Monday, October 26, 2009

Partial Recovery in Global Pensions?


Reuters reports that Pensions funds recouping some of 2008 losses:
Pension funds tracked by the OECD recovered $1.5 trillion (918 billion pounds) in the first half of 2009 of the $5.4 trillion they lost in market value last year, the Organisation for Economic Co-operation and Development said on Monday.

"The recovery in pension fund performance has continued through September 30, 2009, on the back of strong equity returns, but it will be some time before the 2008 losses are fully recouped," the Paris-based agency said.

Pension funds staged a partial recovery in the first half, generating investment returns of 3.5 percent in nominal terms, said the OECD, whose 30 members are mostly rich industrialised economies (click on image above to enlarge).

Best performing funds in the OECD area were, on average, in Norway and Turkey, with nominal returns of more than 10 percent, compared with nominal returns of 4 percent for funds in the United States, the report said.

Total pension funds assets still remained 14 percent below their December 2007 levels as of June 30, 2009, it said in a report called OECD Pensions Markets in Focus.

"Thanks to the stock market rally in emerging markets, some non-OECD countries have already largely made up their 2008 investment losses," the report said.

By the middle of the year, Chilean pension funds had largely made up their 2008 losses, while assets of Israeli pension funds were above their December 2007 level, the report said.

The market value of pension funds tracked by the OECD fell to $22.4 trillion by the end of 2008 from $27.8 trillion at the end of 2007.

Global share prices as measured by the MSCI All-Country World Index have risen close to 70 percent from a trough in early March.

Click here to read the OECD report on pensions. The rally in global stock markets has helped fuel the partial recovery in OECD pension assets but it will take years before these assets fully recover. Why? Because given the low bond yields throughout the developed world, it is unrealistic to expect stocks to continue rising at this blistering pace.

However, I have argued that a liquidity driven rally means that stock prices can disconnect from fundamentals for a while but not indefinitely. Global stock markets are pricing in a global V-shaped recovery but the recovery may be more modest than what is being priced in.

Paul Hannon and John W. Miller of the WSJ report that Trade Data Underscore Weakness of Recovery:

Global trade flows slipped in August after rising for the two previous months, an indication that the economic recovery is more fragile and anemic than previous data have hinted.

The Netherlands Bureau for Economic Policy Analysis said trade volumes fell 2% from July, according to an algorithm based on customs data from 23 developed countries and 60 emerging markets, accounting for 95% of global trade.

The report is closely watched because it comes out before those compiled by the World Trade Organization and other institutions.

Global trade flows plummeted in the final months of last year as demand slowed and banks financed fewer cross-border transactions. Volumes were down 13% in August compared with the previous year.

The trade crisis has hit exporting powerhouses such as Japan and Germany particularly hard, sparked minor waves of protectionism almost everywhere, and inspired world leaders to make more funds available for trade finance.

The International Monetary Fund says world trade will fall 11.9% overall in 2009, the biggest drop since the Great Depression. The IMF sees a modest 2.5% increase in 2010.

Flows steadied during the second quarter of 2009, inspiring hopes of a recovery. The Organization for Economic Cooperation and Development said Friday that exports from the Group of Seven leading industrial nations rose 0.8% from the first quarter, although imports continued to fall, by 2.5%.

The Netherlands Bureau for Economic Policy Analysis, also known by its Dutch acronym CPB, calculated that trade was up 3.7% in July over June, prompting many observers to conclude that a true recovery was under way.

Many analysts, however, say the trend has bottomed out but that it is too early to predict where it will end in the next few months.

In a report released with the numbers, the CPB warned against placing too much emphasis on one month's trade figures, saying they are "volatile." It noted that in the three months to August, trade flows were up 1.8% on the three months to May.

One point of concern is that exporters are increasingly dependent on Asia to fuel export growth. Imports by emerging markets in Asia, including China were up 6.6% in the three months leading up to August, the CPB said.

"Chinese demand is sucking up a lot of that Middle Eastern petrochemical product that's not flowing into Europe or the U.S.," says Richard Longden, a spokesman for Ineos Group Ltd., a U.K.-based petrochemical group. "The challenge that remains particularly for European producers is the slow return of domestic demand."

Global trade is a key barometer for global growth. And the challenges plaguing European producers have been exacerbated by the appreciation of the euro relative to the U.S. dollar. This is one reason why I believe it's silly to claim the death-defying dollar is doomed. Moreover, the Chinese disconnect will jeopardize the global recovery by harming global trade.

So while OECD pension assets have recovered from 2008, mostly because global equity markets have soared from their March lows, the future looks very uncertain. Liquidity rallies can only last for while, but ultimately the fundamentals have to justify the valuations or else gravity takes over.

[Note: Read Jeremy Grantham's latest comment posted on ZH.]

Perhaps this is why Canadian federal Finance Minister Jim Flaherty says "comprehensive reform" to federally regulated pension plans is on its way:

In question period Monday, Flaherty said his department has completed a "vast consultation" with various stakeholders across the country, led by his parliamentary secretary Ted Menzies. The consultation began last January.

Flaherty said this consultation will result in reforms which will be announced soon.

He added that the federal government has also created a working group with the provinces and territories to find a collaborative solution to pension problems in Canada, as fewer than 10 per cent of pension plans in Canada are federally regulated.

"This is a serious issue. It is not to be dealt with on the back of an envelope or by a knee-jerk reaction. It's to be dealt with collaboratively, intelligently and thoroughly by governments working together in Canada," Flaherty said.

Reports say these reforms could include allowing funds to carry a greater surplus than they can currently. Existing legislation prevents federally regulated employers from over-funding their pension plans by more than 10 per cent. The goal of this is to protect federal tax revenue, as contributions to pension plans are exempt from taxes.

The government is also considering requiring pension plans to report more often. Currently, if a federally regulated plan does not have a deficit, it only has to report every three years.

However, the Conservative government won't consider creating a federal program to protect pensioners in case a company goes bankrupt, something NDP Leader Jack Layton has proposed in the past.

Ontario is the only province that has a pension benefits guarantee fund, which provides the province's pensioners with up to $1,000 a month in the event a plan fails to provide its full benefit, or any benefit at all. It is funded by corporate contributions, and the government has no legal obligation to top it up.

However, the Ontario government has admitted that with only about $100 million in funds, the pension guarantee fund is dramatically underfunded.

Public and private pension plans across the country have taken a beating from the financial crisis as well as historically low interest rates, with many suffering serious solvency deficits as a result. In addition, the recession has pushed many companies into bankruptcy, leaving some pensioners in the lurch.

Many interest groups have called for a vast overhaul of Canada's pension system to protect pensioners as Canada's population ages.

A recent survey by the Office of the Superintendent of Financial Institutions put the average solvency ratio for the 400 or so private plans it regulates at 0.88 or 88 per cent as of June 30.

That means that, on average, the total value of assets in all federally regulated private plans were 12 per cent lower than liabilities. That was a three per cent improvement from December 2008 when the assets of such plans were 15 per cent short of liabilities.

But while the average solvency deficit was 12 per cent, it is much greater for some plans and in some cases has reached 50 per cent of more.

The time for comprehensive pension reforms can't come soon enough. I will reserve judgment until I see the final proposals. But I warn the Government of Canada, any proposals that do not address the serious governance gaps at our public pension plans are doomed to fail.

Finally, the Globe and Mail reports that in a speech given in Montreal today, Bank of Canada Governor Mark Carney warned banks against 'hubris:

Bank of Canada Governor Mark Carney, a former international investment banker, is taking aim at his former counterparts on Wall Street and in the City of London.

In remarkably forceful comments Monday, Mr. Carney suggested bankers in the United States and Europe are suffering from hubris, have lost sight of their proper role in the economy, and can't be trusted to operate in the best interests of the financial system.

“The financial system must transition from its self-appointed role as the apex of economic activity to once again be the servant of the real economy,” Mr. Carney said in a speech in Montreal. “Stronger institutions and a system that can withstand failure are necessary conditions. But full realization of this objective also requires a change of attitude.”

The comments were directed mostly at banks in the U.S. and Europe, based in New York and London, cities Mr. Carney worked in during a 12-year career with Goldman Sachs. They're also test grounds for the complex financial products and runaway risk-taking behind the financial crisis.

I went over Mr. Carney's entire speech and thought it was excellent and well articulated. In fact, I think the Bank of Canada can work with OSFI to play a key supervisory role of Canada's large public pension plans as well as federally regulated private pension plans.

The time for a new governance framework is long overdue and if the Government of Canada is going to get serious on pension reforms, it has to get serious about revamping the governance at Canadian public pension funds.

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