Monday, May 9, 2011

Pension Gap Creating Tension?

Before discussing my latest topic, I want to bring something to your attention. Frederic Bettan, Managing Partner & CEO of Swing Capital contacted me to include their fund in my post on Quebec's Absolute Return Fund. Along with his partner, Michel Nahmany, they claim to run one of the largest F/X programs in Quebec (and maybe Canada). I edited my comment and will add more funds that I missed (just contact me).

There is a lot of alpha talent in Quebec but the problem is capital is scarce and forget seeding funds. We need more families like the Bass family in the US to come up here and take a gamble on our alpha talent. I would put some of our guys up with the best and brightest in New York and London. Why are they living in Montreal instead of these big financial centers? Because the quality of life is better here, not to mention that we have some of the prettiest women in North America (you notice them right away when the weather warms up!).

On Monday, I had lunch with one of the best Canadian convertible bond arbitrage managers in Canada, Marc Amirault, President and CIO of Crystalline Management Inc., a fund that has delivered high risk-adjusted returns. What I like about Marc is that what you see is what you get. He lost weight, quit smoking (excellent decision!), and looked a lot better than the last time I saw him. He's a very experienced manager who is a straight shooter and takes care of his clients.

I respect a guy like Marc who has made it in Quebec a lot more than anyone of those hot shot hedge fund managers in New York or London. If you can make it in Montreal, you can literally make it anywhere. What I like about him is his background. He worked many years at the Caisse de dépôt et placement du Québec, so he understands the ins and outs of pension funds. He had to claw his way to success when he ventured off on his own. Nobody handed him a big fat cheque with no strings attached.

And when it comes to convertible bond arbitrage in the Canadian market, very few managers have his experience or track record. He told me all about 2008, "a tough year," and how crazy the US contagion got up here. "At one point there was no market for Canadian corporate bonds. Barrick Gold bonds -- A rated -- were trading 15% above US Treasuries" (crazy!) . Some of his fund of funds clients redeemed but his pension fund clients stuck by him, and his fund recovered nicely.

I told him if I were a hedge fund, I would try to avoid fund of funds as much as possible, especially the hot money out of Switzerland and Middle East, and stick with patient capital like pension funds. Most fund of funds redeem at the first sign of trouble. And unlike the US, a fund in Quebec can't just put up a gate to stop redemptions (that's kiss of death up here). I also told him that some of the best hedge funds in the world got whacked hard in 2008, including Citadel. Back then many investors were redeeming from Citadel and I told people on my blog to jump on the opportunity to get into that elite hedge fund (those who took my advice made great returns).

Crystalline Management Inc. has some capacity left. The fund is small and Marc will cap the convertible arbitrage strategy at a certain size. As he told me, "I'm not into the asset gathering game, focusing all my attention on performance, and I don't like how a lot of the pension consultants operate, full of conflicts of interest" (tell me about it!). If you're a small or large pension fund, I urge you to contact Marc directly ( and meet with him and his team. An investment in a fund like his can pay off in many ways because you won't just be getting high risk-adjusted returns, you'll be investing in an experienced manager in a niche market who understands the importance of process over performance (not all convertible arbitrage funds are the same, some use a lot more leverage than others!). Just the knowledge leverage he and his team can offer you is worth the investment and he's thinking of branching out to more liquid strategies so he can become a top performing multi-strategy fund.

Now, let me get to my latest topic. Bill Tufts of Fair Pensions For All brought to my attention a recent Stats Canada study. He wrote an op-ed in Digital Journal, Pension gap creating tension between haves and have-nots:
Statscan released a report today on the status of pension plans in Canada. Most Canadians do not have a pension plan while government workers do. Now more government workers have pension plans that private sector employees.

In its report Statscan shows that pension plan membership in the private sector is falling and that most public sector employee have access to gold-plated plans. Membership fell 2.1% in the private sector as more employees were dropped from plans and the public sector on a hiring spree increased the number of employees on it's plans.

The recent troubles in the economy have forced more and more companies to reevaluate the viability of pension plans. Many companies have either changed plans to defined contribution, frozen plans to new members or closed their pension plans completely.

A defined benefit pension plans is one where the company or taxpayer guarantees an income for the employee in retirement. This contrasts with the defined contribution plan where the employees can only draw income against the funds that have accumulated inside the pension plan.

The Labour Force Survey done by Statscan shows employment numbers at the end of 2009. The pension plan membership numbers were also as of the end of 2009. At that time there were 3.4 million public sector employees and 10.6 million private sector employees. Those with defined benefit pension plans included 2.8 million public sector employees (82%) and 1.7 million private sector employees (16%).

The private sector has suffered hardship over the past three years but the public sector has remained unscathed. There has not been much discussion around the disparity between public sector employees with gold-plated pension and private sector with much lower coverage.

Earlier this year the LA Times wrote an article called The pension haves vs. the have-nots. The article asked "Can the substantial disparity between public and private sector retirement benefits be sustained much longer? We think that it probably cannot". It cannot be sustained financially or politically.

There is the implicit promise in defined benefit pensions that the employer or taxpayer will make good for any pension shortfalls and will be responsible for guaranteeing the income stream promised to the employees in retirement. Governments at all levels are starting to face serious challenges from pension shortfalls. Although the public sector pensions have been trying to suggest that the fall in stock markets was the main reason for the pension shortfalls, this is only a small part of the problem.

The number one determinant of rising pension costs is skyrocketing wages. We saw this when Ontario Teacher's Pension Plan reported it's performance for 2010, a record year for investment performance, yet the pension shortfall grew even bigger. The same story is happening across Canada in municipalities, universities and other government organizations.

An irritant for taxpayers is the fact that government are depositing ever increasing amounts of tax dollars into the public sector plans in order to shore them up. The report from Statscan shows the numbers.
Total employer and employee contributions to RPPs in 2009 amounted to a record high of $53.4 billion. Employers contributed 71% of the total, up from 67% in 2008.

About 33% of the employer contributions, roughly $12.6 billion, were for unfunded liabilities, more than twice the amount in 2008.
Statscan does not show if the shortfalls were paid into public sector plans or private sector ones. We do know the $12.6 million for shortfalls was paid into defined benefit plans because defined contribution plans cannot have an unfunded liability. This means that just the unfunded liability contributions averaged over $2,700 per employee. On top of that there was the additional $40.8 billion paid into these plans, the major portion of it by the employer.

Last year over 60% of Canadians did not make a contribution into their RRSP account, the largest majority stated a lack of funds was the major reason for not making a contribution. That did not stop them however, from contributing heftily to the pension plans of their neighbors in the public sector. Ever increasing portions of taxes are going into these plans.

In 2009 the total RRSP contributions for all Canadians were $33.0 billion down from $33.3 in 2008.
I thank Bill for sharing his thoughts with me but I take issue with some of his points above. First and foremost, the number one determinant of rising pension costs is not skyrocketing wages but historically low interest rates (read my comment on Ontario Teachers' 2010 results). Second, the main reason that Canadians aren't tucking away more savings is that household debt is hitting record highs as the Canada bubble inflates fueled by Canada's mortgage monster. Third, pensions aren't free for public sector workers -- they pay up to 8% of their salary for their pension benefits and because of this they're limited in what they can put in an RRSP.

But I do agree with Bill that pensions apartheid between the public and private sector is going to be a major political issue of the future. I think the Conservatives should increase the retirement age to 67 and scrap early retirement altogether. They should also introduce an increase in the contribution rate and cuts in benefits.

If federal government employees don't like it, tough luck! I'm currently working on contract for a federal government department and have no benefits whatsoever. Moreover, there is a stupid rule that the unions implemented that limits contracts to 90 days per calendar year, so even if I wanted to work longer, I can't. Apparently this is done to protect workers and prevent abuse from the federal government but the bottom line is that it prevents people like me who like working on contract from working longer than 90 days per calendar year.

Finally, last Friday I discussed the $30 billion pension surplus fight continues. Please go back to that comment and see the addendum which includes feedback from Bernard Dussault, the former Chief Actuary of Canada and Jim Murta of Murta's actuarial blog.

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