Friday, February 5, 2016

Canadian Pensions Cooling on Infrastructure?

Matt Scuffham of Reuters reports, Canada pension funds pull back on infrastructure as prices climb:
Canada’s biggest pension funds say they are walking away from more and more global infrastructure deals, citing concerns that intense competition for assets has driven valuations too far.

The shift could help cool global prices for tunnels, airports, toll roads, energy networks and other infrastructure as Canadian pension plans are among the world’s biggest and most active buyers.

Pension funds’ investment in infrastructure has risen since the 2008 financial crisis, as plunging interest rates and bond yields drove these players to seek steady returns elsewhere. Global equity and commodity turmoil has done little to dampen that interest and intense competition for a limited number of assets has been reflected in recent valuations.

Some investors, particularly in private equity circles, complain that the Canadian funds – dubbed “maple revolutionaries” because of the strategy of direct equity investments they pioneered in the 1990s – have a tendency to overpay.

Senior executives at the leading Canadian funds defend the merits of past infrastructure deals, but say they are worried prices no longer reflect the illiquidity of the assets, which cannot be sold quickly like stocks or bonds.

“The market is overheated. We have stepped out of the bidding for a lot of assets over the last two or three years,” a senior executive at one of Canada’s biggest public pension funds, who declined to be named, told Reuters.

Among recent deals with no Canadian participation, British rail rolling-stock owner Eversholt Rail Group was sold for $3.8-billion (U.S.) to Hong Kong’s Cheung Kong Infrastructure Holdings (CKI).

Canadian funds still expect infrastructure to grow as a proportion of their overall investments because most plans have money rolling in and view infrastructure as a good match for long-term liabilities. But they say want to be more selective.

Canada’s biggest 10 public pension funds have more than trebled in size since 2003 to more than $1.1-trillion (Canadian) in assets. A third of that is now held in alternative assets such as infrastructure, real estate and private equity.


Four Canadian pension funds now rank among the world’s top 10 infrastructure investors, according to Boston Consulting Group. At the end of 2014 the four funds had $36.8-billion (U.S.) infrastructure assets under management, equivalent to 41 per cent of the total infrastructure assets held by the top 10.

One New York-based investment banker, speaking on condition of anonymity, said private equity firms that have lost an infrastructure auction to a Canadian pension fund often grumble they paid too much, referring to rival bids as “dumb money”.

For example, last year’s acquisition by Canada’s CPPIB and Hermes Infrastructure of a 30 per cent stake in Associated British Ports for about $2.4-billion valued the business at around 20 times earnings compared with multiples of 10 to 12 that investors say are typical for the sector.

But recent prices do not necessarily mean buyers are paying too much said Dougal Macdonald, the head of Morgan Stanley Canada, which has advised on a number of deals involving Canadian pension funds.

“In a low rate environment, target returns across virtually all asset classes have come down. It is simply a resetting of returns for the right assets,” he said.

Canadian pension funds typically look for nominal returns of 6 to 8 per cent from infrastructure, a few percentage points above what they would expect from fixed-income investments. Bankers note that private equity funds often seek returns of 20 per cent or higher, meaning pension funds can afford to pay more.


Still, Canadian executives said their funds should avoid being drawn into bidding wars as part of competing consortia.

“You’ve got to try and avoid auctions because they can get crazy. If you’re just walking around with an open cheque book in these markets you’re going to pay too much,” said another executive with one of Canada’s three largest pension funds, who declined to be named because of the sensitivity of the issue.

The executive said Canada’s largest funds should co-operate more frequently. However, such “club deals” remained rare for the top three – the CPPIB, the Caisse de dépôt et placement du Québec and the Ontario Teachers’ Pension Plan.

In the past they often found themselves competing against each other as well as foreign rivals that include South Korea’s National Pension Service, Dutch pension fund APG, Australia’s Future Fund, private equity and some sovereign wealth funds.

Among recent deals, New South Wales Premier Mike Baird hailed a “stunning result” for the Australian province after a consortium including the Caisse agreed to pay $7.5-billion for an electricity network last year, significantly more than analysts expected.

The group had seen off competition from other investors including the CPPIB and a unit of another Canadian pension fund. The Caisse said at the time it was confident the acquisition met its investment objectives.

Canadian funds are also involved in a takeover battle for Australian port and rail giant Asciano AIO.AX, with Brookfield Asset Management BAMa.TO bidding against a consortium that includes the CPPIB.

Asciano’s shares are trading below both groups’ offers but at 34 times their earnings still look expensive compared with its nearest rival Aurizon, valued at 13 times its earnings.

“There’s a lot of money chasing assets,” an executive at an Ontario-based fund said. “The important thing is to maintain our discipline”.
None of this surprises me. Three years ago, I openly asked whether pensions are taking on too much illiquidity risk and whether their collective search for yield is inflating an infrastructure bubble.

In April of last year, Ontario Teachers' CEO Ron Mock sounded the alarm on alternative investments stating: “There’s a lot of money crowded into the broadly defined alternatives space. We find it too expensive. It’s time for us to step back.”

I want you to all remember my rule of thumb, when everyone is doing the same thing, paying outrageous prices for liquid or illiquid investments, or investing in the hottest hedge funds or whatever hot new strategy or theme investment banks are peddling, it typically means lower returns ahead.

Call it the law of unintended consequences. When I was working at PSP back in 2005, I sent a Fortune article to the president and senior management which discussed why Tom Barrack, the king of real estate was cashing out. I specifically highlighted this quote, which remains my favorite investment quote of all-time: "There's too much money chasing too few good deals, with too much debt and too few brains."

That didn't exactly win me any friends over in the Real Estate department where the then head of Real Estate at PSP, André Collin, was fuming but I couldn't care less as my job wasn't to coddle people, it was to warn them about risks lurking ahead (something Gordon Fyfe never fully appreciated and ended up regretting).

That same year, I flew over to London to attend some Barclays conference on commodities and came right back to Montreal to work on a board presentation arguing against commodities as an asset class (too many investment banking cheerleaders peddling BRICS and commodities at that conference) .

The investment bankers didn't like me a lot as I made them do a lot of grunt work and finally decided against recommending commodities in PSP's portfolio. Mihail Garchev who is still at PSP helped me look at the numbers and it just didn't make sense. That decision alone saved PSP billions in losses.

Unfortunately, at the time, PSP was taking all sorts of stupid risks in its credit portfolio, including selling CDS and buying ABCP. In the summer of 2006, I looked at the issuance of CDOs and CDO-squared and cubed products, and warned PSP's senior managers of the bursting of the U.S. housing bubble and how it will wreak havoc on credit markets, but nobody took my dire warnings seriously (to be fair, some were worried too and nobody had any idea how bad things would get).

In fact, I remember calling people at Goldman to discuss ways we can short ABX (an index of subprime debt) and this made them somewhat nervous: "Why would you want to do that? The U.S. housing market is great. " (felt like saying "because I don't trust you guys and I don't want you to question me, just tell me if you can do it and how much it will cost us!". But nothing came out of this because PSP's management decided not to hedge our credit risk back then).

I wrote about that experience here and how it cost me my job here. Anyways, that's all ancient history now but all this to say when everyone is doing the same thing, following the crowd, listening to their trusted investment bankers peddling them hot investment ideas, it typically doesn't end well.

There are booms and busts in everything. That goes for public markets and private markets. You'll have cycles and typically dumb money is on a feeding frenzy when you're at the top of the cycle.

Now, as far as infrastructure, there's no question it's an important asset class. I know, I worked with Bruno Guilmette, PSP's former head of infrastructure, on the board presentation to introduce that asset class at PSP back in 2005.

The best way to think of infrastructure is as an investment similar to real estate but with a much longer investment horizon, providing steady cash flows (yield) over a very, very long time. Typically infrastructure investments yield returns in between stocks and bonds over a very long period.

Why do pensions love infrastructure? Because pensions need to match assets with liabilities and with rates at record lows and likely staying ultra low for years, they need to find a relatively safe, secure and scalable substitute to long bonds which aren't yielding enough to match their long dated liabilities which go out 75+ years (there's a duration mismatch with long bonds and yields are too low).

And when you're a big Canadian pension fund, you're not going to invest in an infrastructure fund, you're going to invest huge sums directly. Unlike private equity which is almost exclusively, if not exclusively, done via fund investments and co-investments, all of Canada's Top Ten invest in infrastructure directly (same with real estate but there are also a lot of fund partnerships in that asset class).

The problem is when everyone is looking to find prize infrastructure assets, things get expensive because everyone is playing the bidding game. This is what the article above discusses. Note how many "senior executives" are complaining publicly to that reporter, off the record of course.

Still, there have been some interesting deals lately. For example, Borealis Infrastructure, an investment arm of OMERS and arguably one of the best infrastructure investors in the world, just bought a 24.15% stake in Spain’s largest operator of oil storage facilities and pipelines:
Borealis Infrastructure – part of the OMERS pension system – is acquiring a 9.15% stake in Compania Logistica de Hidrocarburos, or CLH, from Cepsa and a 15 stake from Global Infrastructure Partners.

Financial terms of the two deals were not immediately available.

CLH, Borealis Infrastructure’s first investment in Spain, expands the pension fund manager’s European infrastructure portfolio which already includes investments in the United Kingdom, Germany, Sweden, Finland and the Czech Republic.

CLH has 40 storage facilities and 4,000 kilometres of pipelines in Spain. The company also has 16 storage facilities and more than 2,000 km of pipelines in the United Kingdom.
Back in November, CPPIB, OMERS and Ontario Teachers’ bought a stake in a Chicago toll road:
Three Canadian pension funds have signed a deal to buy the company that operates the Chicago Skyway toll road for US$2.8 billion.

The Canada Pension Plan Investment Board, Ontario Municipal Employees Retirement System and Ontario Teachers’ Pension Plan will each hold a one-third stake in Skyway Concession Co. LLC, which runs the toll road under a concession agreement that lasts until 2104.

The Skyway runs 12.5 kilometres and connects the Dan Ryan Expressway to the Indiana Toll Road.

Skyway Concession, owned by Cintra Concesiones de Infraestructuras de Transporte S.A. and Macquarie Atlas Roads and Macquarie Infrastructure Partners, took over operations of the toll road in 2005 under a 99-year deal for US$1.83 billion.

The company is responsible for all operating and maintenance costs of the Skyway, but has the right to all toll and concession revenue.

The deal is subject to regulatory approvals and customary closing conditions.
As you can see, there of plenty of deals going on but things might be getting frothy and with risks of deflation and a global slowdown looming, I guess a lot of infrastructure investors are scrutinizing the multiples they pay on these investments a lot more closely.

And while many are cooling off on infrastructure, some are even selling assets. AIMCo just announced the sale of Autopista central toll road in Chile:
Alberta Investment Management Corporation ("AIMCo") is pleased to announce the successful divestment of its 50% interest in Autopista Central de Chile, a Santiago-based toll road infrastructure asset, on behalf of certain of its clients, to Abertis Infraestructuras SA ("Abertis") for € 948 million (approximately CAD 1.5 billion).

The sale of Autopista Central represents the culmination of a very successful private investment for AIMCo and a demonstration of its ability to manage this unique asset through the investment life cycle. This mutually beneficial transaction further provides a unique opportunity for Abertis to consolidate its interests under its Chilean Road Portfolio, furthering its current strategy.

Autopista Central is a 61-kilometer, six-lane highway in Santiago that went into operation in 2007. AIMCo acquired a 50% stake in Autopista Central de Chile in December 2010, on behalf of certain of its clients, joining a consortium of companies with 100% ownership of Autopista Central SA unit, a Santiago-based provider of toll roads operations services. The consortium, now solely-owned by Abertis, holds the concession until 2031.

"AIMCo has enjoyed working with the strong management team of Autopista Central and our partner Abertis over the last five years," says Ben Hawkins, Senior Vice President, Infrastructure & Timberlands at AIMCo. "Autopista Central has one of the best management teams in the industry, and the acquisition will allow Abertis to achieve further synergies and benefits to its portfolio. We are happy to have been an owner of this important piece of infrastructure to Santiago, and remain committed to investing further in Chile given the right opportunities."

AIMCo Chief Executive Officer, Kevin Uebelein, states further, "Today's transaction realizes excellent gains for AIMCo's clients. Our talented and capable team of Infrastructure investment professionals maximized the value of this asset through each stage of the investment lifecycle as evidenced by this outcome."
I will leave you with something AIMCo's former CEO Leo de Bever shared with me via email earlier today on this topic:
When I was at Ontario Teachers, we were one of the first Canadian funds to start investing in infrastructure. The market was inefficient, and we probably made more money than we should have because as others followed suit, prices started to rise.

With the rapid growth of pension and sovereign wealth funds, the money is piling into this asset class faster than the supply of good investments. Some of the new investors are seeking top line yield without factoring in risk. The biggest risk of infrastructure is political and contractual: whenever there is a dispute between a few investors and a lot of taxpayers or users, the investors are in danger of losing out. With publicly owned infrastructure, that cost is just quietly absorbed.

Reliability of contracts and concession provisions are key to attracting capital on good financial terms. With interest rates low, target returns of 6% to 8% may look like a king's ransom, but pricing infrastructure as a risk free bond makes little sense, because it ignores efficiency of capital use and operating risks. The unit cost of capital on many publicly financed projects may be low, but in many cases they end up having to raise a lot more dollars. Some of the best projects I never financed ended up badly for that reason.

Most government owned social infrastructure has been underpriced for decades because of the political pressure to keep user rates low, resulting in a lot of deferred maintenance and no provision for capital replacement. It seems that we need bridges falling down and water pipes bursting before we make that connection.

There should be a growing opportunity for pension funds to fund new infrastructure, as governments look for more efficient ways to deal with these issues. I have been surprised that this is not happening faster.

The main reason seems to be that no one is held accountable for the social opportunity cost of deficient infrastructure caused by congestion, grid failure, and water pollution from poor sewage treatment capacity planning. I see this as one of the factors holding down future GDP growth potential.

Canada's federal government is embarking on a big infrastructure build program. That could be great, and is long overdue, assuming it targets the right investments. We should think carefully about not just building more of what we already have. The future may need different facilities, reflecting, for example, what I see as a trend to more distributed production of energy, and more emphasis on decentralized ways to improve efficiency of water use and treatment.
Smart guy that Leo de Bever and you'll recall the 'godfather of infrastructure' was warning investors of how expensive infrastructure was getting back in July 2010 when he stated the following:
"I did a fair bit of the early infrastructure stuff among Canadian pension funds," he said. "And in the beginning you could get an honest 14 per cent return on equity because the market was very inefficient." To do the same thing these days, with a number of players competing for deals, would take a whole pile of leverage, he suggested.
But ended with this comment:
"In most places, water and sewage are going to take an enormous amount of capital because everything is starting to leak," he said. "Given that the fiscal positions of a lot of these governments is pretty weak, private capital has to come in at some point, and that's when I think infrastructure will become attractive again."
So while Canada's big pensions are cooling on infrastructure, it doesn't mean they've written this asset class off entirely. Quite the opposite, they still invest heavily in infrastructure but are scrutinizing deals a lot more carefully.

It's also worth noting that some funds, like the Caisse, are taking on greenfield infrastructure projects in Quebec. While some are questioning whether it can make money on these projects, I'm very confident it will do just fine (the Caisse hired the right people to oversee these greenfield projects).

Below, an investment in infrastructure panel at Global Investment Conference 2013 featuring Neil Petroff, former CIO of Ontario Teachers' Pension Plan and other experts. This was three years ago but take the time to listen to Neil's comments as well as those of others.

Also, André Bourbonnais, CEO of the Public Sector Pension Investment Board, Winston Wenyan Ma, managing director and head of the North America Office at China Investment Corporation, Ron Mock, CEO  of Ontario Teachers Pension Plan, and Michael Sabia, CEO of Caisse de dépôt et placement du Québec, participated in a panel discussion about Canadian pension plans and investment strategy. Bloomberg's Scott Deveau moderated the panel last April at the Bloomberg Canada Economic Series in Toronto. Even though this panel took place almost a year ago, listen to their comments very carefully as they're still highly relevant.

Lastly, I embedded a long History channel documentary on America's crumbling infrastructure. While Ted Cruz, Donald Trump, Marco Rubio, Hillary Clinton and Bernie Sanders debate each other to be America's next leader, the country's infrastructure is falling apart.

Given Friday's lackluster U.S. jobs report, I think it's time for America's leaders to take advantage of ultra low rates for years and start investing massively in the nation's infrastructure. Unlike minimum wage retail and restaurant jobs, infrastructure jobs pay decent wages and help grow the economy.

Thursday, February 4, 2016

Are Banks The Next Big Short?

Philip Baker of the Australian Financial Review reports, Deutsche Bank's troubles unmask bigger risks:
At the Deutsche Bank annual meeting in Frankfurt in 2015 a disgruntled investor got up in front of the microphone and asked the board of directors if there was a financial scandal the bank wasn't involved in.

A month earlier, the bank had been fined $US2.5 billion by US and British authorities after a seven-year investigation for its part in rigging benchmark interest rates.

Investors were baying for blood, as tougher regulatory requirements and litigation seemed to be taking their toll on the bank's share price.

At the time, stock in Deutsche Bank was closer to €30, well down from its pre-global financial crisis high of €177, while on Tuesday night shares in the bank fell to a fresh low of €15.54, prompting a new wave of worries.

For a start, Deutsche Bank is trading on a price to book valuation of 0.34 times, which implies the market thinks that almost 70 per cent of its loans are impaired and some nasty news is just around the corner.

The bank posted a €6.8 billion loss in 2015, thanks to a €12 billion write-down linked to litigation charges and restructuring costs, and it set aside more to cover any potential litigation.

At a time when it seems like a cottage industry has sprung up in predicting the next financial crisis, there's talk that although this current period of turbulence might not be the next crisis, it will certainly do until that next crisis does arrive.
Heart of the problem

At the heart of these latest concerns is that investors are losing faith in what central banks can do. But the performance of big global bank stocks like Deutsche Bank has also sparked the selling.

It was August 2014 when Paul Schulte, the chief executive of SGI Research, warned Australian investors that all was not well at Deutsche Bank and he still thinks the bank has several problems to deal with.

First, he said that more than any other global investment bank Deutsche had too many leftover assets from the global financial crisis – more than $US10 billion ($14.1 billion) by his estimates – that are very illiquid and simply too hard to value.

With regard to all the financial scandals mentioned at 2015's annual meeting, he also thinks there are further fines to come, while Deutsche also seems to have a large book of commodity-related derivatives that are under stress from the collapses in most commodity prices.

Schulte says there is still too much leverage at Deutsche and it is in the centre of a sclerotic system of Euro-paralysis, which prevents any dramatic sort of "TARP" program.
'Over-stretched, badly run'

"This has been brewing under everyone's nose, because while people thought that the problem was periphery banks in Ireland or Spain, the actual problem is that Deutsche Bank, and the French banks with lots of toxic debt in commodities, are over-stretched, badly run, have no sense of risk management and are organs of state capitalism," Schulte says.

So far this calendar year shares in Deutsche Bank have fallen 30 per cent but it's not flying solo. Citi is down 22 per cent, Goldman Sachs is down 16 per cent, JP Morgan is down 14 per cent, Morgan Stanley is down 23 per cent, Bank of America Merrill Lynch is down 22 per cent and Credit Suisse 22 per cent.

Shares in UBS are also down 20 per cent in 2016, slipping 7 per cent on Tuesday night after its latest profit numbers implied its strategy of moving away from the volatile investment banking business to focus on steady business of wealth management wasn't working so well.

That compares to a 7 per cent fall in the Dow Jones and S&P 500, a 5 per cent decline in the FTSE 100 and 11 per cent drop in the DAX.

As for the next crisis, it is always hard to predict. But with so much debt around and growth hard to come by, there is a mismatch between rising credit, falling growth, trade and prices, and a financial market that is in the mood to sell everything.
More bad news for Deutsche Bank, Jonathan Stempel of Reuters reports it now faces a U.S. lawsuit over $3.1 billion mortgage loss:
Deutsche Bank AG must face a U.S. lawsuit seeking to hold it liable for causing $3.1 billion of investor losses by failing to properly monitor 10 trusts backed by toxic residential mortgages, a federal judge ruled on Wednesday.

U.S. District Judge Alison Nathan in Manhattan said Belgium's Royal Park Investments SA/NV may pursue claims that the trustee Deutsche Bank National Trust Co ignored "widespread" deficiencies in how the underlying loans were underwritten and serviced, and failed to require that bad loans be repurchased.

Royal Park, which is seeking class-action status on behalf of other investors, said Deutsche Bank breached its fiduciary duties in part out of fear it might lose business or prompt retaliation over the German bank's own problem loans.

"Plaintiff's allegations of high default rates, large economic losses, and widespread investigation into RMBS securitization allow the court to draw the reasonable inference that defendant had actual knowledge" of defective loans, the judge wrote.

Nathan dismissed some secondary claims.

In its June 2014 complaint, Royal Park said its own securities had become "completely worthless." The 10 trusts date from 2006 and 2007.

Deutsche Bank spokeswoman Oksana Poltavets declined to comment. Royal Park's lawyers did not immediately respond to requests for comment.

Bond issuers appoint trustees to ensure that payments are funneled to investors, and handle back-office work after securities are sold.

Many investors have in recent years sued trustees, as well as lenders and underwriters, over losses on badly underwritten mortgages.

The case is Royal Park Investments SA/NV v. Deutsche Bank National Trust Co, U.S. District Court, Southern District of New York, No. 14-04394.
Things are not looking good for the once mighty Deutsche Bank (DB). And I agree with that disgruntled investor who got up in front of the microphone and asked the board of directors if there was a financial scandal the bank wasn't involved in (Deutsche was one of a few banks at the center of the $35 billion ABCP meltdown in Canada in 2007).

But the problems are not only at Deutsche Bank. Laura Noonan, Rochelle Toplensky and Ralph Atkins of the Financial Times report, Credit Suisse results deepen bank gloom:
Credit Suisse shares (CS) tumbled to a 24-year low on Thursday after the Swiss bank revealed its first full-year loss since 2008, providing further evidence of the impact of market volatility and low global growth on financial firms.

Vowing to step up drastic cost cuts, Credit Suisse chief executive Tidjane Thiam warned of a “particularly challenging” time for banks.

“Clearly the environment has deteriorated materially during the fourth quarter of 2015 and it is not clear when some of the current negative trends in financial markets and in the world economy may start to abate,” he said. Credit Suisse shares were down 13 per cent by late afternoon in Europe.

The Credit Suisse warning followed 2015 results from European rivals Deutsche Bank and UBS last week that showed sharp falls in fourth-quarter earnings. UBS finance chief Kirt Gardner described trading conditions as “treacherous”.

Despite an overall small bounce in European financial stocks on Thursday, the sector is the worst performing sector in the Euro Stoxx 600 index during the past month, dropping just under 20 per cent.

Globally, the financial sector is the worst performing in the MSCI World Index. The S&P 500 financials are the worst performing major sector this year, down nearly 12 per cent.

Mr Thiam cited a litany of negatives for banks including uncertainties on Chinese growth, the abrupt drop in oil prices, large mutual fund redemptions of financial assets and the impact of “asynchronous policies” of leading central banks.

This has resulted in lower client activity, reduced issuance of securities by companies and material shifts in the prices of some asset classes.

Banks’ stocks have also been hit by investor worries over the groups’ exposure to the US energy sector following the slump in oil prices and expectations that weak economies will see the US Federal Reserve and other central banks delay interest rate rises longer than investors had been expecting last year.

Low interest rates hurt banks because the gap between what they charge for lending and what they pay for deposits shrinks. The most extreme case is when central bank rates are negative — banks are almost never able to pass the full impact of this on to depositors, but borrowers get lower interest rates, especially those with variable rate loans. This means the bank’s margin falls.

“The common themes globally are lower for longer [interest] rates, risk-off and less growth — and those are all bad for banks,” said Mike Mayo, New York-based analyst with CLSA.

Credit Suisse’s global markets division lost almost SFr3.5bn ($3.5bn) in the fourth quarter as it wrote down the value of distressed debt it held and took a SFr2.66bn hit to goodwill.

Revenues at Credit Suisse’s investment banking arm, which advises clients and arranges deals for them, were 20 per cent lower than a year earlier as income from debt underwriting “fell significantly” in torrid market conditions.

The Swiss bank’s private banking arm suffered net outflows of SFr4.1bn, mirroring the experience of UBS, whose shares plunged 8 per cent on Tuesday after it revealed its key wealth management division had net outflows of SFr3.4bn in the fourth quarter.

Mr Thiam acknowledged that conditions had been “particularly challenging” but suggested the share price fall was overdone: “You can’t be deaf to the markets, but these are very nervous markets,” he told reporters in Zurich.

Speaking to analysts, David Mathers, Credit Suisse’s chief financial officer, shot down suggestions the bank should have gone for a bigger capital increase than the SFr6bn it got from investors at the end of last year.

“Part of the point of the cap raise was to fund restructuring and re-engineering of the group. That’s clearly coming through,” Mr Mathers said. “We have not to lose our nerve,” Mr Thiam added.

The bank also promised to cut costs faster, but this did little to appease analysts.

“A key takeaway from this banks results season is that the market has no appetite for “jam tomorrow” despite some very low valuations,” said Jon Peace, analyst at Nomura.
I'm afraid the new negative normal and ultra low low rates for years spell big trouble for big banks, especially European ones saddled with bad loans. And the risks of contagion are rising.

In fact, Anna-Louise Jackson and Dakin Campbell of Bloomberg report, Bank Bear Market Gets Worse as Goldman, Citi Sell Off Again:
The 2016 financial stock rout worsened Tuesday as the country’s biggest investment banks plunged almost 5 percent amid a gathering storm of economic and financial threats.

Goldman Sachs Group Inc. sank the most since November 2012 to lead the Dow Jones Industrial Average to a 295-point loss, while Citigroup Inc., Bank of America Corp. and Morgan Stanley slid 4.7 percent or more. The KBW Bank Index declined 3.2 percent to extend its bear-market plunge since July to 23 percent.

Tuesday’s losses worsened the second-biggest share decline to start a year in two decades for American financial stocks and followed similar losses in Europe after UBS Group AG earnings at the wealth management and investment-banking businesses slumped in the fourth quarter. Concerns ranging from falling interest rates to China and investor disaffection amid increasingly volatile markets spurred the retreat.

“Concerns about problems in the energy sector and a slowdown in the Chinese economy are leading to fears of a global recession,” Jim Sinegal, an equity analyst at Morningstar Inc., wrote in an e-mail. “As a result, bank stocks are getting hit hard as investors factor in higher credit losses, slower growth, lower capital markets activity, and a continued low-interest rate environment.”

All but eight companies in the 90-member Standard & Poor’s 500 Financials Index slipped as the gauge flirted with a two-year low, while the S&P 500 Capital Markets Index tumbled 4.2 percent to levels last seen in August 2013. All 14 members of the latter group declined. The losses came as the 10-year Treasury yield fell below 1.86 percent for the first time since April, while a pair of Federal Reserve financial stress indexes reached the highest since December 2011.

The gap between the two-year and 10-year Treasury yields shrank to its smallest since January 2008. At the same time, predictions for 10-year yields are being cut as U.S. economic data falls short of expectations, potentially curbing further Fed increases. The year-end weighted average forecast in a Bloomberg survey has fallen to 2.69 percent, from about 3.2 percent six months ago.

“The mere thought that rate hikes won’t happen has caused investors to sell banks,” said Mike Mayo, an analyst at CLSA Ltd. “The regulators spent the last eight years helping to make banks less risky,” he said. “But still, on a day like today, they’re not perceived as less risky.”

Plunging energy prices posed another headwind as market speculation focused on the 19 percent of the Bloomberg High Yield Index made up of energy bonds. Oil capped its biggest two-day drop since March 2009 before government data forecast to show U.S. crude stockpiles expanded, exacerbating a global glut. Futures fell below $30 a barrel in New York after a 5.5 percent slide.

Oil has lost 19 percent this year amid volatility in global markets. Royal Dutch Shell Plc had its debt rating cut to the lowest since Standard & Poor’s began coverage in 1990, while Sanford C. Bernstein & Co. warned investors in Asian producers to prepare for a wave of writedowns.

“The yield curve still isn’t cooperating on both up and down days, and oil having two rough days has put the market back in a nervous mode, which is obviously not good for investment banking,” said Jesse Lubarsky, a financial-stocks trader at Raymond James & Associates Inc. in New York.

Selling in financial stocks has gone well past banks in 2016. Discount brokerages Charles Schwab Corp., E*Trade Financial Corp. and TD Ameritrade Holding Corp. have each lost about a quarter of their value this year. Fund firms Franklin Resources Inc., Waddell & Reed Financial Inc. and Legg Mason Inc. are nursing losses ranging from 12 percent to 28 percent.

Financials were the most-favored group among large-cap managers as of Oct. 31, according to data from Goldman Sachs Group Inc. An exchange-traded fund tracking the stocks attracted the second-highest cash flows in the month leading up to the rate liftoff.

“All of this is coming together to create a capitulation trade,” said Charles Peabody, an analyst at Portales Partners LLC in New York. “The investment community came in overweight bank stocks coming into the year largely on the idea that Fed rate hikes would create a positive earnings catalyst,” Peabody said. “What they’re quickly learning is the Fed’s ability to raise rates is limited.”
I don't know exactly what's going on with big banks across the world but clearly the brutally cold chill of deflation is rattling them. Still, cries of a "global banking crisis" are premature at this stage.

Things appear to have calmed down on Thursday with the Financial Select Sector SPDR ETF (XLF) up marginally (1 per cent) but still negative for the year. Some analysts think commodities are bottoming out but that remains to be seen.

I saw explosive moves in shares of Consol Energy (CNX) and Freeport McMoran (FCX) Thursday morning propelling the S&P Metals and Mining sector (XME) up but I've seen many explosive short covering rallies in this sector peter out after big pops. I need to see sustained follow-through and a rise in bond yields to believe in this rally in energy and commodities.

Problems in Europe's highly levered banks might also explain the big drop in high beta small cap biotech shares (XBI). I'm not sure if there was a carry trade that was unwound but it sure looks that way for all risk assets, not just biotech shares.

Are banks the next big short? I certainly hope not but this is a very challenging environment for all banks and it could get a lot worse before it gets better.

Below, Raoul Pal, Global Macro Investor Publisher, explains his concern over European banks and lists his troubled bank list. If you listen to Pal, you just want to curl up in the fetal position and cry.

For a more uplifting view, Dick Bove, Rafferty Capital, discusses the financial sector as financial stocks slide, stating bank balance sheets are in excellent shape. Great comments but he's talking about U.S. banks and ignores the risk of contagion.

Wednesday, February 3, 2016

Time To Dismantle Costly CPP?

Barbara Shecter of the National Post reports, Canada Pension Plan has no cost advantage over other large public pensions:
Proponents of expanding the Canada Pension Plan, or launching a similar large-scale retirement vehicle in Ontario, often tout the element of lower costs through economies of scale. But a new study from the Fraser Institute says the CPP has no clear cost advantage over other large public sector pensions.

The study by Philip Cross, a former chief economic analyst for Statistics Canada, compared the total costs of CPP and five large public sector pension plans in Ontario.

The author says his study is unique because it looked at a complete picture of both investment and administrative costs.

Economy of scale is often used as a rationale by those who favour CPP expansion, suggesting that the relative cost of plans declines as they grow and accumulate more assets. However, Cross says his study shows such claims “are simply not true.”

The study, to be released publicly on Tuesday, concludes that CPP, the largest plan scrutinized over the period from 2009 to 2014, was in fact the costliest as a percentage of assets.

“Specifically, the CPP with $269 billion in assets had the highest average cost-to-asset ratio at 1.07 per cent during that time,” the Fraser Institute, a research think-tank, said in a statement.

Cross contends that CPP’s reputation for being low cost is “coloured by incomplete comparisons that don’t account for all related costs.”

Furthering the notion that size does not correlate with cost, the study concluded that the Ontario Teachers’ Pension Plan — the second-largest fund, with $154 billion in assets — was only the fourth costliest, with an average cost ratio of 0.63 per cent.

The study looked at and dissected two cost categories: investment and administrative.

The smallest fund in the study, OPTrust — with just $17 billion in assets — was found to have the highest average investment costs as a percentage of assets. This was followed by CPP, with the second-highest investment costs.

Another of the smaller funds scrutinized, the Ontario Pension Board, had one of the lowest average investment costs.

Cross speculated that fund growth through asset accumulation might actually raise costs, since the complexity of implementing investment strategies calls for more — and costly — external expert counsel.

Debate over expansion of the Canada Pension Plan has raged in recent years, with some experts arguing Canadians aren’t saving enough for retirement and need a boost from the national public pension.

Ottawa and the provinces came close to agreeing to enhance CPP a couple of years ago, but fears about the strength of the economy derailed those efforts.

The government of Ontario responded with plans to launch its own provincial pension plan, the Ontario Retirement Pension Plan (ORPP), which could be rolled into an expanded national plan should that be embraced.

The Fraser Institute has weighed in on the CPP and ORPP before. A study published in July suggested that ramping up government-driven mandatory retirement savings programs could lead to less voluntary savings, resulting in no overall impact on how much Canadians have to fund their golden years.
Benefits Canada also reports, CPP more costly than other public sector pensions:
The Canada Pension Plan (CPP) is more costly than five public sector pension plans, according to a new report by the Fraser Institute.

The report compared the total costs, including investment and administrative of the CPP with five large public sector plans based in Ontario, including: the Ontario Teachers’ Pension Plan (OTPP), the Ontario Municipal Employees Retirement System (OMERS), the Healthcare of Ontario Pension Plan (HOOPP), the Ontario Pension Board (OPB), and the OPTrust.

It found that the CPP, which is the largest plan with $269 billion of assets, had the highest expense ratio at 1.07% of its assets on average for the whole period between 2009 and 2014. The OTPP, the next largest plan at $154 billion of assets, had the fourth highest average expense ratio (0.63%).

“In fact, there may be diseconomies of scale for larger public pension plans because of the complexity of implementing their investment strategies, which include contracting out for external experts – a practice that has become increasingly popular, with plans investing more in non-traditional assets such as real estate, infrastructure, and private equity,” said the report.

“These more aggressive investment strategies raise costs. Whether they are justified by higher rates of return will not be known for decades, and depend on whether the assumption that markets have mispriced these assets is borne out.”
The Fraser Institute put out this press release on comparing the costs of the Canada Pension Plan with public pension plans in Ontario. You can read the full report here.

Before I tear this study and its authors to pieces, let me first commend them for at least attempting to shed some light on costs at Ontario's public pension plans. When it comes to public pensions, I'm all for more transparency on costs, fees, leverage, benchmarks, compensation, diversity, and anything else that Canadians deserve to know about.

In short, I believe that Joe and Jane Maple Leaf deserve to know a lot more about what is going on at Canada's public pensions, as well as financial markets, which is why I started this blog back in June 2008, much to my personal demise (not that I had much of a choice!).

I have no problem taking on Canada's Top Ten, shining a light on their activity, but when I read these studies on the CPP from the Fraser Institute, I can't help but wonder who funds this nonsense and what is their ultimate political goal?

Just so you know, I have experience working as a senior investment analyst at two of the largest Canadian pension funds, the Caisse and PSP Investments, but I've also worked as a fixed income analyst at BCA Research, an economist at the National Bank, and as a senior economist at the Business Development Bank of Canada and then Industry Canada.

All this to say, I know the Fraser Institute all too well. It was recently ranked as the top think tank in Canada by the University of Pennsylvania, but it was always a right-wing think tank with an axe to grind against big government or anything else perceived to be big government (like Big CPP even though it's a Crown corporation that operates at arms-length from the government).

One of the authors of this study, Philip Cross, has extensive experience at Statistics Canada, an organization which I respect, and then worked for the Macdonald-Laurier Institute. He is also a member of the Business Cycle Dating Committee at the CD Howe Institute.

But for all his credentials and experience, Cross has an axe to grind with the Canada Pension Plan and he has even written articles in -- you guessed it, the National Post!! -- arguing we should forget talk of a pension crisis, Canadians are very well protected in their retirement.

Really? That's news to me because I've been arguing all along that we need real change to Canada's Pension Plan and that now more than ever, our politicians need to stop dithering and enhance the CPP once and for all. And this despite the crisis in the Canadian economy which will more than likely usher in negative interest rates here just like in Japan and elsewhere.

This is all part of the new negative normal and a period of prolonged ultra low rates which are here to stay as long as the deflation supercycle keeps wreaking havoc on the global economy.  This too is why I want our political leaders to get on to enhancing the CPP as soon as possible and finally realize the brutal truth on defined-contribution plans: they aren't working and will condemn millions of Canadians to pension poverty.

This is why unlike the Fraser Institute, I welcome Ontario's "Wynning" pension strategy and think it's a real shame our political leaders are once more squandering a golden opportunity to enhance the CPP once and for all.

Now that I got that out of the way, let me briefly go over some critical points of the Fraser Institute study comparing the costs of CPP with other Ontario public pension plans. You can click on the table below which summarizes the costs at various Ontario pensions relative to the CPP (click on image):

My first criticism of this study is it's comparing apples to oranges. Apart from PSP Investments, which is growing fast and has a similar profile to CPPIB (but still a lot smaller), there's is nothing like our national pension fund in Canada (the Caisse is huge but it manages money of mature Quebec pension plans which pay out more than they receive in contributions).

How can you compare CPPIB, a national pension fund which is growing fast, to smaller Ontario plans which cover only a small subset of the Canadian population? This is just silly and doesn't take into account CPPIB's mandate, challenges and advantages which are unique to it.

It's one thing managing $20 billion, $50 billion or even $150 billion, but when you're in charge of $270 billion and growing fast, you simply cannot take the same approach that others take and your costs will be relatively higher for all sorts of reasons.

CPPIB is a global powerhouse which is investing in public and private markets all over the world. It has over two dozen distinct investment programs (or “business units”) which are global in scope and competition is very intense among some of the world’s biggest investment institutions -- many of which are trillion dollar behemoths.

In other words, because of its sheer size and liquidity advantages, CPPIB is engaging in investments activities that others are not doing either because they don't need to or because they can't (too small, too mature, etc). Sure, it's doling out huge fees in private equity, an activity which it does exclusively through external investment partners (fund investments and co-investments with top private equity funds), but it's also engaging direct investments in real estate and infrastructure (the latter is all direct investments).

CPPIB is also doing large deals which will better position itself for the future. For example, the acquisition of GE's Antares Capital was the biggest deal of 2015 and one which will benefit the Fund over the very long run. But you need to pay the people running this financing arm and they don't come cheap (still a lot cheaper than doling out huge fees to many private equity funds to do the same activity in the mid market space).

The Fraser Institute study talks about "diseconomies of scale of large public pensions because of the complexity of implementing their investment strategies" but it fails to explain the J-curve effect of private equity investments and how large transactions like the GE deal or other big deals might be expensive at first but over the long run, they will lower costs significantly.

And just to be clear, when you're the size of CPPIB, you're not paying 2 & 20 to private equity funds or hedge funds. You're paying significantly less than smaller pension funds which can't use their size as leverage.

The second major criticism I have with the study is that CPPIB is very transparent in terms of all its costs. It is all broken down across operational, transactional and performance fees with driving factors. For example, look at page 53 and 54 of the Fiscal 2015 Annual Report which provides details on all costs and where it's clearly stated:
As a cost-conscious organization, we take managing costs seriously. We have a long-standing practice of allocating operating expenses to the investment departments to provide a complete view of the costs associated with generating the investment returns and to encourage cost awareness across the organization. This cost transparency promotes constructive conversations between the departments receiving the cost allocations and the departments allocating the costs that are focused on value for spend and accountability for the expenditures.
If CPPIB has high transaction costs compared to other smaller plans in a given year it's because their multiple businesses have pursued many investments over that period of time, not because it's hiding anything from the public.

Also, it's important to note performance fees are driven by high performance and they correlate to strong investment returns for the benefit of contributors and beneficiaries.

This brings me to my third major criticism of the study, the lack of understanding of CPPIB's mandate. At the end of the study, the authors question CPPIB's investment strategy, dismissing it as an "unproven experiment" and stating the following:
Of course, the rising expense of the CPP’s investment strategy after 2007 could be justified if the rate of return remains high. The problem is that we will not know for years, or even decades, if the rate of return stays elevated. This is especially true of the CPP’s purchase of illiquid assets such as infrastructure, land, and private equity. This strategy presumes first that these assets are mispriced because they are relatively unknown and infrequently traded, and second that the mispricing of assets is on the low and not the high side. In other words, there is a presumption of market failure in price discovery, which large pension funds can identify and profit from better than other investors such as hedge funds.

This view may be borne out by a higher return to CPP investments over the decades. Or it may be disproven if returns falter. It is important to remind people that this is an experiment in progress, not the execution of a proven strategy. It is worth remembering that The Economist observed recently that hedge funds once “sold themselves as clever and flexible enough to take advantage of opportunities that conventional fund managers neglected,” but this claim has been disproven over time(The Economist, 2015, August 1: 62).

It is also worth noting that high returns earned by the CPPIB’s assets will not benefit its members; the CPP remains largely a pay-as-you-go pension plan, with only 17% funded by CPPIB investments. Since members will not benefit from higher returns, why does management undertake investment strategies that involve more risk? Meanwhile, younger Canadians are already overpaying in terms of the ratio of their contributions to benefits, to compensate for the underfunding before the CPP was overhauled in 1997 (Canada, OSFI, 2013; Godbout, Trudel, and St-Cerny, 2014).

At a minimum, the CPPIB has not done a good job explaining publicly why its strategy justifies the additional expense and risk in its investments. Nor has it been shown that an active investment strategy has not distracted management from maximizing the efficiency of both the administrative and investment arms of the CPP, something it promised to do when it adopted this new strategy in 2006. This reference to improving efficiency seems to have been its last utterance on the subject, making it appear to be an empty slogan when maximum efficiency should be the foundation for the operations of the entire CPP, or indeed of any organization entrusted with the public’s money or supported by taxes (it is telling that the lower cost OPB refers to efficiency in its Annual Report, but the CPPIB does not). Developing intricate investment strategies and opening branches around the world may create a more interesting work environment for managers, but this does not guarantee the rate of return that results from higher efficiency and lower costs.
Wow, powerful accusations!! Unfortunately, none based on facts and it proves how utterly ignorant and biased the authors are when it comes to CPPIB, its activities and its mandate. In fact, right on CPPIB's website, it clearly states: "CPPIB invests the assets of the CPP with a singular objective – to maximize returns without undue risk of loss. Our investment strategy is designed to capitalize on our comparative advantages."

Unlike all those other public pensions in Ontario which the study alludes to, CPP is not a fully-funded plan and as such it can take risks in public and private markets that these other plans cannot or will not take. Its objective is clearly stated, "to maximize returns without undue risk of loss." Period. This is their statutory fiduciary responsibility, a point which seems to have been lost by the authors of this study.

Importantly, the notion that higher returns do not benefit members is nonsense. The higher the return, the cheaper the cost of financing the CPP over the long run, which means lower pay-as-you go contributions for Canadians in the future.

And unlike what the authors state, CPPIB has been very clear explaining why its strategy justifies the expenses and risks it takes. Perhaps the authors of this study should take the time to read my public blog comments where I go over in detail CPPIB's annual results like when it gained a record 18.3% in Fiscal 2015.

What else? Mark Wiseman, CPPIB's CEO, has repeatedly told media outlets that he expects CPPIB to under-perform its reference (benchmark) portfolio, which is one of the toughest to beat, in periods when markets are roaring and outperform it during bear market cycles. It has delivered a solid 7.3% 10-year annualized rate of return which translates into multi-billions of net investment income over its passive reference (benchmark) portfolio, which is one reason why the Fund is actuarially on solid footing.

As far as shifting assets into private markets, this is the strategy that pretty much every large Canadian pension fund has been doing over the last decade but unlike large U.S. pensions, they're investing directly whenever they can, significantly lowering the costs. Only in private equity do they do a lot of fund investments but also co-investments with their partners which brings the total fees down considerably.

Also, while shifting assets into private markets isn't without risks, if you read Leo de Bever's comments on why Norway's giant pension fund should invest in unlisted real estate and infrastructure, you would gain a deeper appreciation for this long-term strategy.

Will the next ten years be a lot tougher than the last ten years for CPPIB and others to achieve their target rate of return? You bet they will but if I had a choice of having my retirement money in the CPP and other large well-governed Canadian DB plans or some crappy Canadian mutual fund charging me ridiculous fees or even a low-cost index fund which mimics public markets, there's no question I'd choose CPP which is more diversified and a lot more secure.

All this to say that this Fraser study comparing the cost of CPP to other Ontario pensions isn't very good as it's full of false and grossly biased claims. I suggest Philip Cross and his co-author talk to a real pension experts like Leo de Bever, Jim Leech, Doug Pearce, John Crocker, Claude Lamoureux, Bob Bertram and Neil Petroff before they ever publish such a spurious study on the high costs of CPP.

But let me not be too hard on them, after all, I want to see more studies shining a light on public pensions. And their findings aren't all terrible. They just need to be put in proper context and they need to be openly discussed by real pension experts who actually know what they're talking about.

One thing the study demonstrates is why fully-funded HOOPP is one of the best pension plans in the world as it's delivering stellar results at a fraction of the cost of other smaller and larger plans. But here too, you need to be careful as HOOPP's approach cannot be replicated by everyone, especially much larger pensions like OTPP (which does everything HOOPP does and invests in external hedge funds and private equity funds) or CPPIB which is way too big to do everything internally.

If anything, this study makes OPTrust look somewhat bad as it has a very expensive cost structure relative to much bigger and smaller pensions but here too, you need to be very careful interpreting costs relative to results. If you look at OPTrust's Annual Report 2014, the latest one available, you will see the Plan is fully funded and it achieved an investment return of 12%, net of external management fees, outperforming the Plan’s 6.2% composite benchmark portfolio.

Can OPTrust improve its cost structure by doing more internally? It probably can but the bottom line is it's delivering great results net of all external management fees and it's fully funded allowing it to increase its inflation protection to its members.

The bottom line is when most Canadian DB and DC plans are reeling because of the turmoil in global markets, all of the DB pensions discussed in this Fraser Institute study are doing just fine and the last thing we need is to spread more disinformation on why there are several reasons to oppose CPP expansion, including its cost structure.

I hope this comment lays all these criticisms to rest but I realize that public pensions, including the CPP and ORPP, are widely politicized and unfortunately, the real pension experts are not the ones being consulted to carry out such studies. Instead, we get academic or quasi-academic hacks publishing spurious studies that are not putting their findings in proper context.

If Philip Cross and Joel Emes or anyone else at the Fraser Institute wants to challenge my views, I'd me more than happy to give them an opportunity to reply to my comments (my email is I'd be even happier if someone like Leo de Bever wrote a study comparing all of Canada's large public pensions. When it comes to pensions, I like reading people who actually know what they're talking about.

Below, the Auditor General of Canada Michael Ferguson says the federal government is taking too long to provide disability benefits to some pensioners. Ferguson issued a series of reports Tuesday on government inefficiencies, mostly highlighting the incompetence of Harper's Conservative government.

None of this has anything to do with the way CPPIB is run but it underscores the need to have a strong national pension plan which provides secure pensions and disability payments to Canadians who need them most. In the near future, CPPIB will pass its next special examination, and I'm sure it will lay to rest a lot of the misinformation being spread on its supposedly high cost structure.

Lastly, I kindly remind all of you that unlike the Fraser Institute, the Leo Kolivakis Institute doesn't have big banks and insurance companies funding it, so if you like reading my comments, please subscribe or donate on the right hand side of this blog and show your appreciation for the best free lunch on pensions and investments on the internet. Thank you and have a great day!

Tuesday, February 2, 2016

Ultra Low Rates For Years?

David Brown wrote an excellent comment for the South China Morning Post, Major economies will be saddled with ultra low rates for years:
Global markets are digging themselves into a deep hole. Sheer panic seems to be setting in over the spectre of world economic slowdown, chronic deflation worries and financial markets caught in a tail-spin. 2016 is shaping up as another painful phase of the seven-year-old global financial crisis.

The trouble is that global policymakers seem to be running out of fresh ideas to deal with this new leg of contagion. The major central banks have already deployed most of their monetary armoury in dealing with successive waves of the crisis since 2008.

Global central banks are close to running on empty. Interest rates have been slashed to rock bottom levels and a tonne of quantitative easing has already been thrown into the monetary reflation pile.

There is one very obvious clue to what happens next. Interest rates either need to go a lot lower or else the QE generators need to get cranked up again. The implication for markets is that the major economies will be saddled with ultra low rates for years.

It is causing mayhem for monetary policymaking and forcing rushed decisions. The European Central Bank is already setting the stage for another likely deposit rate cut in March, which will push euro zone rates even deeper into negative territory. [The interest rates of G7 nations are converging towards the Japan model, which have been hovering near zero for 20 years.] The interest rates of G7 nations are converging towards the Japan model, which have been hovering near zero for 20 years.

The Bank of England is also having second thoughts about monetary policy tightening and looks set to postpone a well-flagged plan to hike UK interest rates until at least 2017. The central bank believes the UK economic outlook is too fragile to sustain higher rates at this stage.

Deepening financial market turmoil will also stop the US Federal Reserve dead in its tracks on rate tightening. Despite the strength of the domestic economy and extremely positive employment trends in recent years, the US central bank is fretting again about the weakness of the global economy.

Worries about China and the fragility of emerging economies, especially Brazil and Russia, could put future US rate hikes on ice for a long while. And if conditions start to deteriorate much further, threatening to derail growth altogether, the Fed could be pushed into a dramatic policy U-turn. Last December’s rate rise would need to be reversed and the Fed might even need to consider kick-starting QE again to extend its bond-buying programme.

If the global slowdown starts to get out of hand and deeper deflation persists then interest rates around the world will continue to converge towards zero and remain that way for a long while. The Fed slashed rates near to zero at the end of 2008 and held them there for seven years. The same fate could befall other economies over coming years.

The experience of Japan in the last three decades is bound to resonate. From the mid-1990s onwards, Japan has struggled with episodes of recession, weak recovery and chronic deflation. Even after repeated rounds of government and Bank of Japan policy interventions the economy is still struggling. The legacy has been interest rates stuck at ultra-low levels for 20 years.

A global crash is not inevitable. Markets seem to be turning a drama into a crisis, but it is no hard landing yet. Growth in China may be at its weakest for 25 years, but it is still robust at 6.9 per cent. Underlying economic growth running around 2 per cent in the US and UK looks reasonable too. Even the euro zone’s underlying 1.5 per cent growth rate is far from being a disaster. Growth simply needs to be re-energised.

Global policymakers can call a halt to the slide, but they need to make a united stand, to think and act together. The ECB’s hint last week that it might add more monetary stimulus in March is a positive step, but more needs to be done by other central banks too.

The leading nations need a much more coherent and co-ordinated strategy to deal with damaging global headwinds. By working together through supranational bodies like the Group of Seven, G20 and International Monetary Fund, the leading nations can make a difference.

Better co-ordination of monetary and fiscal reflation on a broad front could turn the tide. And the major nations should avoid competitive currency devaluations which are little more than short term beggar-thy-neighbour palliatives.

The world economy can avoid becoming a victim again. Global policymakers simply need to pull together and promote the right remedies to beat the blues. Urgency is the watchword now.
On Friday, I wrote a comment on the new negative normal which I subsequently edited over the weekend to include comments from former chairman Ben Bernanke who said the Federal Reserve should consider using negative rates to counter the next serious downturn:
“I think negative rates are something the Fed will and probably should consider if the situation arises,” Bernanke said in the interview last month.

Read full interview: Bernanke: I never expected 0% rates to last so long

Former Fed Vice Chairman Alan Blinder urged the Fed during the financial crisis to set negative interest rates for overnight deposits — essentially charging banks a fee to park funds at the central bank.

Blinder argued this would force banks to find more productive uses for the money.

Bernanke and his colleagues opted not to push interest rates below zero, worried that the costs outweighed the benefits. In particular, there was a concern that money-market funds wouldn’t be able to recover management fees.

But experience in Europe has shown this fear was unfounded.

In the region, the European Central Bank, the Swiss National Bank and the central banks of Denmark and Sweden have deployed negative rates to some degree.

For instance, earlier in December, the ECB cut its deposit rate to negative 0.3% from negative 0.2%.

Bernanke said he was surprised by how negative rates have been able to fall in Europe.

Bernanke suggested negative rates can’t be the Fed’s primary tool to combat a recession.

“The scope for negative nominal rates is fairly limited,” he said.

At some point, people begin to hoard cash, which has a zero interest rate, he noted. And quirks in the U.S. financial system also limit the utility of negative rates, he said.

Bernanke said he hadn’t heard anecdotes of ordinary people being affected in Europe, as personal checking accounts are not paying negative rates.
We can argue about the scope of negative nominal interest rates and quantitative easing, but there's no denying that central banks are the only game in town and there's a deflation tsunami coming our way which means ultra low rates or negative rates are here to stay.

Bloomberg reports that factories in the euro area slashed prices of goods by the most in a year in January, highlighting the deflationary risks that’s keeping alarm bells ringing at the European Central Bank. And the Korea Times reports that consumer price growth fell to below 1 percent in January, stoking worries of deflationary risks.

I know of a few large public pension funds in Canada, like the Caisse, that have systematically got it wrong on the direction of interest rates and they're not the only ones buying Wall Street's garbage on the "busting of the bond bubble."

Bursting of the bond bubble? Tell that to all those JGB bears who got their heads handed to them over the last 20 years betting against Japanese bonds. And now that the Bank of Japan has joined the "negative rate club," these JGB bears are getting massacred.

I've long argued that when it comes to asset allocation, you need to keep in mind six major structural issues:
  • The global jobs crisis
  • Aging demographics
  • The global pension crisis
  • Rising inequality
  • High and unsustainable debt all over the world
  • Technological advances 
Now, we can argue about how much each of these structural factors contribute to global deflation, but there's no doubt that they exacerbate deflationary headwinds all over the world and that's why rates will remain ultra low for years to come.

What are the implications of deflation and ultra low or negative rates that could last decades? Well, for one thing, it means we should expect much lower returns ahead and a lot more volatility in financial markets as risk premiums get crushed across the board.

This is just common sense. The yield on the 10-year U.S. Treasury bond currently stands at 1.86% and it's dropping fast along with oil prices. This means institutions looking to make an annualized target rate-of return of 7% nominal or more over the next decade need to take a lot more risk to achieve that return.

Where are they taking that risk? In stocks, corporate bonds but increasingly in illiquid private equity, real estate and infrastructure and also in hedge funds that promise absolute returns even though they're incapable of escaping the market carnage.

But if rates remain ultra low, won't that be good for residential and commercial real estate? Not necessarily. If deflation becomes entrenched, low rates will exacerbate debt and increase unemployment at the worst possible time. It can easily spiral into a debt deflation crisis and you'll see rising vacancy rates and/ or declining rental rates.

In this environment, real estate is the asset class that makes me most nervous. This is especially true in prime markets like New York and London which rely on vibrant financial markets. They're going to suffer the most because they rose the most since 2009.

But it's not just real estate that will suffer if deflation becomes more entrenched. All asset classes will exhibit a prolonged period of low or negative returns except for...good old nominal bonds!

Still, there is a titanic battle over deflation going on and central banks aren't going down without a fight. This means there will be plenty of opportunities to capitalize on short-term swings in these markets but individuals and institutions will need to get more accustomed to volatility and playing a game which isn't exactly easy to play even for the most experienced traders.

I know, I trade these markets, I'm on these markets and see firsthand how tough they are to trade. I don't care who you are, it's a brutal environment out there. Period.

Below, Russell Rhoads, education director at the Chicago Board Options Exchange’s Options Institute, explains the change in the volatility regime.“We actually appear to be coming out of a low-volatility regime and going into a high-volatility regime, which is normally characterized by VIX "spending more time in the 20s,”  he says.

But he also adds: “The VIX was elevated going into 2016 and has stayed up in the 20s without the same sort of follow-through to the upside that we saw in August because there's been a lack of surprise, for lack of a better term.”

What this means is that while the market is extremely edgy, there's a lack of complacency, and there's room for an upside surprise in the near term. I stick by my comments on why the bloodbath in stocks is over and why oil's nightmare dominated Davos.

I'm still waiting for high beta stocks, especially high beta biotech stocks, to decouple from oil but that's proving to be very difficult in an uncertain environment where deflation fears reign. Still, stay tuned, when rates are ultra low for years, you just never know where the next bubble is brewing!!

Monday, February 1, 2016

CPPIB's Focus on Gender Diversity?

CPPIB has a message to all women in finance, it's actively looking for you:
At CPPIB, our goal is to have an employee population that reflects the communities in which we operate. This is because we believe that diversity - of insights, backgrounds and experiences - leads to better decisions and business outcomes. Attracting, developing and retaining talented women is particularly important to our success as a high-performing global organization. By 2020, our goal is to have half of all of our new hires be women.

To help us achieve these goals, we have a variety of programs and resources ­ including coaching, mentoring, sponsorships, and internships ­ that help attract women early in their careers and then provide them with ongoing development and growth opportunities so they can enjoy the most challenging and fulfilling careers possible.

As part of our commitment to supporting the development of women, we recently established a partnership with Women in Capital Markets, the largest network of professional women in the Canadian financial sector and voice of advocacy for women in our industry. An element of this partnership is a new women’s internship program designed specifically for women in undergraduate programs who are curious about business and interested in exploring and being mentored in the world of finance and investments. This four month summer internship teaches technical skills used in the financial and investment industries, enables participants to engage in meaningful work and activities designed to develop business acumen, and provides opportunities to collaborate with colleagues, leaders and industry experts.

Our focus on gender diversity was recently underscored when our President and CEO, Mark Wiseman, was honoured with a “WCM” Leadership Award. This annual award recognizes members of the financial community who have demonstrated a commitment to advancing and supporting women working in capital markets.

In receiving this award, Mark commented that “we have made a commitment to advancing the role of women at our firm and in our industry...No organization can achieve the best business results when they restrict themselves to half the population in recruiting, developing and retaining talent. This Leadership Award truly recognizes the efforts of our entire organization to advance and support the careers of women in capital markets.”

Learn more about CPPIB career opportunities and our commitment to diversity by visiting our Careers page.
Diversity, or lack of diversity, is a hot topic these days, especially in Hollywood where Viola Davis had her say on the debate at the SAG Awards over the weekend. I'm not going to get into the whole Hollywood diversity debate except to say that my favorite movie of all-time remains The Shawshank Redemption (1994) featuring one of my favorite actors, the great Morgan Freeman.

When you are a great actor, you'll be recognized by your peers. Period. Having said this, there undoubtedly is a lack of diversity in Hollywood and more importantly, lack of diverse, original ideas which explains the crappy movies that have been coming out in the last decade.

In fact, I had an email exchange with a friend of mine who is an entertainment lawyer bemoaning all this:
In my humble opinion, Hollywood has been in a recession for over a decade, and the main reason is deflation of original ideas, not piracy!

I was watching a classic comedy, Sideways (2004), with Paul Giamatti. When is the last time Hollywood came up with a script that compares to this???

Forget it, as long as Hollywood remains oblivious to people's reality, I'm not going to shed a tear for these jerks!
To which my friend replied:
I didn’t want to shed any tears for them either, but I couldn’t help it when they announced that Star Wars VII had earned a billion dollars faster than any other movie in history and would shatter Avatar and Titanic worldwide box office records within a month. Disney is a money-printing machine.

However, only two companies account for nearly all of Hollywood’s profits this year (Disney and Universal), while others were suffering layoffs (Paramount, Weinstein Co., and Relativity).
I found his reply very interesting and think it explains why Disney's shares (DIS) have done well over the last five years and it may be time to buy the recent dip. If you're looking for a recession-proof industry, this is it, but make sure you're investing in the right company, one that reflects real diversity and has original content.

Anyways, enough on Hollywood, let's get back to the real world and CPPIB's push for more gender diversity. I've been an outspoken critic of the lack of diversity in the workplace at Canada's Top Ten so I welcome all these initiatives to introduce a more diverse workforce.

In my opinion, it's simply indefensible for any public pension fund, government organization, Crown corporation or even large private sector employer like a federally regulated bank not to have a truly diverse workforce. 

So, in that regard, I applaud CPPIB's push for more gender diversity. Mark Wiseman may be a creature of habit but he comes from a family with diverse interests and his partner of more than 22 years, Marcia Moffat, was a vice-president at the Royal Bank of Canada before joining Blackrock as head of the Canadian business (a little conflict of interest there but I'm sure it's all kosher).

According to the Globe and Mail article,  they met on his first day at the University of Toronto. “I am, I think, the world’s greatest Jewish Christmas tree cutter,” Wiseman said. “My kids get all the holidays.”

The chair of the Board at CPPIB,  Dr. Heather Munroe-Blum, might have gotten in a bit of hot water over her own pension benefits, but there's no denying she's an extremely accomplished lady, receiving many accolades from the academic community including honorary degrees from various universities and the Order of Canada.

According to Wikipedia, Dr. Munroe-Blum trained as an epidemiologist and has led large-scale epidemiological investigations related to psychiatric disorders.  She is the author or co-author of over 60 scholarly publications, including four books. She has served on the board of directors of the Medical Research Council of Canada (now the Canadian Institutes of Health Research) as well as on international reviews of the German Academic Exchange Service (DAAD), the Swiss National Science Foundation, and the National Institute of Mental Health (USA).

My father and brother are psychiatrists at McGill and I think very highly of doctors, especially those on the front lines fighting mental illness in our society.

Was CPPIB's focus on more gender diversity pushed from the top? I don't know but knowing a bit about Heather Munroe-Blum (never met the lady), I can guarantee you she's definitely no pushover and had something to do with it.

And again, while I applaud all these initiatives on introducing more diversity at the workplace, the sad reality is that a lot more needs to be done. When I look at CPPIB's board of directors or it senior management team, I see a lot of white Anglo-Saxon Canadians, but I definitely don't see a snapshot of Canada's diverse population. 

I'm not going to sugarcoat it. Diversity initiatives are all great but when you dig a little deeper at CPPIB or the rest of Canada's Top Ten, you'll see how pathetically diverse they are at the board or senior management level. And while women are properly represented at the board level (by law, they have to be!), we have yet to have a woman nominated to the position of CEO of a major Canadian pension fund (hopefully that will change with Ontario's new ORPP).

What else? I challenge all of Canada's Top Ten to take a page from the Royal Bank of Canada and publish their own Diversity Blueprint and provide their own vision and priorities for diversity and inclusion and back it up with hard statistics that are readily available on their website.

For example, the Royal Bank publishes a Diversity and Inclusion Report as well as an Employment Equity Report and a diversity report card setting out initiatives and whether they were met.

Now, the Royal Bank isn't exactly a paradigm of diversity, especially in upper management and a lot of this stuff is corporate marketing fluff, but it has done more than any other organization to promote diversity at all levels and unlike other organizations, it has a recruitment program specifically designed for people with disabilities.

On page 5 of its Diversity and Inclusion Report, the bank provides us with hard numbers (click on image):

You might be wondering why don't all of Canada's big banks, large public pension funds, Crown corporations and government organizations follow the Royal Bank and publish their own diversity reports reflecting objectives and a scoreboard (it would be nice if they published statistics on pay equity too).

The answer is pure laziness and nobody really wants to report on diversity at all levels of their organization because if they did, most Canadians would be appalled.

When I privately confront the leaders of Canada's Top Ten pensions on diversity in the workplace, especially in regard to persons with disabilities, they either dismiss me or state some generic statement like "we take employment equity very seriously."

Really? Where are the statistics in your annual report or on your website? Worse still, when applying to jobs at Canada's Top Ten pensions, some of them don't even ask you to self-identify your gender or whether you're a visible minority, aboriginal or person with a disability.

My favorite is when I confront leaders and they assure me "they take diversity seriously" but always make sure they hire the "best and brightest" no matter their gender, sexual orientation, ethnicity or disability.

Of course, this is all nonsense as the unemployment rate for people with disabilities is running close to 75% and it's not because they lack competence or skills for jobs (the unemployment rate for aboriginals is equally appalling). In most cases, they're more skilled and a lot more competent than people with no disability but our society systematically discriminates against people with disabilities and so do our public and private organizations.

All this to say I welcome any initiative which focuses on diversity but there's a lot more that needs to be done on this front at all of Canada's Top Ten public pensions.

And just so you know, while CPPIB is publicly discussing gender diversity, others like the Caisse have made significant improvements in terms of diversity in the workplace under Michael Sabia's watch. But you won't hear of this push for diversity at the Caisse which is one of the few public pensions that asks candidates to self-identify when applying to positions.

Still, the Caisse also needs to hire more people with disabilities and allow them to access that bloody elevator at the main entrance on Jean-Paul Riopelle which is only reserved for big shots like Sabia.

Let me stop right there because this is a topic that makes my blood boil for a lot of personal reasons and the leaders at Canada's Top Ten all know exactly what I'm talking about. While they quietly make off like bandits in what is essentially a rigged system, Canada's best senior pension and investment analyst has been relegated to the blogosphere, in large part because he suffers from Multiple Sclerosis (and is doing just fine, knock on wood!).

Below, listen to CPPIB leaders talk about their commitment to diversity and their programs to support women. Mark Wiseman is right, there's been progress but there's a lot more room for improvement, including a recruitment program that specifically targets persons with disabilities.

Lastly, a little note to Mark Wiseman, the next time you're dining at La Bettola Di Terroni, lay off the San Giorgio pizza. Pizzas and ham and cheese sandwiches are fine once in a blue moon but you need to take better care of your health and go for the tuna salad more often (follow Matt Embry's advice as much as possible regardless of whether or not you have MS).

Also, next time you're in Montreal, I'll take you and your PSP counterpart to lunch at Milos and we'll enjoy the best healthy lunch special at the best restaurant in the country (Toronto has big bucks but it's no Montreal when it comes to fine dining, especially Greek restaurants).

As far as the rest of the leaders at all of Canada's Top Ten, take my comments on diversity very seriously. It's a topic that makes some of you uncomfortable but that's ok, in life, we have to deal with inconvenient and uncomfortable truths, not run away or hide from them.

I hope you take my diversity challenge seriously and back it up with your own diversity blueprint and report which is made publicly available for all stakeholders.

And for pete's sake, if you haven't subscribed to Pension Pulse yet, what are you waiting for? Better yet, hire me and pay me big bucks, putting yourselves out of the misery of reading my blog comments! -:)