Showing posts from June, 2008

Pensions and the Toxic Debt Time Bomb

There is a time bomb about to explode and it has to do with pension funds that invested in risky and no-so-risky colateralized debt obligations (CDOs). Last July, Bloomberg markets wrote an excellent piece entitled, The Poison in Your Pension (click hyperlink to view). The article describes how banks were selling the riskiest CDO tranches, known as toxic waste, to public pension funds and state trust funds (click on image above to see who are the buyers of CDOs).

CDOs are packages of securities backed by bonds, mortgages and other loans. It turns out that some large public pension funds, including the California Public Employees' Retirement System (CalPERS), the largest U.S. public pension fund, invested in the equity tranches of CDOs to boost their returns. And CalPERS was not the only public pension fund to invest in these risky assets.

Once the subprime crisis hit, the values of these securities plummeted. I quote from the article:

"Because CDO contents are secretive, fund …

It's All About Deflation Stupid!

Amazing how many people are fixated on inflation. The media's myopic focus on inflation is understandable given the surge in oil and commodity prices.

Looking for answers, the media and politicians have decided to focus their attention on speculators like hedge funds and Commodity Trading Advisers (CTAs) that speculate on commodity trends. Pension funds have also come under close scrutiny as the U.S. Congress contemplates a proposal to ban pension funds from investing in commodity futures. The next time you fill up your gas tank or buy groceries, just remember that chances are your pension contributions are helping drive up the price of oil and other commodities.

Why are pension funds investing in passive commodity futures indexes, especially here in Canada where the S&P/TSX is dominated by energy and commodity shares? The rationale for investing into commodities and other hard assets like real estate, infrastructure and timberland is that they are "inflation sensitive&qu…

The Mother of All Ursas?

Michael Metz, Chief Investment Strategist at Oppenheimer once remarked that "it's worse being a bear when you're right". Indeed, if you make money during a down market, don't tell your neighbors.

Big institutions have all sorts of ways to make money during bear markets including investing in hedge funds as well as developing internal absolute return strategies. Unfortunately, while hedge funds sound sexy, the reality is that most hedge funds are charging fees for disguised beta. Just like private equity funds, if you are not invested in the top hedge funds - and there aren't that many of them increasing their capacity to accept new capital - you are going to get creamed in these treacherous markets.

But there is another way for large and small investors to make money in down markets. Financial engineers have developed new products that anyone can buy and sell to make money when stocks dive. They are called Short and UltraShort Proshares ETFs and you can read …

Alternative Investments and Bogus Benchmarks

This week, I will dig deeper into the issue of alternative investments, focusing once again on the benchmarks that Board of Directors use to compensate their investment managers at public pension funds.

The bear market that gripped public markets following the tech meltdown was a perfect storm for pension funds. Returns on public stock indexes fell and liabilities grew as interest rates fell to historically low levels.

At the time, pension funds were worried they would suffer severe funding shortfalls. To juice up their sagging portfolios, pension fund managers moved their asset allocation away from public stocks and bonds and into alternative investments like real estate, private equity, hedge funds, infrastructure, commodities and timberland. A recent study by Watson Wyatt Research shows that despite their skepticism, pension funds continue to drive the growth in alternative investments. Every sophisticated and not-so-sophisticated pension fund wants to emulate the Harvard and Yale en…

The ABCP's of Pension Governance

The asset-backed commercial paper (ABCP) crisis that hit Canada last August highlights the need to look deeper into a subject that receives little attention in the financial press, namely, pension governance.

Several of the largest public pension plans in Canada, including the Caisse de dépôt et placement du Québec, Ontario Teachers Pension Plan, and PSP Investments were among the institutions that held asset backed commercial paper in their books. (see Diane Urquhart's Another Made-in-Canada Defective Investment Productfor a critical review of the Third Party ABCP market).

So what does the ABCP crisis have to do with pension governance? It turns out, a lot. Pension governance is the system of structures and processes implemented to ensure both the compliance with laws and the effective and efficient administration and investment of the pension plan.

In essence, pension governance covers the "who" and the "what" of decision making at pension funds. Who is ultimat…