Friday, July 22, 2016

PSP Investments Gains 1% in FY 2016

Rob Kozlowski of Pensions & Investments reports, PSP Investments returns 1% for fiscal year:
Public Sector Pension Investment Board, Montreal, returned 1% in the fiscal year ended March 31, a news release said.

The C$116.8 billion ($89.5 billion) pension fund exceeded its policy benchmark return of 0.3%, and its best-performing asset class was real estate at 14.4%, followed by infrastructure at 12.7%.

Natural resources returned 6.9%; private equity, 2.4%; and public markets, -3.2%.

A final asset class, private debt, was first instituted in November and thus one-year returns are not yet available.

As of March 31, the actual allocation was 58.8% public markets, 17.4% real estate, 10.7% private equity, 7.4% infrastructure, 3.1% cash and cash equivalents, 2.1% natural resources and 0.5% private debt.

PSP Investments manages the pension assets of Canadian federal public service workers, Canadian Forces, Reserve Forces and the Royal Canadian Mounted Police.

Officials at the pension fund could not be immediately reached to provide further information.
I too reached out to PSP to arrange a conversation with André Bourbonnais, PSP's President and CEO, but they told me he "wasn't available". Instead a very nice lady called Anne-Marie Durand, Senior Manager, External Communications, was polite enough to respond to my email and told me she'd be happy to answer my questions via email.

Note to PSP and all other pensions: I work very hard covering your fiscal year results. The least you can do is have the decency to provide me with a short phone conversation with the CEO or CIO of your organization. I have no time to waste emailing questions to your communications people who aren't investment officers. Moreover, some of the material may be sensitive in nature and not suitable or appropriate for email correspondence.

Now that I got that out of the way, let me get to work because there is a lot to cover. Unfortunately, the journalists are asleep this week because apart from the one article I posted above, there isn't any coverage on PSP's fiscal year 2016 results by the major media outlets (by the way, you can now follow PSP Investments on Twitter here @InvestPSP).

PSP Investments did put out a press release which was published on Yahoo, PSP Investments' net assets reach $116.8 billion (added emphasis is mine):
  • One-year total portfolio return of 1% resulting in $0.9 billion of value added above the policy benchmark return
  • Five-year annualized return of 8.9% resulting in $6.4 billion of value added above the policy benchmark return
  • Ten-year annualized net return of 5.9% resulting in $7.2 billion of cumulative net investment gains over the return objective
MONTRÉAL, July 21, 2016 /CNW Telbec/ - The Public Sector Pension Investment Board (PSP Investments) announced today that its net assets under management reached $116.8 billion at the end of fiscal year 2016 (fiscal 2016), compared to $112 billion at the end of the previous fiscal year. The total portfolio generated a return of 1%, exceeding the policy benchmark return of 0.3%, and created $0.9 billion of value added.

Over the past five fiscal years, PSP Investments has recorded a compound annualized return of 8.9%, compared to 7.3% for the policy benchmark. It generated investment income of $37.3 billion, and $6.4 billion of value added above the benchmark. For the 10-year period ending March 31, 2016, PSP Investments recorded an annualized net return of 5.9%, and generated $7.2 billion of cumulative net investment gains over the return objective.

"In a year characterized by high volatility and negative returns in most markets and by significant changes internally, our team has been able to provide a positive performance, both in absolute terms and against our policy benchmark return," said André Bourbonnais, President and Chief Executive Officer of PSP Investments. "Most of our private market asset classes, and more particularly real estate, recorded strong returns during the year and surpassed their respective benchmarks. However, public equity markets posted negative returns and private equity underperformed. Our overall performance suffered as a result. After five consecutive years of positive, often double-digit returns, PSP Investments continues to exceed our long-term real return objective of 4.1%, thereby contributing to the long-term sustainability of the public sector pension plans whose assets we invest in order to provide financial protection for those who dedicate their lives to public service," Mr. Bourbonnais added.

Corporate highlights and strategic initiatives

"Fiscal 2016 was a year of significant change for PSP Investments. After assuming his position as President and CEO at the end of fiscal 2015, André Bourbonnais immediately undertook a broadly-based strategic review," said Michael P. Mueller, Chair of the Board. "That review is having a transformational effect. It has resulted in a new direction and a shift in organizational responsibilities, as well as in investment, operational and compensation models. PSP Investments is becoming a more cohesive organization with an increased capacity to deliver on its mission and mandate."

Among the strategic initiatives undertaken in fiscal 2016, the position of Chief Investment Officer was enhanced with responsibility for implementing a total portfolio approach and evolving the portfolio construction framework by pursuing cross-functional investments with an efficient mix of asset classes.

Private debt, which focuses on principal debt and credit investments in primary and secondary markets worldwide, was introduced as a new asset class in November 2015. It is a long-term asset class that offers attractive premiums on underlying illiquidity.

Although it remains committed to Canada, PSP Investments is expanding its global footprint. It opened an office in New York where the private debt market is centred. It is developing London as a European hub to pursue private investment and private debt opportunities.

"Our strategic efforts reflect considered, deliberate choices, and were undertaken with a view to enhance the construction of our portfolio," said André Bourbonnais. "The impact of these strategic changes will not be felt overnight, but they are consistent with our long-term perspective. Our vision is to be a leading global institutional investor that reliably delivers on its risk-return objective by focusing on a total fund perspective. We seek opportunities to invest innovatively at scale. Our investment approach is to leverage select business-to-business relationships and gain local market insights to identify deployment opportunities. The positive returns we generated in many asset classes during fiscal 2016 result from the ongoing implementation of this strategy."

Portfolio highlights by asset class

PSP Investments' net assets increased by $4.8 billion in fiscal 2016. Gains are attributable to net contributions of $4.0 billion and comprehensive income of $0.8 billion. Strong returns in Real Estate, Infrastructure and Natural Resources were partially offset by lower returns in Private Equity and negative returns in Public Markets.

Public Markets
  • At March 31, 2016, Public Markets had net assets of $68.6 billion, compared to $76.3 billion at the end of fiscal 2015. In fiscal 2016, Public Markets recorded investment income of negative $2.5 billion, for an overall return of negative 3.2%, compared to a benchmark return of negative 2.3%. Most of Public Markets strategies performed above their respective benchmark, but the Value Opportunity Portfolio had a fairly significant negative impact on Public Markets' performance. Over a five-year period, Public Markets has generated an annualized return of 7.9%, compared to a benchmark return of 7.5%.
Real Estate
  • At March 31, 2016, Real Estate had net assets of $20.4 billion, an increase of $6.0 billion from the previous fiscal year. Direct ownership and co-investments accounted for 88% of Real Estate assets, an increase from 86% at the end of fiscal 2015.
  • In fiscal 2016, Real Estate generated investment income of $2.3 billion, for a total return of 14.4%, compared to a benchmark of 5.1%. Over a five-year period, Real Estate investments produced an annualized return of 12.9%, compared to a benchmark return of 5.5%.
  • In fiscal 2016, Real Estate deployed $3.5 billion in new investments broadly diversified across geographies and sectors, and had unfunded commitments of $1.5 billion for investments closed during the year.
Private Equity
  • As at March 31, 2016, Private Equity had net assets of $12.5 billion, an increase of $2.4 billion from the previous fiscal year. Direct investments and co-investments accounted for 40% of the assets in the Private Equity portfolio, in line with fiscal 2015.
  • In fiscal 2016, Private Equity generated investment income of $279 million, for a return of 2.4%, compared to a benchmark return of 8.9%. The portfolio generated distributions of more than $1.0 billion during the year, from realized capital gains, interest and dividends. Portfolio income was primarily generated by investments in funds, including targeted funds of funds portfolio, and by gains in certain direct holdings. However, overall portfolio performance was offset by positions primarily in the communications and energy sectors, which were impacted by macro-economic factors, resulting in lower valuation multiples for many investments. Over a five-year period, Private Equity investments generated an annualized return of 11.1%, compared to a benchmark return of 11.2%.
  • In fiscal 2016, Private Equity committed a total of $2.7 billion to funds with existing and new partners, and completed new direct investments and co-investments of $1.2 billion, including the acquisition of AmWINS Group, a leader in the wholesale insurance industry in the United States, and of Homeplus, one of South Korea's largest multi-channel retailers, in a deal led by fund partner MBK Partners.
  • As at March 31, 2016, Infrastructure had net assets of $8.7 billion, an increase of $1.6 billion from the previous fiscal year. Direct investments accounted for 86% of the assets in the Infrastructure portfolio, up slightly from 85% at the end of fiscal 2015.
  • In fiscal 2016, the Infrastructure portfolio generated investment income of $940 million, for a return of 12.7%, compared to a benchmark return of 5.5%. The portfolio return was driven mainly by direct investments in the transportation and utilities sectors in Europe and emerging markets. Over a five-year period, Infrastructure investments generated an annualized return of 9.6%, compared to a benchmark return of 6.5%.
  • In fiscal 2016, Infrastructure acquired a participation in Allegheny Hydro, LLC, and reinvested in Angel Trains Limited, Cubico Sustainable Investments Limited and AviAlliance GmbH. It also committed to an agreement to acquire a New England portfolio of hydroelectric assets from ENGIE Group for an enterprise value of US$1.2 billion.
Natural Resources
  • As at March 31, 2016, Natural Resources had net assets of $2.5 billion, an increase of $1.0 billion from the previous fiscal year. Direct investments accounted for 96% of Natural Resources assets.
  • In fiscal 2016, Natural Resources generated investment income of $150 million, for an overall return of 6.9%, compared to a benchmark return of 5.1%. Portfolio returns were primarily driven by investments in timber and agriculture, which generated a return of 20.5%. Valuation gains were materially offset by markdowns in oil and gas investments. Since its inception in June 2011, Natural Resources has generated an annualized return of 11.1%, compared to a benchmark return of 4.5%.
  • In agriculture, Natural Resources continued to expand and add to the number of investment platforms in which it participates alongside high quality, like-minded operators in some of the world's lowest cost regions, including Australasia, North America and South America.
Private Debt
  • Private Debt was approved by the Board of Directors as an asset class in November 2015. It focuses on principal debt and credit investments, in primary and secondary markets worldwide. Private Debt's priority is to provide credit capital to non-investment grade US and European corporate borrowers. It has a target allocation of 5% of PSP Investments' assets under management. At March 31, 2016, Private Debt had funded net assets of $640 million across six direct investment transactions.
  • In fiscal 2016, Private Debt generated net investment income of $1.4 million, resulting in a rate of return of 3.0%, compared to a benchmark return of negative 3.9%. Portfolio returns were driven by upfront fees, coupon interest, valuation adjustments and foreign exchange gains and losses. The return of the asset class was negatively impacted by the fluctuation in the Canadian dollar, resulting in significant foreign exchange losses for the year. The rate of return in local currency (US dollars) amounted to 9.1% for the year.
  • In fiscal 2016, Private Debt committed to a total of US$2.3 billion, including a significant financing commitment alongside partner Apollo Global Management, LLC, to participate in the take private transaction of The ADT Corporation, a leading home and business security monitoring company.
For more information about PSP Investments' fiscal year 2016 performance or to view PSP Investments' 2016 Annual Report, visit

About PSP Investments

The Public Sector Pension Investment Board (PSP Investments) is one of Canada's largest pension investment managers with $116.8 billion of net assets under management as at March 31, 2016. It manages a diversified global portfolio composed of investments in public financial markets, private equity, real estate, infrastructure, natural resources and private debt. Established in 1999, PSP Investments manages net contributions to the pension funds of the federal Public Service, the Canadian Armed Forces, the Royal Canadian Mounted Police and the Reserve Force. Headquartered in Ottawa, PSP Investments has its principal business office in Montréal and offices in New York and London. For more information, visit or follow Twitter @InvestPSP.
Since when did PSP's website become and not Both websites work but I guess given the "global focus" is more appropriate.

Anyways, let's get on with analyzing PSP's fiscal 2016 results but before we do, please take the time to read the Chair's Report (page 12), the President's Report (page 14) and the interview with PSP's CIO, Daniel Garant, on "One PSP" on page 23 of  PSP's 2016 Annual Report.

The complete 2016 Annual Report is available here and in my opinion, it's excellent and well worth reading all of it which I did yesterday. But if you can't read it all, at least read the passages I mentioned because it's important to note, this isn't Gordon Fyfe's PSP, it's clearly André Bourbonnais's PSP, and there are important strategic and cultural shifts going on at this organization.

Of course, as you will read below, there are some benchmark legacies from the Gordon Fyfe/ André Collin/ Derek Murphy/ Bruno Guilmette days that still linger at PSP (the players change but gaming benchmarks goes on unabated, especially in Real Estate).

Actually, since I'm a stickler for benchmarks, let's begin with PSP's benchmarks which can be found on page 36 of the 2016 Annual Report (click on image):

As you can see, the benchmarks for Public Markets are pretty straightforward and widely recognized in the industry. However, when it comes to Private Markets, things become a lot less clear.

Private Equity has a benchmark which reflects the Private Equity Universe (plus the cost of capital), which is fine, but Real Estate, Infrastructure, and Natural Resources all have "custom benchmarks" which reflect their cost of capital, and this is far from fine.

Why are benchmarks critical? Because benchmarks are how you calculate the value-added of an investment portfolio which determines compensation of senior investment officers. And if the benchmarks don't reflect the risks, opportunity cost and illiquidity of the underlying portfolio, pension fund managers can easily game their benchmark to their advantage.

Let me show you what I mean. Below, I embed the PSP's portfolio and benchmark returns which can be found on page 37 of the 2016 Annual Report (click on image):

As you can see, PSP Investments reports portfolio returns vs benchmark returns for fiscal year 2016 and the annualized portfolio returns vs benchmark returns for the last five fiscal years.

This is great, every pension fund should report this along with a clear and in-depth discussion on the benchmarks they use to gauge value added in public and private markets.

Now, notice the huge outperformance of the Real Estate portfolio in fiscal 2016 (14.4% vs 5.1% benchmark return) and over the last five fiscal years (12.9% vs 5.5% benchmark return)?

The same goes for the Infrastructure portfolio. In fiscal 2016, it returned 12.7% vs 5.5% for its benchmark and over the last five fiscal years, it returned an annualized rate of 9.6% vs 6.5% for the benchmark (over a longer period, the benchmark for Infrastructure seems appropriate).

So what's the problem? The problem is these two asset classes make up a quarter of PSP's asset mix and when I see such outperformance over their respective benchmark over one or five fiscal years (especially in Real Estate), it immediately signals to me that the benchmark doesn't reflect the risks of the underlying portfolio.

Not only this, PSP's Real Estate has accounted for the bulk of the value-added since its inception (both in dollar and percentage terms), and this has helped senior officers at PSP collect multi millions in compensation.

Now, for comparison purposes, I looked again at my comment on CPPIB's fiscal 2016 results. PSP and CPPIB are similar pension funds in many ways except the latter is much bigger. But they both have fiscal years that end on March 31st and their asset mix and liquidity profile are similar.

So why did CPPIB gain 3.4% in fiscal 2016 and PSP only 1%? A big factor behind this relative outperformance is that CPPIB doesn't hedge currency risk whereas PSP is 50% hedged, so the former enjoyed currency gains across the public and private market investments (PSP is reviewing its currency hedging policy and will likely move to no hedging like CPPIB).

But it's not just currency gains, CPPIB had a stellar year and really fired on all cylinders across all its investment portfolios. The overall results don't reflect this but if you dig deeper and analyze the results properly, you will see this.

CPPIB's Real Estate and Infrastructure portfolios also enjoyed great performances in fiscal 2016, returning 12.3% and 9.3% respectively (click on image):

Notice, however, that CPPIB doesn't report the same way as PSP, namely, portfolio returns over one and five fiscal years relative to benchmark returns.

This is because CPPIB has one of the toughest Reference (benchmark) Portfolios in the industry (CPPIB provides an in-depth discussion on risk and how they benchmark investment activities and they do consider opportunity cost and illiquidity). It has an elaborate and detailed way to measure risk of each investment but I wish it did report the same way as PSP because then I can show you the outperformance (or value-added) over benchmark at CPPIB is considerably less over one and five fiscal years for Real Estate (Yes, PSP returned more in RE but a bigger reason is the benchmark used in RE is alot easier to beat at PSP).

I've discussed PSP's private market benchmark issues before (see last year's comment) and I want to make it clear, I have nothing against PSP's Real Estate team. Neil Cunningham is a great guy and he and his team are delivering outstanding results but if I was sitting on the Board of PSP, they wouldn't be getting away with this benchmark (Note: Even with a tougher benchmark, they would still outperform with these type of returns).

Anyways, all this discussion on benchmarks and outperformance leads me to compensation. I highly suggest you read the entire Compensation section which begins on page 72 of the 2016 Annual Report. Below, I embed the summary compensation table (along with footnotes) which can be found on page page 79 (click on image):

A few brief remarks on compensation
  • The compensation is fair and in line with short-term and mostly long-term performance. Sure, the senior investment officers at PSP get paid extremely well, especially by Montreal standards, but given the size of the fund and the investment activities across public and private markets that require specialized skill sets and given what other large Canadian pensions pay their senior investment officers, it's not outrageous.
  • What I find outrageous are the lavish severance packages. When I read how much former officers Bruno Guilmette and John Valentini earned, I almost fell off my chair. The amount includes a severance package which is clearly outlined in the previous annual report but still, these are huge packages. At least Bruno was a senior investment officer ("alpha generator") but John was an interim CEO for nine months before André Bourbonnais was appointed CEO so that factored into his compensation (no worries, he landed on his feet quickly at Fiera Capital).
  • Noticeably absent from these former officers is Derek Murphy, PSP's former head of Private Equity. He left the organization soon after Bourbonnais took over the helm (either he quit or settled but his name doesn't appear in the table above). He is now running a PE firm in Montreal called Aquaforte which helps institutional investors get a better alignment of interest with general partners (GPs). 
And the points below on the new incentive plan are taken from the 2016 Annual Report:
  • It was agreed that the incentive compensation framework should be less formulaic and produce less volatility in year-to-year payouts while allowing management and the Board to differentiate rewards based on components which go beyond investment performance alone. An overriding goal was to shift investment performance measurement from purely relative,
    medium-term metrics to long-term absolute, total fund results. Another goal was to encourage more cooperation across the organization, again aligning individual success with the total fund, not just its component parts. This is a key element of One PSP. It was also decided that senior management should have a larger proportion of its compensation deferred and performance conditioned. 
  • The new incentive compensation plan will be driven  by two key elements: 1) an annual overall assessment of PSP Investment’s performance based on a mix  of relative (five-year) and absolute (seven-year) total fund investment performance, as well as five-year relative investment performance for individual asset classes, and the achievement of business units’ respective annual objectives derived from PSP Investments’ five-year business strategy, and 2) an annual assessment of personal objectives. 
Lastly, let me end this comment with some positive feedback:
  • First, as I stated, you should all take the time to read the entire 2016 Annual Report, especially the Chair and President's report, as well as the interview with the CIO on "One PSP". The Annual Report is excellent and provides a lot of details I cannot go over here.
  • Second, there is no question that André Bourbonnais is trying to steer the ship toward a new and solid direction. He and his senior team have laid out a detailed strategic plan which includes cultivating One PSP, improving the brand locally and internationally, increasing the global footprint, creating scalable and efficient investment and operational activities, and developing their talent. 
  • Third, in my opinion, enhancing the role of the CIO with responsibility for implementing a total portfolio approach and evolving the portfolio construction framework by pursuing cross-functional investments with an efficient mix of asset classes is critical and very smart.
  • Fourth, I was happy to see PSP is finally taking an initiative on diversity in the workplace, just like CPPIB is doing. I'm a big believer in diversity in the workplace at all levels of the organization and think that PSP, CPPIB and all of Canada's Top Ten pensions have a lot of work to do on this front not just by promoting women and offering them equal pay but also by promoting visible minorities and incorporating other disadvantaged minorities like aboriginals and especially people with disabilities (Note to PSP: You should ask candidates to self-identify when they apply for jobs and have specific programs targeting minorities. All Canadian pension funds should follow the Royal Bank's model and significantly improve on it).
  • Fifth, the introduction of private debt as an asset class makes a lot of sense. You should all read a paper by professor Amin Rajan, The Rise of Private Debt as an Institutional Asset Class, to understand what private debt is all about and why PSP is perfectly placed to take advantage of this asset class.
  • Sixth, I'm glad PSP is on Twitter and communicating a lot more about its investment activities (they should add a dedicated YouTube channel). You can find the latest articles on PSP here, including one that discusses the hire of Oliver Duff as managing director of principal debt and credit investments (Europe), to lead a European private debt push.
That is all from me, I am literally pooped and want to go out to enjoy the summer weather. Before I do, I want to wish you a great weekend and publicly thank the few who support this blog via your donations and subscriptions.

As for Mr. Bourbonnais and the rest of PSP, I wish you a lot of success and even though the new shift will have some bumps along the way, I'm confident the Fund and its beneficiaries and contributors will be better off in the long run.

Below, a speech by André Bourbonnais, President and CEO of PSP, given earlier this year at Le Cercle Canadien de Montréal on the challenges PSP confronts. You can also watch it here. The speech was mostly in French with some English and it's well worth listening to.

I hope to meet Mr. Bourbonnais one day and discuss PSP, pensions, investments and a lot more.

Thursday, July 21, 2016

CalPERS Smears Lipstick on a Pig?

Timothy W. Martin of the Wall Street Journal reports, Calpers Reports Lowest Investment Gain Since Financial Crisis:
The largest U.S. public pension posted its lowest annual gain since the last financial crisis due to heavy losses in stocks.

The California Public Employees’ Retirement System, or Calpers, said it earned 0.6% on its investments for the fiscal year ended June 30, according to a Monday news release.

It was the second straight year Calpers failed to hit its internal investment target of 7.5%. Workers or local governments often must contribute more when pension funds fail to generate expected returns. Calpers oversees retirement benefits for 1.7 million public-sector workers.

Calpers’ annual results are watched closely in the investment world. It is considered a bellwether for U.S. public pensions because of its size and investment approach. Many pensions currently are struggling because of a sustained period of low interest rates.

“This is a challenging time to invest,” Ted Eliopoulos, Calpers’ chief investment officer, said in the release.

The last time Calpers lost money was during fiscal 2009 when the fund’s holdings fell 24.8%.

The giant California plan ended 2016 with roughly $295 billion in assets, and more than half of those funds are invested with publicly traded stocks. Those investments declined 3.4%, though the performance beat internal targets.

Fixed income produced the largest returns at 9.3%, though the results under performed Calpers’ benchmark. The California retirement giant’s private-equity portfolio posted returns of 1.7%.

Real estate holdings returned 7.1%, but that was below Calpers’ internal target by more than 5.6 percentage points.
Rory Carroll of Reuters also reports, CalPERS reports worst year since 2009 amid market volatility:
California's largest public pension fund posted a 0.61 percent return on investment in its most recent fiscal year, its worst showing since 2009, which it blamed on global market volatility.

The result marked the second straight year the California Public Employees' Retirement System or CalPERS failed to meet its assumed investment return of 7.5 percent.

If the $302 billion public pension fund consistently misses the 7.5 percent target, state taxpayers could be forced to make up any shortfall in pension funding.

Last fiscal year, CalPERS returned 2.4 percent on its total portfolio, marking a significant decline from previous years when the fund earned double digit returns of more than 10 percent. The result for the year ending June 2016 was the worst since an investment loss of 23.6 percent in 2009.

The yearly rates of return, once audited, help determine contribution levels for state agency employers and for contracting cities, counties and special districts in fiscal year 2016-2017.

Speaking at a CalPERS meeting, Chief Investment Officer Ted Eliopoulos said performance for the year was driven primarily by global equity markets, which represent a little over half of the fund's portfolio. Equities delivered a return of negative 3.4 percent.

"When 52 percent of your portfolio is achieving a negative 3.4 percent return, that certainly sets the main driver for the overall performance of the fund," said Eliopoulos, who had projected flat returns for the year in June.

Inflation assets returned a negative 3.6 percent return, helping drag down the fund's overall performance, Eliopoulos said.

Fixed income and real estate investments were bright spots in the portfolio, posting 9.3 percent and 7.1 percent returns respectively.

In response to the drop from previous years, Eliopoulos said CalPERS would reduce risk from its portfolio and have simpler investments that do not require paying fees to money managers.

Fund officials, recognizing that the wave of retiring baby boomers means it will pay out more in benefits than it takes in from contributions and investment income, have projected that the fund could have negative cash flow for at least the next 15 years.
And James Rufus Koren of the Los Angeles Times reports, CalPERS posts worst year since 2009, with slim returns:
California’s largest public pension fund made a return of less than 1% in its most recent fiscal year, the fund’s worst performance since 2009.

The California Public Employees’ Retirement System said Monday that its rate of return for the year ended June 30 was just 0.61%. What’s more, Ted Eliopoulos, the pension fund’s chief investment officer, said the poor year has pushed CalPERS’ long-term returns below expected levels.

“We have some challenges to confront,” Eliopoulos said during a conference call. “We’re moving into a much more challenging, low-return environment.”

CalPERS assumes that, in the long-term, it will earn investment returns averaging 7.5% a year. If the fund fails to meet that goal, the state’s taxpayers could be forced to make up any shortfall in pension funding.

Now, after two consecutive years of lackluster returns, CalPERS’ long-term averages have fallen below that crucial benchmark. Over the past 20 years, average investment returns now stand at 7.03%. Returns over the last 10 and 15 years now average less than 6%.

At this time last year, the fund had averaged annual returns of 7.8% over a 20-year period.

Over the past few years, many public pension funds have lowered their expected annual returns, according to pension consulting firm Milliman, and CalPERS could do likewise. That would increase pension costs for state and local government agencies that have employees covered by the pension giant.

Such a change is likely more than a year away, though. CalPERS next year will reassess its investment strategies, a process that, starting in 2018, could lead the pension fund to change how it manages its money and to lower its return expectations.

“We quite clearly have a lower return expectation than we had just two years ago,” Eliopoulos said. “That will be reflected in our next cycle. We are cognizant that this is a challenging environment for institutional investors.”

CalPERS last lowered its expectations in 2012, cutting anticipated returns to 7.5% from 7.75%, where they had stood for more than a decade.

CalPERS officials had recommended the rate be cut further, to 7.25%. But government agencies that pay into the pension system on behalf of their employees said that large of a reduction in expected returns would cut too deeply into their budgets.

As expected returns go down, the amount local governments have to pay for pension benefits rises. And small changes in expected returns can add up to big changes in what government agencies have to pay.

The shift from 7.75% to 7.5% in 2012 increased the state’s annual pension bill by $167 million. That doesn’t include the additional cost to local governments.

Last year, the CalPERS board approved a plan that could gradually lower the pension fund's expected rate of return to 6.5%, but — paradoxically — only cuts the expected rate in years of outsized investment gains.

CalPERS saw positive returns in a few types of investments last year. Its bond portfolio saw a particularly dramatic uptick of 9.3%, in line with a global bond rally driven by economic turmoil.

But the same factors that drove up the value of bonds cost CalPERS in other areas, specifically its stock investments, which make up more than half of the pension fund’s portfolio and lost 3.4% for the year.

During the same period, the Global Dow index, which tracks global stocks, fell 8.5%.

CalPERS also lost money on its investments in forest land, where its holdings lost 9.6% of their value. Forest land accounts for only 1% of the pension fund’s overall portfolio, however.

In a statement Monday, Eliopoulos said he was proud of eking out a positive return in a year of market volatility.

Since an investment loss of nearly 24% in the year ended June 30, 2009, CalPERS has seen annual returns fluctuate wildly, with double-digit gains in some years and tiny gains in others. For the years ended in June of 2012 and 2015, the fund earned 1% and 2.4%, respectively.
Dan Walters of The Sacramento Bee also reports, CalPERS’ unfunded liabilities grow as investment earnings lag:
You can smear lipstick on a pig, but that doesn’t change its innate porcinity.

Officials of the California Public Employees Retirement System, the nation’s largest pension trust fund, tried Monday to cast its very anemic investment earnings – well under 1 percent – in a positive light.

“Positive performance in a year of turbulent financial markets is an accomplishment that we are proud of,” CalPERS’ chief investment officer, Ted Eliopoulos, said in a statement as the fund’s 0.61 percent investment performance for 2015-16 was released.

That’s not as outlandish as it sounds because CalPERS is not alone. Pension funds and other big-scale investors around the world are seeing very slight, or even negative, results in an era of political and economic volatility, particularly in Europe, and interest rates near zero.

Eliopoulos said a a 3.4 percent loss in stocks, which are 52 percent of the CalPERS portfolio, dragged down its overall performance.

But the fact that CalPERS is not alone is not comforting. It means there’s almost nothing Eliopoulos can do on his own to generate higher returns – and, in fact, he sees an extended period of low trust fund earnings.

Over the last two years of earning just a fraction of the assumed 7.5 percent “discount rate,” CalPERS has fallen behind its assumptions by $30-plus billion. Thus, the entire trust fund has shrunk in relative terms because “contributions” by state and local governments and their employees fall well short of pension payouts and the earnings needed to bridge the gap haven’t been there.

With the fund stuck at around $300 billion for two years, it’s about $100 billion short of fully funding its pension obligations, and falling shorter each day. And that shortfall is based on its 7.5 percent discount rate, even though the average return has been under that mark for decades.

CalPERS has ramped up mandatory employer contributions to more than $10 billion a year and will continue as long as investment earnings lag.

But how far can they go? The state, counties and most special districts don’t have huge pension costs relative to their budgets – just 2.9 percent of the state budget. But cities are hit hard because they devote much of their budgets to police and fire personnel who have the most expensive benefits.

Soaring pension costs have contributed to the bankruptcies of three cities, and under the revised schedule that went into effect July 1, contributions of 50 percent of payroll, or more, for police and fire personnel are not uncommon.

If one cannot fairly fault CalPERS for anemic earnings, its overseers can be fairly criticized for maintaining the 7.5 percent earnings assumption that their own advisers say is too high.

Lowering it to a more realistic level, say to the 5-6 percent range, would sharply increase the unfunded liability and thus ramp up political pressure for more tax dollars from employers, or perhaps for modifying pension promises. It would risk a backlash in the form of one of the many pension reforms that have surfaced in recent years.

But just as a pig with lipstick is still a pig, a pension fund in crisis is still in crisis, and ignoring that reality benefits no one, including pensioners.
Lastly, and most importantly, let's go over CalPERS's news release, CalPERS Reports Preliminary 2015-16 Fiscal Year Investment Returns:
The California Public Employees' Retirement System (CalPERS) today reported a preliminary 0.61 percent net return on investments for the 12-month period that ended June 30, 2016. CalPERS assets at the end of the fiscal year stood at more than $295 billion and today stands at $302 billion.

CalPERS achieved the positive net return despite volatile financial markets and challenging global economic conditions. Key to the return was the diversification of the Fund's portfolio, especially CalPERS' fixed income and infrastructure investments.

Fixed Income earned a 9.29 percent return, nearly matching its benchmark. Infrastructure delivered an 8.98 percent return, outperforming its benchmark by 4.02 percentage points, or 402 basis points. A basis point is one one-hundredth of a percentage point.

The CalPERS Private Equity program also bested its benchmark by 253 basis points, earning 1.70 percent.

"Positive performance in a year of turbulent financial markets is an accomplishment that we are proud of," said Ted Eliopoulos, CalPERS Chief Investment Officer. "Over half of our portfolio is in equities, so returns are largely driven by stock markets. But more than anything, the returns show the value of diversification and the importance of sticking to your long-term investment plan, despite outside circumstances."

"This is a challenging time to invest, but we'll continue to focus on our mission of managing the CalPERS investment portfolio in a cost-effective, transparent, and risk-aware manner in order to generate returns for our members and employers," Eliopoulos continued.

For the second year in a row, international markets dampened CalPERS' Global Equity returns. However, the program still managed to outperform its benchmark by 58 basis points, earning negative 3.38 percent. The Real Estate program generated a 7.06 percent return, underperforming its benchmark by 557 basis points. The primary drivers of relative underperformance were the non-core programs, including realized losses on the final disposition of legacy assets in the Opportunistic program.

"It's important to remember that CalPERS is a long-term investor, and our focus is the success and sustainability of our system over multiple generations," said Henry Jones, Chair of CalPERS Investment Committee. "We will continue to examine the portfolio and our asset allocation, and will use the next Asset Liability Management process, starting in early 2017, to ensure that we are best positioned for the future market climate."

Today's announcement includes asset class performance as follows (click on image):

Returns for real estate, private equity and some components of the inflation assets reflect market values through March 31, 2016.

CalPERS 2015-16 Fiscal Year investment performance will be calculated based on audited figures and will be reflected in contribution levels for the State of California and school districts in Fiscal Year 2017-18, and for contracting cities, counties, and special districts in Fiscal Year 2018-19.

The ending value of the CalPERS fund is based on several factors and not investment performance alone. Contributions made to CalPERS from employers and employees, monthly payments made to retirees, and the performance of its investments, among other factors, all influence the ending total value of the Fund.

The Board has taken many steps to sustain the Fund as part of CalPERS' Asset Liability Management Review Cycle (PDF) that takes a holistic and integrated view of our assets and liabilities.
You can read more articles on CalPERS's fiscal 2015-2016 results here. CalPERS's comprehensive annual report for the fiscal year ending June 30, 2015 is not yet available but you can view last year's fiscal year annual report here.

I must admit I don't track US public pension funds as closely as Canadian ones but let me provide you with my insights on CalPERS's fiscal year results:
  • First, the results aren't that bad given that CalPERS's fiscal year ends at the end of June and global equity markets have been very volatile and weak. Ted Eliopoulos, CalPERS's CIO, is absolutely right: "When 52 percent of your portfolio is achieving a negative 3.4 percent return, that certainly sets the main driver for the overall performance of the fund." In my last comment covering why bcIMC posted slightly negative returns during its fiscal 2016, I said the same thing, when 50% of the portfolio is in global equities which are getting clobbered during the fiscal year, it's impossible to post solid gains (however, stocks did bounce back in Q2).
  • Eliopoulos is also right, CalPERS and the entire pension community better prepare for lower returns and a lot more volatility ahead. I've been warning about deflation and how it will roil pensions for a very long time. 
  • As far as investment assumptions, all US public pensions are delusional. Period. CalPERS and everyone else needs to lower them to a much more realistic level. Forget 8% or 7%, in a deflationary world, you'll be lucky to deliver 6% annualized gains over the next ten years.CalPERS, the government of California and public sector unions need to all sit down and get real on investment assumptions or face the wrath of a brutal market which will force them to cut their investment assumptions or face insolvency. They should also introduce risk-sharing in their plans so that all stakeholders share the risks of the plan equally and spare California taxpayers the need to bail them out.
  • What about hedge funds? Did CalPERS make a huge mistake nuking its hedge fund program two years ago? Absolutely not. That program wasn't run properly and the fees they were doling out for mediocre returns were insane. Besides, the party in hedge funds is over. Most pensions are rightly shifting their attention to infrastructure in order to meet their long dated liabilities. 
  • As far as portfolio returns, good old bonds and infrastructure saved them, both returning 9% during the fiscal year ending June 30, 2016. In a deflationary world, you better have enough bonds to absorb the shocks along the way. And I will tell you something else, I expect the Healthcare of Ontario Pension Plan and the Ontario Teachers' Pension Plan to deliver solid returns this year because they both understand liability driven investments extremely well and allocate a good chunk into fixed income (HOOPP more than OTPP).
  • I wasn't impressed with the returns in CalPERS's Real Estate portfolio or Private Equity portfolio (Note: Returns in these asset classes are as of end of March and will end up being a bit better as equities bounced back in Q2). The former generated a 7.06 percent return, underperforming its benchmark by 557 basis points and suffered relative underperformance in the non-core programs, including realized losses on the final disposition of legacy assets in the Opportunistic program. CalPERS Private Equity program bested its benchmark by 253 basis points, earning 1.70 percent, but that tells me returns in this asset class are very weak and the benchmark they use to evaluate their PE program isn't good (they keep changing it to make it easier to beat it). So I'm a little surprised that CalPERS new CEO Marcie Frost is eyeing to boost private equity.
In a nutshell, those are my thoughts on CalPERS fiscal 2015-16 results. Is CalPERS smearing lipstick on a pig? No, the market gives them and everyone else what the market gives and unless they're willing to take huge risks, they need to prepare for lower returns ahead.

But CalPERS and its stakeholders also need to get real in terms of investment projections going forward and they better have this conversation sooner rather than later or risk facing the wrath of the bond market (remember, CalPERS is a mature plan with negative cash flows and as interest rates decline, their liabilities skyrocket).

Hope you enjoyed reading this comment, please remember to kindly donate or subscribe to this blog on the right-hand side to show your support and appreciation for the insights I provide you.

Below, Ted Eliopoulos, CalPERS Chief Investment Officer, comments on positive investment performance during a challenging fiscal year.

Also, Réal Desrochers, head of the Private Equity Program at CalPERS discusses what they look for in terms of general partners (GPs) and how they need to shift the portfolio in the future.

One area where CalPERS can improve on private equity is by disclosing all the fees it pays out to external managers. But don't hold your breath on that as it's a hot political potato.

On that last point, you should all read Yves Smith's latest comment, CalPERS Reported That It Made Less in Private Equity Than Its General Partners Did (Updated: As Did CalSTRS), it's excellent.

Wednesday, July 20, 2016

bcIMC Dips 0.2% in Fiscal 2016

Canada News Wire reports, bcIMC Reports Fiscal 2016 Annual Returns:
British Columbia Investment Management Corporation (bcIMC) today announced an annual combined pension return, net of costs, of -0.2 per cent for the fiscal year ended March 31, 2016, versus a combined market benchmark of -0.3 per cent.

Fiscal 2016 was a challenging year for investors. However, within a low return environment, our investment activities generated $133 million in additional value for our pension plan clients, driven by strong performance in private markets and real estate. Relative outperformance within the public equity markets, especially Canadian equities and emerging markets, as well as outperformance within our mortgages program, also contributed to investment returns.

"On behalf of our clients, bcIMC manages a diverse and quality portfolio of assets and we follow an investment discipline that focuses on the long term," said Gordon J. Fyfe, bcIMC's Chief Executive Officer and Chief Investment Officer. "Maintaining our discipline allows us to manage market risks during periods of volatility so our investments can provide stable cash flows and will appreciate in value over time."

As a long-term investor, bcIMC's mandate is to invest the funds not currently required by our clients to pay pensions and other benefits. On average, $75 of every $100 a pension plan member receives is due to our investment activities.

In fiscal 2016, we continued to build relationships globally, expanded our investment products and assessed investment opportunities that align with our clients' long-term, risk and return objectives.

Fiscal 2016 Investment Highlights
  • Committed $2.6 billion in new capital in our Private Equities program, of which $730 million was in direct investments.
  • Deployed approximately $1.1 billion in direct investments in infrastructure.
  • Committed $1.1 billion through the mortgage program to commercial real estate across Canada.
  • Awarded an additional US$200 million China-A share quota from China regulators so we have the opportunity to invest in the region's new service economy.
  • Completed two Real Estate developments (745 Thurlow and Northwoods) and currently have 26 properties in various stages of progress across Canada
"Our investment professionals generated additional value for our clients in a low return environment. They are making the strategic investment decisions that enable us to continue to grow our clients' long-term wealth, while also protecting the value of their funds," added Fyfe.

For the year, bcIMC's managed net assets were $121.9 billion. As at March 31, 2016, the asset mix was as follows: Public Equities (47.5% or $57.9 billion); Fixed Income (21.4% or $26.3 billion); Real Estate (14.4% or $17.5 billion); Infrastructure (5.9% or $7.1 billion); Private Equities (5.6% or $6.8 billion); Mortgages (2.3% or $2.8 billion); Other Strategies—All Weather (1.5% or $1.8 billion); Renewable Resources (1.4% or $1.7 billion). For more information, bcIMC's 2015–2016 Annual Report is available on our website at

About bcIMC

With $121.9 billion of managed net assets, the British Columbia Investment Management Corporation (bcIMC) is one of Canada's largest institutional investors within the global capital markets. We offer our public sector clients responsible investment programs across a range of asset classes: fixed income; mortgages; public and private equity; real estate; infrastructure; renewable resources. Our investments provide the returns that secure our clients' future payments and obligations.
The article above is bcIMC's official press release available here. Those of you who want to delve deeper into fiscal 2016 results can do so by reading the Annual Report which is available here.

I didn't find any press coverage of bcIMC's fiscal 2016 results in major news outlets (either journalists are asleep or bcIMC isn't reaching out to them) but someone in Ottawa sent me a short article from Richard Dettman of News1130, BC pension fund posts no gain for 2015-16:
BC’s giant public-sector pension fund manager is reporting its first decrease since the financial crisis. The BC Investment Management Corporation says its assets under management in the year to the end of March were down $1.7 billion to $123.6 billion. Its biggest losing bet was on emerging markets, followed by Canadian stocks.

The BC fund underperformed its peers, such as Quebec’s Caisse de depot which returned 9.1 per cent last year and the Ontario Teachers’ Pension Plan which made 13 per cent. The four-year average return by bcIMC is 9.4 per cent.

CEO and chief investment officer Gordon Fyfe says bcIMC “plans to increase client returns by bringing more asset management in-house,” specifically its “private markets and public equities,” rather than using outside firms.

Canada’s fifth-largest pension fund says it is “rebuilding its base,” hiring 76 new people and reviewing compensation “to attract and retain skilled professionals.”
When Gordon Fyfe left PSP to head bcIMC two years ago, I stated he was going to focus on private markets and hire some people away from PSP.

One major hire from PSP is Jim Pittman who joined bcIMC in April of this year to head bcIMC's Private Equity group (scroll over "Private Equity" on bcIMC's organization chart). This is an excellent hire and I have nothing but good things to say about Jim who I'm confident will do a great job building out direct and fund investments at bcIMC.

[Note: Jim actually left PSP on good terms, took a break and was then hired at bcIMC. The former head of Private Equity at PSP, Derek Murphy, started a private equity firm based here in Montreal called Aquaforte which assists Limited Partners (LPs) to establish aligned, high-performing, private equity partnerships with General Partners (GPs). I'm pretty sure he's helping Jim with his activities at bcIMC.]

The other major and recent change at bcIMC is the creation of a subsidiary to manage real estate assets in-house. Gary Marr of the Financial Post reports, B.C. pension fund creates giant, multi-billion-dollar real estate company:
The Canadian commercial real estate industry will soon face a new multi-billion-dollar competitor in the marketplace.

British Columbia Investment Management Corp. said Wednesday it will take its $18 billion in real estate assets under management and create a new private company, to be called QuadReal Property Group, which will look to expand in Canada and globally.

BcIMC, which provides investment management services to the province’s public sector and invests the funds not currently required to pay pensions and other benefits, will set QuadReal up with an independent board of directors to oversee its operation.

As part of the move to internalize management of its real estate operations, the new company has retained Remco Daal as its co-president to head up its Canadian operations. Daal was the president of Bentall Kennedy, one of the companies that was providing external management to the B.C. pension fund.

The majority of bcIMC’s Canadian real estate assets are currently managed externally by Bentall, GWL Realty Advisors and Realstar. Management of real estate assets from those companies will begin to transfer to QuadReal in 2017. Roughly 500 employees are coming over from Bentall Kennedy to join the new entity.

“They’ve had a great run under the existing model and they are moving to more of a Canadian model as to how they manage their real estate,” said Daal, referring to the internalization of real estate, which is common for other major domestic players like the Ontario Municipal Employees Retirement System and Caisse de dépôt et placement du Québec.

With assets of $123 billion, 14 per cent of which is allocated to real estate, QuadReal expects to be saving money on fees as it begins to expand its base. Real estate allocation is slated to rise 18 per cent and bcIMC total assets will rise to about $150 billion in the next four years.

“We expect there will be assets for which we compete and opportunities for tenants which we compete,” said Daal, referring to the asset managers they are now dropping. “It’s all fair game.”

Last year, bcIMC started studying the internalization and brought in Jonathan Dubois-Phillips to look at that possibility. He will act as co-president and run QuadReal’s international operations.

The new company has no specific type of asset class in real estate it is eyeing and says it will be market driven. There is clearly no appetite to sell Canadian assets, which include Bayview Village, the luxury mall in north Toronto.

“The domestic portfolio is of a quality that we can’t replicate. The income stream is solid, solid and that’s ultimately what what our clients want,” Daal said.
While there may be no appetite to sell Canadian assets, the truth is bcIMC's Real Estate portfolio is almost entirely invested in domestic real estate, something which has hurt the fund's overall returns relative to its larger peers which are more diversified across global real estate (in other words, bcIMC cannot benefit from capital appreciation and currency appreciation which comes from investing in foreign real estate assets, especially if it doesn't hedge currency risk).

Now, this brings me to an important point, it's not exactly fair to compare bcIMC's fiscal year 2016 results to those of its other large Canadian peers because apart from the different fiscal year, bcIMC is expanding its investments in private markets and bringing these assets internally. It will take a few more years for bcIMC  to shift from a plain vanilla fund to one that is more diversified across global public and private asset classes.

Having said this, the fiscal year 2016 results and value-added are nothing to write home about but over a four-year period, which is what compensation is based on, the results are better (click on image):

And if you look at the returns by asset class for the combined pension plan clients (page 16 of Annual Report), they're actually quite decent across public and private assets (click on image):

The big returns came from Private Equities, Infrastructure and Real Estate but Canadian and Emerging Market public equities outperformed their respective benchmarks even if they were negative returns. The Bridgewater All-Weather portfolio also added value (see my last comment).

Keep in mind, however, as of now, nearly 50% of bcIMC's assets are in Public Equities, so no matter how well Private Markets perform, if global stocks get clobbered during the fiscal year, it will impact overall returns (click on image):

One thing I found odd in the fiscal 2016 Annual Report is that I couldn't find a discussion on the benchmarks used for each asset class. I'm a stickler for benchmarks because that determines value-added, compensation and risk-taking behavior at Canada's large pension funds.

The only mention of benchmarks I saw was on page 14 where they show index returns for the fiscal year (click on image):

But there is no discussion on private market benchmarks (if someone knows where I can find a discussion on bcIMC's benchmarks, please let me know).

As far as compensation, the table below from page 37 of the Annual Report provides a summary of compensation of bcIMC's senior managers (click on image):

Gordon Fyfe's compensation increased the most on a percentage and absolute basis but is significantly below what he was making at PSP. As far as the other senior managers, their compensation increased marginally and is way below what their peers in the rest of Canada earn.

Again, when looking at compensation, keep in mind it's four-year results that count and bcIMC's asset mix is still heavily weighted in public equities, which partly explains the variation in the compensation of its senior managers relative to their peers at other large Canadian public pension funds (still, they are top earners in British Columbia's public sector, so I don't feel bad for them).

To summarize, bcIMC's fiscal 2016 results aren't great but they're not that bad either given its asset mix is still heavily weighted in public equities. You can read all recent news pertaining to bcIMC here including their recent acquisition of a 10% stake in Glencore Agri (CPPIB owns a 40% stake).

Below, Manulife's Donald Guloien says the $78 trillion of unfunded pension liabilities poses a risk but also opportunities in the wealth management space.

He's right but read my comment on the big CPP clash where I share my thoughts on defined-benefit vs defined-contribution plans and why we need to build on the success of Canada's large DB pensions.

Tuesday, July 19, 2016

Hard Times in Hedge Fundistan?

Rob Copeland of the Wall Street Journal reports, Bridgewater’s Flagship Fund Falters as Another Thrives:
The world’s largest hedge-fund firm posted billion-dollar swings in its largest funds during the first half of the year, highlighting how unpredictable markets are roiling many of Wall Street’s most prominent traders.

Bridgewater Associates LP’s flagship hedge fund dropped about 12% through the end of June, according to people familiar with the firm. That marked the worst start to a year for the Pure Alpha fund since 1995. Pure Alpha bets on and against markets world-wide in an effort to stay ahead of macroeconomic trends.

Meanwhile, the firm’s slightly smaller All Weather fund rose 10%, according to these people. All Weather uses a risk-parity strategy intended to adapt to a number of market conditions.

It wasn’t clear exactly how much Bridgewater gained or lost in dollar figures, as the firm runs permutations of its funds that use borrowed money and other trading strategies to amplify bets.

Pure Alpha is the firm’s largest fund, amounting to about 45% of the firm’s roughly $150 billion under management, according to a person familiar with the matter. All Weather encompasses about 40% of the asset base, this person said. A fund that blends the two approaches accounts for the remainder.

Institutional Investor’s Alpha trade publication reported Bridgewater’s June performance figures Wednesday.

Bridgewater’s billionaire founder, Raymond Dalio, has been outspoken in predicting an eventual economic crunch. In a client note this spring reviewed by The Wall Street Journal, he said “the global economy is slowly moving toward an inflection point” that will be reached within the next year.

In that note, he repeated his longtime thesis that persistent low central bank interest rates will be increasingly ineffective in boosting economies world-wide.

And yet the S&P 500 is up 4% this year, including dividends, despite volatility that followed Britain’s vote to exit the European Union last month.

The average hedge fund lost about 1% through June 30, according to early estimates from researcher HFR.

But Bridgewater is hardly the average hedge-fund firm. Not only is it the largest by assets, but it has made more money for its clients than any other hedge fund in history, according to asset manager LCH Investments. Its clients include some of the world’s largest sovereign-wealth funds and pension funds.

Before this year’s losses, Pure Alpha reported an average annualized return of 13%, after fees. Backers continue to line up to hand over more money, as there is an extensive waiting list of prospective investors into the fund, people familiar with the fund said. It has risen every year since 2000.

Automated, computer-driven approaches similar to All Weather did well in the immediate wake of Britain’s vote last month, benefiting from longstanding bets on a strengthening U.S. dollar.

The Salient Risk Parity Index is up 19% this year, off a 12% loss in 2015.

This year’s positive performance for such funds follows a period last fall when some rivals blamed risk-parity funds for selling their portfolios all at once in a market swoon, exacerbating a downturn.

Mr. Dalio, who is credited with helping invent the risk-parity strategy decades ago, took the unusual step afterward of publicly defending the approach as a worthy long-term performer. He has indicated that the majority of his net worth is invested in Bridgewater’s risk-parity funds.
In January 2013, I openly asked whether the world's biggest hedge fund is in deep trouble, stating the following:
When I invested in Bridgewater over 13 years ago, it was just starting to garner serious institutional attention. Now, the whole world knows about Ray Dalio, Bob Prince and Bridgewater's approach. When I hear investors telling me investing in Bridgewater is a "no-brainer," I get very nervous and start thinking that the firm's success has become its worst enemy.

Let me be clear, I've met Ray Dalio, Bob Prince and many others from Bridgewater. There is no doubt they run a first-rate shop, striking the right balance, and deserve their place among the world's biggest and best hedge funds. But in this industry success is a double-edged sword and I don't like seeing hedge fund managers plastered all over news articles and engaging in silly deals.

Also, as I explained yesterday, there are good reasons to chop hedge fund fees in half, especially for these large quantitative CTAs and global macro funds. Why should Ray Dalio or anyone else managing over $100 billion get $2 billion in management fees? It's ridiculous and I think institutional investors should get together at their next ILPA meeting and have a serious discussion on fees for large hedge funds and private equity shops.

In my opinion, these large funds should charge no management fee (or negligible one of 25 basis points) and focus exclusively on performance. The "2 & 20" fee structure is fine for small, niche funds that have capacity constraints or funds just starting off and ramping up, but it's indefensible for funds managing billions as it transforms them into large, lazy asset gatherers, destroying alignment of interests with investors.

Now, one can argue that Bridgewater is becoming the next Pimco, a mega asset manager which successfully manages a lot more in assets. That's fine but then why charge 2 & 20?
Earlier this year, I criticized Bridgewater's radical transparency, stating the following:
[...] the bigger problem I have with this "radical" view of how people should interact in a company, especially a large hedge fund full of competitive individuals is on philosophical and ethical grounds. Let me explain. Ray Dalio may have mastered the machine but people aren't machines. His mechanistic/ deterministic view on markets and how the economy and world work cannot be translated into the way people should or can realistically interact with each other. 

In short, while you can code many relationships in the economy and financial markets, human interactions are far more complex. People aren't machines and when you try to impose some mechanistic deterministic view on how they should interact with each other (in order to control them?), you're bound to stifle creativity and breed contempt and an atmosphere of animosity, especially when the fund underperforms.

What else? I believe what ultimately matters is what Bridgewater employees are thinking and saying when the cameras and iPads are off or when they leave the shop. Bridgewater can tape all the meetings they want but Ray Dalio can't read minds and he doesn't know what is being said in private when employees are venting to each other or their partners at home (unless he's secretly taping them at the workplace and their homes, which is a sign of disrespect, not to mention it exhibits traits of a delusional paranoid tyrant).

Also, Gapper is right, there's an elitist (and narcissistic) air to all this. They hire a bunch of Ivy League kids and if after 18 months they manage to "get to the other side" of their emotions they then  become part of the Bridgewater "Navy SEALs," the select few who have mastered their emotions and are able to view things without their emotions getting in the way.

It's such nonsense and while it's great for marketing purposes, when the fund starts losing money, it exposes the shortcomings of this elitist mechanistic approach. Worse still, it leaves no room for real diversity at the workplace (how many people with disabilities does Bridgewater hire?) and you end up with a bunch of emotionally challenged robots at "the other end" who follow rules to conform to what their master wants, not because they truly believe or want to live by these ridiculous rules governing their every interaction.

Sure, Bridgewater is a great hedge fund, one of the best. But in my opinion, it's a victim of its success and it's gotten way too big and in order to control this explosive growth, they've implemented this 'radically transparent' cultural approach without properly thinking through what this entails or whether it stifles diversity, creativity, camaraderie and cooperation.  
As you can see, I hold nothing back when it comes to my thoughts and truth be told, I actually like Bridgewater a lot but I have zero tolerance for nonsense, especially when it comes from an elite hedge fund managing hundreds of billions of pension and sovereign wealth fund assets.

Of course, the news isn't all bad. After declining 6% last year, Bridgewater's All Weather Fund bounced back this year, but this has more to do with the fact that LDI and risk parity provided most shelter in Brexit storm:
Large weightings to fixed income helped LDI and risk-parity portfolios lost the least after dramatic movements in financial markets following the British “yes” vote on the referendum to leave the European Union. A LDI growth portfolio only fell 78 basis points. A risk-parity portfolio as measured by the Salient Risk Parity index, fell 107 basis points. A simple 90/10 or 60/40 portfolio of equities and fixed income and a risk-based growth portfolio had the greatest losses. The 90/10 portfolio fell more than 3%.

Is Bridgewater's Pure Alpha Fund in big trouble? Without doing a proper and intense due diligence, I don't know but it's definitely a sign that this mammoth hedge fund has gotten way too big.

In fact, Alexandra Stevenson and Matthew Goldstein of the New York Times report that Bridgewater is slowing its hiring:
After years of rapid internal growth, the world's biggest hedge fund appears to be slowing down.

The $154 billion hedge fund, Bridgewater Associates, run by the billionaire Ray Dalio, is known for hiring hundreds of people every year. Yet it is now telling recruitment firms to cancel interviews with prospective employees, according to three people briefed on the matter.

In recent weeks, dozens of interviews were canceled and advanced negotiations with prospective employees were cut short by the firm, those people said.

And some of the firm's external recruiters have been told Bridgewater will not use them for the time being, said the people, who were not authorized to discuss the matter publicly. Bridgewater emphasizes secrecy in its communication with investors and the external recruiting firms, and the people requested anonymity because they did not want their relationship with the firm to be affected.

It was unclear whether the suspension of recruiting in some areas was temporary or a reflection of a new push to gradually shrink the size of the firm. At the moment, there does not appear to be any talk of layoffs. The firm employs 1,500 people, most of them at its sprawling headquarters in Westport, Conn.

Still, the signs of a pullback in recruiting at Bridgewater are emerging at a time when a number of hedge funds, struggling with poor performance and unhappy investors, are starting to cut back. For example, William A. Ackman's $12 billion Pershing Square Capital Management, whose main fund is down 19.1 percent this year, recently fired a dozen employees.

The average hedge fund is up 1.6 percent this year through the end of June, according to the Hedge Fund Research Composite Index, the broadest gauge of hedge fund performance. By contrast, the Standard & Poor's 500-stock index is up 5.76 percent.

Bridgewater is not immune to the industry's pressures. It has had uneven performance in its two main portfolio funds, and at least one prominent investor has pulled out a significant sum of money over the last year.

The firm's flagship Pure Alpha fund, which makes broad bets on global economic trends, is down 8.8 percent, while its All Weather fund, which the firm contends will "perform well across all environments," is up 10.4 percent.

But last year, those performances were reversed: The All Weather fund lost investors 6.9 percent, while Pure Alpha gained 4.7 percent.

Over the last two years, the University of California's Board of Regents, the endowment for the state university system in California, has withdrawn the $550 million it had invested with Bridgewater.

Jagdeep Singh Bachher, the chief investment officer for the University of California regents, said in an interview that Bridgewater made money for the endowment, but that a decision was made to focus on investment strategies that would do best. He also said there were some concerns about the future direction of Bridgewater's leadership.

It has been a tumultuous year for the firm. Bridgewater publicly prides itself on what it calls "radical transparency" in its dealing with employees, but is very private about discussing its operations. The firm is in the process of reorganizing its core management committee that reports directly to Mr. Dalio, who founded Bridgewater in 1975.

This year, Greg Jensen, a co-chief investment officer who was seen as the heir apparent, was removed from his role as co-chief executive after reports of a schism between him and Mr. Dalio. Bridgewater hired Jon Rubinstein, a former Apple executive who had worked closely with Steven P. Jobs, to replace Mr. Jensen.

Bridgewater has publicly denied there were any internal rifts. The firm is known for its unusual culture, where employees are encouraged to question and sometimes admonish one another. Mr. Dalio encourages all employees to read "Principles," a little white book that each is given and that includes 210 motivational tips like, "Don't worry about looking good — worry about achieving your goals."

Publicly, the firm attributed the management shake-up to the need to "strike the right balance" for Mr. Jensen, who Bridgewater said was balancing too much as both co-chief executive and co-chief investment officer.

Mr. Dalio, who is 66, has created a core committee of managers that share top executive positions as part of a transition plan for when he retires. The firm has communicated to investors that the arrangement is part of a "planful transition from a founder-led boutique to a professionally managed institution."

Nevertheless, it has worried some investors.

"The management transition, in my view, it just didn't feel smooth," Mr. Bachher, of the University of California regents, said.

Despite the management transition and the apparent slowdown in hiring, Bridgewater continues to plan to expand its headquarters.

Connecticut has given Bridgewater $22 million in financial aid in an effort to keep the firm from moving its headquarters out of the state. The money is expected to go toward the expansion of Bridgewater's complex in Westport as well as its facilities in Wilton and Norwalk, according to the State Bond Commission.

Bridgewater recently received tentative approval from Westport town officials for its expansion plan, according to public documents filed in Westport's town hall. The plans would include the construction of an underground parking garage and another building at the Bridgewater campus at 1 Glendinning Place, the firm's headquarters tucked away in the woods and surrounded by streams.

It is accessible only by a nondescript road.
I agree with Jagdeep Singh Bachher, the former CIO of AIMCo who is now the CIO of the University of California regents, the management transition at Bridgewater just doesn't feel right.

Let me also publicly state this: I think Greg Jensen should leave Bridgewater to start his own global macro hedge fund and his seed investor should be none other than Ray Dalio.

This might sound odd but it will reassure investors and it will show the world that Ray Dalio isn't a power-hungry tyrant who needs to control all his employees through "radical transparency" or any other coercive means (if he had a fallout with Greg Jensen, he should send him off with the money he's owed and seed his new macro fund just like Soros did with his protege who enjoyed the biggest launch ever).

Like I said, I don't mince my words, and if you think I'm too critical of the world's biggest hedge fund, you should read the rest of this comment because unlike Bridgewater, the majority of hedge funds absolutely stink and should be shut down immediately.

Unsurprisingly, Bloomberg reports 84 percent of investors in hedge funds pulled money in the first half of the year, and 61 percent said they will probably make withdrawals later this year, according to a Credit Suisse Group AG study released Tuesday. The main driver among those who redeemed: their fund underperformed.

[Update: Fortune reports that in the first six months of the year, investors yanked roughly $600 million out of Bill Ackman's funds. The money, including $360 million in the second quarter alone, equals roughly 5% of the just over $12 billion Ackman’s Pershing Square manages, and about 30% of the money that could have left the fund since the beginning of the year under Ackman’s strict withdrawal rules. (Ackman’s previous firm closed after it was hit with a wave of withdrawals following poor performance in 2002.)]

Bloomberg also reports that Europe’s hedge-fund industry contracted for a sixth straight quarter and investors are starting to withdraw money from mediocre Asian hedge funds that charge high fees, a trend that’s forcing changes in the economics of the business, according to the global head of prime brokerage at Nomura Holdings Inc.:
“Organizations and investors don’t like to pay 2-and-20 when funds are not making money,” Nomura’s Christopher Antonelli said in an interview. “The big investors are forcing that change and they will continue to do that by starting to pull money. You don’t get any more money if you don’t change.”

Hedge funds charge the most among asset managers, traditionally raking in 2 percent in management fees and 20 percent of investment gains. They’re now seeing investors push back after many have failed to beat benchmarks amid volatile market conditions. Globally, 84 percent of investors in hedge funds pulled money in the first half of the year, with underperformance being the main driver of redemptions, according to a Credit Suisse Group AG study released Tuesday.

“With the new launches, we are seeing more varied fee structures and we will continue to see that,” Antonelli said.
You can forget about 2 & 20, it's dead, and the worst is yet to come for hedge funds because their day of reckoning still lingers as investors wake up and realize what a scam most hedge funds truly are.

What else? It astounds me to see hedge funds still partying despite huge losses. News Max Finance reports, Hedge-Fund Manager Fired Following Hamptons Party Gone Awry:
Moore Capital Management, the $15 billion hedge fund run by billionaire Louis Bacon, fired portfolio manager Brett Barna after reports about a party he hosted in the Hamptons in Long Island over the weekend.

“Mr. Barna’s personal judgment was inconsistent with the firm’s values," the firm said in an e-mailed statement. “He is no longer employed by Moore Capital Management.”

The New York Post reported on Wednesday that Barna hosted a pool-party fundraiser for an animal rescue charity at a rented $20 million mansion in Bridgehampton on Sunday. Barna had said there would be 50 guests, but 1,000 showed up, the newspaper said, citing the owner, who asked not to be identified. They drank excessively, damaged furniture and stole art work, the owner told the Post.

Barna didn’t respond to phone calls or e-mailed requests for comment. He’d been with the New York-based firm for more than six years.
A couple of points here. First, after reading the New York Post article, even if there was sauce added with salacious details, in my opinion, Moore Capital did the right thing to terminate Brett Barna's employment (not that they had much of a choice).

Second, even though Barna has come out to say the party was "good clean fun", I don't know what he was thinking throwing such an outrageous party where people armed with cell phones can use their Twitter, Facebook and Instagram accounts to broadcast live what is going on there.

Not too bright. My suggestion to Mr. Barna is to take a big chunk of his severance package from Moore Capital and donate it to an organization in New York City which feeds desperately poor and hungry people, including many kids that go to school hungry. He and his over-privileged Hampton buddies partying like drunken adolescents should also volunteer at least one month of their time to feed people in a soup kitchen or homeless shelter to see real world struggles.

I better stop because I sound like a self-righteous jerk and I don't want to beat on a man after he was fired but some of these people in Hedge Fundistan need a reality check and they need to start acting more their age and realize they represent an organization even when off duty.

Below, I embedded a few clips related to this comment. First, Bridgewater Associates, the $154-billion hedge fund run by Ray Dalio, is telling recruitment firms to cancel interviews with potential employees.

Second, Robert Leonard, global head of capital services at Credit Suisse, discusses a survey which polled more than 200 allocators with almost $700 billion invested in hedge funds. He explains why many investors are cutting allocations to underpeformers and moving into strategies and funds which are performing.

Third, CNBC's Robert Frank reports on the party at a rented mansion in the Hamptons which reportedly left it in shambles and got Barna banned from Airbnb.

After being fired following a raucous fundraiser that went viral in the Hamptons, Brett Barna, former Moore Capital Management portfolio manager, spoke out about the event with CNBC's Kelly Evans (fourth clip).

I also embedded a short clip of the party which was posted in the New York Post article. "Good clean fun"? Looks like Barna and his guests were trying to recreate Mykonos at the Hamptons (no wonder the Hamptons housing market is crashing).

Lastly, whenever I hear about guys called Brett, Brad, Brent, Kyle or Tucker partying up like adolescents in the Hamptons, it reminds me of that classic George Carlin skit on guys named Todd.

Hope you enjoyed this comment and remember, while hedge funds are charging you 2 & 20 for mediocre returns, my comments are absolutely free so please join premiere pension funds who support this blog and subscribe and/ or donate on the top right-hand side under my picture.