Wednesday, August 24, 2016

Beware Of The Big Bad Caisse?

This comment is bilingual, so please bear with me as I will explain it below. At the end of June, Patricia Cloutier and Valerie Gaudreau of Le Soleil reported, Tous les régimes de retraite de Québec passent à la Caisse de dépôt:
Dans l'espoir de faire des économies et d'améliorer leurs rendements, tous les régimes de retraite de la Ville de Québec seront dorénavant gérés par la Caisse de dépôt et placement du Québec (CDPQ).

Cet actif, qui s'élève à environ 2 milliards $, était auparavant géré par un comité composé de fonctionnaires de la Ville et de représentants syndicaux. La Caisse de dépôt, qui gère déjà le bas de laine des employés des Villes de Laval, Sherbrooke, Terrebonne et Magog, a ainsi ouvert la porte mardi à son plus gros déposant dans le secteur municipal. «On est très heureux de les accueillir. C'est une belle marque de confiance et de reconnaissance pour nous», soutient Maxime Chagnon, porte-parole de la CDPQ.

Dans la région de Québec, la CDPQ gère aussi les fonds des employés de l'Université Laval et d'une partie des employés de la commission scolaire de la Capitale.

En mêlée de presse, le maire de Québec, Régis Labeaume, a dit s'être entretenu avec le président et chef de la direction de la Caisse, Michael Sabia. «J'ai parlé à M. Sabia cette semaine, je lui ai dit qu'on lui envoyait 2 milliards $. J'ai dit qu'on voulait du bon rendement, il nous a promis tous les efforts. Je pense qu'on fait un bon coup. Ils sont très bien équipés», a-t-il commenté.

«On était dû pour changer et viser de plus gros rendements», a poursuivi M. Labeaume selon qui les syndicats ont aussi tout intérêt à percevoir de bons rendements depuis que la loi 15 oblige le partage à parts égales des déficits entre employés et employeurs. «Ils ont beaucoup plus d'intérêt maintenant pour le rendement car ils doivent payer 50 %», a-t-il dit.

Propos «indécents»

Jean Gagnon, président du Syndicat des cols blancs de la Ville de Québec, juge ces propos du maire «indécents». «Il faut être drôlement culotté pour s'approprier une démarche dont il était 100 % absent», soutient le syndicaliste. Selon lui, ce sont les syndicats qui ont tiré la sonnette d'alarme en ce qui a trait aux coûts élevés du régime. Un travail d'équipe de plusieurs mois s'est ensuite enclenché en collaboration avec la direction générale de la Ville.

Selon M. Gagnon, les employés municipaux sont eux-mêmes des contribuables et se sont intéressés depuis très longtemps au rendement des régimes de retraite. «Sauf qu'avant, je me faisais dire de me mêler de mes affaires!» lance-t-il, irrité.

La première solution envisagée par la Ville et les syndicats a été de créer un gros bureau de gestion des fonds à l'interne, avec une vingtaine d'employés, raconte M. Gagnon. Mais la structure aurait été lourde, et l'expertise, à développer. «Quand on a vu la proposition que la Caisse nous a faite, on ne pouvait avoir mieux», dit-il.

«La Caisse a eu un mauvais épisode en 2008, mais on sait qu'ils ont appris de leurs erreurs et ne referont pas ce genre de connerie-là», commente M. Gagnon, en parlant des pertes colossales enregistrées par la CDPQ il y a huit ans.

Alors qu'à l'heure actuelle, les frais de gestion des régimes de retraite des cadres, employés manuels, fonctionnaires, professionnels, pompiers et policiers sont de 0,29 %, ils pourraient maintenant descendre à 0,17 %, explique M. Gagnon.

Le représentant syndical évalue qu'entre les mains de la CDPQ, les rendements de ces régimes devraient augmenter, au minimum, de 1 %. Ce qui représente une économie de 22 millions $, tant pour les citoyens de Québec que pour les employés. «C'est une solution gagnant, gagnant», plaide-t-il.

Au 31 décembre 2015, les six régimes de retraite de la Ville de Québec comptaient plus de 9500 participants actifs, retraités et bénéficiaires.

Le chef de l'opposition à l'hôtel de ville, Paul Shoiry a aussi salué la décision mardi. «La Caisse de dépôt connaît des bons rendements depuis quelques années. Leur expertise est connue et je pense que financièrement, ça peut être une bonne chose. C'est probablement une très bonne décision», a dit l'élu de Démocratie Québec.
The article above was written at the end of June and basically discusses how the city of Quebec transferred $2 billion to the Caisse to manage its pension assets which were previously managed by a city pension plan. The Caisse didn't solicit this business, it was approached to do this.

The main reason behind this move? Performance. The passage of Bill 15 in Quebec's National Assembly forces public sector employees to share the risk of the pension plan, which means if a deficit occurs, they and the plan's sponsor need to contribute more to shore it up (not sure if it's Bill 15 but that is what the article states).

It is estimated that the plan's performance will increase 1% which represents a savings of $22 million. In addition to this, there will be significant administrative savings, passing from 29 basis points to 17 basis points. The union representing Quebec City's public sector employees pushed hard for this.

Now, the person who brought this to my attention shared this with me: "This is a terrible idea because it is setting a dangerous precedent as other cities and municipalities will follow and it will mean the end of many small equity and fixed income shops in Quebec that rely on these city and municipal pensions for mandates."

He told me that Quebec's financial community is dying and "nobody cares". He said "The only thing Finance Montréal does is attract back office jobs to Montreal and help firms like Morgan Stanley and Societé Générale open up middle office jobs, which is good but not enough. There are no front office jobs being created here and that's terrible."

He said this will concentrate "more power in the hands of the Caisse and will jeopardize the emerging manager program which was set up to reinvigorate Montreal and Quebec's financial community."

He also told me that PSP's CEO André Bourbonnais who sits on the board of Finance Montréal "went ballistic" when he found out that the Caisse will now be managing Quebec City's pension assets because "he knows what it means for Quebec's financial community."

I listened patiently to his qualms and then I asked him: "Why are you bothering me with this? I'm just a pension blogger trying to make a buck trading some biotech shares and here you are ranting and raving about the big, bad Caisse taking over Quebec's city and municipal pensions."

Alright, so you all want to know my thoughts? I'll share them with you and be very blunt so you are all crystal clear on them. I think it's about time that all of Quebec's defined-benefit pensions be managed by the Caisse.

And I'm not saying this to suck up to the Caisse or its senior managers. I couldn't care less of what they think of me. I'm thinking of what is in the best interests of plan members and sponsors as well as Quebec taxpayers. And from my expert vantage point, there is no question whatsoever that they're doing the right thing for their contributors, beneficiaries and the province's taxpayers.

Will other unions in Quebec follow the decision of Quebec City's public sector union and transfer their pension assets to the Caisse? I certainly hope so especially if it's in their members' best interests. I just finished a comment on the disaster at the Dallas Police and Fire Pension where I recommended almagamating all city and local pensions at the state level and improve their governance.

Will there be collateral damage because of decisions to transfer pension assets to the Caisse? Yes, no doubt about it. The person who shared this with be is right to lament that it will impact many Quebec based funds as well as consultants, actuarial shops and lawyers and accountants dealing with setting up new funds and managing their business. It will also impact brokers as they will receive less commissions.

Such is life, it is tough. When my buddy's father closed up his children manufacturing shop in the nineties after Eaton's closed stores and eventually sent bankrupt, it meant he and others had to lay off many employees. He later admitted to me that he had too much concentration risk relying on Eaton's.

The same goes for Quebec funds and consultants relying solely on Quebec's small to mid size city and municipal pensions for all their business. If that is their business model, they're going to close shop too.

The problem in Quebec is everyone knows each other and it's a little fraternity. I call it "la petite mentalité québécoise" (the small Quebec mentality). It's not just me. A French Canadian friend of mine once told me: "There are two type of Quebecers, those who think like Ginette Reno and those who think Celine Dion."

I have no problem with Ginette Reno or Celine Dion, god bless both of these singers. But I understand what my friend was saying, either you're going to think big time and act accordingly or close yourself off to what is familiar in your own surroundings. And if you're going to do that, then you won't enjoy big time success.

There are Quebec based private funds that think like Ginette Reno and others that think like Celine Dion. The latter are enjoying huge success while the former enjoy success but on a much smaller scale and their business model leaves them much more exposed to client concentration risk.

Again, such is life and it isn't always fair. I know all about that on a personal and professional level, but I'm not going to shed a tear for Quebec based funds that close shop because of the right decision of Quebec City or other cities to transfer pension assets to the Caisse which will do a much better job, delivering better risk-ajusted results at a fraction of the cost.

The person who shared this with me didn't like my response. He lamented "the Caisse's results especially in fixed income weren't as strong as those of Ontario Teachers'," to which I replied "And, who cares? The Caisse's 2015 overall results were excellent even if Fixed Income underperformed its Ontario Teachers' peers" (not to mention you need to be extremely careful when intepreting results from Canada's highly leveraged pensions).

And in its recent semiannual update, the Caisse said over five years, the weighted average annual return on clients' funds reached 9.2%, generating net investment results of $86.8 billion for this period. With respect to its benchmark portfolio, the Caisse produced $9.4 billion of value added. For the first six months of the year, the average return stood at 2.0%, generating $1.6 billion of value added. Net assets totalled $254.9 billion.

Now, I don't know if André Bourbonnais who sits on the board of Finance Montréal "went ballistic" when he found out that the Caisse will be managing Quebec City's pension assets. This might be all hearsay which is completely false.

But I will tell you what I think, there is no doubt in my mind that Quebec and Montreal's finance cummunty is shrinking (this is happening everywhere) and there needs to be a lot more done to attract front office jobs to our beautiful city. And I think that both André Bourbonnais and Michael Sabia need to use their power to do a lot more to help this city's finacial community to flourish once again.

How should they do this? That's a tough question. Most Quebec hedge funds, just like most hedge funds, absolutely stink. Most have closed shop in the last few years (the only hedge fund I would invest in is my friend's currency hedge fund and even he is battling for returns with one arm tied behind his back). The same goes for private equity funds, which are much fewer.

Maybe the focus should be more on opening up another long only shop like Hexavest or opening up a big global macro shop. Or maybe this city needs to make a huge pitch to the United Nations to bring its pension operations here. I argued for this in a recent post of mine.

I don't know the answers but all I can tell you is the financial landscape is being irrevocably altered and it will impact pensions, hedge funds, private equity funds, mutual funds, banks, insurance companies, and many third party vendors and service providers.

Life is tough, you need to live through, accept and adapt to change, some of us a lot more than others. On that note, make sure you read my earlier comment on whether it's time to plunge into stocks. I certainly don't get paid enough for sticking my neck out and sharing my insights with all of you.

Below, take the time to listen to a panel session from the recent International Pension Conference of Montréal (IPCM) featuring Leo de Bever, AIMCo's former CEO.

I already went over the conference here but noticed this session was made public after my post. You can watch all the sessions here.

Tuesday, August 23, 2016

Disaster Strikes Dallas Police & Fire Pension?

Brett Shipp of WFAA reports, Dallas police, fire pension board facing disaster:
The past month has been an emotional roller coaster for Dallas police and firemen. Thursday afternoon, the bad news continued.

The Dallas Police and Fire Pension System is a billion dollars in the red, and the plan to bail the system out is already being called "unacceptable" by some.

The bailout plan, unveiled Thursday, is a proposal that police and fire employees knew was coming. But the fact is, the Dallas Police and Fire Pension System is actually closer to $2 billion in the hole.

If things keep going the way they are going, the pension fund will be broke by 2030. That's why consultants unveiled the bailout plan, which one police veteran called so drastic he believes it will be voted down by rank-and-file.

The plan calls for dramatic reductions in cost-of-living adjustments and deferred retirement option plans, also known as the drop program.

What's more, the City of Dallas would immediately have to contribute $600 million into the fund just to keep it solvent.

"There is no choice. There have to be deep cuts," said pension fund board member and Dallas City Council member Phillip Kingston. "We tried to make them the least painful as possible. There have to be deep cuts and there is no guarantee the city is going to love contributing the amount that being asked."

The pension fund got into trouble after former administrators made millions of dollars in risky real estate investments. Some of those administrators and advisors are reportedly now under federal investigation.

The pension system is in such bad shape pension system officials says dramatic cuts must be made beginning this October.
Tristan Hallman of the Dallas Morning News also reports, Can Dallas Police and Fire Pension fund be saved? Officials propose changes to head off insolvency:
Jim Aulbaugh, a battalion chief for Dallas Fire-Rescue, is skeptical of any attempts to save his and his colleagues' pensions.

"I don't think it will make any difference," said Aulbaugh, a 33-year veteran. "It's a sinking ship that can't be saved."

But Dallas Police and Fire Pension Fund board members still believe they can salvage the system. And on Thursday, they unveiled a new plan built mostly on big cuts, new revenue and the hope that the city will pump new money into the fund.

Firefighters and cops, who are rallying for higher salaries at City Hall, understand that their retirements are in jeopardy. The pension system, set back by significantly overvalued real estate investments, is hurtling toward insolvency by 2030.

The fund has $3.27 billion in unfunded liabilities and less than $2.7 billion in assets -- a funding ratio of 45 percent. Pensions are generally thought to be in danger if their funding ratio is less than 80 percent. The fund would need its members and the city to double their contributions to meet its requirements.

Texas Pension Review Board Chairman Josh McGee said the fund is "in a world of hurt" and is unaware of a state pension system in worse shape.

"It's going to take shared sacrifice from all sides to actually fix the system," he said. "That's going to be difficult."

The proposals represented pension system officials' first concrete steps at comprehensive fixes.

Kelly Gottschalk, the system's executive director, said the fund's proposals would solve nearly two-thirds of the funding problem.

The most significant proposal is adding restrictions to the Deferred Retirement Option Program, better known as DROP. The program allows veteran officers and firefighters to "retire" in the eyes of the system, but continue working for their paychecks while their pension checks are sent to a separate investment fund. They pay a fee of 4 percent of their paychecks, less than the 8.5 percent contribution they'd make otherwise.

DROP gave recipients an 8 percent to 10 percent annual return even while the system earned significantly less. And actual retirees can keep their money in DROP indefinitely, accruing interest, and withdraw it whenever they want. That makes up $1 billion of the fund's money.

The proposal won't end that practice because the system needs the money. But it will tie it to Treasury bond yields.

That plan, if approved, will probably force cops and firefighters to either retire sooner or stay in the normal fund longer. Once in DROP, members could earn a 3 percent interest rate for seven years. Then, the money will earn nothing until they retire.

The plan will trim cost-of-living increases, base payments on a five-year highest-salary average rather than three years, and raise all members' contributions to 9 percent. DROP recipients will have their contributions refunded when they withdraw.

Members must approve the plan. So officials also restored reduced benefits for officers hired in the last few years in return for the cuts.

Officials hope the city will join them in a request to increase the contributions on both sides. That means millions more taxpayer dollars would be sunk into the fund. The city currently contributes the maximum allowed percentage, which will amount to roughly $118 million this fiscal year.

Jim McDade, president of the Dallas Fire Fighters Association, said he hopes members and the city will do what it takes. Benefits are important, he said. Dallas cops and firefighters don't pay into or receive Social Security.

"In the end, we have to save our pension," he said.

Police Lt. Ernest Sherman, a 26-year veteran, said he doesn't mind the proposed cuts.

"If the changes have to be made for the betterment of the pension, I'll be fine," he said.

But he said pension officials should have been more frank about the pension fund's troubles. He said the hopefulness sounded like all the other proposed fixes he has heard over the years.

And he fears that all the changes may not be enough. Gottschalk worries that the proposals will cause a run on the system by DROP members like Aulbaugh, the battalion chief, who said he's considering it.

Even if there is no run, the pension fund may even have a difficult time meeting its now-lower annual investment return target of 7.25 percent. And another economic downturn could hurt the system further.

"I don't know how you save a system like that except with steep cuts and big increases in contributions," said Steve Malanga, a senior fellow who studies pensions at the conservative research group Manhattan Institute. "Even so, the risk will remain very high for years to come."
Zero Hedge provided more background and analysis in its comment, Dallas Cops' Pension Fund Nears Insolvency In Wake Of Shady Real Estate Deals, FBI Raid (added emphasis is ZH):
The Dallas Police & Fire Pension (DPFP), which covers nearly 10,000 police and firefighters, is on the verge of collapse as its board and the City of Dallas struggle to pitch benefit cuts to save the plan from complete failure.  According the the National Real Estate Investor, DPFP was once applauded for it's "diverse investment portfolio" but turns out it may have all been a fraud as the pension's former real estate investment manager, CDK Realy Advisors, was raided by the FBI in April 2016 and the fund was subsequently forced to mark down their entire real estate book by 32%Guess it's pretty easy to generate good returns if you manage a book of illiquid assets that can be marked at your "discretion". 

To provide a little background, per the Dallas Morning News, Richard Tettamant served as the DPFP's administrator for a couple of decades right up until he was forced out in June 2014.  Starting in 2005, Tettamant oversaw a plan to "diversify" the pension into "hard assets" and away from the "risky" stock market...because there's no risk if you don't have to mark your book every day.  By the time the "diversification" was complete, Tettamant had invested half of the DPFP's assets in, effectively, the housing bubble.  Investments included a $200mm luxury apartment building in Dallas, luxury Hawaiian homes, a tract of undeveloped land in the Arizona desert, Uruguayan timber, the American Idol production company and a resort in Napa. 

Despite huge exposure to bubbly 2005/2006 vintage real estate investments, DPFP assets "performed" remarkably well throughout the "great recession."  But as it turns out, Tettamant's "performance" was only as good as the illiquidity of his investments.  We guess returns are easier to come by when you invest your whole book in illiquid, private assets and have "discretion" over how they're valued.

In 2015, after Tettamant's ouster, $600mm of DPFP real estate assets were transferred to new managers away from the fund's prior real estate manager, CDK Realty Advisors.  Turns out the new managers were not "comfortable" with CDK's asset valuations and the mark downs started.  According to the Dallas Morning News, one such questionable real estate investment involved a piece of undeveloped land in the Arizona desert near Tucson which was purchased for $27mm in 2006 and subsequently sold in 2014 for $7.5mm.  Per the DPFP 2015 Annual Report:
In August 2014, the Board initiated a real estate portfolio reallocation process with goals of more broadly diversifying the investment manager base and adding third party fiduciary management of separate account and direct investment real estate assets where an investment manager was previously not in place. The reallocation process resulted in the transfer of approximately $600 million in DPFP real estate investments to four new investment managers during 2015. The newly appointed managers conducted detailed asset-level reviews of their takeover portfolios and reported their findings and strategic recommendations to the Board over the course of 2015 and into 2016. A significant portion of the real estate losses in 2015 were a direct result of the new managers’ evaluations of the assets.
Then the plot thickened when, in April 2016, according the Dallas Morning News, FBI raided the offices of the pension's former investment manager, CDK Realty Advisors.  There has been little disclosure on the reason for the FBI raid but one could speculate that it might have something to do with all the markdowns the pension was forced to take in 2015 on its real estate book.  At it's peak, CDK managed $750mm if assets for the DPFP.

With that background, it's not that difficult to believe that DPFP's actuary recently found the plan to be in serious trouble with a funding level of only 45.1%.  At that level the actuary figures DPFP will be completely insolvent within the next 15 years.  Plan actuaries estimate that in order to make the plan whole participants and/or the City of Dallas would need to contribute 73% of workers' total comp for the next 40 years into the plan...seems reasonable.

According to an article published by Bloomberg, a subcommittee of the pension's board recently submitted a proposal that would at least help prolong the life of the fund.  The subcommittee proposal calls for cost of living adjustments to be reduced from 4% to 2% while participants would be expected to increase their contributions to the plan.  Of course, taxpayers were asked to also provide "their fair share" equal to roughly $4mm in extra plan contributions per year, a request that would likely require the approval of the Texas legislature.  If approved, the proposal is anticipated to keep the plan solvent through 2046...at which point we assume they'll go back to taxpayers for more money?

A quick look at the plan's 2015 financial reports paints a pretty clear picture of the plan's issues.

Starting on the asset side of the balance sheet, and per our discussion above, DPFP was forced to mark down it's entire real estate book by 32% in 2015. Private Equity investments were also marked down over 20% (click on image). 


This came as over 50% of the assets were diverted into illiquid real estate and private equity investments back in 2006 (click on image).

But asset devaluations aren't the only problem plaguing the DPFP.  As we recently discussed at great length in a post entitled "Pension Duration Dilemma - Why Pension Funds Are Driving The Biggest Bond Bubble In History," another issue is DPFP's exposure to declining interest rates.  Per the table below, a 1% reduction in the rate used to discount future liabilities would result in the net funded position of the plan increasing by $1.7BN (click on image).


And of course the typical pension ponzi, whereby in order to stay afloat the plan is paying out $2.11 for every $1.00 it collects from members and the City of Dallas effectively borrowing from assets reserved to cover future liabilities (which are likely impaired) to cover current claims in full.  This "kick the can down the road" strategy typically ends badly for someone...like most public pension ponzis we suspect this one will be most detrimental to Dallas taxpayers. 


All of which leaves the DPFP massively underfunded...an "infinite" funding period seems like a really long time, right?
Since when did Zero Hedge become experts on pensions? Some of the stuff they write in their analysis is spot on but other stuff is totally laughable, like pensions causing the biggest bond bubble in history (Note to Zero Hedge: There's no bond bubble, it's called deflation stupid! And go back to school to understand the evolution asset-liability management and why in a deflationary environment, bonds are the ultimate diversifier).

Unlike Zero Hedge, I don't take issue with the asset allocation of the Dallas Police and Fire Pension (DPFP) but rather in the shady, non-transparent way that they run their operations.

I can sum up the biggest problem at DPFP in three words: Governance, Governance and GOVERNANCE!!!!!!!!!!

I'm sick and tired of covering US public pensions with such awful governance and when disaster strikes, everyone blames public pensions and wants to dismantle them.

Folks, the pension Titanic is sinking, and what we're seeing in Dallas, Chicago, Detroit, Tampa Bay, will be playing out in many US cities when the chicken comes home to roost.

When disaster struck Greece, and there was no money left to pay public pensions, they had to drastically cut benefits. Of course, this being Greece, it's business as usual for Tsipras et al. as his government is increasing the civil service and turning a blind eye to undeclared income which now stands at 25% of GDP (I think it's more like 50%).

In the United States, once public pensions go insolvent, sure, benefits will be cut and contributions will be increased but taxpayers will also be called upon to shore them up in the form of soaring property taxes and utility rates.

Instead of amalgamating city and municipal pensions at the state level and fixing the governance to manage more assets in-house, they're introducing one Band-Aid solution after another.

As far as Dallas Police and Fire Pension, it's a disaster and a real shame because not only is police morale low following the heinous shootings that rocked that city, now a lot of police officers and fire fighters are asking themselves whether they can count on their pension to be there when they retire.

I love Dallas. It's a beautiful city. I visited it on a business trip back in 2004 when I was working at PSP Investments. I went with Asif Haque who now works at CAAT pension and Russell (Rusty) Olson, the former pension director of Kodak's pension fund and author of Investing in Pension Funds and Endowments. We visited funds there and then drove to Houston which was nice but nowhere near as nice as Dallas (in my opinion).

Anyways, I don't know how Dallas is now but it's sad to see their police and fire pension on the verge of insolvency. In my opinion, this pension desperately needs the services of a Rusty Olson (don't know if he's still alive and kicking), a Ted Siedle (aka the pension proctologist) or even Harry Markopolos, the man who exposed the fraud at Madoff's multi-billion hedge fund Ponzi and author of No One Would Listen (great book, a must read).

At the very least -- and this is friendly, unsolicited advice -- the DPFP should contact my friends at Phocion Investment Services and make sure their performance, risk and operations are being run properly and compliant with the highest standards.

In fact, if I was the sponsor or member of this pension plan, I would be demanding a comprehensive investment and operational risk audit of all activities at the Dallas Police and Fire Pension by an independent and qualified third party. And I'm not talking about the standard audit from a chartered accounting firm that basically signs off on activities.

[As an aside, back in 2004, I was elected to sit on the Board of the Hellenic Community of Montreal and the first thing I demanded was to hire a forensic accounting firm to go over all the books. I trusted nobody and refused to sign off on anything if the books weren't properly audited by real experts who know how to uncover shady dealings. Things drastically improved since then, or so I hear.]

As far as investments go, one infrastructure expert shared this with me when it comes to the infrastructure investments at the Dallas Police and Fire Pension:
"[It's] a true ‘mess’ in the US pension world. I met one of their investment team a couple years ago and learned that their infrastructure allocation was being used to fund extremely risky managed lanes toll roads in Dallas. Speaks to importance of picking the right advisors and investments when making an illiquid allocation"
When I pressed him on what exactly he meant by "extremely risky managed lanes toll roads in Dallas," he elaborated and shared this with me:
As of 2015, their infrastructure investments were as per below (click on image).


Notwithstanding allocating all your infrastructure allocation investments to one manager (JPM is good but 1 – too much manager concentration, 2 – maritime and Asian infra are high risk strategies that should only form a small part of a diversified infra/real asset program), their co-investments in LBJ Express and North Tarrant are in managed lanes.

Managed lanes utilize variable tolling, to optimize traffic flow. They are constructed next to the free alternative and will change their tolls on a frequent basis based on prevailing traffic conditions on the free alternative. For example, if there is an accident or it is during rush hour, these lanes will increase their tolls as more drivers want to use them.

As anyone in infrastructure knows, forecasting traffic for regular toll roads or airports is much more of an art than a science so you could surmise just how extremely difficult it is to forecast and manage these types of managed lane investments. Definitely not for beginners or inexperienced US plans such as Dallas Police.

http://www.bloomberg.com/news/articles/2015-09-17/drivers-decry-rise-of-toll-lanes-as-texas-s-lbj-expressway-opens

Given what the article above mentions regarding Dallas’ real estate investments, I am not surprised. Scary to think about though and by the time it gets back to the Police, they are the losers and it is not fair. See the attachment on them selling their stakes in these investments, probably at the worst possible time.

If you would like to quote, please keep anonymous. When I read about this though it reinforces if US plans think they are going to make wise illiquid infrastructure investment decisions without someone experienced on their side or in house, they will prove disappointed. And the traditional GPs are definitely not fully on their side.
This person knows what he's talking about and he's right, the traditional GPs are definitely not on their side.

If you would like to contact me to discuss this comment, feel free to shoot me an email at LKolivakis@gmail.com and I'll be happy to discuss my thoughts.

Lastly, you can read The Long-Term Financial Stability Sub-Committee's presentation to the full Board at the August 11th Board Meeting by clicking here.

Below, WFAA reports on why the Dallas Police and Fire Pension is facing a real disaster. Broke in 14 years? Unless they implement serious reforms that increase contributions, cut benefits, shore up governance and introduce risk-sharing, this pension will be lucky to be around in five years.

Monday, August 22, 2016

Time To Plunge Into Stocks?

Sam Ro of Yahoo Finance reports, The stage is set for the next 10% plunge in stocks:
The stock market continues to trend higher as earnings growth remains lackluster. This has caused valuations to get very expensive, signaling a stock market that’s becoming increasingly due for a sharp sell-off.

Everyone is flagging this anxiety-inducing pattern, and yet the market continues to rally arguably nonsensically.

“The S&P 500 has advanced 6.8% YTD (8.4% including dividends) despite a more modest improvement in the earnings outlook (+1.4%),” RBC’s Jonathan Golub observed in a note to clients on Monday. “Put differently, the market’s move higher has been fueled almost exclusively by multiples.”

Most analysts argue that these record-high stock prices are unsustainable without a significant pickup in earnings growth. Unfortunately, there isn’t much hope for that.

“Since EPS trends have typically been associated with S&P 500 index patterns, a sharper-than-expected uptick in profits would be a necessary prerequisite for additional upside,” Citi’s Tobias Levkovich said on Friday. “[A Citi survey suggests] new positive developments would need to emerge to justify more in terms of net income generation. With outstanding issues such as the impact of Brexit and/or fiscal policy post the US elections, it seems challenging to come to any powerful conclusions at this juncture.”

The Fed wants to hike, and the S&P fell 10% after the last hike.

Economic data in the US has been positive, highlighted by notably strong labor market and housing market data. This has put pressure on the Federal Reserve to tighten monetary policy with an interest rate hike sooner than later.

In fact, three members of the Fed have signaled that a hike will come sooner in just the past week. Last Tuesday, NY Fed President William Dudley said “we’re edging closer towards the point in time where it will be appropriate to raise rates further.” On Thursday, San Francisco Fed President John Williams said every meeting, including the one coming in September, should “be in play” for a rate hike. On Sunday, Fed Vice Chair Stanley Fischer said “we are close to our targets.”

“A more hawkish Fed could trigger a return of volatility if financial conditions (USD, credit spreads) start to deteriorate again,” Societe Generale’s Patrick Legland said on Monday. “The S&P 500 fell 10% following the first rate hike last December.

In that same breath, Legland warned of the importance of earnings to the stock market.

“US company earnings were better than expected in Q2,” he acknowledged. “But the sharp increase in valuation ratios (S&P 500 forward P/E 17x, P/B 2.9x) puts the onus on EPS growth at a time when global GDP growth remains uninspiring” (click on image).


Could fund flows save the day?

The sad thing about the current stock market rally is that it comes at a time when retail investors are spilling out of the stock market.

“US equity funds saw outflows deepen to a new 6 year low in July,” Credit Suisse’s Lori Calvasina observed on Thursday (click on image).

Perhaps this trend is set to turn around. Indeed, with bonds and bond funds offering little yield, no yield or even negative yield, perhaps we’ll finally witness the so-called “Great Rotation” of money out of bonds and into stocks.

“One way that share prices could surge would be to anticipate a new flow of money towards the fairly despised equity asset class,” Citi’s Levkovich posited.
Not everyone is convinced of the "Great Rotation" from bonds into stocks. Akin Oyedele of Business Insider reports, The 'great rotation' isn't happening:
Stocks are susceptible to a pullback in September, according to UBS chief equity strategist Julian Emanuel.

Emanuel wrote in a note to clients on Wednesday that this trouble is because a likely seeming and recently touted source of fund inflows may not materialize: The so-called great rotation from bonds into stocks. 

This idea first gained traction early in 2013, when investors started a massive shift in their asset allocations away from bonds and to stocks.

That prompted calls that bond funds would experience a mass exodus as investors moved to equities.

The rotation was meant to boost the stock market at a time when some pundits believed that the 30-year bull market in bonds was ending. However, investors kept pouring into bond funds. And the bull market in bonds is still going.

"While a number of bull market peaks (2000 in particular) have been accompanied by enthusiastic public buying, such exuberance catalyzed by a rotation away from cash and bonds seems unlikely in 2016," Emanuel wrote.

There won't be any great rotation because it has already happened, as stocks rose to record highs and bond yields slid to record lows (click on image).


Additionally, the rally to all-time stock market highs has largely been supported by companies repurchasing their own shares, or buybacks. Buybacks — not retail investors — have been the biggest source of demand for stocks since 2009, according to HSBC

"In this context, set against VIX trading near cycle lows after a parabolic S&P 500 summer rally, ahead of more US and European political and Fed uncertainty, stocks appear vulnerable to a pullback into the seasonally weak September period," Emanuel wrote.

But is there something else driving the volatility (fear) index to cyclical lows? Saqib Iqbal Ahmed of Reuters reports, Focus on VIX futures shorts hides the real story:
Judging by the way hedge funds have been betting on Wall Street, they see U.S. stock market volatility remaining low, but it may not be that simple.

CBOE Volatility Index (VIX) futures contracts allow a play on implied volatility in stock prices and can provide a hedge on equity returns, but big speculators are currently net short 114,088 contracts in VIX futures, just under the record level set earlier this month, according to U.S. Commodity Futures Trading Commission positioning data through August 16.

After trading in a range for most of the past year, U.S. stock prices recently broke out to record highs and hedge funds have reluctantly bought into the rally. Their net long/short exposure has increased to 22.8 percent, a top quartile level, but still shy of the 5-year peak of 24.5 percent set last December, according to Credit Suisse data.

On the face of it, the CFTC data could be seen as evidence that speculators strongly believe in the lasting power of the recent rally in equities and expect the CBOE Volatility Index (VIX), which is near historic lows, will remain subdued.

"That's not exactly right," said Maneesh Deshpande, head of equity derivatives strategy at Barclays.

Deshpande and other derivatives market experts say speculators are to a large extent just selling VIX futures to the issuers of exchange-traded products (ETPs) who need protection against volatility.

With the S&P 500 stock index (SPY) near a record high, demand for these is quite strong.

For instance, money flows into the iPath S&P 500 VIX Short-Term Futures ETN (VXX), the most heavily traded long volatility ETP, are the strongest in three years, according to data from Lipper. In turn, that's creating steady demand for VIX futures that the hedge funds are only too happy to supply.

"Strong inflows into long VIX ETPs means the issuers of these products have to go and buy VIX futures," Rocky Fishman, equity derivatives strategist at Deutsche Bank.

Even in the absence of those inflows, the way these ETP products work means that as market volatility declines it requires these product issuers to buy more VIX futures contracts.

It is in response to this strong demand for VIX futures that speculators have ramped up the selling of VIX futures. Essentially, these funds are acting as liquidity providers, not making outright bets.

THIRST FOR PROTECTION

Over the last month and a half, as stocks rallied, investors have been loading up on ETPs that profit from a jump in volatility. Roughly $1.73 billion has poured into long VIX ETPs since the start of July, according to Deutsche's Fishman.

Investors may be looking to protect recent gains, or simply betting that stock market volatility has drifted too low and the CBOE Volatility Index (VIX) is ripe for a rally.

Friday was the 13th straight session when the VIX closed below 13, the longest the index has lingered so low in about two years.

With less than three months to go before the U.S. presidential election on November 8th stocks may fall and volatility may rise as investors assess the political risk to equities.

Speculators selling VIX futures may suffer if volatility rises too quickly but much of their short position is likely to be hedged, analysts said.

"They might be selling the front one or two month VIX contracts but then they are buying the (further out) contracts as a hedge, or they might be short S&P 500 and short VIX futures simultaneously," said Nitin Saksena, head of U.S. equity derivatives research at Bank of America Merrill Lynch.

"They are not as exposed to a rise in volatility as you might think," he said.

The risk is if the market moves violently, leaving those with short positions with little time to monetize their hedges.

In the event of a decline on the S&P 500 index like the one seen in August 2015, when it lost as much as 11 percent over the course of four days, the large short positioning could trigger even more volatility.
Is volatility cheap? Is the VIX index (VIX) ready to rip higher? Sure, if stocks plunge, the VIX will soar but I personally think the bigger risk now is stocks continue grinding higher and volatility will remain historically cheap.

Of course, if investors start moving away from exchange-traded funds back into actively managed funds, then there will be less selling of VIX futures to the issuers of exchange-traded products (ETPs) who need protection against volatility. That too can trigger more volatility but so far nothing suggests there's a massive shift out of ETFs into actively managed funds (quite the opposite).

So what is driving the demand for US equities? GFC Economics posted an interesting tweet showing the drop in real estate arrears is supporting the rally in US equities (click on image):



But it's not only US equities that are outperforming. Good old US bonds (TLT) have been outperforming equities, a point underscored in several tweets put out by Charlie Bilello of Pension Partners (click on image):


As you can see, over the last 15 years US bonds outperformed stocks (7.5% annualized vs 6.3% annualized), especially on a risk-adjusted basis, which goes to show you "stocks for the long-run" is a bunch of nonsense.

Admittedly, over the last 20 years, as Charlie Bilello shows in his tweets, the performance of stocks vs bonds is equal at 7.9% and over the last five years stocks have vastly outperformed bonds (16.2% vs 7.1%) but with a lot more volatility (Charlie should show risk-adjusted figures too).

Charlie has done a very interesting analysis on Valuation, Timing, and a Range of Outcomes, showing stocks were “overvalued” in September 1996 and from there, they would go on to become much more overvalued, rising for another three and a half years to their peak in March 2000. After that, a nasty bear market ensued, taking the S&P 500 down over 50% from its peak.

The point being just because stocks are overvalued, it doesn't mean they can't become a lot more overvalued, especially when global central banks are still pumping massive liquidity into the financial system (John Maynard Keynes was right, "markets can stay irrational longer than you can stay solvent," especially these high-frequency algorithmic, schizoid markets).

This is why I ignore people telling us the safest place to park your money with stocks near record highs is in cash. Really? I beg to differ, in these markets, cash is trash, provided you're in the right stocks and sectors.

Sure, stock valuations that aren't supported by earnings growth are doomed to collapse at some point but when exactly that some point is is tough to predict. It can be months or even years away. In the meantime, if you're not playing the game, you're missing out on huge gains.

So, is it time to plunge into stocks and hope that liquidity gains will continue even if there are some major pullbacks along the way? That all depends on your risk tolerance. Mine is very high, so I got whacked hard when biotechs got slaughtered over the last year.

Still, I don't regret recommending to load up on biotech shares last August as that is exactly what I've been doing, loading up on them whenever they got clobbered. And after today's Pfizer deal to buy Medivation for $14 billion, you'll see momentum continue in the biotechs (with crazy volatility, of course).

These days, I'm busy trading and buying biotech shares I like (click on image):


Do I recommend you buy individual biotech shares? Not if you want to sleep well at night, you are better off sticking to the biotech ETFs (IBB and equally weighted XBI) but even they are volatile. I must tell you, however, from a trading perspective, I like the way a lot of names have been performing lately, including Valeant Pharmaceuticals (VRX).

This is why when I read a lot of smart money is betting against stocks,  I can't understand why they're so confused, the real smart money is making a killing snapping up Medivation and many other biotech shares at the right time.

Are these elite hedge funds worried about Janet Yellen or Stanley Fisher? No. Am I worried about the Fed? No, I haven't been worried about the Fed because I know the real threat out there remains global deflation, not inflation, so if the Fed raises rates, it will trigger a crisis in emerging markets and risk importing deflation in the US.

And I don't think the oil rally is going to end well because I take the bond market's ominous warning very seriously. Having said this, I expect the stock market rally everyone hates will continue a lot longer than most people expect but you've got to pick your stocks and sectors a lot more carefully and always remember, in this deflationary environment, bonds are the ultimate diversifier.

All I can tell you right now is what I've been telling you for a while, I see no summer crash but given my bullish US dollar views, I remain highly skeptical of a global economic recovery and would take profits or even short emerging market (EEM), Chinese (FXI),  Metal & Mining (XME) and Energy (XLE) shares on any strength. And despite huge volatility, I remain long biotech shares (IBB and equally weighted XBI) as I see great deals in this sector and momentum is gaining there.

Below, "Fast Money" trader Tim Seymour and Simeon Hyman, ProShares Advisors, share their take on dividends stocks. I agree with those that think valuations in dividend stocks are out of whack but this doesn't mean they can't gain further in a deflationary world where investors are starving for yield.

Also, the market leadership appears to be shifting with lower-quality stocks are leading the rally. Eddy Elfenbein of the Crossing Wall Street blog and Craig Johnson of Piper Jaffray discuss with Brian Sullivan.

Third, Timothy Ng, Clearbrook Global Advisors CIO, and Joe Tanious, Bessemer Trust Principal and Investment Strategist, discuss the current market environment and what investors are looking for within passive and active management.

Fourth, CNBC's Meg Tirrell reports on the action in the IBB biotech ETF after Pfizer announced it was buying Medivation and what some other big M&A deals could be coming down the line. The "Fast Money" traders weigh in.

Lastly, Ken Kamen, President of Mercadien Asset Management talks with Bobbi Rebell about what he believes will drives stocks higher and which candidate the markets believe will win the Presidential election.

On that note, please remember to plunge into your pocketbook and subscribe and/ or donate to this blog on the top right-hand side. I thank all of you who graciously support this blog via your dollars.





Friday, August 19, 2016

Canadian Pensions Unloading Vancouver RE?

Katia Dmitrieva of Bloomberg reports, Ontario Teachers’ Pension Plan seeking buyers for minority stake in $4-billion Vancouver real estate portfolio:
The Ontario Teachers’ Pension Plan is seeking buyers for a minority stake in its $4 billion real-estate portfolio in Vancouver, including office towers and shopping malls, according to people familiar with the matter.

Cadillac Fairview, the real-estate unit of Canada’s third-biggest pension fund, is looking to raise about $2 billion from the sale, according to the people, who asked not to be identified. Cadillac Fairview has hired CBRE Group Inc. and Royal Bank of Canada for the sale, the people said. Spokespeople for Cadillac Fairview, CBRE, and RBC didn’t immediately respond to requests for comment or declined to comment.

Cadillac Fairview is the latest pension group seeking to reduce its holdings in the Vancouver commercial market, where prices have reached record highs amid an influx of foreign cash even as new supply drives up vacancy rates. Ivanhoe Cambridge and the Healthcare of Ontario Pension Plan are seeking about $800 million for their office towers in Burnaby, British Columbia, just outside of Vancouver.

The Cadillac Fairview portfolio, which hasn’t yet started marketing, includes 14 properties in downtown Vancouver and Richmond, with some of Canada’s largest shopping centers, office towers, and historic buildings up for grabs. The assets include a portfolio of waterfront properties including Waterfront Centre, a 21-story tower on the harbor built in 1990; the 238,000-square-foot PricewaterhouseCoopers Place; and The Station, a historic property built in 1912 that serves as North America’s largest transport hub, currently pending approval for an added office tower.

Some of the country’s biggest retail assets are also in the mix, such as the Pacific Centre, a downtown retailer with 1.6 million square feet for which Cadillac Fairview submitted a proposal this year to expand. It’s the third-most profitable shopping mall in Canada, according to brokerage Avison Young, with $1,599 in sales per square foot. The center also contains eight office towers of two million square feet, including 701 West Georgia and the HSBC building.

Asset Gains

The net asset value of Cadillac Fairview’s real estate holdings increased 13 per cent to $24.9 billion in 2015 over the prior year amid high demand for assets in North America, according to the latest financial report from the Toronto-based pension fund. It also lists six of the Vancouver properties as worth at least $150 million.

Demand for Vancouver offices has sent prices of properties to record highs in recent transactions, including Anbang Insurance Group Co.’s purchase of the Bentall Centre. The vacancy rate in the city rose to a 12-year high of 10.4 per cent as of June 30 as tenants absorbed 1 million square feet of new space since the same time last year, according to Avison Young. Buildings downtown, where most of Cadillac Fairview’s properties are located, are faring better, with vacancy tightening to 7.8 per cent from 9.8 per cent at the end of 2015.

Additional space is set to flood the market, with six office towers under construction for delivery as soon as this year totaling about 802,700 square feet, and 10 buildings proposed for the city, including Cadillac Fairview’s Waterfront Tower, according to Avison Young’s mid-year 2016 report. Despite the vacancy, rental rates for the best quality assets in Vancouver are the highest in Canada and some U.S. cities such as Chicago and L.A. at about $30 a square foot, Avison Young said.
Earlier this month, Katia Dmitrieva and Nathalie Obiko Pearson of Bloomberg reported on how the Canadian housing boom was fueled by China's billionaires:
The walls of Clarence Debelle’s Vancouver office on Canada’s west coast are lined with gifts from his real estate clients: jade and turtle dragon figurines; bottles of baijiu, a traditional Chinese alcohol; and enough special-edition Veuve Clicquot to fuel several high-end cocktail parties.

They are the product of Vancouver’s decade-long real estate frenzy. The city, with its stunning views of the mountains and yacht-dotted harbor, has long been one of the world’s most expensive places to live but price gains have reached a whole new level of intensity this year. Low interest rates, rising immigration, and a surge of foreign money—particularly from China—have all driven the increases.

Consider the latest milestones:
  • The cost of a single-family home surged a record 39 percent to C$1.6 million ($1.2 million) in June from a year earlier.
  • More than 90 percent of those homes are now worth more than C$1 million, up from 65 percent a year earlier, according to city assessment figures.
  • Vancouver is now outpacing price gains in New York, San Francisco and London over the past decade.
  • Foreigners pumped C$1 billion into the province’s real estate in a five-week period this summer, or about 8 percent of the province’s sales.


After copious warnings over the last six months, including from the Bank of Canada, that price gains are unsustainable, the provincial government of British Columbia moved last week. Foreign investors will have to pay an additional 15 percent in property-transfer tax as of Aug. 2 and city of Vancouver was given the authority to impose a new tax on empty homes.

As Canada waits to see what effect, if any, the moves may have, here are the stories from the city’s wild ride.
The great Canadian Vancouver real estate bubble, eh? Just keep buying Vancouver real estate and wait for all those Chinese billionaires and multimillionaires to buy your house at a hefty premium, especially if it has good Fen Shui.

I've been short Canadian real estate for as long as I can remember, and have been dead wrong. I've also been short Canada for a long time and still think this country is going to experience some major economic upheaval in the next few years.

Canada's banks are finally sounding the housing bubble alarm but it's too late (they have good reason to be scared). This silliness will likely continue until you have some major macro event in China or Paul Singer's dire warning of a major market breakdown because of the implosion of the global bond bubble comes true.

Since I've openly criticized Paul Singer's views on bonds being "the bigger short", I can't see a major backup in yields as driving a housing crash in Canada or elsewhere. Instead, what worries me a lot more is the bond market's ominous warning on global deflation and how that is going to impact residential and commercial real estate, especially if China experiences a severe economic dislocation.

Now think about it, why are several large Canadian pension funds looking to unload major commercial real estate in Vancouver? Quite simply, the upside is limited and the downside could be huge. That and the fact they're looking to sell for nice gains and diversify their real estate holdings geographically away from Canada (incidentally, geographic diversification is the reason why foreign investors would consider buying Canadian real estate at the top of the market).

Some of Canada's large pensions, like bcIMC, are way too exposed to Canadian real estate. The rationale was that liabilities are in Canadian dollars so why not focus solely on Canadian real estate, but this increased geographic risk. This is why bcIMC is now looking to increase its foreign real estate holdings (read more on this here).

Real estate is a long term investment. Pensions don't buy real estate looking to unload it fast (even opportunistic real estate can take a few years to realize big gains) but rather keep these assets on their books for a long time to collect good yield (rents). Even if prices decline, a pension plan with a long investment horizon can wait out a cycle to see a recovery.

That is all fine and dandy but what if pensions buy at the top of a bubble and then there's a protracted deflationary episode? What then? Vacancy rates will shoot up, prices will plummet and rents will get hit as unemployment soars and businesses go bankrupt. They then can be stuck with commercial real estate that experiences huge depreciation and depending on how bad the economic cycle is, it could take many years or even decades before these real estate assets recover even if money is cheap.

I mention this because a while back, I publicly disagreed with Garth Turner on his well-known Canadian real estate bubble blog, Greater Fool, telling him that he's wrong to believe the Fed will raise rates because of higher inflation and that will be the transmission mechanism which will spell the death knell for Canada's real estate bubble.

Instead, I explained that once global deflation becomes entrenched, companies' earnings will get hit hard, unemployment will soar and many highly indebted Canadian families barely able to make their mortgage payments will be forced to sell their house even if rates stay at historic lows.

Admittedly, this is a disaster scenario, one that I hope doesn't come true. What is more likely to happen is real estate prices will stay flat or marginally decline over the next few years, but that all depends on how bad the next global economic downturn will be. And some parts of Canada, like Vancouver and Toronto, will experience a more pronounced cyclical downturn than others (for obvious reasons).

Those are my thoughts on Canadian pensions unloading commercial real estate in Vancouver. As always, if you have any thoughts, shoot me an email at LKolivakis@gmail.com. And please remember to kindly subscribe or donate to this blog via PayPal at the top right-hand side to show your appreciation for the work that goes into these comments.

Below, CTV News reports on the latest developments in the Canadian real estate market. The way things are going, I think Capital Economics is right, the housing bubble 'will end in tears'.

Update: It looks like the good times are over as Zero Hedge reports the average home price in Vancouver just plunged 20% in one month.

A friend of mine who up until recently lived in Vancouver sent me this after I sent him the Zero Hedge comment on Vancouver home prices plunging:
No surprise. Once government decides to get involved in letting the air out of bubble, things tend to spin out of control.

Maybe I was wrong, perhaps 15% is big enough to have the Chinese think twice about Vancouver.

If this is so, Vancouver and all of BC is about to experience a massive recession. Any growth in BC in the last five years came from residential construction. Every other sector (mining, forest products, tech) has done nothing. Tourism is still a bit of a bright star but there is only so much you can do with Whistler and the cruise boats.

Never occurred to me that the Chinese may consider Calgary as a destination.
My friend  told me the Chinese might view this new tax as prejudicial and it's clearly impacting the market: "a lot of offers were pulled after the tax went into effect."

Unlike me, he thinks that a macro event in China will only accelerate capital out of that country (says "capital controls in China are a joke") and if the loonie keeps falling, Canada will remain a destination of choice.

He also told me that "commercial real estate isn't very correlated to residential real estate in Vancouver because most Chinese are self-employed and work out of their home doing in import-export trading."

That may be true but it's hard to see how a recession won't impact commercial real estate in Vancouver. Still, foreign investors are looking at diversifying their real estate holdings and they will buy some of the real estate Canadian pensions are unloading in that city.

Thursday, August 18, 2016

Bring In The UN Pension Peacekeepers?

Kambiz Foroohar of Bloomberg reports, UN’s $54 Billion Pension Fund in Power Struggle Over New Rules:
The United Nations needs some financial peacekeepers. A dispute over whether new regulations governing the $54 billion UN Joint Staff Pension Fund will result in higher fees paid to outside bankers or modernize oversight of the 67-year-old trust has divided fund CEO Sergio Arvizu and union leaders, sparking accusations of mismanagement.

Lost in the fight is the fund’s performance: the account returned 5 percent the past decade, according to a June 30 report by Northern Trust Corp. That 10-year performance compares with 5.1 percent for the California Public Employees’ Retirement System, the largest in the U.S., and the 5.7 percent median for U.S. public pensions, according to Keith Brainard, who tracks pensions for the National Association of State Retirement Administrators.

Yet internal rules approved this month that shift authority over issues such as staffing and budgeting from Secretary-General Ban Ki-moon’s office to Arvizu have fueled the spat. At stake is a fund with more than 126,000 participants which pays about 71,000 retirees in 190 countries. Those payments go out in 15 currencies, including dollars, euros, kroners and rupees.

“We have arguably one of the most complex pension plan designs,” said Arvizu, a 55-year-old former director of investments at Mexico’s social security institute, via e-mail.

Divided Leadership

Adding to the complexity is the pension’s structure. Arvizu oversees benefits and operations and reports directly to the UN General Assembly, the main body representing all 193 member countries. The investment division is headed by Carolyn Boykin, a former president of Bolton Partners Investment Consulting Group. Boykin reports to Ban.

The fund’s broad investments are typical for a pension: it holds 61.3 percent of assets in stocks and 29 percent in fixed income, according to an internal report. It also has 6.9 percent in categories such as real estate, timberland and infrastructure and 2.7 percent in alternative investments, including private equity, commodities and hedge funds.

Moreover, the UN pension is 91 percent funded, above the 73.7 percent median for state pensions, Brainard said. If a plan can meet its projected payments, “it’s in good shape,” he said.

With backing from the UN General Assembly, Arvizu in 2014 began campaigning for changes he said were needed to modernize pension management at an institution famous for its Cold War-era bureaucracy. His argument: running an investment fund can’t be judged the same way you measure success for a humanitarian mission.

The union pushed back, seeing in the proposals the potential for managers to direct more investments to external institutions, undermining UN oversight and undercutting returns.

“This is a plan to move the pension fund outside the UN financial regulations,’’ said Ian Richards, president of the Coordinating Committee for International Staff Unions and Associations of the UN system, which has more than 60,000 members. “We don’t feel this management should get flexibility over how to manage the fund without all the checks and balances.’’

‘Outsourcing to Wall Street’

Allegations of mismanagement and conflicts of interests followed. On its website, the main UN union urged its members to “protect our pension fund: stop its exit from the UN at a time of outsourcing to Wall Street.”

In a letter to members last year, Arvizu said he was facing a “malicious campaign with gross misrepresentations.” The allegations triggered an internal investigation by the UN’s anti-corruption watchdog, which cleared Arvizu.

Fund officials reject the idea that they are planning to outsource management.

“There are no plans to privatize the pension fund, it’s not even an issue,’’ Lee Woodyear, the spokesman for the fund, said in a phone interview. “There are a lot of checks and balances in place and the new rules solidify what’s already taking place in practice.’’

Yet Arvizu, who joined the UN fund in 2006, argues he does need flexibility to hire and promote employees with specialized experience.

“The expertise to carry out this work -- including entitlements, risk management, plan design, asset liability management, and client services -- are different from other parts of the United Nations system,” he said.

Measuring Risk

The UN also needed to adopt modern tools for measuring risk and ensuring transparency, he said. Asset liability management studies, which help managers assess risk and strategy, “were not done before in the fund,” Arvizu said via e-mail.

Relations between management and the unions soured further when benefits management software installed in 2015 had delays enrolling beneficiaries. Thousands of new retirees, some of whom had to wait six months before receiving payments, were enraged.

“No doubt more could have been done with 20/20 hindsight to ensure that no new retiree was delayed,’’ said Woodyear. “There were delays, and the fund was slow to communicate clearly on the delays.’’

‘Compliance Risks’

Yet disputes keep flaring up. In July, the fund’s Asset and Liabilities Monitoring committee warned the pension was “exposed to significant governance, investment, operational and compliance risks.’’

According to an analysis by the UN union, the fund faces “significant concentration risks’’ from its two biggest portfolios, North American Equity and Global Fixed Income, which combined account for $30.5 billion. Two senior investment officers run these funds and vacancies in risk management have not been filled.

That’s now underway, Boykin said, hinting at the fund’s broader concerns about bringing capable professionals into the global body.

“The hiring process at the UN is lengthy,” she said.

Union leaders say they’ll keep pressing for the backlog of beneficiary payments to be fixed and on management to scale back the scope of the new regulations. But like other battles at the UN, little can happen quickly: the next fund review won’t take place until July 2017.
The last time I covered the UN's pension fund was last year when I discussed the United Nations of Hedge Funds. I see things are only getting worse at the United Nations Joint Staff Pension Fund (UNJSPF).

A person familiar with the UNJSPF's operations and politics shared this with me:
[...] the real problem is investment underperformance, YTD 190 basis points BELOW the policy benchmark followed by dismal performance in 2015.  The story I was told was that the recent attacks on the CEO (who doesn't manage the investment portfolio) were a diversionary tactic. The purpose was to distract the audience from the dismal investment returns since the current Representative of the Secretary-General (RSG), Carolyn Boykin arrived and put a stop to tactical asset allocation. The Chairman of the Investments Committee and the Director of Investments left shortly after Boykin's arrival, as did the Chief Risk Officer. Very ugly.
In an odd governance structure, Ms. Boykin doesn't report to the pension fund CEO Sergio Arvizu. She reports to UN Secretary-General Ban Ki-moon and there's even a picture of her shaking hands with him on the top of the UNJSPF's website (click on image):


Ah, the United Nations, a vast organization full of important diplomats debating the world's entrenched problems. I have tremendous respect for the UN and even joined McGill's model UN club during my undergrad years where along with other students, we got to visit Princeton, Harvard, Columbia, Yale and Univ of Pennsylvania to simulate UN committees and debate other university students on key global issues. We also visited the United Nations on a few occasions (only from the outside).

And we performed exceptionally well and won many model UN events. There were a lot of very talented students representing McGill University back then (much smarter than me), including Tim Wu who is now a professor of law at Columbia's Law School. Tim is credited with popularizing the concept of network neutrality in his 2003 paper Network Neutrality, Broadband Discrimination (Tim is a genius, had a 4.0 GPA while studying biochemistry and biophysics at McGill and then went on to study law at Harvard. He was also one of the nicest guys I met at McGill).

Anyways, enough reminiscing on my model UN undergrad days, let's get back to the real UN and its pension woes. My contact sent me a recent critical analysis of the pension fund's management and performance done by the UN Staff Union which you can all read by clicking here (note its date, July 2016).

Now, if you take the time to read this report, you'll see it's pretty scathing. There are some concerns that I agree with -- including the sections on performance, risk management, governance and the way tactical asset allocation decisions are taken -- but there are parts where quite frankly, I thought it was a bit ridiculous and too harsh.

In particular, this part on Boykin taking part in the Closing Bell ceremonies at the NYSE sponsored by Blackrock, "one of the top ETF providers" (click on image):


So what? Blackrock does business with everybody which is why it's the world's largest asset manager and able to attract talented individuals like Mark Wiseman to its shop.

But my contact shared this background with me on this event:
The "Closing Bell" appearance was a very sore subject within the Investment Management Division, (IMD) because the staff who worked on the Low Carbon Index project, which was completed BEFORE Boykin arrived at the UN, were not invited to the event. Boykin wanted to take full credit.
Ok, so maybe Boykin might be a narcissistic power hungry leader (I don't know the lady) who wants to be the center of the universe. She won't be the first nor the last alpha type at the UN which is a notorious breeding ground for such personalities.

Unfortunately, there may be more to this story. According to the UN Pension blog, when Secretary-General Ban Ki-moon appointed Boykin to the UN Pension Fund as his Representative for Investments in September 2014, rumors swirled like snowflakes that the new RSG had a spotty record -- something to do with the Maryland State Retirement and Pension System where she was Chief Investment Officer from 1999 to 2003 (read the background here).

I can't comment on Ms. Boykin's personal qualifications. I'm sure she's qualified or else she wouldn't have been selected for the job.

But I can comment on the performance and more importantly governance of the UN pension fund. The latest performance figures (as of July, gross of fees) are provided publicly by Northern Trust, the master record keeper (click on image):


As you can see, the YTD performance of the pension fund relative to its policy benchmark is weak (5.06% vs 6.96%) but I wouldn't read too much into one year's performance. It's meaningless for pensions which have a very long investment horizon.

According to the Bloomberg article above, the account returned 5 percent over the past decade, which isn't great but it's in line with what other large US public pension funds delivered during that period (Canada's large pensions vastly outperformed their US counterparts during the last decade).

More importantly, the article states the UN pension is 91 percent funded, above the 73.7 percent median for state pensions. It's the funding status of the plan that ultimately counts and on this front, there are no alarm bells ringing.

Having said this, if the governance is all wrong, you can expect weak performance to persist and the funding status of the plan to deteriorate, especially if low and negative rates are here to stay. And don't forget, the UN pension is a mature plan, meaning there is little room for error if its pension deficit grows.

And it's the governance of the UN pension that really worries me. Just like many state pensions, it's all wrong with far too much political interference.

[Update: Read the latest comment from the UN Pension Blog going over investment performance and the health of the fund. "Looking ahead, it is clear that the Fund is facing a number of challenges in terms of leadership, governance, investment performance and its ability to pay retirees."]

The UN pension needs to adopt the same governance rules that has allowed Canada's Top Ten pensions to thrive and become the envy of the world. It needs to adopt an independent, qualified investment board to oversee the pension and hire experienced pension fund managers to bring assets internally and save the pension a bundle on fees.

Before it does all this, the UN needs to perform a thorough operational, performance and risk management audit of its pension. And I mean thorough and not the politically sanitized version. Have it done by Ted Siedle, the pension proctologist, or better yet hire me and my friends over at Phocion Investment Services here in Montreal and we will provide you with a comprehensive and detailed audit report on the true health of the UN pension.

What else do I recommend? I highly recommend the United Nations transfers the operations of its pension to the beautiful city of Montreal. I know, such a self-serving recommendation, but before you dismiss it, think about these points:
  • Montreal is home to ICAO
  • The city has world class universities, a diverse population and many fluently bilingual and multi-lingual finance and economics students with MBAs, Master's and PhDs.
  • Two of the largest Canadian public pension funds, the Caisse and PSP, are here and there are great private sector pensions here too (CN, Air Canada, etc.). There are many experienced pension professionals who can manage assets internally at a fraction of the cost of what it costs the UN to farm assets to external managers, many of which are underperforming. Of course, this assumes the UN gets the governance right, allowing its pension fund to compensate ts staff properly.
  • Moving to Montreal would not only cut costs, it would distance pension managers from the politics of the UN's General Assembly.
  • Rents are much cheaper in Montreal and it's a short plane ride away from New York City with no time difference.
The UN should really consider the pros and cons of moving its pension management division to Montreal. I can put together a team of highly qualified investment managers with years of experience at a moment's notice (not holding my breath but I'm dead serious on this recommendation of moving the UN's pension operations to Montreal).

But before the UN even contemplates this suggestion, it has to first fix its pension governance so that potential candidates will want to come work at the UN pension fund.

Why not fix the governance and hire people from New York City where financial talent abounds? Yeah, it can do that but it will cost the UN a lot more money and I strongly doubt they will get a better long term performance.

Those are my thoughts on the UN pension. As always, if you have anything to add or just want to reach out to me, feel free to send me an email at LKolivakis@gmail.com.

Below, once again, AIG's CIO Doug Dachille discusses the risky business of insurance companies seeking returns. It's too bad CNBC didn't post the entire interview on-line because Dachille also discussed problems in the securitization market and how AIG is going out to buy loans directly from banks.

In any case, listen very carefully to his comments, Dachille clearly spells out the giant ALM problem all pensions, insurance companies and retail investors are confronted with in an era of record low rates.

I also embedded an older clip (March of this year) where Dachille talked about the hedge fund market and the reallocation of his company's portfolio. The United Nations of Hedge Funds and other pensions investing in hedge funds should listen carefully to him.