Monday, August 31, 2015

CalPERS Looks To Cut Financial Risk?

Melody Petersen of the Los Angeles Times reports, In strategy shift, CalPERS looks to cut financial risk:
California taxpayers have never paid more for public worker pensions, but it's still not enough to cover the rising number of retirement checks written by the state's largest pension plan.

Even before the stock market's recent fall, staffers at the California Public Employees' Retirement System were worried about what they call "negative cash flows."

The shortfalls — which totaled $5 billion last year — are created when contributions from taxpayers and public employees who are still working aren't enough to cover monthly checks sent to retirees.

To make up the difference, CalPERS must liquidate investments.

With more than $300 billion in investments, the nation's largest public pension fund is in no danger of suddenly running out of cash.

But even its staff acknowledges in a recent report that despite fast-rising contributions from taxpayers, the pension fund faces "a significant amount of risk."

To reduce that financial risk, CalPERS has been working for months on a plan that could cause government pension funds across the country to rethink their investment strategies.

The plan would increase payments from taxpayers even more in coming years with the goal of mitigating the severe financial pain that would happen with another recession and stock market crash.

Under the proposal, CalPERS would begin slowly moving more money into safer investments such as bonds, which aren't usually subject to the severe losses that stocks face.

Because the more conservative investments are expected to reduce CalPERS' future financial returns, taxpayers would have to pick up even more of the cost of workers' pensions.

Most public workers would be exempt from paying any more. Only those workers hired in 2013 or later would have to contribute more to their retirements under the plan.

The changes would begin moving CalPERS — which provides benefits to 1.7 million employees and retirees of the state, cities and other local governments — toward a strategy used by many corporate pension plans. For years, corporate plans have been reducing their risk by trimming the amount of stocks they hold.

The plan is the result of CalPERS' recognition that — even with significantly more contributions from taxpayers — an aggressive investment strategy can't sustain the level of pensions promised to public workers. Instead, it could make the bill significantly worse.

At an Aug. 18 meeting, CalPERS staff members laid out their plan for the fund's board, saying the changes would be made slowly and incrementally over the next several decades.

That isn't fast enough for Gov. Jerry Brown. A representative from the governor's finance department addressed the CalPERS board, saying the administration wants to see financial risks reduced "sooner rather than later."

"We know another recession is coming," said Eric Stern, a finance department analyst, "we just don't know when."

Behind the growing cash shortfalls: the aging of California's public workforce. As more baby boomers retire, CalPERS estimates that the number of government retirees will exceed the number of working public employees in less than 10 years.

Another reason for the cash shortages: the large hike in pension benefits that state legislators voted to give public workers in 1999 when the stock market was booming.

CalPERS lobbied for those more expensive pensions. In a brochure, the fund quoted its then-president, William Crist, saying the pension-boosting legislation was "a special opportunity to restore equity among CalPERS members without it costing a dime of additional taxpayer money."

That has turned out to be wishful thinking. Now, cities and other local governments are cutting back on street repairs and other services to pay escalating pension bills.

Chris McKenzie, executive director of the League of California Cities, said governments are in the midst of a six-year stretch in which CalPERS payments are expected to rise 50%.

Some cities are now paying pension costs that are equal to as much as 40% of an employee's salary, according to CalPERS documents.

The cost is highest for police, fire and other public safety workers who often receive earlier and more generous retirements than other employees.

In recent years, three California cities have declared bankruptcy, in part, because of the rising costs.

McKenzie said that despite the escalating pension bills, most cities are in favor of the plan by CalPERS staff. Many city finance officials believe that CalPERS' investment portfolio is currently "too volatile," he said.

About 10% of cities don't support the plan, McKenzie said. "Some said they simply can't afford it," he added.

Representatives from two public employee labor unions speaking at the Aug. 18 meeting said they generally supported the plan.

The plan must be approved by CalPERS' board, which is scheduled to discuss it again in October.

Last year, governments sent CalPERS $8.8 billion in taxpayer money, while employees contributed an additional $3.8 billion, according to financial statements for CalPERS' primary pension fund. Those combined contributions fell $5 billion short of the $17.8 billion paid to retirees.

At the heart of the plan is the gradual reduction in what CalPERS expects to earn from its investments. Currently, CalPERS assumes its average annual investment return will be 7.5% — an estimate that has long been criticized as being overly optimistic.

After several years of double-digit returns, the giant pension fund's investments earned just 2.4% in 2014, according to preliminary numbers released in July.

Under the new plan, as CalPERS moved more money to bonds and other more conservative investments to reduce risk, the 7.5% rate would gradually be reduced.

CalPERS is still recovering from the Great Recession of 2008 and 2009, when it suffered a 24% loss on its investments.

Today its $300 billion in investments is estimated to be only about 75% of what it already owes to employees and retirees. A market downturn would create an even deeper hole.

In presentations, CalPERS told city finance officials that if its investments drop below 50% of the amount owed for pensions, even with significant additional increases from taxpayers, catching up becomes nearly impossible.
That last paragraph is sobering and I think a lot of delusional U.S. pension funds which are in much worse shape than CalPERS are already in a situation where they will never catch up and thus face very hard choices as they scamble to address their perpetual funding crisis.

Importantly, pension funding is all about matching assets with liabilities and it's very path dependent. What this means, in a nutshell, is you're starting point is critical. If you're already in a pension deficit, taking on more risk investing in stocks, high yield bonds, emerging markets, or even real estate, private equity and hedge funds, you might end up digging an even bigger hole for your pension, one you'll never climb out of.

On the investment front, CalPERS is doing what it has to do to reduce risk and stabilize the volatility of its funding ratio. It wisely nuked its hedge fund program which it never really took seriously and is now looking to reduce risk by increasing its exposure to bonds.

Bonds? Isn't the Fed ready to jack up rates? Why in the world would CalPERS invest in bonds, especially now that so many financial gurus like Paul Singer and Alan Greenspan are warning of a big bond bear market? Shouldn't CalPERS double down here, especially after sustaining huge losses in energy investments, and just bet big on a global recovery?

No, CalPERS is doing the right thing and let me explain why. While we might be on the verge of a cyclical recovery in the global economy placing upward pressure on bond yields, make no mistake, deflationary forces are alive and well and the biggest structural risk going forward for all pensions is deflation, not inflation.

Why? I outlined six structural factors which are deflationary and bond friendly:
  • The global jobs crisis: Jobs are vanishing all around the world at an alarming rate. Worse still, full employment jobs with good wages and benefits are being replaced with partial employment jobs with low wages and no benefits.
  • Demographics: The aging of the population isn't pro-growth. As people get older, they live on a fixed income, consume less, and are generally more careful with their meager savings. The fact that the unemployment rate is soaring for younger workers just adds more fuel to the fire. Without a decent job, young people cannot afford to get married, buy a house and have children.
  • The global pension crisis: A common theme of this blog is how pension poverty is wreaking havoc on our economy. It's not just the demographic shift, as people retire with little or no savings, they consume less, governments collect less sales taxes and they pay out more in social welfare costs. This is why I'm such a stickler for enhanced CPP and Social Security, a universal pension which covers everyone (provided governments get the governance and risk-sharing right).
  • Rising inequality: The ultra wealthy keep getting richer and the poor keep getting poorer. Who cares? This is how it's always been and how it will always be. Unfortunately, as Warren Buffett and other enlightened billionaires have noted, the marginal utility of an extra billion to them isn't as useful as it can be to millions of others struggling under crushing poverty. Moreover, while Buffett and Gates talk up "The Giving Pledge", the truth is philanthropy won't make a dent in the trend of rising inequality which is extremely deflationary because it concentrates wealth in the hands of a few and does nothing to stimulate widespread consumption (I know, we can argue that last point but for the most part, you know I'm right).  
  • High and unsustainable debt in the developed world: Government and household debt levels are high and unsustainable in many developed nations. This too constrains government and personal spending and is very deflationary.
  • Technology: Everyone loves shopping on-line to hunt for bargains. Technology is great in terms of keeping productivity high and prices low, but viewed over a very long period, great shifts in technology are disinflationary and some say deflationary.
Keep these six structural factors in mind the next time you hear someone warning you of the scary bond market. With all due respect to Fed Vice Chairman Stanley Fischer, inflation isn't rebounding anytime soon and the Fed would be making a monumental mistake if it hikes rates in September thinking so. All this will do is send the mighty greenback higher, stoke a major crisis in emerging markets, and reinforce global deflation which will decimate pensions.

And when it comes to deflation, there's only one thing which will save you, nominal bonds. Period. Nothing else will save your portfolio from the ravages of deflation, especially if it's a virulent debt deflation spiral.

I want all of you smart senior pension officers to go back and read my analysis of HOOPP's 2014 results and Ontario Teachers' 2014 results. These are two of the best pension plans in the world. they're both fully funded and instead of cutting benefits, they're in the enviable position of increasing benefits by adjusting their inflation protection.

Ron Mock, President and CEO of Teachers, told me bonds serve three functions in their portfolio: 1) they provide a negative correlation to stocks; 2) they provide return and 3) they move opposite to their liabilities. "If rates go up, our liabilities decline by a lot more than the value of our bond portfolio, which is exactly what we want to maintain the plan fully funded." Jim Keohane, President and CEO of HOOPP, shares the exact same views.

But investing in bonds when yields are at a record low ultimately means CalPERS will have to drop its pension rate-of-return fantasy and cut its rosy investment projection of 7.5% which is uses to discount future liabilities. And it's not just CalPERS. Most U.S. public pensions use insanely rosy investment projections. Neil Petroff, the former CIO of Ontario Teachers, once told me bluntly: "If they were using our discount rate, they'd be insolvent."

But cutting the discount rate has implications. Your liabilities go up and you have to make hard choices as to how you will shore up your plan to make up the difference. This is where I think California and other states are going to run into major problems.

Why? Because unlike Ontario Teachers', HOOPP and other Canadian plans, they have not implemented a shared risk plan. Read the article above. It clearly states:
"Most public workers would be exempt from paying any more. Only those workers hired in 2013 or later would have to contribute more to their retirements under the plan."
What this means is California's taxpayers are going to get socked with higher real estate taxes to make up the difference.

But California has a huge problem with real estate taxes due to Proposition 13. A close friend of mine who lives near Standford shared this with me on why homes are so expensive out there:

Unless you are moving out of town most people only buy once in California because of Proposition 13, which limits property taxes to a 2% increase per year anchored at the price you bought your home. There are homes right beside each other where one owner who has been there for 30 years or so is paying a measly $3000 in property taxes and the other owner just moved in and is paying $30000 even if both homes are identical in worth.

There is also no motivation to downsize because of the climate....little 95 year old granny living alone in a 6 bedroom home can get away with a space heater, or even just a good blanket, in her bedroom all winter long. She doesn't face the heating bills others face on east coast so no need to move to a condo until the inevitable, which by the way, happens on average a decade later around here.


Then you have the self serving local politicians who own homes and argue we can't possibly build densely or upwards because, oh my god, we might block the sun!!


Lastly, we have the IPOs from time to time (Google, Facebook, LinkedIn, etc.) that instantly make millionaires out of thousands of young adults who have no idea of home values. They just need somewhere to park their cash.


All of this equals expensive homes. We are lucky we got in at all....right after the 2008 crash when everybody was scared to death that the economy would collapse. So now of course we support everything stated above.
So where is the money going to come from to pay for California's public pension shortfall? Where else? Higher sales and income taxes and higher real estate taxes for new home buyers.

But with taxes in California already sky high, there's no political incentive to tax people more to pay for public pensions. The exact same thing is going on elsewhere in the U.S. where public pensions are already taking a big bite out of state budgets.


And wait, things are about to get a lot worse. As mentioned in the article above, the aging of California's public workforce is behind the shift in strategy. As more baby boomers retire, CalPERS estimates that the number of government retirees will exceed the number of working public employees in less than 10 years.

What this means is CalPERS and other U.S. public pensions are going to confront serious longevity risk in the future. It may not doom them but they'd better prepare for it now.

Lastly, according to the Naked Capitalism blog, CalPERS has a serious problem with its private equity portfolio. I'm not going to comment on Yves Smith's latest rant against private equity and CalPERS. She raises some good points but totally exaggerates or misses other key points. I've explained why CalPERS cut its external managers in half and why private equity is important but so is reporting the results and all the fees paid out to these external managers. Failure to do so is a serious breach of fiduciary duties.

Below, take the time to watch CalPERS latest investment committee from August 17, 2015. There are two parts but Ted Eliopoulos, CalPERS' CIO, kicks things off with a detailed discussion on their private equity portfolio. Listen carefully to his comments on long term performance and fees.


Friday, August 28, 2015

Betting Big on a Global Recovery?

Dan Strump and Josie Cox of the Wall Street Journal report, U.S. Stocks Rally Amid Recovery in Global Markets:
Stocks soared for the second day in a row, with the Dow Jones Industrial Average erasing its losses for the week, as renewed optimism about the U.S. economy eased concerns about the pace of global growth.

The gains came amid a broad rebound in financial markets, which had been pummeled by anxiety about China’s slowdown since the world’s second-largest economy shocked investors by devaluing its currency earlier this month.

Oil prices soared more than 10% to their biggest percentage gain in six years amid a surge in commodities.

The Dow Jones Industrial Average jumped 369.26 points, or 2.3%, to 16654.77. Coupled with Wednesday’s 619-point surge, blue chips are now up 1.2% for the week.

The gains are the latest in a week of wild swings for stocks. Traders say the deep declines of Monday and Tuesday left investors eager to snap up stocks on the cheap, although many remain concerned that bigger market swings are here to stay as uncertainty mounts over the course of interest-rate increases by the Federal Reserve.

“It certainly looks calmer, but it’s hard to know how sustainable these moves are,” said Patrik Schöwitz, a global multiasset strategist at J.P. Morgan Asset Management, which has about $1.8 trillion under management globally. “It’s definitely too early to say that the latest bout of volatility is over,” he said.

The S&P 500 gained 47.15 points, or 2.4%, to 1987.66, while the Nasdaq Composite added 115.17 points, or 2.45%, to 4812.71.

Investors have taken solace in the firming pace of U.S. economic growth, as emerging markets look increasingly shaky. Gross domestic product, the broadest measure of goods and services produced across the U.S., expanded 3.7% in the second quarter, the Commerce Department said Thursday, well ahead of expectations and up from an initial estimate of 2.3% growth.

The data showed upward revisions to consumer spending and business investment, while a separate report showed initial jobless claims fell more than expected last week, suggesting the labor market remains healthy.

Oil prices staged a rebound, rising 10% to $42.56 a barrel in New York. That helped spur a recovery in oil and gas stocks, with energy companies in the S&P 500 gaining 4.9%.

“The U.S. economy is still shining,” said Doug Cote, chief market strategist at Voya Investment Management.

The recent tumult in markets globally has left many investors questioning the Federal Reserve’s course on interest-rate increases. While the recent slide in stocks gives them leeway to keep interest rates lower for longer, the stronger pace of economic growth could place added pressure on the central bank, they said. Until recent weeks, many investors were gearing up for an increase in short-term rates at the Fed’s meeting next month.

“There is zero inflation across the globe, so the Fed has cover not to raise rates, but the economy is surging so I’m at 50-50 right now for September,” Mr. Cote said.

U.S. stocks snapped a six-day losing streak Wednesday and on Thursday the rally spread into Europe and Asia. The pan-European Stoxx Europe 600 closed 3.5% higher. The Shanghai Composite Index led Asian markets higher, closing up 5.3% after five consecutive days of losses.

Strategists at Rabobank said in a note to clients that markets were in a “fragile equilibrium.”

On Wednesday, Federal Reserve Bank of New York President William Dudley said the case for a September rate increase has grown “less compelling” given the market turmoil, reassuring investors who may have been concerned that higher rates would put additional strain on markets at a volatile time.

Ultralow interest rates since the global financial crisis have sent stocks sharply higher.

“Markets have for days been looking for some sort of positive cue,” said Paul Markham, an equity investor at asset manager Newton, which has $75.9 billion under management.

He said that cue had in part come from Mr. Dudley’s comments, but “it remains to be seen how long that shot in the arm will last.”

Investors will be watching for more clues from policy makers later Thursday when a conference of central bankers begins in Jackson Hole, Wyo.

Next week, the U.S. labor-market report for August will shed more light on the pace of jobs growth in the U.S.

In currency markets, the U.S. dollar rose against the euro and the yen following the stronger U.S. growth data.

U.S. 10-year Treasury yields were at 2.168%, down marginally. Yields fall as bond prices rise.
At this writing on Friday morning (10:00 am), you can see that oil prices, stocks, yields are all down  but the U.S. dollar and gold are up (click on image):


So what is going on? Why is it such a crazy volatile week for stocks and bonds? There are a few things going on at the same time but let me walk you through some of my thoughts.

First, as I've repeatedly warned you, be prepared to see violent countertrend rallies in the sectors that have been clobbered over the last three months, ie energy (XLE), oil services (OIH) and metal and mining stocks (XME).

Countertrend rallies are particularly violent when stocks in unfavorable sectors are massively shorted by big trading outfits betting on stocks, bonds, currencies and commodities. These are the same trading outfits that love to put on huge carry trades to leverage up their returns.

But when stocks are heavily shorted as traders bet on more decline, they are vulnerable, especially when there's a buying panic going on. What happens then is a massive short squeeze as short sellers are forced to buy back shares to cover their margins.

Now, take a look at some stocks in the commodity and energy sectors which rallied sharply on Thursday (click on image):


I  took a snapshot of these stocks on Thursday evening just to show you how powerful these countertrend rallies can be. You will notice the primary trend for almost all these stocks is down and if you look at their one year chart, you'll see despite the rally, they're way below their 200-day moving average.

And yet these shares all rallied huge on Thursday fueled by short covering, panic and legitimate buying where investors are betting on a global recovery (thus the title of that portfolio above I created on Yahoo Finance last night).

[Note: On Friday, the biggest gainers were small cap oil and gas exploration stocks which got decimated over the last year. The two top gainers were Midstates Petroleum Company (MPO) and Emerald Oil (EOX), up 101% and 55% respectively in one day, but if you look at their one year chart, it's a bloodbath!]

Now, the trillion dollar question all portfolio managers and traders are wondering is this the real deal or is it another head fake where the market goes up and then drops right down to new lows or to retest lows?

My own thinking has been to steer clear of energy and commodity shares, especially after China's Big Bang, fearing that there will likely be further devaluations out of China and this will heighten global deflationary pressures.

But there are some big moves happening in markets, some of which are definitely signaling a potential turnaround in the global economy. Take the huge and unbelievable rally in coal stocks going on right now in companies like Arch Coal (ACI) and Peabody (BTU). The former hit a low of $1 earlier this month and is now trading above 8$ while the latter more than doubled during that time.

These are huge moves for coal shares in a sector that has been obliterated and where many companies have filed for Chapter 11, wiping out shareholders (I lost a ton when Patriot Coal went under but Alpha Natural Resources and Water Energy also wiped out shareholders when they filed for bankruptcy).

Is King Coal coming back from the dead? With China slowing down, I strongly doubt it but clearly there are big investors betting on these shares. Billionaire investor George Soros bought stakes in the two coal companies I mentioned above but the dollar amount is peanuts relative to the size of his overall stock holdings. I don't know if he's still buying coal shares this quarter but clearly momentum traders are having fun playing these shares (be very careful trading and investing in this sector, you can get killed).

More interestingly, another famous investor, Carl Icahn, announced on Thursday his fund is taking a significant stake in Freeport-McMoRan (FCX), a major copper miner who has been clobbered this year. That announcement sent shares of Freeport soaring on Thursday after the close even after the stock ran up almost 30% (click on image):


Of course traders are selling the news Friday and the stock is well off its highs in the after-hours session on Thursday evening. If anything, I suspect short sellers covered and then resumed their shorts on Friday and other traders used this news to get out and lock in profits.

So why is Icahn, a well-known activist, taking an 8.5% stake in a copper giant like Freeport? I don't know but it's a ballsy move by a legendary investor as the trend is clearly not in his favor just like it hasn't been on another major holding of his, TransOcean (RIG) which announced a cut in its dividend earlier this week and hit a 52-week low. I can say the same thing about Chesapeake Energy (CHK), another big holding of Icahn Associates.

A lot of people are getting excited over Icahn's latest move but I would temper this enthusiasm. Freeport-McMoRan (FCX) isn't Apple (AAPL) or Netflix (NFLX) and it remains to be seen how Icahn will use his clout to shake things up at that company to unlock value.

But there might be another reason to buy Freeport, energy and commodity shares and it has nothing to do with activism. What if the world economy isn't falling off a cliff? What if fund managers are overly pessimistic on global growth going forward?

These are the questions I grapple with every day as I trade and observe the crazy gyrations in markets. Sure, China is slowing down but I think investors need to take a step back here and remember who China sells its products to and who leads the global economy.

Importantly, it's the U.S. and eurozone that still wag the tail of the global economy, not China. And even in China, too many investors listening to Jim Chanos on CNBC are blowing things way out of proportion.

People need to take a step back and think a little and stop reacting to all this negative news. Ambrose Evans-Pritchard of the Telegraph recently discussed why China is in a serious bind but this is not yet a 'Lehman' moment and how reflation threatens eurozone bonds as money supply catches fire there.

Evans-Pritchard ends his latest comment on this note:
While the ECB is in one sense capping yields by buying bonds, this effect could be overwhelmed by fundamental forces if the markets start to price in higher growth. Yields rose rather than fell with each episode of QE in the US.

Bill Gross, the legendary bond guru at Janus, said in April that German Bunds were the “short of a lifetime”. Yields surged threefold and he made a windfall profit.

The great question for the bond market is whether Europe and America are caught in a permanent Japanese deflation trap, or whether their economies are breaking free and returning to normal after six years of chronic malaise. If the latter, the bond sell-off has barely begun.
When it comes to bonds, I prefer heeding the dire warning of the bond king than listening to Evans-Pritchard, but he raises a good point, namely, if the global economy isn't as bad as everyone fears and if growth in the eurozone follows that of the U.S. and starts coming back strong, we might see a significant backup in global bond yields.

I've said it before and I'll say it again, there's a lot of stimulus out there as central banks across the world slash rates and engage in quantitative easing. All that global liquidity is highly accommodative and supports risk assets. The drop in the euro also helped stimulate growth there as will the drop in yuan and emerging market currencies. It will eventually feed into growth.

But the world still suffers from major structural headwinds which are deflationary and bond friendly. This is why I'm not taking bond bears like Alan Greenspan or Paul Singer too seriously at this time. Unless we see major growth and the return of high paying jobs with great benefits, deflation still rules the day. Period.

So you can follow George Soros and Carl Icahn, betting on a global recovery, but be careful trading these sectors (take profits along the way!) as the structural problems that plague this world still haunt us. I'm still sticking with my biotech call knowing full well it will be extremely volatile but I'm convinced the secular uptrend in this sector is far from over.

One thing is for sure, these are brutal markets for everyone, including big name hedge funds that have taken a beating this year.  If the flash crash of 2015 rattled your nerves, don't worry, you're in good company. Try to stay focused and stop listening to the noise, it will only drive you crazy.

Below, Caroline Bain, senior commodities economist at Capital Economics, told CNBC on Thursday that the rout in commodities is overdone.  "We certainly think that the authorities in China have the firepower in terms of monetary and fiscal policy to enact enough stimulus for the economy to at least meet the growth rate they're targeting," says Bain. She may be right but the ominous sign from commodities is still weighing heavily on global markets.

And CNBC's Steve Liesman talks with Federal Reserve Bank of Minneapolis President Narayana Kocherlakota, about the challenges of zero-bound rates and tail risks to the U.S. economy.  Listen carefully to Narayana Kocherlakota, in my opinion, he's one of the best Fed presidents and understands the real risks of raising rates too early.

On that note, I wish all of you a great weekend. Please remember to kindly donate and/ or subscribe to this blog using PayPal at the top right-hand side under the "click my ads" banner which I also appreciate. I work hard to provide you with the latest on pensions and investments and would like to see more institutions step up to the plate to donate and subscribe.



Thursday, August 27, 2015

Hedge Funds Take a Beating?

Rob Copeland of the Wall Street Journal reports, Hedge Funds Bruised by Stocks’ Meltdown:
Hedge-fund managers like to promise their investors protection from market swings. In the recent stock swoon, many were caught off guard.

Billionaire managers such as Leon Cooperman, Raymond Dalio and Daniel Loeb are deeply in the red this month, left flat-footed by the quick plunge for stocks world-wide. Mr. Cooperman’s Omega Advisors posted a 12% decline this month through Wednesday and 10% this year. Mr. Loeb’s Third Point LLC and William Ackman’s Pershing Square Capital Management are also down big, erasing their gains for the year.

Other traders suffered amid this week’s volatility. Monday, when the market collapsed more than 1,000 points in its largest ever intraday point decline, marked one of the worst days for many managers since the crisis.

That is a hit to an industry that has for years excused its relative underperformance compared with benchmarks by promising that collections of bets on and against markets—a so-called long/short strategy—would insulate the impact of any future market gyrations.

“We’ve struck out this month so far,” said one hedge-fund manager.

There is some evidence that hedge funds are offering some protection in the deluge, since many are doing better than the 7.8% drop in the S&P 500 index this month. Stock hedge funds are down on average 5% this month, according to researcher HFR Inc.

A turnaround may yet be in the cards for some star managers. Mr. Cooperman’s Omega, for instance, was down 15% through Tuesday, but found some relief Wednesday as bets on U.S. and Japanese equities began to recover some losses.

Omega was up 3% on Wednesday alone, and Mr. Cooperman maintains his conviction that the bull market is alive, according to a person familiar with his thinking.

Hedge funds collect some of the highest paydays on Wall Street because they promise to be uncorrelated, or move out of sync, with the markets at large.

“If you were expecting all hedge funds to be a hedge against market downside, that obviously wasn’t the case here,” said Neal Berger, chief investment officer at hedge-fund investor Eagle’s View Capital Management LLC. He said he preferred managers with less exposure to the stock market.

Problems have been compounded, in the short-term at least, by a widespread conviction that the recent plunge will be followed by a fast snap back. Managers bought a record number of stocks earlier this week, Morgan Stanley said. While the S&P 500 rose nearly 4% Wednesday, it remains down for the week.

Representatives of Mr. Loeb’s Third Point, for instance, have told clients he maintains convictions in Third Point’s core positions, and is looking to add to them on what the firm sees as a short-term dip.

Third Point was down about 7% for the month through early this week, people familiar said. Third Point was up 5.7% through the end of July.

Activist managers, who became the darlings of Wall Street in recent years, are struggling in particular.

The outspoken Mr. Ackman’s Pershing Square ran into a wall, losing more than 10% to fall into the red for the year. In a letter to investors Wednesday, the firm blamed “significant volatility” and fears about China.

Activist Nelson Peltz’s Trian Fund Management is down 5.7% through Wednesday, pushing the firm into negative territory for the year, according to a person familiar with the firm.

David Einhorn’s Greenlight Capital is in a worse spot, down about 5% this month alone through earlier this week, and in the red by double digits in the year to date, according to a person familiar with the matter. For Mr. Einhorn, who in his most recent quarterly letter told investors he was struggling to find new ideas when “perception supplants reality,” troubles are compounded by an emphasis on hard-hit stocks like Micron Technology Inc. and SunEdison Inc.

Even managers not yoked to the stock market, like the world’s biggest hedge fund, Bridgewater Associates, are struggling. With Bridgewater down 4.7% for the month through Friday, its boss Mr. Dalio sent a note to clients Monday—later posted publicly—with a rather contrary view: that the Federal Reserve may launch a fresh round of quantitative easing rather than dramatically tighten.

Market observers had lately coalesced around a view that the Fed was likely to raise its historically low interest rates in September for the first time since 2006.

Late Tuesday, as Mr. Dalio’s prediction began to gain attention, he added an addendum to the public note, hedging his assessment. “To be clear, we are not saying that we don’t believe that there will be a tightening before there is an easing,” Mr. Dalio wrote. “We are saying that we believe that there will be a big easing before a big tightening.”

Bridgewater remains in the black for the year.
Hedge funds put brave face on stocks turmoil, some see bargains:
Just after the Dow Jones Industrial Average plunged over 1,000 points on Monday morning, New York-based hedge fund manager Sahm Adrangi sent around his weekly note showing his fund lost 2 percent so far in August. His conclusion regarding the market turbulence: it's a buying opportunity.

Adrangi, whose $350 million Kerrisdale Capital is still up 10 percent so far this year, stands with several other well-known hedge fund managers in saying they're staying the course in U.S. equities markets, including Leon Cooperman's Omega Advisors and Larry Robbins' Glenview Capital. Omega has lost 11 percent this month and Glenview is down 5.5 percent.

Still, "we are not getting a signal from the corporate sector or our analysts that there has been any deterioration in outlook," said Steven Einhorn, a partner at Omega Advisors, who said his firm believes stocks will rebound.

While that view may not be shared by investors whose fortunes depend on such things as the price of oil or the health of the Chinese economy, most hedge fund managers contacted by Reuters remain upbeat about prospects for U.S. stocks even after the Dow tumbled 3.6 percent and the Standard & Poor's 500 index dropped 3.9 percent in a single day. For the year, the Dow is down almost 11 percent and the S&P 500 has lost 8 percent.

Helping accelerate the recent slide, many hedge funds' in-house risk managers have been ordering traders to sell to curb losses during the turbulence. And analysts at Bank of America estimate that hedge funds specializing in stock investments have recently cut their net long exposure to 35 percent from 39 percent.

For some, the selling frenzy indicates how at least part of the investing public is inclined to panic, said David Tawil, who runs Maglan Capital, a hedge fund with about $75 million in assets under management.

"This is like a runaway train and it speaks volumes to the temperament of today's market participants," Tawil said.

Meanwhile, Jeffrey Gundlach, co-founder of DoubleLine Capital, one of the most successful fixed-income fund companies, warned that the sell-off may not be over.

"The market is wounded and it takes time for people to get around to feeling good again," Gundlach said in a telephone interview with Reuters. "You don't correct all of this in three days."

Hedge funds' month end performance numbers are expected in about a week and so far, investors in these funds have shown little taste for racing for the exits. At the same time, managers are not going out of their way to soothe frayed nerves with special calls or intra-month reports.

MUTUAL FUNDS

Unlike hedge funds, which lock up their investors' capital for months at a time, mutual funds have to redeem their investments immediately if their investors, usually people saving for retirement, want out.

Mutual fund Longleaf Partners, run by Mason Hawkins, whose holdings include Chesapeake Energy and Wynn Resorts, is down 16.22 percent so far this year.

While it's not known whether Longleaf has suffered outflows this year, that sort of performance may have accelerated investor exits from U.S. stock funds in August, after clients had already pulled $79 billion out in the first seven months of 2015, marking the fastest annual outflows since 1993.

Hedge funds meanwhile took in $64.3 billion in new cash in all types of strategies in the first seven months of the year.

Some of that cash has flowed into so-called global macro funds that bet big on currencies and recently increased their bets on 10-year U.S. Treasuries, seen as a haven in times of market stress.

Global macro funds rose 0.17 percent for the year through the end of last week while the average stock hedge fund was down 0.16 percent, according to data from Hedge Fund Research.

By the end of Monday, the Balter Discretionary Global Macro, subadvised by Willowbrook Associates' Phil Yang, had gained 1.69 percent in August, partly on a bet that oil prices would keep falling.

Macro funds returned 5.5 percent in the first half of the year, prompting investors to add $8.5 billion in new money alone in July, data from eVestment show.
No doubt about it, macro funds are where investors are focusing their attention. There are several reasons for this, top of which is they can deliver scalable alpha that smaller funds can't, but also because investors feel macro trends will dominate the landscape following China's big bang.

This is why investors are licking their chops to invest in Scott Bessent's new fund. But Soros's protege isn't the only superstar macro manager launching a new fund. Chris Rokos, a former top trader at Brevan Howard Asset Management, expects to raise about $1 billion for his hedge fund that’s set to start trading in the fourth quarter:
Rokos Capital Management will initially have the capacity to manage $3 billion, said the person, who asked not to be identified because the information is private. The 44-year-old is awaiting approval from U.K. regulators to start his London-based firm.

Rokos is courting investors three years after leaving Brevan Howard, the hedge fund he co-founded, where he had generated more than $4 billion. He’s starting out as macro funds have underperformed the industry in the last five years.

Rokos Capital’s assets will be divvied up between Rokos, Borislav Vladimirov, a former colleague at Brevan Howard, and Stuart Riley, who used to work as Asia-Pacific co-head of macro trading at Goldman Sachs Group Inc., the person said. Rokos Capital has about 50 employees and has made hires including economist Jacques Cailloux from Nomura Holdings Plc.

Once licensed, Rokos will offer clients a range of fees -- a management levy of 1 percent to 2 percent of assets and a 20 percent to 30 percent cut of profits, the person said.
Let me plug Chris Rokos, an extremely private, wealthy and brilliant trader who has assembled a top team which he will need to confront these brutal markets. If you want to work for him, you need to be highly quantitative and come from the right pedigree.

Speaking of quant funds, some are doing much better than others. Alternative investment management company Dormouse recently released July performance figures above most of its peer fund managers and global investment industry benchmarks:
Dormouse, which was founded in 2011 by former IKOS CIO Martin Coward and opened to outside capital in 2014, booked a gain in July of 5.86%. The tally brings the fund’s year-to-date return to 26.32%, compared with 0.93% for the HFRX Macro/CTA Index.

Dormouse is a quantitative systematic managed futures firm that utilizes rigorous scientific methodologies to test and develop rule-based strategies for investing in global financial markets.

When it opened to outside capital in 2014, Howard described the fund as a systematic multi-strategy fund focusing on identifying under- or over-priced liquid securities across stock indices, fixed income, rates, FX and commodities, and exploiting the increased correlation between asset classes.

Coward, who is generally considered to be one of the pioneers of European quantitative hedge funds, co-founded IKOS in 1992 and led it until December 2009. During his tenure, IKOS' unique trading strategies enabled it to become one of the most successful hedge funds in the world, with peak assets of $3.5 billion.

Following his departure from IKOS, Howard spent most of the next two years battling his estranged wife, IKOS chief Elena Ambrosiadou, in court; the two filed more than 40 lawsuits against each other in four countries, alleging spying, theft and a wide range of other alleged misdeeds.

The legal action culminated in mid-2013 when a British court determined the trading code developed by Howard while he was at IKOS were property of the firm.
His private life was all over the British papers and international media but it's none of my concern. The fact remains that Martin Coward is running one of the world's top quant funds and unlike other top funds his assets haven't mushroomed as he maintains the focus on performance.

And his ex-wife, Elena Ambrosiadou, has been displaced as the "queen" of hedge funds by Leda Braga who started Systematica Investments in January after years under prominent European hedge fund firm BlueCrest Capital Management.

Braga’s BlueTrend led a revival in computer-driven hedge funds in July, spurred by a slide in commodity prices and the strengthening dollar:
A former top trader at Michael Platt’s BlueCrest Capital Management, Braga, 49, saw her fund gain 6.2 percent last month, putting it 3.1 percent up for the year, according to a person familiar with the matter. Her Geneva-based Systematica Investments now runs almost $9 billion, said the person, who asked not to be identified because the data is private.

Computer-driven hedge funds rely on algorithms to make trades and generally make money when trends are consistent. Oil, currencies, bonds and stock indexes all reversed direction in June, in part because of Greece’s decision to walk out of talks with creditors and China’s stock market plunge.

Gains for Braga’s fund, which opened at the start of the year, were more than matched by the smaller $2.9 billion quantitative program run by U.K. firm Cantab Capital Partners, which earned 6.3 percent in July after an 8.6 percent June decline, according to an investor letter seen by Bloomberg. Aspect Capital’s $890 million Diversified Fund rose 9.2 percent last month, a spokeswoman at the London-based firm said.

The gains reflect a wider trend for quant funds. The Newedge CTA Index showed the funds, which trade on futures, gaining 3 percent in July after averaging a loss of 4.2 percent the previous month.
Sometimes I miss my days at the Caisse investing in top L/S Equity, global macro and CTA funds. I would be great at approaching all these funds I write about above but I'd grill them hard as I'm older, more experienced trading these crazy schizoid markets, more cynical, and less tolerant of poor excuses for underperformance, especially from managers who charge hefty fees and focus on asset gathering, not performance.

There is so much nonsense that is still going on in the hedge fund industry that makes my eyes roll! Stop falling in love with your hedge funds, there are plenty of titans that rise and fall in this industry. Stop listening to your useless investment consultants who typically recommend you chase the hottest funds. And if you do chase after hot funds, get ready to be burned alive.

My advice is to drill down into their portfolios and analyze their potential going forward keeping in mind the big macro themes that dominate the landscape. Drill and grill no matter who it is! Dalio, Ackman, Griffin, Loeb, whoever it is, always grill them hard and if they get pissed off or irritated, good, at least you know you're doing your job right (you're just a number to them and they should be just a number to you).

And don't just grill them when they get it wrong. Grill them hard even when they get it right. Hedge fund billionaire Crispey Odier recently made £225m from the Great Fall of China. The man who predicted the credit crunch (he wasn't the only one, even I did) saw his main hedge fund surge about 9 percent this month by betting against China after losing money on the wager earlier in the year:
The gain by Odey European, a $3.2 billion strategy that bets on rises and falls in stocks, pared its loss for the year to an estimated 5 percent as of Monday, the person said, asking not to be identified because the information is private.

Odey, 56, is among hedge fund managers profiting from the slump in China, which saw European stocks post the biggest losses since the financial crisis on Monday as the rout spread. His London-based firm, which manages $12.8 billion, told investors in a letter last month that a devaluation in China would mean deflation breaking out across the world.

Odey European’s bets on China had led to a record 19 percent loss in April. It was “attacked on all sides” after wagering China’s economic troubles would cause a slowdown that could embroil the developed world, it told investors.

Omni Macro Fund, managed by Stephen Rosen, is another hedge fund racking up profits. The fund, which manages more than $500 million, climbed 4.9 percent in the month through Aug. 21, a spokesman for the company said via e-mail. Its strategies include betting on the slowdown in China, over-valuation of global equities and a bearish view on commodities via copper futures, he said.

China’s stocks extended the steepest five-day drop since 1996 in volatile trading on Wednesday, as a rate cut failed to halt a $5 trillion rout.

The slump in global equities has resulted in many hedge funds nursing losses. The industry fell 2.3 percent this month through Aug. 21 and 1.1 percent this year, according to the HFRX Global Hedge Fund Index.
Odey is on the record with his bearish views but the volatility in his funds and his bearish views make me nervous. He can easily get killed in these markets and I predict he will have a very rough fourth quarter. If he was in my portfolio, I'd sit down with him and have a really long chat on his views and risk management.

As I stated in my latest comment peering into the portfolios of top funds, I'm increasingly weary of  of overpaid, over-glorified and in many cases, under-performing "hedge fund gurus" charging 2 & 20 for sub-beta returns. Donald Trump is right, hedge funds are "getting away with murder," but not only for the reasons he cites.

Lastly, these Risk On/ Risk Off markets are brutal. I know, I trade them and was busy loading up on biotech and got frazzled by the flash crash of 2015 but kept my cool and stuck with my positions. I'm sure some funds like Ken Griffin's Citadel made a killing scooping up shares of Apple, Amazon, Netflix, Disney, JP Morgan and GE on Monday morning as they all flash crashed. Griffin knows all about alpha, beta and beyond which is why he's now the "king" of hedge funds.

But most hedge funds stink and even brand name funds (like Einhorn's Greelight Capital) are having a tough year in 2015 as extreme volatility and low liquidity is wreaking havoc on their fund's performance (wait till the real liquidity time bomb explodes). It doesn't help that many of them got the macro environment wrong or worse still, are ignoring macro altogether.

This is why I predict barring a huge rally in the fourth quarter, 2015 will be another brutal year for hedge funds. Don't worry, there will be plenty of dumb money chasing after them even as they underperform public market benchmarks and deliver negative alpha (I call it the hedge fund Stockholm syndrome).

Below, John Burbank, Passport Capital, discusses how he is navigating today's market moves and how he managed a big gain in July. Also, his projection on the Fed raising rates. Very smart man, listen carefully to his comments. I'm not surprised his fund is doing so well this year.

And one pro discusses why he thinks we could be setting up for Q4 rally. He might be right and many hedge funds (and their investors) are desperately hoping he is as they're taking a beating so far this year.


Wednesday, August 26, 2015

Chicago's Huge Pension Conflicts?

Matthew Cunningham-Cook of the International Business Times reports, At Chicago Pension Fund, Questions Raised On Conflicts of Interest:
Chicago pension officials wanted to know where to deposit the $11 billion that the city’s teachers had saved for their retirement benefits, so they turned in 2014 to the outside consulting firm they’d hired for financial advice. Such consultants are employed to provide guidance that's expected to be impartial -- not shaped by private business relationships that might make its recommendations less than objective.

So when the firm, Callan Associates, told pension trustees at a February meeting to give the cash to a bank called Bank of New York Mellon (BNY), the board’s trustees agreed to follow the advice. What they were not told at that meeting, however, is that BNY pays Callan for both general consulting services and financial education programs.

Those payments, say financial experts, represent an inherent conflict of interest. They effectively strip consultants like Callan of their objectivity by giving them an incentive to push their pension clients to use banks that are paying the consulting firms, the experts say.

Government regulators and auditors have in recent years raised concerns about undisclosed business relationships between financial institutions and consultants who are supposed to provide objective counsel. Auditors have documented lower investment returns at pension funds that rely on consultants with divided loyalties.

In Chicago, the conflicts could prove particularly costly for the city’s taxpayers and 63,000 educators. That’s because the bank Callan recommended, BNY, is a Wall Street behemoth that has repeatedly faced law enforcement action for skimming money from its clients. In fact, just after Chicago handed over teachers’ money to the bank, BNY agreed to pay more than $700 million to settle federal charges against it for defrauding its pension fund clients. Callan had previously faced sanctions from the Securities and Exchange Commission (SEC) for failing to disclose to clients that it was getting payments from BNY Mellon in exchange for referring brokerage business.

Callan did not respond to International Business Times' questions about its financial relationships. In its marketing material and financial disclosure documents, the firm has said, "We are independently owned and operated with interests that are precisely aligned with those of our clients.”

Ted Siedle, a former SEC attorney, said he sees no alignment of interests for Callan clients.

“It’s clear that Callan has conflicts of interest, and it’s likely those conflicts have an adverse effect on performance," he told IBTimes.

Feds Taking ‘A Careful Look’

In recent years, conflicts of interest in the shadowy world of finance have drawn increased attention from regulators and policymakers. In the wake of the financial crisis, lawmakers uncovered evidence that banks were pushing clients into investments that the banks themselves were betting against. That prompted deeper concerns about conflicts of interest and ultimately led the U.S. Labor Department to propose a rule mandating that financial advisers to individual investors provide advice that is solely in the interest of their clients.

But while the department has considered a similar rule for those advising pension funds, such an initiative has not moved forward.

In the absence of such a regulation, Rep. George Miller, D-Calif., sent a letter to the Department of Labor in 2014 saying the agency needs to "take a careful look” at conflicts of interest with pension consultants. In response, Phyllis Borzi, the Labor Department official in charge of regulating pensions, said the department was “committed to addressing" such conflicts in regard to pensions.

Evidence of conflicts has been mounting. In 2005, the SEC surveyed 24 major investment consultants and found that 13 had significant conflicts of interests that they had disclosed to investors. One of those firms investigated was Callan Associates. Using the findings of the SEC’s 2005 review, the Government Accountability Office (GAO) later found that pension funds that used conflicted consultants had 1.3 percent lower rates of returns than those that did not. As of 2006, those consultants were helping manage $4.5 trillion of assets.

If the GAO’s estimates are accurate, conflicted consultants cost pension funds $58 billion in unrealized returns every year.

Controversies surrounding financial conflicts of interest have periodically generated headlines.

In 2004 , Mercer, a major consultant, was criticized for receiving money from asset managers it recommended to pension funds, specifically in Santa Clara, California. In 2009, Consulting Services Group was criticized in an investigation for recommending that the pension fund of Shelby County, Tennessee, invest in its own hedge fund, which paid large fees to the company. In 2013, New York's Superintendent of Financial Services Benjamin Lawsky subpoenaed documents from 20 of the largest investment consulting firms, reportedly to evaluate their potential conflicts of interest (the results of Lawsky’s investigation have not yet been made public).

Most recently, in December 2014, IBTimes reported that the San Francisco pension fund's consultant, Angeles Investment Advisors, was pushing the city to allocate 10 percent of its portfolio to hedge funds but did not disclose that its own firm reserves the right to collect additional fees from pension clients when those clients invest in hedge funds. Angeles was later fired by the pension fund in favor of a company that claims to have fewer conflicts of interest.

‘The Bank Was Stealing’

In Chicago, where the teachers pension fund trustees are both educators and appointees of Mayor Rahm Emanuel, questions about conflicts of interest were not about investments. Instead, they were about which bank should get the lucrative contract to receive and disburse the pension fund’s $11 billion in assets.

In February 2014, when Callan recommended that pension trustees choose BNY for these so-called custodial services, Callan’s representatives did not explicitly tell pension trustees of their firm’s relationship with BNY or the 2007 SEC enforcement action against the consulting firm. Callan’s 2013 report on Chicago’s private equity investments did briefly mention the firm’s business with BNY, but pension trustees interviewed by IBTimes said they were unaware of the relationship.

At the February meeting, Callan also did not mention any of the ongoing legal issues related to BNY Mellon and its performance as a custodian for pension funds, even though the bank was just then the subject of law enforcement scrutiny. Indeed, one month after Chicago’s gave BNY the deal for custodial services, BNY agreed to pay $714 million to settle claims against it for bilking its pension fund clients by manipulating the rate at which pension funds’ currency holdings are traded internationally.

U.S. Attorney Preet Bharara, who brought the federal charges against BNY, said at the time that public pension funds "trusted the bank to be honest about the financial services it was providing and to deal with them fairly.” But, charged Bharara, BNY "and its executives, motivated by outsized profits and bonuses, breached this trust and repeatedly misled clients” about the currency rates they were charging their clients. Specifically, prosecutors said, the bank got the best currency exchange “rates for itself, gave its customers the worst or close to the worst rates, and kept the difference for itself.”

The federal investigation and lawsuit had been ongoing since 2011 but went unmentioned by Callan in its recommendations. At the time of the settlement, the New York Times reported that a BNY Mellon employee had been quoted in an email asking if it was “time to retire after raping the custodial accounts.”

The $714 million paid by BNY Mellon is negligible, however, compared with estimates provided by investigator Harry Markopolos, who first blew the whistle on the scam in 2011. In an interview with King World News, reported by Business Insider, Markopolos placed the scale of damages far higher -- at more than $2 billion. 
IBTimes asked Chicago teachers pension staff members if they had been informed about Callan’s conflict of interest with BNY Mellon and if they are concerned that such a conflict may have encouraged Callan to avoid mentioning the problems surrounding BNY’s custodial services. The fund’s executive director, Charles Burbridge, said that he has “not had the opportunity to look into the issues."

BNY Mellon declined to comment in response to questions from IBTimes. In a statement in March, the bank declared that it is pleased to put the “matters behind us, which is in the best interest of our company and our constituents.”

Finance experts question whether pension funds should continue to trust their money with BNY Mellon.

“It's hard to see how any fiduciary can keep doing business with BNY Mellon after these revelations,” Susan Webber, principal of Aurora Advisors, a financial consulting firm, said. “BNY Mellon flagrantly misrepresented its foreign exchange trading practices to customers. Consistently reporting the worst or nearly the worst price of the day to clients means the bank was stealing.”

For Siedle, the former SEC attorney, Chicago’s relationship with its consultant and decision to deposit retirees’ money in BNY is a cautionary tale that should prompt action.

“With the nationwide attack on defined-benefit pensions,” he said, “it is now more urgent than ever that Chicago teachers and other pension funds across the country launch independent investigations into how conflicts of interest have affected their portfolio.”
Ted Seidle, the pension proctologist, is absolutely right, now more than ever U.S. public pension funds need to scrutinize their relationships with external consultants, hedge funds, and of course private equity and real estate funds. They all want a piece of that multibillion dollar public pension pie but trustees need to uphold their fiduciary duty and make sure they're is proper alignment of interests.

As far as BNY Mellon, they were caught overcharging pension funds on foreign exchange transactions but I've got news for you, this type of stuff goes on all the time especially in unregulated currency markets. Big banks and custodians are always trying to screw their clients on F/X trades and to a certain degree, clients know this and allow it (there is a certain give and take in F/X markets but banks and clients need to be reasonable or else they get a very bad reputation and nobody will trade with them).

But as far as Callan Associates, one of the big consulting shops in the U.S., it should have disclosed that BNY pays Callan for both general consulting services and financial education programs. Failure to disclose this is grounds for termination of its contract with Chicago's pension fund.

When I was investing in hedge funds a long time ago, I'd always use a legal side letter to cover ourselves as much as possible from operational risk or any other negative surprises. Even then, it wasn't always foolproof.

I'm shocked at how sloppy some contracts are nowadays. It should clearly stipulate that failure to disclose serious conflicts of interest will mean termination of a contract and heavy fines and penalties.

Importantly, these conflicts of interest aren't just going on in Chicago, they're going on all over the United States where lack of proper pension governance means the entire public pension fund system is vulnerable to investment consultants fraught with conflicts of interest.

Of course, some consultants are better than others and are offering truly independent and outstanding advice, but for the most part it's been and continues to be a miserable failure and it's costing these U.S. public pensions billions in performance and fees.

And Chicago's pension woes don't end with consultants' conflicts. A report recently uncovered that teacher pension perks are not uncommon across Illinois:
Hundreds of school districts across Illinois cover either all or most of their teachers’ retirement contributions.

The issue is in the spotlight as Illinois’ largest district is in the middle of tense contract negotiations and the cash-strapped district is seeking help from legislators.

The Chicago Tribune reports thousands of teachers get a better deal than Chicago teachers.

Some districts, including in suburban Wheeling, say picking up pension costs helps keep them competitive. Some unions have also argued it’s a cost saver because if the money was paid as a salary it would be subject to payroll tax.

Mayor Rahm Emanuel wants teachers to pay the full contribution. The cash-strapped district has paid most of the 9 percent contribution. The Chicago Teachers Union argues that amounts to a pay cut.
I have a question for these public-sector unions: what planet do they live on? Have they not heard of shared risk for their pension plan? They should follow Ontario Teachers' Pension Plan and implement it immediately along with the governance that has allowed it to become one of the best pension plans in the world.

As far as Illinois, it's a pension hellhole and I don't just blame the unions for this sorry state of affairs. Just like in other states, its government has failed to top up its public pensions, which is why pension deficits keep growing. Record low interest rates aren't helping either and wait till deflation hits pensions and decimates them.

Below, the market's dramatic selloff was difficult and uncomfortable but merely "choppy seas" for long-term investors. Chris Ailman, CIO of the California State Teachers' Retirement System (CalSTRS), recently spoke on CNBC stating "we're going to ride this out." They don't have much of choice but listen to his comments as to why the long run is the only thing that matters for pensions.

Tuesday, August 25, 2015

Questioning Harper's Retirement Policies?

Dean Beeby of CBC News reports, Document raises questions about Harper retirement policies:
Canada scores poorly among developed countries in providing public pensions to seniors, according to an internal analysis of retirement income by the federal government.

And voluntary tax-free savings accounts or TFSAs, introduced by the Harper Conservatives in 2009, are so far unproven as a retirement solution and are largely geared to the wealthy.

Those are some highlights of a broad review of Canada's retirement income system ordered by the Privy Council Office and completed in March this year by the Finance Department, with input from several other departments.

The research, compiled in a 30-page presentation deck, was created as the government came under fire from opposition parties, some provinces and retiree groups for declining to improve Canada Pension Plan or CPP payouts through higher mandatory contributions from workers and businesses.

The CPP issue has already become acrimonious in the federal election campaign, with Conservative Leader Stephen Harper saying on Aug. 11 that he is "delighted" to be making it more difficult for Ontario to launch its own version of an improved CPP. The federal Liberals are hoping to use Harper's clash with Ontario Liberal Premier Kathleen Wynne over pensions to win seniors' votes in the province and beyond.

A heavily censored copy of the internal document was obtained by CBC News under the Access to Information Act.

The review acknowledges that Canada trails most developed countries in providing public pensions, and is poised to perform even worse in future.
Low among OECD countries

"In 2010, Canada spent 5.0 per cent of GDP on public pensions (OAS/GIS and C/QPP), which is low compared with the OECD (Organization for Economic Co-operation and Development) of average of 9.4 per cent," it noted.

"The OECD projects that public expenditure on pensions in Canada will only increase to 6.3 per cent of GDP by 2050 – much lower than the 11.6 per cent of GDP projected for OECD countries on average."

The document also says Canada's public pensions "replace a relatively modest share of earnings for individuals with average earnings" compared with the OECD average of 34 countries; that is, about 45 per cent of earnings compared with the OECD's 54 per cent.

"Canada stands out as one of the countries with the smallest social security contributions and payroll taxes."

The Harper government since at least 2013 has resisted repeated calls to enhance CPP, saying proposed higher premiums for businesses could kill up to 70,000 jobs in an already stagnant economy. Instead, the government has promoted voluntary schemes, such as pooled pension plans for groups of businesses, as well as TFSAs.

Speaking Sunday at a campaign stop in eastern Ontario, Conservative Leader Stephen Harper said, "Our view is that, you know, we have a strong Canada Pension Plan. It is, unlike the arrangements in many other countries, it's solvent for the next 75 years, for generations to come."

"Our judgment is [that] what Canadians want and need are additional savings vehicles," he said.

The document notes that participation rates for TFSAs rise with income, with only 24 per cent of those making $20,000 annually or less contributing, compared with 60 per cent in the $150,000-plus bracket.

The review also acknowledges "it is still too early to assess their effectiveness in raising savings adequacy."

Much of the document is blacked out under the "advice" exemption of the Access to Information Act, including a section on policy questions. The research may have underpinned a surprise announcement in late May by Finance Minister Joe Oliver that the government was considering allowing voluntary contributions by workers to their CPP accounts.

The review takes issue with Statistics Canada's data showing a sharp decline in personal savings by Canadians since 1982, arguing that when real estate and other assets are factored in, savings are as high as they have ever been. "Taking into account all forms of private savings suggests no decline in the saving rate over time."
Ignores evidence?

The provincial minister in charge of implementing the Ontario Retirement Pension Plan, the province's go-it-alone CPP enhancement, says the internal review shows Harper is ignoring hard evidence.

"This document is further confirmation that Stephen Harper is continuing to bury his head in the sand," Mitzie Hunter, associate minister of finance, said in an interview. "CPP is simply not filling the gap. … It's unfortunate that Mr. Harper has really chosen to play politics rather than address serious concerns for retirement security in Canada."

"TFSAs, which Harper touts as a cure-all, are really untested and they're only really benefiting the wealthiest Canadians."

Susan Eng, executive vice-president of CARP, which lobbies for an aging population, said the review cites evidence that single seniors are especially vulnerable to poverty, and that young Canadians and the middle class are not saving enough.

"The government repeats that mandatory employer contributions would be 'job-killing payroll taxes' despite the briefing clearly stating that Canada's social security contributions and payroll contributions are amongst the lowest among similar OECD countries," she said.

But Harper spokesman Stephen Lecce argues the document also found Canada compares well with other OECD countries on income replacement, ranking third; and that the poverty rate for Canadian seniors is among the lowest in the industrial world.

Lecce also cited a series of measures, including boosting Guaranteed Income Supplement payments and introducing income splitting for pensioners, that together have removed about 380,000 seniors from the tax rolls since 2006.

"Our position is clear, consistent with our Conservative government's efforts to encourage Canadians to voluntarily save more of their money, we are consulting on allowing voluntary contributions to the Canada Pension Plan."
So the CBC got hold of an internal document which questions Harper's retirement policies? All they need to do is read my blog on a regular basis to figure out that there isn't much thinking going on in Ottawa when it comes to bolstering Canada's retirement system.

I've repeatedly blasted the Harper Conservatives for pandering to Canada's powerful financial services industry which is made up of big banks, big insurance companies and big mutual fund companies that love to charge Canadian retail investors huge fees as they typically underperform markets.

In the latest pathetic display of sheer arrogance (and ignorance), our prime minister criticized Ontario's new pension plan, calling it a "tax" and stating he's 'delighted' to slow down Kathleen Wynne's pension plan.

Amazingly, and quite irresponsibly, the Conservatives pledged to let first-time buyers withdraw as much as $35,000 from their registered retirement savings plan accounts to buy a home, in a yet another election move aimed at the housing market.

Now, think about this. Canada is on the verge of a major economic crisis which will be worse than anything we've ever experienced before and instead of bolstering the Canada Pension Plan for all Canadians,  the Conservatives are pandering to big banks which are scared to death of what will happen when the great Canadian housing bubble pops as Chinese demand dries up fast.

Great policy, have over-indebted Canadians use the little retirement savings they have to buy a grossly overvalued house in frigging Toronto, Vancouver or pretty much anywhere else so they can spend the rest of their lives paying off an illiquid asset that will make them nothing compared to a well-diversified portfolio over the next 30 years.

"Yeah but Leo, you can never lose money in housing, especially when you buy in a top location. Never! It's the best investment, much better than investing in these crazy markets. Plus, you pay no capital gain tax on your primary residence when you sell it."

I've heard all these points so many times that I just stopped getting into arguments with friends of mine who think "real estate is the best investment in the world." Admittedly, I've been bearish on Canadian real estate forever but the longer the bubble expands, the harder the fall.

And mark my words, it will be a brutal decline in Canadian real estate, one that will last much longer than even the staunchest housing bears, like Garth Turner, can possibly fathom. But unlike what Garth thinks, the problem won't be inflation and rising U.S. interest rates. It's going to be all about debt deflation and soaring unemployment. When Canadians are out of a job and paying off crushing debt, they won't be able to afford their grossly overvalued house and lowering rates and changing our immigration policies to bring in "rich Chinese, Russians, Syrians, etc" won't make a dent to the decline in housing once debt deflation is in motion.

Enough on housing, let me get back to the Harper's retirement policies and be fair and objective. Unlike the Liberals, I like TFSAs and think they benefit all Canadians who are prudent and save their money. Sure, higher income earners like doctors, lawyers, accountants, dentists, and engineers are the ones that are saving the most using TFSAs but the reason is because they need to save since they have no defined-benefit retirement plan to back them up.

But there are also many blue collar workers and lower income workers who are using their TFSAs too. Yes, they can't contribute their $10,000 annual limit but they're contributing whatever they can to save for their future.

I have  a problem with people who categorically criticize TFSAs. We get taxed enough in Canada and this is especially true for high income professionals with no defined-benefit plan. Why in the world wouldn't we want to encourage tax-free savings accounts?

Having said this, when it comes to retirement, there's no question in my mind that all these high income professionals and most other hard working Canadians are better served paying higher contributions to their Canada Pension Plan to receive better, more secure payouts in the future.

In other words, enhancing the CPP should be mandatory and the first policy any federal government looks to implement. Period. You simply can't compare tax-free savings accounts or any other registered retirement vehicle available to having your money pooled and managed by the Canada Pension Plan Investment Board.

Now, the Harper Conservatives aren't stupid. They know this. They read my blog and know the brutal truth on defined-contribution plans. But they're caught in a pickle, pandering to the financial services industry and dumb interests groups which claim to look after small businesses.

If our big banks and other special interest groups really had the country's best interests at heart, they wouldn't flinch for a second on enhancing the CPP for all Canadians, building on the success of the CPPIB and other large well-governed defined-benefit plans which are properly invested across global public and private markets.

I will repeat this over and over again, good retirement policy makes for good economic policy, especially over the very long run. Canadian policymakers need to rethink our entire retirement system, enhance the CPP for all Canadians and get companies out of managing pensions altogether. We can build on the success of CPPIB (never mind its quarterly results) and other large well-governed DB plans. If you need advice, just hire me and I will be glad to contribute my thoughts.

On that note, back to trading these crazy, schizoid markets dominated by high-frequency algorithms. Don't worry, the flash crash of 2015 is over, for now. If you watched CTV News in Montreal last night, you saw a lot of nervous investors worried about their retirement. This is why I hate defined-contribution plans because they put the retirement responsibility entirely on the backs of novice investors who will do the wrong thing at the wrong time (like sell in a panic as some big hedge fund loads up on risk assets).

Below, Prime Minister Stephen Harper reacts to the report on retirement policies obtained by CBC. Whoever wins the elections this fall, I hope they will have the good sense and the courage to enhance the CPP for all Canadians once and for all.

And billionaire distressed asset investor Wilbur Ross said Tuesday the stock market correction is in the sixth-perhaps the seventh-inning. I agree, it will be very volatile but I think we're heading up from here.