will achieve “market competitive returns” on the project.

“We are taking the traffic risk here,” Sabia said. “This is unusual because generally, it’s governments that take that risk.”

Matti Siemiatycki, an associate professor of urban planning at the University of Toronto, said this is a first for Canada, so it’s an untested funding model.

“Internationally, there have been privately funded and financed commuter rail lines, but in most cases, they don’t recover their operating costs, let alone their capital costs,” Siemiatycki said.

He said because it has holdings in engineering, train manufacturing and train operating companies, the pension fund does have an advantage. But he’s not sure it will be enough.

“It’s possible they can realize economies, but it doesn’t take away the fact that most transportation systems in North America are not recovering their operating costs, let alone their capital costs, so that will be the Caisse’s challenge,” he said.

Sabia said the Caisse intends for most of the revenue to come from fares, which he said will be similar to the ones currently charged by the AMT.

“That’s a big chunk of it but, of course, as you know municipalities today have made a public policy decision to encourage people to use public transit,” Sabia said. “We would expect that current practice would continue and contribute to the overall financing of the project.”

Because the trains will be fully automated, Sabia said the operating cost of the network will be low.

The Caisse, which has a real-estate investment division, will also try to recoup some of the investment through development along the line, but Sabia said the bulk of the revenue will come from ridership. The Caisse expects a daily ridership of 150,000, compared with 85,000 that currently use the Deux-Montagnes line, the 747 airport bus and buses across the Champlain Bridge.

The Caisse has promised trains will leave every three to six minutes from the South Shore and every six to 12 minutes on the West Island and Deux Montagnes Line, for the duration of its 20-hour operation schedule from 5 a.m. to 1:20 a.m. The Caisse estimates it will take 40 minutes to take the train from either Ste-Anne-de-Bellevue or Deux-Montagnes to downtown. It will take 30 minutes to go from Central Station to the airport. It will take between 15 and 20 minutes to travel from Brossard to downtown.

Tall said the decision to follow Highway 40 was made because of work going on in the Turcot Interchange. That work would have prevented crews from building dedicated lines for the next five years. He said building along that corridor would also cost $1 billion more because it would require a track dedicated to passenger traffic.

The thorny issue of parking remains unsolved, however. Currently, many stations along the Deux-Montagnes line are over capacity and there is no space to build new parking spots.

Tall said the Caisse will speak with municipalities about this issue and hopes to come up with a solution.
Michael Sabia has gone from being an outsider to a rainmaker in Quebec. When he took over the provincial pension fund, it was $40 billion in the hole. He's managed to grow its asset base by $130 billion since then and is now looking to invest directly in Quebec's infrastructure with this "risky" foray into a greenfield project.

I put "risky" in quotations because unlike that associate professor of urban planning quoted in the article above, I'm more optimistic and think he is underestimating Macky Tall, CEO of CDPQ Infra and his senior team, many of whom have worked on greenfield infrastructure projects and know what they're doing when it comes to managing such large scale projects. No other large Canadian pension fund has as much operational experience when it comes to greenfield infrastructure projects, which is why they typically avoid them.

So, while Sabia garners all the attention, there are a lot of people under him who deserve credit and praise for this huge project. One of them is a friend of mine who has nothing but good things to say about Michael Sabia, Macky Tall, CDPQ Infra's team and the Caisse in general.

No doubt, greenfield infrastructure projects carry bigger risks but they also offer bigger rewards down the road. Will everything go smoothly in this project? Of course not, there isn't one major greenfield infrastructure project that goes off without a hitch but the people working on this project have actual operational experience and a track record of delivering on such projects below budget (which isn't easy) easing my concerns about recouping operating and capital costs.

So, I would tell the media and critics to ease up and have faith in Macky Tall and his team at CDPQ Infra. They are all very experienced and highly ethical individuals who will deliver on this and other greenfield projects if they are asked to in the future. And trust me, there will be no Charboneau Commission on this project which is great news for Quebec's taxpayers.

Below, Jason Magder of the Montreal Gazette discusses the Caisse's $5.5-billion Réseau électrique métropolitain (REM) project. Talk about "Making Quebec Great Again" (my girlfriend came up with that playing on Trump's campaign logo).

Speaking of Making America Great Again, David Walker, former U.S. comptroller general, and former Gov. Howard Dean, (D-Vt.), discussed which candidate has the best tax plan for voters and corporate America on Monday morning on CNBC Squawk Box.

Listen closely to David Walker's response to Gov. Dean's question at the end of this clip where he states the need to "pursue public-private partnerships" and tap into the trillions of "patient capital" from U.S. pensions to invest in America's crumbling infrastructure.

In Canada, we're already there and unlike in the United States, our large public pensions operate at arms-length from the government (got the governance right) and invest directly in mature and now greenfield infrastructure projects. This will hopefully make not only Quebec but Canada great again. I'll end it on that optimistic note.


Friday, April 22, 2016

Pity The Hedge Fund Manager?

Will Wainewright and Nishant Kumar of Bloomberg report, Hedge Funds Suffer Worst Outflows Since Financial Crisis Era:
Hedge funds suffered the worst withdrawals last quarter since the tail-end of the financial crisis as wild swings in stocks and commodities caused losses at some of the best-known firms.

Investors pulled a net $15 billion between January and March, reducing assets under management to $2.86 trillion from $2.9 trillion, Chicago-based Hedge Fund Research Inc. said Wednesday. The last time outflows were higher was in the second quarter of 2009, when $43 billion was redeemed.

Clients are redeeming after many hedge funds failed to protect them during market turmoil in the second half of last year and again at the start of 2016. Managers including John Paulson, Chase Coleman, Andreas Halvorsen, Ray Dalio and Bill Ackman posted losses in some of their funds last quarter, even as global stocks edged out a small gain with dividends reinvested.

Hedge funds following macro economic trends to bet across asset classes suffered $7.3 billion in outflows, while those betting on corporate events saw about $8.35 billion pulled out, the data showed. Fund managers speculating on the success or failure of mergers and acquisitions attracted $400 million.

Clients of Tudor Investment Corp. have asked to pull more than $1 billion from the hedge fund firm founded by billionaire Paul Tudor Jones after three years of lackluster returns. Tudor’s main BVI Global, a macro fund, fell 2.8 percent in the first quarter, according to an investor document. That follows gains of 1.4 percent in 2015 and 3.5 percent in 2014.
Goldman’s Cautions

Och-Ziff Capital Management Group LLC, the largest publicly traded U.S. hedge-fund manager, saw its assets fall by about $1 billion in March to $42 billion on April 1, according to a company filing. Och-Ziff had $47.5 billion under management at the end of 2014. The OZ Master Fund, the firm’s main multistrategy pool, lost an estimated 3.4 percent through March, according to the filing.

Hedge funds are bleeding cash just as Goldman Sachs Group Inc.’s Mike Siegel and UBS Group AG are advising clients to increase allocations to alternative money managers as a protection against volatile markets. Siegel, who oversees about $190 billion at the bank’s asset management unit said insurers should use hedge funds to diversify even after their recent declines.

Hedge funds lost an average 2.6 percent in the first two months of the year after a 1.1 percent loss in 2015, according to the HFRI Fund Weighted Composite Index. They recovered some losses in March as equities and commodities markets rallied.

But their correlation with market volatility has led to investors questioning their use as a shock absorber in a portfolio. The New York City’s pension fund for civil employees voted to exit its $1.5 billion portfolio last week, deciding that the loosely regulated investment pools didn’t perform well enough to justify the high charges. They typically charge investors a 2 percent management fee and keep a fifth of profits.
Paulson, Coleman

Paulson & Co.’s Advantage and Advantage Plus funds, which wager on companies going through corporate events including spinoffs and bankruptcies, tumbled 15 percent in the first quarter, according to a person familiar with the matter.

Halvorsen’s Viking Global lost 8.8 percent in the quarter, Coleman’s Tiger Global Management hedge fund lost about 22 percent, Dalio’s Pure Alpha fund tumbled 6.7 percent and Ackman’s activist hedge fund Pershing Square Capital Management lost 25.6 percent.

Managers deciding to return capital to investors were responsible for some of the drop, HFR President Ken Heinz said in a statement. Michael Platt’s BlueCrest Capital Management, once one of Europe’s largest hedge funds, said in December that it would return money to its clients.

Hedge-fund shutdowns outnumbered startups last year for the first time since 2009, HFR said last month. There were 979 fund closures and 968 startups.
You can add Blackstone's Senfina to that list above, it is down 15 percent year-to-date.

Mary Childs and Lindsay Fortado of the Financial Times also report, Investors pull $15 billion from hedge funds:
Hedge funds have suffered their worst quarter in seven years after more than $15 billion was pulled out by investors starting to fight back against the high fees being charged across the industry.

The total amount invested in hedge funds fell to $2.86 trillion in the first three months of the year, marking the first time since 2009 that the sector has faced two consecutive quarters of net outflows, according to data from Hedge Fund Research.

Sharp market moves have wrongfooted many firms, leading to poor performances in the first quarter from funds such as Bill Ackman's Pershing Square, and rankling investors already disgruntled over fee structures charging 2 per cent for management as well as 20 per cent of profits. A broad index of hedge fund performance fell 0.7 per cent in the first quarter, according to HFR.

Fed up with paying "exorbitant fees" for poor returns, the New York City Employees' Retirement System has cut its $1.5 billion program, pulling money from managers including Perry Capital and Brevan Howard. The shift comes about 18 months after California's pension scheme also scrapped hedge funds from its portfolio.

At the same time, sovereign wealth funds have been withdrawing billions from asset managers globally as they turn their attention to supporting their own faltering oil-dependent economies.

Letitia James, public advocate for the New York pension scheme, attacked managers who "balk at negotiations for investor-favorable terms" believing they "could do no wrong, even as they are losing money".

"If they were truly fiduciaries and cared about our members, they would never charge large fees for failing to deliver on their promises," she said. "Let them sell their summer homes and jets, and return those fees to their investors."

The largest first-quarter redemptions in the sector came from macro strategies, which saw investor outflows of $7.3 billion, and event-driven funds, in which $8.3 billion was pulled — more than half from activist strategies.

However, some pension funds are also boosting their exposure to hedge funds. Finland's state scheme plans to invest $500 million in the sector this year, while the Illinois State Universities Retirement System is investing $500 million in hedge funds for the first time. US insurers are also tapping the sector to help generate returns.

Many managers, who often pool their own money alongside investors', caution that a volatile market is the worst moment to move away from hedged strategies.

"More up-and-down markets with a lot of dispersion should be a really good environment for hedge funds," said Judy Posnikoff, a founding partner of Pacific Alternative Asset Management Company, which invests in hedge funds. "If we're not in a bull market, where are you going to go?"
Matt Philips of Quarts reports, Hedge funds are doing terribly:
Pity the hedge fund manager.

The elite, highly compensated men—they’re mostly men—who run money for the world’s wealthy are having a devil of a time finding a way to make decent returns. As an asset class, hedge funds lost 0.4% during the first quarter, according to research firm Eurekahedge.

That might not sound like the end of the world. But it’s an especially poor showing, when you realize that investors who simply bought index funds tracking plain-vanilla benchmarks for stocks, such as the S&P 500, or bonds, such as the Barclays Aggregate US index, fared far better. The S&P 500 and the Barclays Aggregate returned 1.4% and 3%, respectively, for the first three months of the year.

Hedge fund clients have noticed that they’re not making money. As a result, they’ve yanked roughly $15 billion in assets from hedge funds in the first quarter, the worst stint of redemptions since 2009, during the nadir of the Great Recession.


Of course, hedge fund managers can argue that while they might be trailing the big indexes this quarter, when they win, they’ll win much bigger than they’ve lost, making their services worth the high fees they charge.

But the surge of withdrawals suggests more and more of their clients don’t see it that way.
According to a team of JPMorgan analysts led by Nikolaos Panigirtzoglou, hedge funders should brace for a total outflow of at least $25 billion this year.

Admittedly, this is represents less than 1% of total assets hedge funds manage, something Mark Yusko reminded me on twitter, but it could be the start of something much bigger (click on image):


Go back to read my recent comments on the bonfire of the hedge funds, a requiem for hedge funds and let them eat their summer homes.

When it comes to hedge funds, I pull no punches and think a lot of hedge fund "gurus" are nothing more than glorified asset gatherers charging alpha fees for leveraged beta.

There are excellent hedge fund managers out there but this is a brutal environment and I openly question whether some of these brand name funds are too big for their own good, and more importantly, for the good of their institutional investors.

What else? Charging 2 & 20 in a deflationary world when interest rates are zero or negative and when you're not delivering real and meaningful alpha on a consistent basis is simply indefensible. Worse still are the lame, pathetic excuses for such lousy underperformance.

I'm so glad I'm out of the allocation business as I would be redeeming from a lot of underperformers, especially from anyone who doesn't look me in the eye and come clean as to why they're down 6%, 8%, 10% or more in a quarter (and I wouldn't wait for them to contact me first).

I have zero tolerance for nonsense and lame excuses and I couldn't care less which hedge fund manager is siting in front of me. If they're blowing smoke up my ass, providing me with lame excuses as to why they're severely underperforming, I wouldn't sit there like a doormat lapping up the nonsense they're feeding me. I would be grilling them hard until they answered all of my questions and I felt comfortable that they are able to come back from such losses.

For example, Miles Johnson and Lindsay Fortado of the Financial Times report, Odey fund loses 31 per cent in four months:
A brutal start to 2016 for Crispin Odey, the outspoken British investor, has wiped out almost half a decade of trading profits in his flagship hedge fund in less than four months.

The value of the €729m Odey European Fund has now fallen 31.1 per cent to the middle of April, dragging it back to its lowest level since January 2012. His large bets against currencies and equities have gone awry, making his stockpicking fund one of the worst performers among large vehicles this year.

Mr Odey, who has been among the most prominent British financiers to back the country voting to leave the EU, has held strongly bearish views on emerging markets and China for more than a year.

In a letter to investors dated March 31, Mr Odey wrote that years of ultra-low interest rates had resulted in a wave of misallocation of capital spending and investment across the world. He believes that continued quantitative easing will result in a grand reckoning for the global economy.

“QE is merely encouraging misdirected investment,” Mr Odey wrote. “Remember it was Keynes, the architect of [central bank] thinking, who said, ‘It is good for people to travel, goods to travel but not for savings to travel.’ The disconnect between travelling and arriving may be coming home to roost. It will make the retreat from Moscow appear painless.”

The latest fall comes after his fund lost 19 per cent of its value in April 2015 while speculating on the value of the Australian dollar. That loss meant that Odey European ended 2015 down by 12.8 per cent, one of the worst performances among large hedge funds in the world that year.
A few things here and it's important you all realize this. I don't care if it's Crispin Odey, Ray Dalio or George Soros, when anyone thinks "the market is wrong and I'm right", it shows an incredible lack of humility and zero in terms of risk management skills.

Even if you believe in Crispin Odey's story, don't fall in love with the story or the manager, focus on the process, performance and people and ask some very tough questions like "how the hell did you allow your fund to lose 20% in three months?" or "why are you taking a huge short bet on the Aussie with no regard to risk management?!?".

Same thing with Bill Ackman whose fund finally jumped in April:
Bill Ackman is having a good month. You can read that again.

After a terrible start to the year, Mr. Ackman’s Pershing Square is up big in April. The assets in his publicly-traded fund have risen 12% this month. The fund has now gained in three straight weeks, the best stretch since it went up three straight weeks in late July and put it at an all-time high in early August.

The fund is still down 17% this year, and about 40% below that high-water mark from August. Pershing Square had been hammered in the first quarter, and since last August, by the precipitous decline in Valeant Pharmaceuticals International The pain, though, spread to other holdings such as Platform Specialty Products as well as a share slide in some of biggest holding.

Valeant is up 27% this month, and his biggest positions in Mondelez, Zoetis and Air Products are all up as well. Even Herbalife, which Mr. Ackman has very publicly bet against, is cooperating, falling 5.2% over the last month.
I actually like the way Valeant (VRX) has been trading lately and Bill Miller might be right, it can easily double from here given how negative sentiment is on this company (click on image):


Still, there has been a lot of technical damage on this stock and the truth is Bill Ackman should have unloaded a huge chunk of it when it was trading above $250 (to be fair, he publicly admitted this after getting clobbered).

More broadly, I like the way the biotech sector has been trading lately as both large (IBB) and small (XBI) biotechs have bounced nicely off their lows and the sector is due for a big rally after suffering one of its worst quarters ever (click on image):


But there is no denying the best sectors so far this year are those leveraged to global growth, namely, emerging markets (EEM), Chinese shares (FXI), energy (XLE), oil and gas exploration (XOP), metals and mining (XME) and industrials (XLI).

In fact, hedge funds that bet big on a global recovery last summer might have suffered a rough patch but guys like Carl Icahn are laughing all the way to the bank nowadays (click on image):


Will this momentum carry through in the second half of the year? That all depends on whether oil doubles by year-end or whether the Great Crash of 2016 clobbers global risk assets, especially if China's pension gamble falls short and another Asian crisis hits us this year.

So far, that surging yen which worried me last week has abated recently and this is good news for global risk assets and hedge funds leveraging their positions using the yen carry trade. Conversely, it's bad news for Crispin Odey who thinks that central banks and the market are wrong and he is right (hedge your positions old chap!!).

But don't shed any tears for Crispin Odey, Alan Howard or Michael Platt, their fortunes might have taken a hit amid market turmoil but they still figure among the richest hedge fund managers in the UK and world.

So, pity the hedge fund manager? Nope, not me, these guys don't know how good they've had it for so long charging alpha fees for leveraged beta but I think institutional investors are fed up and now more than ever, they're willing to walk away and never look back.

I'd love for all these big shot hedge fund managers to really step up to the plate and live and die by their performance figures alone. That's right, no management fee if you are managing multi-billions, show me what you've got!

Of course, the reality is that there's so much nonsense in the hedge fund industry and it's a powerful one. It doesn't surprise me one bit that big hedge funds and mutual-fund companies emerged as winners of Wall Street pay rules proposed Thursday.

And poor Elizabeth Warren, she blasted the SEC for approving Steve Cohen's new firm but fails to realize just how powerful the perfect hedge fund predator is and how he can't wait to come back to charge clients huge fees (at one time, he charged 3 & 50!) for managing their assets (still, Senator Warren can find solace knowing that Wall Street is underwater).

But you've got to hand it to Steve Cohen, he's always ahead of the curve when it comes to picking stocks like Celator Pharmaceuticals (CPXX) which is the number one stock year-to date (click on image):


Then again, despite charges from Zero Hedge, Point72 says it has perfect compliance and Cohen would be the fool of fools if he did anything remotely shady in the stock market (everyone is gunning for him and he knows it).

Also, Steve Cohen doesn't always pick great biotechs. He got clobbered on several positions including Sarepta Pharmaceuticals (SRPT) which got slammed hard yesterday following news that the FDA cast doubts on its proposed drug to treat a fatal form of muscular dystrophy (but stock is bouncing big today on FDA voting questions, up 35% after getting slammed 44% yesterday).

One thing I can guarantee you, Steve Cohen would never accept being down 20% in a quarter and he would never face his investors with lame, pathetic excuses as to why he's down (love him or hate him, the guy has balls and zero tolerance for underperformance).

Below, U.S. Senator Elizabeth Warren, a firebrand for strong financial regulation, asked on Thursday why securities regulators approved Steve Cohen's new firm as an investment adviser after barring the billionaire from managing other people's money until 2018 (if clip doesn't load, watch it here). Bloomberg's Winnie O'Kelley has more on "Bloomberg Markets" (second clip).

Also, CNBC reports that investors are starting to turn away from hedge funds to fight back against the high fees. I wouldn't hold my breath, this isn't exactly a stampede out of hedge funds, at least not yet.

Fourth, Michele Gesualdi, CIO of Kairos, and Ryan Kalish, co-founder of Allocator, discuss hedge fund leverage and changes within the industry.

Lastly, Hugh Hendry, the hedge-fund manager who profited by betting against banks during the financial crisis, said he’s now speculating on a recovery in Japanese stocks as the nation’s policy makers maintain their policy of negative interest rates.

Very interesting discussion, worth listening to his views, especially if you are worried about the Great Crash of 2016 which hasn't happened yet. Please remember to show your support for this blog by contributing via PayPal on the right-hand side. Have a great weekend!