Monday, November 3, 2008

Straight Talk on the Pension Fiasco


I started the day listening to Anna Maria Tremonti on CBC radio's The Current interviewing Keith Ambachtsheer, Director of the Rotman International Centre for Pension Management at the University of Toronto and David Wheeler, Dean of the Faculty of Management at Dalhousie University (click on part one of this link to listen to the interview).

I happen to agree with comments from both Keith Ambachtsheer of KPA Advisory Services and David Wheeler.

Mr. Wheeler mentioned the article in today's Globe and Mail discussing the crisis in university endowments that got whacked in the latest market selloff, forcing them to now cut back:

Stock markets around the world are down more than 30 per cent this year and dropped roughly 17 per cent last month alone. That has cost universities hundreds of millions of dollars because on average more than half of their endowment and pension funds are invested in financial markets.

"We are down big time in terms of the market value of our endowment fund," said David Mitchell, vice-principal of advancement at Queen's University in Kingston. At the end of September - before the worst of the market woes - Queen's had lost more than $100-million in its endowment, which had fallen to $550.6-million from $658.2-million.

Gary Brewer, York University's vice-president of finance, said the school's $300-million endowment fund has lost roughly $45-million this year, and its $1.3-billion pension fund is down nearly $200 million.

"These are substantial numbers and the implications on our operating budget could be significant and could be directly felt in short order," Mr. Brewer said.

He said the university is also dealing with a roughly $44-million deficit in its pension plan.

Others are facing similar losses. U Vic's $150-million endowment was down about 9 per cent at the end of September. Dalhousie University's is down roughly $30-million to $320-million, and the University of Toronto lost nearly 9 per cent during the third quarter on its $5.5-billion pension and endowment funds. For most schools, those losses came on top of weak investment performance last year.

Mr. Wheeler is absolutely correct that we can't expect 9% rates of return going forward, but Mr. Ambachtsheer is also right that the correction was so fierce, so violent, that it brought valuations back to reasonable levels based on historic norms.

In my opinion, the problem with Mr. Ambachtsheer's argument is that we have yet to experience the full extent of the consumer recession which will hit the United States and we still do not know what will happen to the $62 trillion of CDS debt out there in the global financial system and how hard commercial real estate will get hit in the next few years.

In other words, there are still too many hidden risks out there to get overly optimistic.

I am a structural bull on the solar, biotech and infrastructure sectors and was happy to see both Solarfun (SOLF) and Stemcells (STEM) be among the biggest percentage gainers today prior to the elections (Hint: an Obama victory will benefit alternative energy and biotech for many years).

In fact, all solar shares were on fire today, including First Solar (FSLR), Evergreen Solar (ESLR), Renesola (SOL), Trina Solar (TSL), Yingli Green Holdings (YGE) , Canadian Solar (CSIQ), Sun Power (SPWRA), Timminco (TIM.TO) and 5N Plus (VNP.TO).

As I stated in an earlier post, there are reasons to believe in the long-term structural story of solar energy and the recent dislocation in the sector was so severe that it created a tremendous buying opportunity. Many solar companies are already profitable and growing earnings at a feverish pace and others are on their way. At the very least, this sector should be on your radar.

However, I will warn you that it is a very volatile sector and when these shares move up (or down), they move up fast, mostly because the shorts have to cover fast or risk getting slaughtered. This is why you see stocks in this sector swing like mad.

What I found encouraging today was that the price of oil fell and solar stocks moved up. As I told my buddy tonight, with an Obama victory tomorrow, this could be the beginning of the "Great Decoupling" we are waiting for - where solar shares decouple from the price of oil for good (I do not believe in the other decoupling theory which states the rest of the world has decoupled from the United States).

Anyways, back to pension funds and public policy. Bloomberg reported that Canadian Finance Minister Jim Flaherty is seeking support from his provincial counterparts today for additional steps to bolster markets, including help for private pension funds and a renewed push for a single securities regulator:

Flaherty is holding a three-hour meeting that began at 9 a.m. with finance and treasury ministers from the country's 13 provinces and territories at a hotel near the Toronto airport. The officials will discuss easing the growing funding gaps at pension funds because of falling stock prices, Flaherty said in an Oct. 31 interview.

``Right now I'm just gauging the extent of the issue,'' Flaherty said in New York. ``I also want to talk to the provincial finance ministers about it. The provinces have a big part of the regulation as well.''

The Finance Minister should read my pension blog every day and get a hold of the report I wrote for the Treasury Board Secretariat of Canada last summer.

In two words, it's a "bloody mess" because the governance of large public pension funds and securities laws and regulation in Canada are a total farce!

I believe that public pension plans need to be held to the highest standards of governance on all key areas, including oversight, compliance with legislation, benefits administration, funding policy, asset management and last but not least, communication.

It is interesting to note that when you look at the Auditor General's list of Crown corporations, both the Canada Pension Plan Investment Board and the Public Sector Pension Plan Investment Board are exempt from the Financial Administration Act (along with the Bank of Canada and a few others).

Why is this the case? Consider the Treasury Board's overview of the Financial Administration Act:

The Financial Administration Act (FAA) is the cornerstone of the legal framework for general financial management and accountability of public service organizations and Crown corporations. It sets out a series of fundamental principles on the manner in which government spending may be approved, expenditures can be made, revenues obtained, and funds borrowed.

The FAA also provides a procedure for the internal control of funds allocated to departments and agencies by Parliament and for the preparation of the Public Accounts that contain the government's annual statement of expenses and revenues. The financial statements are presented to the Auditor General of Canada, who provides an independent opinion on them to the House of Commons.

By exempting certain Crown corporations from this Act, you allow them to operate in a non-transparent manner, effectively undermining the governance of these organizations.

Importantly, when it comes to public pension funds, we need more transparency and more accountability, not less.

I would force each public pension fund in Canada to report quarterly results, explain in detail all the benchmarks governing each and every investment activity, post their funding policy and ways they would rectify a severe pension shortfall, post all the minutes from each Board meeting so stakeholders know who how each board member voted and finally, subject the pension fund to rigorous, independent performance audits twice a year (on top of any financial audits or special examinations) and post the results on-line.

Am I just a bitter ex-employee with an axe to grind? Sure, many will dismiss my criticism on those flimsy grounds, but the truth is that I saw this pension tsunami coming a long time ago and I warned my superiors about it.

But the purpose of this blog is not for me to pound my chest and scream "I WAS RIGHT" but to jolt stakeholders, government supervisors and concerned citizens into doing something to drastically improve pension governance so that pension funds will be better prepared for the next financial crisis.

My sources tell me that some of the largest public pension funds in Canada are in deep, deep trouble. No surprise there but I ask you, what are we going to do about it? Are we going to sit idly by or force our politicians to clean up this pension fiasco once and for all?

I made my decision a long time ago when I started this blog. It isn't easy writing almost every day but I feel compelled to inform people about issues that pertain to their financial security and public policy.

Hopefully others will join me in my quest to improve the governance of our public pension funds so that we can maintain the pension promise for future generations.

On the eve of the most important presidential election of our lifetime, I think we can all agree that the time has finally come for real change.

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