Time to Clean House at Pensions?

The CBC reports that Ontario cleans house at the OLG:

Ontario's finance minister has fired the head of the Ontario Lottery and Gaming Corporation and accepted the resignations of the entire board of directors in an attempt to head off another scandal.

Dwight Duncan told a news conference at Queen's Park on Monday that he was "taking action to ensure protection of taxpayers money."

Duncan said there had been problems with expenses and they represented "symptoms of much larger problems" at OLG.

The corporation's CEO, Kelly McDougald, was fired "for cause," said the minister. The entire six-member board stepped down.

The provincial auditor general has been asked to conduct a thorough review of OLG expenses.

Both McDougald and the board members were brought in to clean up the scandal-plagued organization.

Duncan released two years' worth of expense claims filed by OLG executives and senior staff that include questionable claims filed by executives going back years.

They included the cancellation of a deposit on a Florida condo by Michael Sharland, the OLG's former vice-president of security and surveillance who took a paid leave of absence in 2007.

Another OLG executive charged the agency nearly $500 for a nanny so that she could attend meetings during a four-month period in 2006.

Other senior staff billed the agency for small items like a $7 pen refill, a $1.12 cloth grocery bag and a $30 car wash.

Hudak calls for Duncan firing

Weekend reports suggested that a freedom-of-information request by the provincial Tories is behind the shakeup.

The Progressive Conservatives made a number of requests concerning the spending habits of OLG executives.

Duncan's announcement on Monday is an apparent attempt to deflect the results of those inquiries.

Shortly after Duncan's announcement, the Conservative leader levelled a number of scathing criticisms at the Liberal government called for the finance minister to be fired.

"The minister came forward with his phony remorse today simply because he got caught," Tim Hudak told reporters Monday afternoon.

The Tories had asked for information on the spending, Hudak said. The Liberals "knew it would be coming up in the opening session of the legislature, [so they] put it out today to head off the scandal," he said.

"But quite frankly, you can switch one Liberal hand-picked CEO with another one. But you're not going to stop the scandalous spending until [Premier Dalton] McGuinty sets the tone by firing one of his ministers.

"There's a concept called ministerial accountability. You can play musical CEOs all you want," Hudak said.

"That's not going to bring an end to this mess. We need the minister to step down."

The changes at OLG also come just a few months after a scandal at the government-run eHealth agency led to the resignation of CEO Sarah Kramer and board chair Alan Hudson.

The eHealth scandal resulted from untendered contracts, as well as lavish spending and picayune expense claims by consultants.

Duncan said Monday that Ontario McGuinty will address the problems at the OLG and outline a "broader set of initiatives" aimed at ending the expense claims problems within the provincial government.

According to the OLG's website, the lotteries generate "approximately $6 billion in annual revenues and $2 billion in annual profit" for the province.

Ten days ago, I posted on how Bonusgate spread to New Brunswick. I specifically mentioned that the Auditor General of Canada should question the bonuses that were recently awarded to senior managers at PSP Investments and relay her concerns to the Treasury Board and Department of Finance.

Moreover, provincial finance ministers should conduct a thorough performance, operational and fraud audit using independent industry experts on every major public pension fund in Canada, including provincial and federal crown corporations like OMERS, Ontario Teachers', and the Canada Pension Plan Investment Board (CPPIB). Some of these funds are hiding much more than others, but they all have secrets they want to keep from the public and they all game their private market benchmarks to reap big bonuses at the end of their fiscal year (again, some are much worse offenders than others).

Last week, the Globe and Mail reported that BC targets salaries for top public executives:

Salaries for top executives who serve on independent B.C. government agencies will be under the microscope as the cash-strapped province hunts for new ways to rein in spending, Finance Minister Colin Hansen says.

The government announced plans to review the fiscal performance of its Crown corporations, health authorities and other arm's-length agencies this week. Yesterday, Mr. Hansen said the often-controversial executive compensation will be part of that review.

"I think those are all issues we have to address," he told reporters in Victoria.

Eight years ago, the B.C. Liberal government launched a core review that aimed to dispense with functions that were not deemed to be essential government services. Now, it is reconsidering what should be arm's-length services, and what could better be delivered as direct government services.

"We want to be pragmatic, we want to look at the most cost-effective way of delivering services to the public ... and if that can be better structured by having an arm's-length organization, then that's what we'll do," Mr. Hansen said.

"If it's better to make sure we have a cohesive and consolidated approach to delivering services by ensuring those are delivered by line ministries, then we will do that."

NDP Leader Carole James said the review of independent government agencies is a bid to distract the public from the province's own mismanagement of public dollars.

"It's the old game of, 'point the finger somewhere else and don't look at us,' " she said yesterday. Ms. James noted that many of the agencies now under review were established by the Liberal government in the name of ending political interference.

The province last year released a list of executive compensation at Crown corporations, health authorities and other arm's-length agencies as it defended wage increases for its own top civil servants.

That list showed close to 150 executives at government agencies such as B.C. Hydro, the Fraser Health Authority and the Insurance Corp. of B.C. who earn more than the $188,000 that Gordon Campbell earned as premier last year.

At the time, the government pointed to those salaries to explain the need to raise the rates for its own senior civil servants.

Salaries at agencies such as the health authorities are approved not by government directly, but by boards that have been appointed by the provincial government.

Some agencies are more arm's-length than others.

Late last month, the province announced fiscal reviews of B.C. Ferries and TransLink, the transit service for Metro Vancouver. Those assessments, conducted by comptroller-general Cheryl Wenezenki-Yolland, may serve as the model for the other agency reviews.

Ms. Wenezenki-Yolland is examining how well the two operators have cut costs and delivered service to the public, and how they compensate senior executives. The announcement came the day the two agencies released details of their top managers' salaries.

B.C. Ferries chief executive officer David Hahn earned more than $1-million when incentives and pension contributions were included, putting him in the upper stratosphere of executives within the broad public service in B.C.

But B.C. Ferries is supposed to be independent of political interference, and officials there have said they will treat the results only as advice.

Meanwhile, the NDP focused its attention yesterday on the government's plans to adopt a harmonized sales tax next July.

Ms. James accused the government of lying to the public about its intentions on the tax during the last provincial election campaign. "Serving the people of British Columbia means telling them the truth," she said. Liberals maintained during the May election campaign that they did not intend to follow Ontario in adopting the HST.

Mr. Hansen told the legislature his government did evaluate the potential change but it wasn't until after the election that his finance analysts persuaded him it was a good move.

I have not covered the British Columbia Investment Management Corporation (bcIMC) much in my blog, but I did go over their 2008-2009 annual report and noticed that its President & CEO, Doug Pearce, got compensated $1,018,323, followed by Lincoln Webb, VP Private Placements who got compensated $616,112 and Bryan Thomson, VP Equity Investments, with a total compensation of $541, 367:

(click on image to enlarge)

Now, these are good compensations but nowhere near what their counterparts are getting in Eastern Canada and bcIMC is one of the largest funds in the country.

How did it perform in 2008-2009? From the annual report, we see that they lost 14.6% in 2008-2009 relative to their benchmark of -11.1%. In other words, they underperformed their benchmark by 3.5%, which is considerable, but their overall results are among the best of the large funds. Interestingly, bcIMC which is known to be "less sophisticated' than its counterparts in Canada, managed to lose a lot less than most of them and its senior managers didn't get paid anywhere near as well as most of their counterparts out east (not that they got paid badly either after losing billions).

Moreover, as shown below, bcIMC clearly presents its benchmarks in its annual report (page 21):

(click on image to enlarge)

I have issues with their private market benchmarks because in the good years, they are easy to beat and in the bad years, they are almost impossible to beat. This will come back to haunt them as private markets suffer a protracted downturn (better to use a spread over public markets to reflect the beta, illiquidity and leverage of private markets).

Finally, I read on Zero Hedge about Michael Moore's Latest Love Story: Capitalism (see video below). I wish Mr. Moore read some of my emails when I was discussing the pension crisis so he could see how the pension crooks steal money legally and get exalted at the same time.

Oh well, you will all have to wait for my movie to come out some time in the future. Till then, I hope politicians will clean house at Canada's public pension funds because while most people are hurting, the pension parrots are laughing all the way to the bank. Come on guys, show us your Lotto 6/49 happy dance!

Ted Kennedy Jr. On Climbing Hills

The world listened yesterday as Ted Kennedy Jr. remembered his father:

My name is Ted Kennedy Jr., a name I share with my son, a name I share with my father. Although it hasn't been easy at times to live with this name, I've never been more proud of it than I am today.

Your eminence, thank you for being here. You grace us with your presence.

To all the musicians who've come here, my father loved the arts and he would be so pleased for your performances today.

My heart is filled -- and I first want to say thank you -- my heart is filled with appreciation and gratitude. To the people of Massachusetts, my father's loyal staff -- in many ways, my dad's loss is just as great for them as it is for those of us in our family.

And to all of my father’s family and friends who have come to pay their respects, listening to people speak about how my father impacted their lives and the deep personal connection that people felt with my dad has been an overwhelming emotional experience.

My dad had the greatest friends in the world. All of you here are also my friends, and his greatest gift to me. I love you just as much as he did.

Sara Brown, the Taoiseach, President Obama, President Clinton, Secretary Clinton, President Bush, President Carter, you honor my family with your presence here today.

I remember how my dad would tell audiences years ago, "I don't mind not being President, I just mind that someone else is."

There is much to say, and much will be said, about Ted Kennedy the statesman, the master of the legislative process and bipartisan compromise, workhorse of the Senate, beacon of social justice and protector of the people.

There is also much to say and much will be said about my father the man. The storyteller, the lover of costume parties, a practical joker, the accomplished painter. He was a lover of everything French: cheese, wine, and women. He was a mountain climber, navigator, skipper, tactician, airplane pilot, rodeo rider, ski jumper, dog lover, and all around adventurer. Our family vacations left us all injured and exhausted.

He was a dinner table debater and devil's advocate. He was an Irishman and a proud member of the Democratic Party.

Here's one you may not know: Out of Harvard he was a Green Bay Packers recruit but decided to go to law school instead.

He was a devout Catholic whose faith helped him survive unbearable losses and whose teachings taught him that he had a moral obligation to help others in need.

He was not perfect, far from it. But my father believed in redemption and he never surrendered. Never stopped trying to right wrongs, be they the results of his own failings or of ours.

But today I'm simply compelled to remember Ted Kennedy as my father and my best friend. When I was 12 years old I was diagnosed with bone cancer and a few months after I lost my leg, there was a heavy snowfall over my childhood home outside of Washington D.C. My father went to the garage to get the old Flexible Flyer and asked me if I wanted to go sledding down the steep driveway. And I was trying to get used to my new artificial leg and the hill was covered with ice and snow and it wasn't easy for me to walk. And the hill was very slick and as I struggled to walk, I slipped and I fell on the ice and I started to cry and I said "I can't do this." I said, "I'll never be able to climb that hill."

And he lifted me in his strong, gentle arms and said something I'll never forget. He said "I know you'll do it, there is nothing you can't do. We're going to climb that hill together, even if it takes us all day."

Sure enough, he held me around my waist and we slowly made it to the top, and, you know, at age 12 losing a leg pretty much seems like the end of the world, but as I climbed onto his back and we flew down the hill that day I knew he was right. I knew I was going to be OK. You see, my father taught me that even our most profound losses are survivable and it is what we do with that loss, our ability to transform it into a positive event, that is one of my father's greatest lessons. He taught me that nothing is impossible.

During the summer months when I was growing up, my father would arrive late in the afternoon from Washington on Fridays and as soon as he got to Cape Cod, he would want to go straight out and practice sailing maneuvers . . . in anticipation of that weekend's races.

And we'd be out late, and the sun would be setting, and family dinner would be getting cold, and we’d still be out there practicing our jibes and spinnaker sets long after everyone else had gone ashore. Well one night, not another boat in sight on the summer sea, I asked him, "Why are we always the last ones on the water?" Teddy, he said, "Well, you see, most of the other sailors we race against are smarter and more talented than we are. But the reason why we are going to win is that we are going to work harder than them and we will be better prepared."

And he just wasn't talking about boating. My father admired perseverance. My father believed that to do a job effectively required a tremendous amount of time and effort.

Dad instilled in me also the importance of history and biography. He loved Boston and the amazing writers, and philosophers, and politicians from Massachusetts. He took me and my cousins to the Old North Church, and to Walden Pond, and to the homes of Herman Melville and Nathaniel Hawthorne in the Berkshires. He thought that Massachusetts was the greatest place on earth. And he had letters from many of its former senators like Daniel Webster and John Quincy Adams hanging on his walls, inspired by things heroic.

He was a civil war buff. When we were growing up he would pack us all into his car or rented camper and we would travel around to all the great battlefields. I remember he would frequently meet with his friend Shelby Foote at a particular site on the anniversary of a historic battle, just so he could appreciate better what the soldiers must have experienced on that day.

He believed that in order to know what to do in the future, you had to understand the past. My father loved other old things. He loved his classic wooden schooner, the Mya, He loved lighthouses and his 1973 Pontiac convertible.

My father taught me to treat everyone I meet, no matter what station in life, with the same dignity and respect. He could be discussing arm control with the president at 3 p.m. and meeting with a union carpenter on fair wage legislation or a New Bedford fisherman on fisheries policy at 4:30.

I once told him that he accidentally left some money, I remember this when I was a little kid, on the sink in our hotel room. And he replied "Teddy, let me tell you something. Making beds all day is back-breaking work. The woman who has to clean up after us today has a family to feed."

And that's just the kind of guy he was.

He answered Uncle Joe's call to patriotism, Uncle Jack's call to public service, and Bobby's determination to seek a newer world. Unlike them, he lived to be a grandfather, and knowing what my cousins have been through I feel grateful that I have had my father as long as I did.

He even taught me some of life's harder lessons, such as how to like Republicans. He once told me, he said, "Teddy, Republicans love this country just as much as I do." I think that he felt like he had something in common with his Republican counterparts: the vagaries of public opinion, the constant scrutiny of the press, the endless campaigning for the next election, but most of all, the incredible shared sacrifice that being in public life demands. He understood the hardship that politics has on a family and the hard work and commitment that it requires.

He often brought his republican colleagues home for dinner and he believed in developing personal relationships and honoring differences. And one of the wonderful experiences that I will remember today is how many of his republican colleges are sitting here, right before him. That's a true testament to the man. And he always told me that, "Always be ready to compromise but never compromise on your principles." He was an idealist and a pragmatist. He was restless but patient.

When he learned that a survey of Republican senators named him the Democratic legislator that they most wanted to work with and that John McCain called him the single most effective member of the U.S. Senate, he was so proud because he considered the combination of accolades from your supporters and respect from your sometime political adversaries as one of the ultimate goals of a successful political life.

At the end of his life, my dad returned home. He died at the place he loved more than any other, Cape Cod. The last months of my dad’s life were not sad or terrifying, but filled with profound experiences, a series of moments more precious than I could have imagined. He taught me more about humility, vulnerability, and courage than he had taught me in my whole life.

Although he lived a full and complete life by any measure, the fact was he wasn’t done. He still had work to do. He was so proud of where we had recently come as a nation, and although I do grieve for might have been, for what he might have helped us accomplish, I pray today that we can set aside this sadness and instead celebrate all that he was, and did, and stood for. I will try to live up to the high standard that my father set for all of us when he said "The work goes on, the cause endures, the hope still lives, and the dream shall never die."

I love you dad and I always will. I miss you already.

I was moved by Ted Kennedy Jr.'s speech, more than any other speech because I know first-hand about "climbing hills". Multiple Sclerosis has presented me with many challenges, and as the years go by, it doesn't get any easier.

But every time I stumble (both literally and figuratively), I manage to get up, dust myself off and forge ahead. Like Ted Kennedy Jr., I am lucky to have the support of my family and close friends and I will fight as long as I have to because no matter how hard it gets, I consider myself fortunate and blessed.

Finally, what I will remember from Ted Kennedy Sr. is his tenacity, his intellect, his sense of humor and his empathy for those less fortunate than he and his family. We all have our part to play in making this a better world for the short period we are here. Let's hope we can honor this man by continuing to fight for what is just and right in our society.

Enjoy your weekend and please watch Ted Kennedy Jr.'s entire eulogy by clicking here. Below is the passage that moved me.

Overhaul or Tweak Pensions?

Reporting for the NYT, Mary Williams Walsh asks, An Overhaul or a Tweak for Pensions:

After more than three years of deliberations, the board that sets the accounting rules for state and city governments is still far away from issuing a new standard for public pension funds.

What may seem like tedious labors over technical matters can have a large impact on public employees, taxpayers and investors. Many municipalities around the country are grappling with serious shortfalls in their pension funds caused by the recession and other woes.

Since the deliberations began, San Diego’s finances have been rocked by a pension scandal; Vallejo, Calif., has filed for bankruptcy after promising costly benefits; and New Jersey has warned that it lacks the cash to comply with its actuary’s instructions.

The panel, the Governmental Accounting Standards Board, heard impassioned testimony on Wednesday on the need to make public pension numbers more straightforward, more closely mirroring the pension accounting for corporations. But proponents of an overhaul were countered at every step by state officials and others who testified that broad changes were unnecessary and would disrupt budgets by introducing market volatility.

The board, an independent nonprofit organization that sets the accounting standards for governments, has said that the next step will be the publication, by next May, of a “due process document” to offer possible changes in the rules. That will engender a new round of public comment and revisions, and eventually a new pension accounting standard. The process is expected to take several more years.

“I have concerns that these efforts may, in fact, be too late,” one speaker, Diann Shipione, told the board. She said that the existing accounting rules were too loose, allowing “pension mischief” to go on for many years.

“As a result of the fuzziness and imprecision,” she said, “we now have many large systems that are essentially insolvent.”

Ms. Shipione, a former trustee of the San Diego city pension fund, eventually became a whistle-blower, insisting that the fund’s financial reporting was false, constituting securities fraud. After a long legal battle, the Securities and Exchange Commission agreed with her. She is now earning a master’s degree in public administration at the Kennedy School of Government at Harvard.

Ms. Shipione told the accounting board that she thought revisions were needed to make it easier to see when states and cities were falling behind on their pension contributions, which she hoped would prompt them to pump more money into the plans.

But some members of the board took issue with her goals. William W. Holder, one member of the accounting board, told Ms. Shipione that the board’s duty was to write rules that produced accurate and informative financial reports — not to promote desirable activities like funding pension plans more robustly.

“We try to avoid bias in setting accounting standards,” he said. “What we don’t try to do is develop some preconceived notion of what that behavior would be, and then write a standard that would encourage it.”

In the corporate world, the Financial Accounting Standards Board writes the rules for pension disclosures. It also seeks to avoid bias, and also works at a slow, deliberative pace.

But FASB has a great deal more power and independence than its governmental cousin. Its rules are enforced by the S.E.C., and it was given an independent funding source in the post-Enron accounting reforms. The corporate pension accounting rules came under harsh criticism at the beginning of this decade, and the FASB has already issued some revisions. Others are still in the works.

The governmental board, by contrast, must still raise its own money. And because no government agency enforces its policies, it must issue rules that states and municipalities will adopt voluntarily. Six of its seven members work on a part-time basis.

Others who spoke on Wednesday sought to assure the accounting board that its existing rules were sound. They acknowledged that some governments had had pension debacles in the last few years but said that was because they did not follow the rules.

Robert A. Wylie, executive director of the South Dakota Retirement System, said that pension woes were largely absent in his state and that his plan had a well-established funding policy.

Mr. Wylie said South Dakota had the ability to reduce promised benefits when times were tight, something forbidden by statute or constitution in many other states. Because of this flexibility, he said, South Dakota had always been able to keep its contributions in line with its benefits. For a state like South Dakota, he said, the existing pension rules were “very workable.”

“Major changes may add to what would be, in our mind, confusion,” he said.

Questions posed by the board members suggested they were leaning toward making narrow changes in the existing rules, like shortening amortization schedules or reducing the number of actuarial methods that plans may use. They did not seem eager to grapple with the question of which discount rate to use to measure public pension obligations — the biggest issue in the minds of critics of the current rules.

A recent study published by the National Bureau of Economic Research found that the discount rates now in use were masking a pension shortfall of $1.2 trillion at the state level.

The questions from the board members also suggested that they were interested in making public pension funds more comparable to each other. The current accounting rules allow so much flexibility that comparisons can be unfair.

Jeremy Gold, an actuary and economist who testified at Wednesday’s meeting, said he expected that when the new standard was finally issued, it would improve the comparability of pension plans.

“The center of gravity is still in favor of sharper pencils, rather than a whole new way of doing things,” said Mr. Gold, who called for radical changes. “This will make Texas, California and New Jersey all comparable while they go to hell in a handbasket.”

The accounting board will reconvene in Washington on Friday for additional testimony.

Some comments on this story. First, I commend Ms. Shipione for stepping forth to speak out at what was going on at San Diego's city pension fund. Last September, I wrote about the need to defend whistleblowers, something which is still not being taken seriously at public pension funds.

San Diego's Retirement System was notorious for taking huge risks in all sorts of alternative investments and lost big money in the Amaranth gamble. But city pension funds across North America are in dire straights and instead of consolidating them into the state funds to save costs, powerful interests want to keep the status quo. When it comes to municipal pension plans, Pennsylvania is king:

Pennsylvania has four times more pension funds than any other state, and more than one-fourth of all the municipal pension plans in the country, according to the Public Employee Retirement Commission, an agency that advises the Legislature on pension issues and oversees the soundness of local plans. The number of local plans is growing by about 30 a year.

Most of the 3,100 retirement systems, for police, firefighters or nonuniformed workers, are small. That's costly for members and taxpayers. Of 2,462 that reported administrative expenses, the cost was $36 million, or $509 annually per member.

The cost per member is $1,519 for administrative expenses for plans with fewer than 10 members, the retirement commission says, and 67 percent of Pennsylvania's local pension systems are that small.

The USA Today asks whether campaign contributions help win pension fund deals:

More than two dozen firms that have surfaced in a broad corruption investigation of public pension funds gave at least $1.97 million in campaign contributions to officials with potential influence over the funds' investments, a USA TODAY analysis shows.

The givers included private-equity giants such as the Blackstone Group, the Carlyle Group and the Quadrangle Group, the firm founded by Steven Rattner, who in July resigned as the White House point man for the auto industry rescue. The contributions are legal, and the firms haven't been accused of wrongdoing related to the giving.

[Note: They should ban these contributions once and for all! Read John Bury's comment, Rules By and For Insiders - Public Pension Plans.]

The Government Accountability Office – the investigative arm of Congress – has laid some of the groundwork for pension reform by publishing a study of the “retirement risks” posed by private pension plans in the United States:

“Many experts agree reforms are needed to make the U.S. private pension system more effective in protecting workers from risks to accumulating and preserving adequate savings for retirement,” says the GAO report. “If no action is taken, a considerable number of Americans face the prospect of a reduced standard of living in retirement."

The July 2009 report is addressed to Rep. George Miller (D-Calif.), chairman of the House Education and Labor Committee. Miller is an advocate of “retirement security.”

As part of its study, the GAO examined the pension systems of the Netherlands, Switzerland and the United Kingdom and found that private pensions in those countries “represent alternative approaches” that could “yield useful lessons for the U.S. experience.”

The GAO also examined four “key” domestic proposals to reform the U.S. private pension system – including a government-sponsored, mandatory system called the Guaranteed Retirement Accounts (GRA) plan.

Under this plan, the federal government (Social Security Administration) would establish and administer a system of retirement savings accounts – guaranteeing a specified rate of return on those accounts.

Currently, pension plans offered by private employers in the United States are voluntary and include tax incentives to encourage participation.

The problem

According to the GAO study, stock market losses and poor economic conditions have put many U.S. workers at risk of not having an adequate retirement income from their private pension plans. Older Americans are less confident in their ability to retire. “Even before the current economic recession, research indicated that pension benefits are likely to be inadequate for many Americans,” the GAO study said.

Pointing to national survey data, the GAO noted that about half of the U.S. workforce was not covered by a pension plan in 2008.
Workers covered by defined contribution plans -- such as 401(k)s and IRAs -- risk making inadequate contributions or earning poor investment returns, the study found, while workers with traditional employer-sponsored, defined-benefit plans risk future benefit losses due to a lack of portability if they change jobs.

Leakage (withdrawing money before retirement), high fees, and “the inappropriate drawdown of benefits in retirement” are other concerns, the GAO said.

Trade-offs

The GAO says its study focused on the Netherlands, Switzerland, and the United Kingdom because their private pension systems address many of the risks that U.S. workers face. Those systems also demonstrate “mandatory approaches can be used to increase coverage or contributions,” the GAO said.

But, as the GAO also noted, mandatory approaches – which have produced nearly universal coverage in the Netherlands and Switzerland -- also pose trade-offs. For example, in the Dutch and Swiss systems, sharing investment risk requires assets to be pooled and thus limits individual choice. And requiring annuities as a way for retirees to draw down their benefits limits people’s access to their assets.

Mandatory, government-run pension system here?

Of the four domestic proposals examined in the GAO report, only one is both mandatory and run by the government. Guaranteed Retirement Accounts (mentioned briefly above) would increase retirement savings by low- and middle-income households and provide a basic retirement income for workers, the GAO said.

Under GRA, both workers and employers would pay a mandatory minimum contribution of 2.5 percent each. Borrowing from the plan would be prohibited; and hardship withdrawals would be allowed only in case of disability.

Tax preferences for 401(k) plans and Individual Retirement Accounts would be replaced by a uniform $600 tax credit for all workers, regardless of income. State and local governments would have to notify the federal government of marriages and divorces so that contributions can be apportioned evenly between husbands and wives. State governments also would have to report who is receiving unemployment benefits to the Internal Revenue Service.

A centralized pension plan such as GRA would make “portability” easier and economies of scale would lower administrative costs, the GAO report said. But such a plan “may also be a costly and complex effort that requires new regulatory and oversight efforts. These costs could be passed on to workers, employers, and taxpayers in general.”

Three other domestic pension proposals examined by the GAO were more voluntary in nature. Two of those three were run by the private sector.

The GAO study concluded that no retirement system or pension proposal is perfect: “The challenge for Congress will be to balance the interests and responsibilities of workers, employers, and the government and find the most promising steps to help Americans achieve retirement security.”

Rep. Miller, to whom the GAO report is addressed, promised in October 2008 that his Labor and Education Committee would continue to “examine what measures may be needed to ensure a safe and secure retirement for workers, retirees and their families.”

At a House Education and Labor Committee hearing in February, Miller said it’s time for Congress to address “difficult questions about the state of our nation’s retirement system as a whole and look to see whether we need to create a retirement system that works for all Americans, not just the fortunate few.”

Over in the U.K., Dr. Ros Altman writes Get Real On Public Sector Pensions:

Today's Times suggests ministers are planning significant changes to council workers' pension arrangements – and probably to most other public sector pensions, too. Naturally, unions have reacted angrily, while taxpayer lobby groups welcome the proposals.

In my view, however, change is inevitable. With private sector final salary schemes across the country in deep deficit, employers are desperately looking for ways to reduce future pensions, or are closing schemes altogether. These economic realities cannot escape the public sector. The costs of these pension commitments have soared way beyond all previous expectations, as public sector employment levels and salaries have risen much faster than expected and workers are living ever longer.

Like almost all private sector schemes, local authority pension funds are in deficit (an estimated £60bn) as investment returns have not kept up with rising pension liabilities. Council tax increases alone cannot fund this shortfall, especially as the number of workers retiring will rise sharply in coming years. Already, about a quarter of some areas' council tax receipts is spent on pensions, and there is a limit to how far this can increase without jeopardising services or risking taxpayer revolts.

Ultimately, central government – that is, taxpayers across the country – will be forced to make up the difference between what councils can afford and the pension obligations they are committed to. But they already underwrite all other public sector pensions and, unlike local authority pensions, most public sector schemes are unfunded, which means absolutely no money has been set aside to pay the future pensions. Taxpayers in years to come will somehow have to find the money.

Government has not properly budgeted for this, having consistently tried to hide the true costs. When considering public sector pay, comparisons are generally made with the private sector, but the costs of pension accrual are not factored in, almost as if they do not exist. Of course pensions are paid many years hence, but the costs are nevertheless real.

A public sector pension is now probably worth about 30% extra salary, but public workers contribute well below 10% to their pensions, and sometimes nothing at all. Taxpayers have to make up all the difference. Also, unlike state pensions, there is no flexibility in these arrangements. When it comes to national insurance pensions, government can decide to change the parameters in order to control taxpayer costs. Indeed, national insurance pensions have been cut over the years, and pension ages will rise sharply, especially for women, as we are all living longer and healthier lives.

Public sector pensions cannot escape such realities forever, and the leaked proposals may herald a new round of reform. It is important to stress that any changes will not affect existing pensioners and will not reduce pensions that existing workers have already accrued.

However, unrealistic expectations will have to change, and we need transparency on the true costs of public sector pension commitments.

Workers are likely to have to either contribute much more each year or face the choice between working longer or receiving less pension in future.

Yes, of course public sector workers deserve a decent pension, but so do all pensioners. With such a low state pension, is it sustainable for good public sector pensions to be increasingly funded by taxpayers, who themselves have no such generous pension arrangements?

Public sector pensions should not be an alternative social welfare pension that is denied to, yet supported by, other taxpayers.

Finally, Pensions & Investments reports that Kennedy remembered for role in pension policy:

Sen. Edward M. Kennedy, D-Mass., who died of brain cancer Tuesday night, played a leading role in shaping U.S. pension policy, including the Pension Protection Act of 2006, the largest single reform of the U.S. pension system since the Employee Retirement Income Security Act of 1974.

Mr. Kennedy, chairman of the Senate Health, Education, Labor and Pensions Committee, was active even through his final weeks, working on pension-related issues in Congress and with the Obama administration.

He was “known for attracting the best and brightest minds, so it (came) as no surprise that Kennedy staffers would be mentioned for any number of positions” for top pension-related posts in the Obama administration, Anthony Coley, a spokesman for Mr. Kennedy, said in a Nov. 10, 2008, Pensions & Investments story, underscoring Mr. Kennedy's influence on pension policy and legislation in his Senate career, stretching back to 1962.

“Sen. Kennedy was very involved in pension issues and always took a pragmatic approach,” James A. Klein, president of the corporate pension advocacy group American Benefits Council, said in an interview.

In regard to Mr. Kennedy's work last December on the Worker, Retiree and Employer Recovery Act of 2008, providing corporate pension funding relief from the market meltdown and economic downturn, Mr. Klein said, “Sen. Kennedy tried to address issues on funding that wouldn't unduly burden the system.”

While Mr. Kennedy was better known for his work on health care, education and civil rights, “on pension issues that were not in the headlines, he worked very collaboratively with his Republican colleagues,” Mr. Klein said.

Ted Godbout, manager-communications at the ERISA Industry Committee, another pension policy advocacy group, said in a statement, “While we did not always agree with Sen. Kennedy's approach to pension and retirement policy, he was a friend of ERIC's and we always respected and admired his leadership and willingness to work with both parties to find common ground. He truly will be missed.”

”Sen. Kennedy was a national treasure,” Amy Borrus, deputy director of the Council of Institutional Investors, said in a statement. “He was one of the most effective leaders in the Senate and a widely respected voice on pension issues.”

In May, concerning allegations that Charles E.F. Millard, a former PBGC director, was inappropriately involved with the hiring managers to invest $2.5 billion, Mr. Kennedy joined five other senators, Republicans as well as Democrats, to refer the case to the Department of Justice, according to a June 1 P&I report.

The landmark Pension Protection Act toughened corporate funding requirements to strengthen the financial condition of pension plans and encouraged automatic enrollment in 401(k) plans, furthering retirement security.

I was chatting with Diane Urquhart today and we both agreed that even though Senator Kennedy went through some personal tragedies and controversies, he was a once in a lifetime politician - a true national treasure. She told me that the Canadian House of Commons couldn't accomplish a fraction of what he has accomplished in over 50 years.

Indeed, Senator Ted Kennedy's legislative record speaks for itself. He championed many great causes that I hold dear to my heart, including the American Disabilities Act, to prevent discrimination against people with disabilities.

If Senator Kennedy were alive today, he would be spearheading the health care debate as well as the pension crisis. And he wouldn't be tweaking anything, but going for an overhaul of the entire system to ensure everyone retires in dignity and security.

Below, I leave you with one of his greatest speeches ever - his 1978 speech on health care. The Senate's last lion will be sorely missed by everyone. May he rest in peace and may we all remember him and fight for what is right to make our society a better one for all, not just for the privileged few.

Holy Halabi! Worst Caisse Scenario?

Bloomberg reports that the Caisse is at risk of losing $462 million on Halabi loan:

Caisse de Depot et Placement du Quebec, Canada’s biggest pension-fund manager, may lose 285 million pounds ($462 million) on debt secured against investor Simon Halabi’s London properties after their value fell about 50 percent, according to two people familiar with the situation.

Caisse de Depot holds the junior portion of a 1.45 billion- pound loan secured against Halabi’s nine office properties, said the people, who declined to be identified because the information isn’t public. The senior portion of the loan, 1.15 billion pounds, was packaged into commercial mortgage-backed securities in 2006. Holders of the bonds, which are in default, rank first when the debt is repaid. Interest payments to the junior lender have already stopped.

U.K. commercial property values have slumped 44 percent since their mid-2007 peak, according to Investment Property Databank Ltd. About 230 billion pounds of loans are outstanding against U.K. commercial properties, according to research from Leicester-based De Montfort University.

“The senior loan itself is already underwater,” Gioia Dominedo, a director in Fitch’s CMBS team in London, said in an interview yesterday. “Property values would have to recover even for the senior to make a full recovery, let alone the junior loan.”

MCR, a corporate restructuring firm, was appointed on Aug. 21 to liquidate Halabi’s London-based property-advisory company, Buckingham Securities Holdings Plc. Kamlesh Bathia, Buckingham’s finance director, didn’t return calls or an e-mail seeking comment.

Francois Gaboury, a Montreal-based spokesman for Caisse de Depot’s real-estate debt unit, declined to comment.

JPMorgan Buildings

Halabi’s properties, which include JPMorgan Chase & Co.’s offices at 125 London Wall and 60 Victoria Embankment, were valued at 1.8 billion pounds when the senior loan was packaged into bonds. In June, they were appraised at 929 million pounds.

Interest payments on the junior portion of the loan were halted after the senior loan became due for repayment on July 15, CB Richard Ellis Group Inc. said in an Aug. 24 statement. Halabi’s trusts can’t refinance the debt and the properties are likely to be sold, Fitch Ratings Ltd. said in June.

“We are obtaining all relevant and necessary advice to formulate a strategy to maximize recoveries,” CB Richard Ellis Inc., the debt’s manager, said in the statement. “We have met and are liaising with the borrower.”

Caisse de Depot had an unrealized first-half loss of C$5.7 billion ($5.2 billion) on real estate, wiping out a 5 percent gain by other investments, according to an Aug. 11 statement. The Montreal-based fund manager said it plans to exit its subordinated-loans business.

There was about 285 million pounds outstanding on the junior loan, Standard & Poor’s said in a June 29 note. David Martin, director of special servicing at CBRE, declined to comment.

The first thing that went through my mind is who is Simon Halabi (that's him above)? The second thing that went through my mind is who is the idiot at the Caisse that structured this deal? I mean who would agree to terms where the Caisse would hold the junior portion of a 1.45 billion- pound loan?

Something really stinks with this deal and I suspect there is a lot more to this than what we know. Anyone who agrees to secure that amount of junior debt should be fired and so should the risk officer and investment committee who approved the deal.

Importantly, there should be a full investigation to see if there were any bribes taken to accept these ludicrous terms. Bring in the best certified fraud examiners to go over all the Caisse's fraud policies and procedures for allocating to external funds, including real estate, private equity and hedge funds.

On August 11th, the Caisse's President and Chief Executive Officer, Michael Sabia, announced changes aimed at repositioning the Caisse’s Real Estate group to focus on its core businesses.

These adjustments are part of the action plan launched by the Caisse last April to concentrate on key operations and streamline its structure.

The organizational and strategic changes include:

• integration of the Cadim division into the SITQ subsidiary;
• cessation of investments in the mezzanine and other subordinated loans sector.

Mr. Sabia also announced the appointment of René Tremblay to the position of Executive Vice-President, Real Estate, and President of the Caisse’s Real Estate group.

“These changes were necessary to ensure the success of the Real Estate group in the context of a weakened global real estate market, especially in the United States. They will allow us to focus our efforts in the businesses that have produced excellent long-term returns: 11.9% over 5 years and 12.1% over 10 years,” said Mr. Sabia.

In 2009, prevailing global market conditions significantly contributed to unrealized declines in value of the Caisse’s less liquid investments. At June 30, decreases in the value of real estate investments amounted to $4.0 billion, while those of other less liquid investments totalled $1.7 billion. The overall decline of $5.7 billion offset the 5% return that the Caisse earned during the semester.

The Globe and Mail reported last week that:

Another sign of trouble in the real estate unit emerged last month when the head of Cadim, the Caisse division responsible for the property mortgages, suddenly left the pension fund manager. No reason was given for Richard Dansereau's departure at the time.

Did Mr. Dansereau structure the Halabi loan while he was the head at the Caisse? Why did he leave the Caisse a month before these announcements were made?

Let's take a closer look at Cadim's investments while Mr. Dansereau was at its helm. If you look at this January 2008 Forum newsletter, you'll see some of Cadim's investments. Skip to page 7, where you see Cadim made commitments to several funds in the most recent quarter to the time that newsletter was published (January 2008):

• A total of US$1.5 billion will be invested in two new Lone Star funds, namely Lone Star Fund VI and Lone Star Real Estate Fund, which will focus mainly on Japan, Europe and the United States;
• In partnership with PSP Investments and Stonehenge, Cadim will invest US$237.5 million in Stonehenge III, which will acquire multifamily residential, office, retail and industrial buildings in the states of New York, New Jersey and Connecticut;
• US$400 million will be invested in daVinci Corporate Opportunity Partners’ Fund V, whose mandate will be to purchase interests in publicly traded Japanese companies that hold mainly real estate assets.

From these commitments, Lone Star funds garnered the most by far, a total of $1.5 billion just for Lone Star Fund VI.

Now, let's stop for a second here to introduce Loan Star funds. Most of you have heard of Donald Trump, but he is a midget compared to real estate's top investors like Tom Barrack of Colony Capital and John Grayken of Lone Star funds.

Barrack is considred to be the world's best real estate investor and he cashed out before the crisis hit. John Grayken is also among the world's best real estate investors. His fund focuses on distressed debt. He made a splash last year following Lone Star Funds' $6.7 billion dive into mortgage-backed assets dumped by Merrill Lynch & Co where got a great deal for Merrill's trash.

But for all his success, Mr. Grayken has dealt with his share of controversies. In April 2006, Lone Star apologized for allegations of embezzlement and other controversies that surround its multibillion-dollar investments in South Korea. Lone Star then said it was donating 100 billion won, or about $106 million, in an apparent move to assuage widespread public sentiment against an estimated $4.4 billion profit it stands to make when it unloads its stake in Korea Exchange Bank.

In January 2008, Mr. Grayken appeared in a South Korean court to refute allegations of stock manipulation in a case that is delaying HSBC Holdings plc's $6.3 billion acquisition of the fund's Korea Exchange Bank.

In March 2009, AltAssets discussed capital returns in private equity, noting the following:

Capital returns are now a rare commodity within the private equity industry. Lone Star Funds (‘Lone Star’) has first-hand experience from its lengthy attempts to extract cash from Korea Exchange Bank, after failing to seal a deal with Kookmin Bank and subsequently HSBC
Holdings last year.

In late January, the board of directors of Korea Exchange Bank declared a dividend of 125 won (US$0.09) per share which would see Lone Star add an additional 41.1 billion won to its coffers. Since taking control of the lender in 2003, Lone Star had invested more than 2.1 trillion won in Korea Exchange Bank.

So far, it has been able to returned an estimated US$2 billion to its coffers. With South Korea’s economy set to contract in 2009 and the country’s largest bank, Kookmin Bank, recording its first quarterly loss in four years, the prospects for Lone Star to dispose of Korea Exchange Bank does not appear to be all that encouraging.

A July 2008 article in the Dallas Morning News focused on Grayken's ability to spot value but also noted the following:

Lone Star's acquisition of the Korean Exchange Bank in 2003 brought the most headlines of late – and not good ones.

South Korean prosecutors accused Lone Star and its South Korean head, Paul Yoo, of manipulating the share price of the bank to get a cheaper price. They also accused Lone Star and Mr. Yoo of spreading rumors about the bank's credit card unit in a similar attempt to buy it for less.

A South Korean court found Mr. Yoo guilty and sentenced him to five years in prison in connection with the credit card rumor accusation. An appeals court overturned the verdict late last month; the country's highest court has yet to rule.

Regardless, the legal skirmishes threaten Lone Star's July 31 deadline to sell the bank to HSBC Holdings Inc.

Some wonder if Lone Star might find itself in trouble because of its aggressive subprime investments as well.

Mortgage deals

The October purchase of Accredited Home Lenders, a San Diego-based subprime mortgage lender, coincided with a subprime meltdown that wiped out nearly all the originators for the risky loans.

Lone Star tried to back out of the deal in June 2007, but Accredited sued to enforce the purchase agreement, and Lone Star eventually bought it for millions of dollars less than it originally offered.

"Lone Star stepped in too early on Accredited," said mortgage industry analyst Bose George of Keefe, Bruyette & Woods in New York.

Lone Star probably isn't interested in servicing the loans it buys, he said, but it will try to squeeze return from the homes backing the bad loans by re-selling them.

In Lone Star's latest mortgage deal, it agreed this week to pay $1.5 billion in cash and to assume $4.4 billion in debt for a $9.3 billion portfolio of mortgages and related servicing operations owned by CIT Group Inc., a New York-based financial company.

In addition, Lone Star also recently took on some of former Wall Street stalwart Bear Stearns' mortgage portfolio as that firm dissolved.

Given Lone Star's track record of producing solid double-digit returns for its private equity funds, its big bet on distressed loans suggests to some that the housing market may have hit bottom.

"If you have enough understanding of the industry, what assets are valuable and what are garbage and junk, there's clearly some high value assets in this group and they're getting it at deep discounts because of the overall paranoia in the market," said David Lykken, president and managing partner at Mortgage Banking Solutions, an Austin consulting firm.

But were home prices to fall further or interest rates to rise, there's a chance Lone Star's newly purchased assets would lose even more value.

"That's the point at which people buying mortgages now will wish they waited," said Mr. Dotzour.

Global reach

Mr. Grayken isn't used to regret. Whether betting on flagging restaurants such as Shoney's or being one of the largest holders of bad German loans, Lone Star has earned respect by posting annual returns of 9 percent to 28 percent, according to a Bloomberg Markets magazine profile of the firm three years ago. A variety of state pension funds have eagerly invested with Lone Star Funds.

The company has about 1,000 employees worldwide, most on North Harwood Street in Dallas, but its investment reach is global. Mr. Grayken isn't even an American citizen, having given up that status in 1999. He travels extensively on an Irish passport to find the next undervalued deal, according to the Bloomberg profile.

By no means is Lone Star alone in buying the bad loans. Big names such as Warren Buffett and other huge private equity firms such as the Blackstone Group have bought in as well. But whether Mr. Grayken's latest bets will turn against him hedges on the economy, most think.

"That's the entrepreneurial risk these companies are taking now," said Mr. Dotzour. "Every day that goes by where gasoline is over $3 a gallon is another day in which gasoline is just sucking the life out of the American consumer."

I checked out Lone Star's global affiliates and was surprised to see they opened up an office here in Montreal:

Montreal
800, de la Gauchetiere West
P.O. Box 1458
South East Portal - Suite 9400
Montreal, Quebec H5A 1K6
Canada
514-879-6310

Now, Montreal isn't exactly considered a hotbed of distressed real estate activity. Why did a sharp guy like Mr. Grayken open up an office here? And let me ask flat out, does PSP Investments' former First Vice-President of Real Estate, André Collin, and his buddy Richard Dansereau, the former head of the Caisse's Cadim, now work for Mr. Grayken?

Here is another question. Does anyone else from the Caisse and PSP Investments now work for Lone Star Funds? I ask this question because I heard Joanne Tosini, a former Vice-President at PSP's Real Estate team, left PSP after receiving over $1 million in total compensation in FY2008:

(click on image to enlarge)

Ms. Tosini left a year after Mr. Collin left PSP Investments after he received a total compensation of $1,439,300 in FY2007:

(click on image to enlarge)

You do not walk away from cushy jobs at a public pension fund paying you that type of money unless you got a much better gig lined up. For full disclosure, PSP Investments should state why these individuals left the organization, where are they now and what relationship does PSP have or had with their current employer.

[Note: Someone sent me an email, confirming that Ms. Tosini now works at Lone Star Funds.]

Finally, Bloomberg reported that Mr. Grayken is securing pledges toward his goal of raising $20 billion to invest in distressed commercial real estate and securities:

Grayken may garner as much as $2 billion by the end of August, said one person, who asked not to be identified because the information is private. Dallas-based Lone Star last year raised $10 billion to buy real estate assets.

Lone Star is doubling the size of its funds as the deepening crisis in commercial real estate increases opportunities to buy at discounts. U.S. commercial property prices fell 35 percent from their peak through May 31, Moody’s Investors Service said last week. Falling rents and occupancies will accelerate defaults and delinquencies in mortgages sold as bonds, pushing the rate of late payments to the highest since at least 1991, Reis Inc. said yesterday.

Each of the new vehicles will have about $10 billion, the people said. Lone Star Fund VII will invest in distressed financial institutions, collateralized debt obligations, residential mortgage-backed securities, corporate debt and consumer loans, according to one person.

The other fund, Lone Star Real Estate Fund II, will invest in assets including commercial mortgage-backed securities and distressed commercial real estate, one person said. A Lone Star spokesman declined to comment.

Pension Funds

Distressed funds take advantage of financial crises by buying debt at deep discounts with the goal of selling it for a profit, or converting it to equity to control a target company.

Lone Star’s investment strategy sets it apart from other real estate investors. The state of Oregon pension fund, which pledged $1.5 billion to 10 new real estate funds in 2008, has had calls by fund managers for less than $500 million of that, according to a presentation on July 29 to the state pension trustees.

“Most of what was drawn was Lone Star doing distressed debt, which is the only strategy that’s been an active, viable strategy,” said Brad Child, senior investment officer for real estate at Oregon, in the presentation to the Oregon Investment Council. “Everyone else has been defensive.”

Many property managers are staying on the sidelines, anticipating better chances to make purchases as prices decline, Child said. Lone Star got $600 million in pledges from Oregon for its 2008 funds and has drawn about three quarters of that.

Grayken’s Investments

Mining for gold amid financial wreckage is familiar territory for Grayken, 53, a former adviser to Texas billionaire Robert Bass who made his name finding value among distressed properties in the early 1990s after the savings-and-loan crisis.

Lone Star was one of the largest buyers of bad loans during the Asian banking crisis starting in the late 1990s. The firm later moved to capitalize on economic woes in Europe, buying property assets in Germany.

Investing in distress has risks. Lone Star has been beset by legal wrangles over some Asian investments. Three of its companies, Accredited Home Lenders Holding Co., Bruno’s Supermarkets LLC and BI-LO LLC, filed for bankruptcy protection this year.

Lone Star last April won the bidding to take over New City Residence Investment Corp., Japan’s first failed real estate investment trust. Creditors of New City rejected Lone Star’s receivership plan on July 15, opening the way for a rival bid.

Lone Star may begin talks to sell Korea Exchange Bank to the California Public Employees’ Retirement System, the Seoul Economic Daily reported July 27. Legal disputes scuppered Lone Star’s previous attempts to sell Korea Exchange Bank.

Sat on Sidelines

When the real estate market peaked in 2007, Lone Star largely sat on the sidelines, limiting its activities to a handful of sales. As the credit crunch set in, the firm bought Accredited Home Lenders for $299 million.

The firm picked up its pace in 2008, buying $30.6 billion of Merrill Lynch’s collateralized debt obligations at a 78 percent discount.

Lone Star also agreed to buy CIT Group Inc.’s home-lending unit for $1.5 billion and take on $4.4 billion of debt and other liabilities. In May 2008, Grayken bought part of a Bear Stearns Cos. unit that made U.S. mortgages through brokers for an undisclosed amount.

Fund managers such as Lone Star raise money by securing capital pledges in multiple closings over several months from investors such as pension funds. A fund usually must be completed one year after the first close.

I wonder how many Canadian pension funds have made commitments to this new Lone Star fund and how many will be increasing their allocation to it. Mr. Grayken has a solid track record but he is taking huge risks to generate those outsized returns.

Moreover, as noted in this Private Equity Real estate article on Lone Star:

Distressed prices are attracting a plethora of investors to the real estate asset class, especially in mature markets such as the US and Europe, however raising funds has been extremely difficult. Roughly $13 billion of value-added and opportunistic vehicles were closed in the first half of 2009 – compared to a total of $68.9 billion and $85.2 billion for the whole of 2008 and 2009 respectively, according to PERE data.

In response to the difficult fundraising environment, many firms have lowered their original targets or allowed institutional investors to shrink previously agreed commitments. In February, New York-based Westbrook Partners allowed investors in its $2.5 billion Fund 8 to reduce their commitments by up to 10 percent without penalty.

So maybe that's why Lone Star opened up an office here in Montreal, to help them raise the money they need to withstand any protracted downturn in the market. Again, that begs the question, who is in charge of the Montreal office? This presentation to Fresno County Employees' Retirement Association did not have the Montreal office in it (it was made in 2005 and the office was not open yet).

But no matter who is running that office, the rules of the game have changed and raising funds has become a lot tougher in real estate private equity, even for superstar managers like John Grayken.

***UPDATE: Appearance of conflicts of interest***

According to this September 11th article by André Dubuc of Les Affaires, Mr. Dansereau left Cadim to join Stonehedge Partners, a real estate fund that the Caisse invests in. The article states that there are no rules governing the delay of joining a fund that you invested with. Incredible but true!

A Lesson in Liquidity?

I want to follow-up on my last post on Harvard's mea culpa. Last week, James B. Stewart reported in the WSJ that Ivy League Schools Learn a Lesson in Liquidity:

Just a year ago, in the midst of the subprime meltdown, many of the nation's top universities and colleges were reporting significant gains. This year, the University of Pennsylvania is being hailed for Ivy League-leading results—with a decline of 15.7% for its fiscal year ended in June.

Results from other schools are still trickling in, but Harvard University has said it is expecting to report a drop of 30%, and Yale University about 25%. Considering the size of these endowments, these are staggering losses in absolute terms—many billions in the case of both Harvard and Yale.

Students soon will be heading back to larger classes, curtailed extracurricular activities and cheaper dining-hall fare. But the results are also of more than academic interest to investors like me, who have to some degree modeled their portfolios on the diversified asset-allocation model pioneered by Yale's chief investment officer, David Swensen. What I refer to as the Ivy League approach for individuals calls for diversification along similar lines as the large university endowments—equities (domestic and foreign), fixed income, and real assets (which includes commodities and real estate), but with a much higher allocation to so-called nontraditional asset categories: emerging-market equities and debt, energy and commodities. Yale allocated just 10% to U.S. equities and 4% to fixed income, with 15% in foreign equities and 29% in so-called real assets as of June 30, 2008.

The major difference is that most individual investors didn't qualify or otherwise couldn't invest in the hedge funds and private equity and venture-capital partnerships that make up a large part of university endowments. At Yale, 25% of the endowment was in what the university calls "absolute return," mostly hedge funds, and 20% was in private equity.

The irony is that turned out to be a huge advantage for individual investors this past year, when, in the midst of unprecedented market turmoil, many endowment managers learned the true meaning of "illiquid." The exits for most private equity and venture-capital funds slammed shut. Existing positions yielded no cash flow even as investment partnerships made new demands for funding. Many investors were forced to sell their liquid investments into weak markets to fund cash needs and to meet prior commitments to investment funds. Asset allocations went wildly out of balance, overweighted to illiquid partnerships as the value of equities plunged. It's a wonder that last year's results weren't even worse.

Liquidity turned out to be the Achilles' heel of the Ivy League model. But what about its core premise—diversification? True, nearly every asset category declined at some point in 2008, even those that were supposed to be uncorrelated, like equities and high-quality corporate bonds.

But for individuals who followed a diversification strategy—and who weren't forced to sell anything at distressed prices—those values have rebounded sharply, with many of the nontraditional categories, such as emerging-market equities and commodities, outperforming U.S. stock indexes. By sticking to liquid alternatives to private partnerships—such as mutual funds, exchange-traded funds, and real-estate investment trusts and publicly traded stocks and bonds—individual investors should have done far better than even the University of Pennsylvania.

Penn, too, found itself in quite a few illiquid partnerships. But it notched its league-beating return with some old-fashioned market timing. Chief Investment Officer Kristin Gilbertson recently told The Wall Street Journal that in early 2008 she started reducing the portion of the endowment in public equities to 43% from 53% and put about 15% in Treasurys. It turned out to be a shrewd move, and by endowment standards, which rarely stray from predetermined asset allocations, a bold one. The highly liquid Treasurys were one of the few assets to hold their value over the period and also enabled the university to meet capital calls from private-equity firms.

Market timing can be difficult, but I suspect some degree of it will increasingly be worked into endowment-allocation models. It will probably take years for the lessons of 2008 to be absorbed. But you can be sure that liquidity will gain new respect.

I think that in the environment we are heading in, there will be a premium placed on liquidity. Long gone are the days where you tie up your money for ten years in private equity or accept lock-ups of three years with some hedge fund (some are stupid enough to do this).

Investors are thinking long and hard about their liquidity needs as their pension plans mature. Some pension funds are eying commercial property, but the majority are standing pat. Mr. Gilbertson's shrewd move into Treasuries saved Penn's endowment fund from serious losses in 2008 and I happen to think that these type of portfolio shifts will be required if you're going to make money in the next decade. But market timing is a double-edged sword because if you're wrong, you risk seriously underperforming your policy portfolio. Again, focus on what Harvard's Jane Mendillo said, you have to stay liquid and be nimble.

Finally, please take the time to listen to my interview with Steve and the crew at Two Beers With Steve Podcast. It is an informal discussion on pensions where I shared some of my thoughts on the pension crisis and its long-term implications.

Will Pensions Follow Harvard's Mea Culpa?

BusinessWeek reports that Harvard Endowment Corrects Course With Return to the Past:

One of the first rules of PR damage control is get control of your message. After being battered by months of bad, really BAD press, Harvard University seems to have had enough of anonymously-sourced, semi-accurate attacks on its investing strategies. Jane Mendillo, who’s run Harvard’s slightly-less-massive endowment fund since July 2008, is on-the-record today in The Wall Street Journal, Bloomberg and probably a few other places I haven’t seen yet (feel free to call them out in the comments, please).

The popular critique of Harvard begins with accusing the endowment of taking too much risk by investing too much with illiquid hedge and private equity funds and usually winds up with sordid tales of egomaniacal leadership gone astray. And it’s not completely off-base. The fund, after decades of amazing returns, fell to earth with a loss of about 30% for the university’s fiscal year which ended in June.

But strangely blameless in these critiques are the members of the Harvard community who spent years complaining that the fund’s managers were paid too much and that the fund wasn’t contributing enough to the university’s annual budget. As a nearly direct result of those criticisms, many of the top managers (and their fearless leader, Jack Meyer) packed up and left the building. And the amount of cash poured into the university’s annual budget quadrupled to $1.6 billion from 1998 to 2008, far outstripping growth of the endowment fund itself which more than doubled from just under $15 billion to over $36 billion (See this recent letter for the data points). The wave of departures also prompted Harvard to rely more on outside managers, giving the university far less say over risk management, far less access to cash and substantially fatter fees for services.

Now Mendillo is reversing course. She tells the Journal she’ll be keeping more money in-house. The fund recently made some big-splash hires, bringing in investment managers from Fortress Investment Group and Caxton Associates. And she’s re-setting expectations for the Harvard community as well, telling Bloomberg that future returns likely won’t be anywhere near the 14% annual gains for the 10 years before the crash and referencing a target of about 8%.

Interestingly, I didn’t see a real “money” quote from Mendillo about the fund’s woes in either story. Bloomberg’s Gillian Wee cast the story as about Harvard increasing its cash position by an unknown amount. The Journal’s Craig Karmin emphasizes the fund’s efforts to sell some of its illiquid investments and bring more money in-house. “That will allow us to be more nimble,” says Mendillo. But neither piece has much of a mea culpa-type statement (you know, “mistakes were made”). Perhaps that’s a subject Mendillo would best like left in the past.

Mendillo doesn't need to publicly apologize but her actions speak louder than words. The WSJ quoted her as saying "We are looking to have a greater portion of our assets managed internally over the next few years...that will allow us to be more nimble...".

Pension parrots are you paying attention? You all suffered the fate of Harvard's horror and Yale's yardstick as you blindly followed them into illiquid asset classes, pumping billions into private equity, real estate and hedge funds. But you pension parrots aren't half as sharp as Jack Meyers, David Swensen or Jane Mendillo, so you will end up getting creamed on those illiquid investments, selling them to into the secondary market for 50 or even 30 cents on the dollar (if you're lucky).

But pension parrots remain undeterred, blinded by the belief that private markets are the way to go no matter what economic cycle we're in. They want more private equity and more real estate. If things go wrong, they can always change the benchmarks and "presto", they manufacture alpha, even if it is based on bogus benchmarks.

Oh baby! What a great gig being part of the private markets at a large Canadian public pension fund. You get to fly first class all over the world, wine and dine with rich managers who are looking to woo you and then you can game your benchmark to claim that you added "significant value added" at the end of the fiscal year, allowing you to collect a big bonus. No wonder his Pension Eminence, Claude "PE" Lamoureux, the former head of Ontario Teachers', loved private equity. It made him stinking rich.

The poor public market guys and gals can't game their benchmarks because hardly anyone can easily beat the S&P500 or EAFE. I don't blame public market managers for feeling duped. If I were working at a large Canadian public pension fund, I'd love to allocate billions into external private funds, taking virtually no risk whatsoever and changing my benchmark at the first sign of trouble.

Speaking of changing benchmarks, I noticed something else going through PSP Investment's FY2009 annual report. When I took a closer look at their pathetic results, I focused more on how real estate significantly underperformed their Policy Portfolio benchmark, but something else caught my attention today. Look at the FY2009 results by asset class below:

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You notice how private equity underperformed its benchmark by 70 basis points (-32.3% vs. -31.6%)? I went back to PSP Investments' FY2008 annual report to look at the results which were equally pathetic:

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I noted the following on page 16:

A significant source of value-added in fiscal year 2008 came from the Real Estate and Private Equity asset classes. Real Estate (included in real return assets) generated a rate of return of 21.9%, surpassing the Policy Benchmark rate of return of 7.6% by 14.3% and was the primary driver of value-added in the Real Return asset class.

Private Equity (included in Equities) generated a rate of return of 10.1%, surpassing the Policy Benchmark rate of return of 3.7% by 6.4%. As a result of the PE team’s careful fund and asset selection, the Private Equity Portfolio has not experienced the negative performance (J curve effect) typically experienced during the early years of such a portfolio.

Equities underperformed the benchmark return primarily due to the underperformance of related public market asset classes in fiscal year 2008, partially offset by the aforementioned private equity outperformance.

So the Policy Benchmark for PSP's Private Equity went went from +3.7% in FY2008 to -31.6% in FY2009? It looks like they changed the benchmark but failed to mention this in the FY2009 annual report. How many times will they change benchmarks in private markets without publicly disclosing it?

What a joke. No wonder public market managers at large Canadian pension funds are fuming. One public market portfolio manager recently told me that he refuses to look at the published salaries in their annual report because his "blood pressure goes up" when he sees how much total compensation the private market fund managers are making beating their "bullshit benchmarks".

And wait, it gets better. Private markets get fiscal advantages that public markets don't have. For example, PSP Investments acquired Telesat for $3.25 billion in October 2007 as well as Revera Inc., which was formerly operated through Retirement Residences Real Estate Investment Trust (RRREIT). These investments pay no corporate tax and they were not marked down. That means that on top of bogus benchmarks, PSP's upper management made big bonuses partly owing to the tax status of these investments.

As shown below, despite those terrible results, PSP's senior private market managers and president reaped big bucks in total compensation in FY2009:

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[Note: My apologies to public market managers with high blood pressure. You're all in the wrong asset class but don't worry, the tide will change.]

Moving on, the FT reports that Dutch pension scheme turns to hedge funds:

These are difficult times for pension plans around the world; market tribulations in 2008 badly hurt their performance record, leaving many teetering and underfunded. Aggravating the trouble caused by plunging asset values, the steep decline in global interest rates has further escalated their liabilities.

Stichting Pensioenfonds ABP, the Netherlands-based pension sponsor servicing 2.7m Dutch education and government workers, did not avoid the rollercoaster. The plan, third largest in the world after the Japanese and Norwegian state pension funds, with €173bn (£149bn, $245bn) of assets, lost 20 per cent in value in 2008, severely denting its funding ratio and asset base. Liabilities, meanwhile, rose to €193bn from €155bn, triggering an ambitious five-year resuscitation plan. As of June, ABP’s recovery was ahead of schedule. Assets have risen to €180.5bn while liabilities have fallen to €185bn. The coverage ratio now stands at 98 per cent, compared with 90 per cent at the end of 2008.

Part of this recovery is due to increased exposure to hedge funds. Earlier this year, ABP raised its allocation to absolute return strategies by one percentage point even as hedge funds in general were reeling from the fallout of their worst ever year in terms of losses and redemptions. The average hedge fund fell 19 per cent last year and industry assets tumbled to $1,300bn from a June 2008 peak of $1,900bn.

The increased allocation to hedge funds looks like small change for the giant plan, but if it is successful the move could help steer ABP toward recovery. The Absolute Return Strategies division now takes up 6 per cent of its balance sheet, about €10bn. It comprise Amsterdam-based Global Tactical Asset Allocation (GTAA), a directional and liquid portfolio that seeks to exploit short-term market inefficiencies around the world; and New Holland Capital of New York, which invests in external alpha, or excess return-seeking hedge funds.

These strategies, and all the plan’s other portfolios, are managed by APG (All Pensions Group), its asset management and administration arm, voluntarily spun off by ABP in March 2008. ABP remains its sole owner.

Gerlof De Vrij, a managing director of Absolute Return Strategies and fund manager of GTAA, is helping oversee it all. Through GTAA, he oversees internal investments in managed futures and global macro strategies that can span anything from a few weeks to years, and also allocates to an array of external managers.

Thanks to its diversity, GTAA delivered gains in 2008 despite widespread losses in most of ABP’s other asset classes – commodities, equities, private equity and real estate. Fixed income, meanwhile, eked out a small gain. That said, the overall absolute return portfolio, including New Holland Capital’s investments, delivered a loss of 5.6 per cent. This year, GTAA’s performance has been “very good,” says Mr De Vrij.

“Hedge funds as an asset class have shown flexibility in the financial turmoil,” he says. APG is upbeat about this investment category.

“Our optimism stems from the fact that they give high returns with relatively low risk,” he says.

“It was last year’s liquidity scare that made hedge funds correlated to all other asset classes, but that’s not how things work fundamentally.”

The APG absolute return division tries to construct a portfolio with no correlation to bonds, currencies, equities or anything else, says Mr De Vrij. “We aim for absolute return and aren’t looking to benchmark our behaviour with other hedge funds or parts of the market.”

The real diversification comes from the fact that its investments can explore not only the liquid parts of the markets but also the more complex and non-traditional ones and can adapt rapidly to change in the marketplace.

Distressed assets still look attractive even though the peak investment period has passed, he argues. But he cautions that only long-term investors can benefit from illiquid strategies and only those who can stomach illiquidity should wade in.

Distressed or not, investors should view all hedge funds as an illiquid asset class, he says. “If you are going to view this asset class as a liquid one, you’ll use it as an ATM and that’s a mistake. If at the first sign of crisis investors take their money back, it won’t allow managers to exploit the complete market cycle,” says Mr De Vrij, who previously led strategy and research at PGGM Investments, another Dutch pension fund, joining ABP in August 2005.

He disagrees with those who hold hedge funds responsible for causing market upheaval. “Yes, speculators can destabilise markets, but if they were to sit on the sidelines, the total market liquidity will just dry up. In many cases, hedge funds have stabilised financial markets.”

However, some sort of regulatory checks-and-balances are warranted in the future. he feels, as self-policing by managers will be inadequate. The events of 2008 jolted investors’ confidence so deeply that it is unclear how quickly it may return. For now, “I feel the industry stress felt late last year is fading. Redemptions are becoming more manageable even though investors have become more risk averse in general.”

Hedge funds are making a range of attempts to regain investors’ trust. Some funds, especially those in distress, are offering better terms, says Mr De Vrij. Still, hedge funds with strong performance will continue to have the power to ask for unchanged fees even though investors these days clearly have an upper hand in negotiations, he adds.

One common misperception, according to Mr De Vrij, is that hedge funds are a risky asset class. “Hedge fund risks aren’t any different than those present in credit, real estate or other strategies as we saw last year when no single asset class was spared by the market turmoil; the fundamental link between hedge funds and other asset classes was the liquidity scare.”

On the performance side, hedge funds are now doing relatively well and will attract fresh capital if they can sustain the momentum, he predicts. The average hedge fund has returned about 7 per cent this year, according to industry estimates.

The question remains: When will investors return? Mr De Vrij reckons that in spite of the recent erosion of confidence, “quality investors” will find their way back into hedge funds. “The better part of hedge funds will survive,” he says. But they will have to resign themselves to more oversight. “We as investors want to see more transparency, risk reporting and proper due diligence processes. We want better checks and balances.”

Commenting on the noise surrounding various regulatory proposals on hedge funds, Mr De Vrij says “active communication” with rule makers is necessary. Being such a large investor in hedge funds, APG constantly engages the Dutch financial regulator in “an active conversation, to explain nuances of absolute return, how it works, why we’re comfortable with it, what risk-adjusted returns mean,” notes Mr De Vrij.

Mr. de Vrij is a smart guy but he conveniently omits a few things. First of all hedge funds are doing well this year because global equities have rallied sharply since March. It's worth repeating this, most hedge funds charge alpha fees (2% management fee and 20% performance fee) for delivering disguised beta. But he says that ABP invests in hedge funds that are not correlated to the markets.

Second, go back to read my comment on demystifying pension fund benchmarks. In that comment, I noted:

Unfortunately, it's not always possible to find the appropriate benchmarks that fits all pension funds in each of this alternative asset classes, but that is why you need a comprehensive performance audit to make sure they are not gaming their benchmarks to easily beat them.

Take hedge funds for example. Some strategies are liquid, others are illiquid, some use leverage, others use no leverage, and so on. Using an absolute return benchmark of T-bills + 500 basis points might seem appropriate, but what if your pension fund manager is investing in highly leveraged illiquid strategies? Up until last year, they would have trounced that benchmark, reaping huge bonuses, but then the music stopped and credit markets seized, effectively killing these strategies.

As I discussed before, it's all about the benchmarks stupid! Unless the benchmarks reflect the risks, beta and leverage of the underlying investments, then you simply do not know if the value added your pension fund manager is claiming to add is really that or just a free lunch.

Some pension funds got cute with hedge funds, investing in asset-based lending (ABL) funds, but they got creamed in 2008. The attraction there is that these funds are not correlated to the overall markets, but they carry their own set of risks and the benchmarks must reflect this (I doubt ABL funds will come back as strong as before the crisis hit).

My final thoughts are that Jane Mendillo is right and if pension funds are smart, they will follow suit by lightening up on private equity and by bringing assets internally to develop their absolute return strategies. In the environment we are heading into, don't try to copy what ABP is doing. You're going to end up paying tons of fees for mediocre results and you do not have the skill set of ABP's hedge fund team who along with Ontario Teachers' hedge fund team, is one of the best in the pension industry.

Remember, small is beautiful and staying nimble is critical for making money in these markets. But while Harvard regroups and tacitly admits its mea culpa, most pension parrots will keep repeating the same mistakes, losing billions in the process. They will all learn the hard way.