Tuesday, April 30, 2013

Caisse's 2012 Annual Report


The Caisse de dépôt et placement du Québec released its 2012 annual report in English late last week. Among other things, this report includes analyses of performance, risk management, and changes in assets. It also discusses the Caisse’s contribution to the economic development of Québec and its responsible investment activities.

Readers can click here to learn more about the following:
I've already covered the Caisse's 2012 results but the annual report provides a lot more details. It is excellent, well written and very informative.

Would like to first draw your attention to the message from the Caisse's president and CEO, Michael Sabia:
In my mind, 2012 is not important in and of itself. The year is important because it is part of a series of years. A period during which we have repositioned la Caisse so that we achieve our
mission in a world that is very different than the one of even five or six years ago. A few themes come to mind.

Balance. The new balance that we have struck between returns and risk. The simple but important idea of understanding thoroughly the assets that we invest in. To have the right tools and to master risks so that we can take the decisions needed to meet the expectations of our clients, our depositors.

Performance. The performance that we have delivered in a volatile and turbulent environment, thanks to an overall portfolio that is today better aligned with the world economy. Since we restructured our portfolios in 2009, our average annual returns: 10.7%. Proceeds from our investment activities: $50.7B. Which bring our assets to $176.2B.

Flexibility. The flexibility that we have built, which gives us the agility we need to seize the interesting investment opportunities that are available in today’s world – always with the goal of producing long-term returns for our depositors. This same flexibility is now permitting us to put in place new investment strategies to take advantage of changes in the structure of the world economy – once again, to the benefit of our depositors and Québec’s businesses.

Québec. Where we have significantly increased our investments, always prioritizing promising businesses and always with an eye to their development and expansion. In terms of numbers, over the last four years, we have undertaken $8.3B of new investments and investment commitments.

Beyond all of that, in my judgment, nothing demonstrates profound change better than when a group of people change how they think about themselves and the work they do. That’s what happened at la Caisse in 2012. And collectively, that’s the thing that we are most proud of.

A Broad Collaboration

We posed this question to our people: given the importance of the changes that are under way in the economic and financial environment, what are the guiding principles for our work in such a world?
Through a series of meetings over a period of many months, in small groups, large groups, in workshops and online, our people thought about and debated which convictions and which behaviours would best serve la Caisse.

Several hundred of our employees participated actively in this broad collaboration. The result is not a directive from top management. It is not a “little red book.”

It’s the affirmation of what our people are, of how they define themselves, and of what they aspire to be.
I took part in some of those meetings as an external consultant and can tell you it's exactly as Michael states above. There was a concerted effort to get input across all the groups at the Caisse to understand the major themes impacting the financial environment and how the Caisse should position itself in this volatile and fragile global environment.

In terms of portfolio changes, in 2012, working with the depositors, the Caisse made changes to the selection of portfolios offered to depositors to deploy the new components of its investment strategy in the years to come. The main changes include:
  • Refocusing the Hedge Fund portfolio on strategies that complement the traditional asset classes, starting July 1, 2012.
  • Creation of the Global Quality Equity portfolio to focus on companies with a stable, predictable return on invested capital, as of January 1, 2013. 
  • Addition to the Private Equity portfolio of a relationship- investing mandate geared to development of long-term relationships with promising companies, as of January 1, 2013.
  • Gradual closing-out of the Global Equity portfolio, starting July 1, 2013.
  • A gradual transition from indexed management to active management for the Emerging Markets Equity portfolio, starting July 1, 2013.
In addition, in November 2012, the Caisse completely closed out the Québec International portfolio, which had begun on April 1, 2010.

For each specialized portfolio, with the exception of the Asset Allocation portfolio and the ABTN portfolio, a benchmark index is used to compare the portfolio managers’ results with the corresponding market. The following changes were made to the portfolios’ indexes:
  • On January 1, 2012, the DEX Adjusted Long Term Government Bond Index was modified to increase the weighting of the Long Term Bond portfolio in provincial bonds.
  • Since January 1, 2012, the benchmark for the Real Estate Debt portfolio has been the DEX Universe Bond Index. The sale of the international component of the portfolio was completed in 2011, which justified removal of the Giliberto-Levy portion (10%) of the benchmark index.
  • On July 1, 2012, the Adjusted Aon Hewitt – Real Estate Index was modified to add the DEX 30 Day T-Bill Index, to reflect the cash held by the Real Estate portfolio.
  • Since July 1, 2012, the benchmark of the Hedge Funds portfolio has been in transition. When the transition period ends on July 1, 2013, the benchmark index will go from 10 strategies to three: futures management, market-neutral and global macro.
  • On January 1, 2013, the index of the Private Equity portfolio was changed to reflect the portfolio’s composition more accurately. The change was due to the addition of the relationship-investing mandate and the higher proportion of direct investments in companies. The index now consists of 50% State Street Private Equity Index (Adjusted) and 50% MSCI World Hedged.
  • The Global Quality Equity portfolio was created on January 1, 2013. Its index consists of 85% MSCI ACWI Unhedged and 15% DEX 91 Day T-Bill. The benchmark index is intended to reflect a traditional equity market investment, but adjusted for the level of portfolio risk.

(Note: Table 10, p. 25, gives a list of the benchmark indexes of the specialized portfolios and the changes made over the past four years.)

The Caisse should be commended for clearly presenting the benchmarks for each specialized portfolio and providing a history of the changes made over the last four years. Don't think anyone else in Canada provides these details (if  I'm wrong, correct me).

The annual report provides a detailed discussion on performance by specialized portfolio. 15 out of the 16 specialized portfolios posted positive results and the expense ratio for these results was 17.9 cents per $100, which is among the lowest in Canada for the large funds.

In terms of evolution of risk measures, noted the following:
The substantial support provided by central banks, and the gradual reduction of systemic risks prompted the Caisse to reduce the rather defensive bias of the overall portfolio. The overall portfolio’s relative exposure to the equity markets went from an underweight position of more than $4 billion at the end of 2011 to an overweight position of $1.5 billion at the end of 2012. This change is the main reason for the evolution of the risk profile of the Caisse’s overall portfolio between the start and the end of 2012 (see Figure 32, p. 44).

In addition to greater relative exposure to the equity markets, the Caisse’s portfolio maintains its protection against an increase in interest rates. Despite this slightly procyclical positioning of the overall portfolio, its level of market risk continues to be moderate, from both  active and absolute standpoints.

Urge my readers to take the time to go over the Caisse's 2012 Annual Report. There is simply too much material to cover in one blog entry but this report is excellent.

Finally, The Canadian Press, in a dispatch published on April 16th, wrongly suggests that Michael Sabia's total compensation and performance-related incentive compensation increased in 2012:
The total amount of the incentive compensation (paid and co-invested) granted by the Board of Directors to Mr. Sabia is exactly the same as that granted in 2011. As Mr. Sabia's salary also remains unchanged, the total amount of his total compensation also remains the same
Given the enormous responsibilities of this high profile job, can tell you Michael Sabia remains underpaid relative to his peers. The media should focus their attention where it counts and be more careful when reporting compensation. Think Michael and the rest of the employees at the Caisse are doing an outstanding job delivering strong risk-adjusted returns and they should be commended for this.

Below, for those of you who speak French, watch Michael Sabia's interview on Radio Canada. Michael rightly put the emphasis on long-term results when the reporter pressed him on one-year results and said there is still a lot of work ahead.

Monday, April 29, 2013

Squeezing Retirees Into Pension Poverty?

Jessica Silver-Greenberg of the NYT reports, Loans Borrowed Against Pensions Squeeze Retirees (h/t, Suzanne Bishopric):
To retirees, the offers can sound like the answer to every money worry: convert tomorrow’s pension checks into today’s hard cash.

But these offers, known as pension advances, are having devastating financial consequences for a growing number of older Americans, threatening their retirement savings and plunging them further into debt. The advances, federal and state authorities say, are not advances at all, but carefully disguised loans that require borrowers to sign over all or part of their monthly pension checks. They carry interest rates that are often many times higher than those on credit cards.

In lean economic times, people with public pensions — military veterans, teachers, firefighters, police officers and others — are being courted particularly aggressively by pension-advance companies, which operate largely outside of state and federal banking regulations, but are now drawing scrutiny from Congress and the Consumer Financial Protection Bureau.

The pitches come mostly via the Web or ads in local circulars.

“Convert your pension into CASH,” LumpSum Pension Advance, of Irvine, Calif., says on its Web site. “Banks are hiding,” says Pension Funding L.L.C., of Huntington Beach, Calif., on its Web site, signaling the paucity of credit. “But you do have your pension benefits.”

Another ad on that Web site is directed at military veterans: “You’ve put your life on the line for Americans to protect our way of life. You deserve to do something important for yourself.”

A review by The New York Times of more than two dozen contracts for pension-based loans found that after factoring in various fees, the effective interest rates ranged from 27 percent to 106 percent — information not disclosed in the ads or in the contracts themselves. Furthermore, to qualify for one of the loans, borrowers are sometimes required to take out a life insurance policy that names the lender as the sole beneficiary.

LumpSum Pension Advance and Pension Funding did not return calls and e-mails for comment.

While it is difficult to say precisely how many financially struggling people have taken out pension loans, legal aid offices in Arizona, California, Florida and New York say they have recently encountered a surge in complaints from retirees who have run into trouble with the loans.

Ronald E. Govan, a Marine Corps veteran in Snellville, Ga., paid an interest rate of more than 36 percent on a pension-based loan. He said he was enraged that veterans were being targeted by the firm, Pensions, Annuities & Settlements, which did not return calls for comment.

“I served for this country,” said Mr. Govan, a Vietnam veteran, “and this is what I get in return.”

The allure of borrowing against pensions underscores an abrupt reversal in the financial fortunes of many retirees in recent years, as well as the efforts by a number of financial firms, including payday lenders and debt collectors, to market directly to them.

The pension-advance firms geared up before the financial crisis to woo a vast and wealthy generation of Americans heading for retirement. Before the housing bust and recession forced many people to defer retirement and to run up debt, lenders marketed the pension-based loan largely to military members as a risk-free option for older Americans looking to take a dream vacation or even buy a yacht. “Splurge,” one advertisement in 2004 suggested.

Now, pension-advance firms are repositioning themselves to appeal to people in and out of the military who need cash to cover basic living expenses, according to interviews with borrowers, lawyers, regulators and advocates for the elderly.

“The cost of these pension transactions can be astronomically high,” said Stuart Rossman, a lawyer with the National Consumer Law Center, an advocacy group that works on issues of economic justice for low-income people.

“But there is profit to be made on older Americans’ financial pain.”

The oldest members of the baby boom generation became eligible for Social Security during the recent housing bust and recession, and many nearing retirement age watched their investments plummet in value. Some are now sliding deep into debt to make ends meet.

The pitches for pension loans emphasize how difficult it can be for retirees with scant savings and checkered credit histories to borrow money, especially because banks typically do not count pension income when considering loan applications.

“The result often leaves retired pensioners viewed like other unqualified borrowers,” one of the lenders, DFR Pension Funding, says on its Web site. That, the firm says, “can make the ‘golden years’ not so golden.”

The combined debt of Americans from the ages of 65 to 74 is rising faster than that of any other age group, according to data from the Federal Reserve. For households led by people 65 and older, median debt levels have surged more than 50 percent, rising from $12,000 in 2000 to $26,000 in 2011, according to the latest data available from the Census Bureau.

While American adults of all ages ran up debt in good times, older Americans today are shouldering unusually heavy burdens. According to a 2012 study by Demos, a liberal-leaning public policy organization, households headed by people 50 and older have an average balance of more than $8,000 on their credit cards.

Meanwhile, households headed by people age 75 and older devoted 7.1 percent of their total income to debt payments in 2010, up from 4.5 percent in 2007, according to the Employee Benefit Research Institute.

Financial products like pension advances, which promise quick cash, appear especially enticing because their long-term costs are largely hidden from the borrowers.

Federal and state regulators are spotting fresh examples of abuse, and both the Consumer Financial Protection Bureau and the Senate’s Committee on Health, Education, Labor and Pensions are examining these loans, according to people with knowledge of the matter.

Though the firms are not directly regulated by states, officials from the California Department of Corporations, the state’s top financial services regulator, filed a desist-and-refrain order against a pension-advance firm in 2011 for failing to disclose critical information to investors.

That firm has since filed for bankruptcy, but a department spokesman said it remained watchful of pension-advance products.

“As the state regulator charged with protecting investors, we are aware of this type of offer and are very concerned with the companies that abuse it to defraud people,” said the spokesman, Mark Leyes.

Borrowing against pensions can help some retirees, elder-care lawyers say. But, like payday loans, which are commonly aimed at lower-income borrowers, pension loans can turn ruinous for people who are already financially vulnerable, because of the loans’ high costs.

Some of the concern on abuse focuses on service members. Last year, more than 2.1 million military retirees received pensions, along with roughly 2.6 million federal employees, according to the Congressional Budget Office.

Lawyers for service members argue that pension lending flouts federal laws that restrict how military pensions can be used.

Mr. Govan, the retired Marine, considered himself a credit “outcast” after his credit score was battered by a foreclosure in 2008 and a personal bankruptcy in 2010.

Unable to get a bank loan or credit card to supplement his pension income, Mr. Govan, now 59, applied for a payday loan online to pay for repairs to his truck.

Days later, he received a solicitation by e-mail from Pensions, Annuities & Settlements, based in Wilmington, Del.

Mr. Govan said the offer of quick, seemingly easy cash sounded too good to refuse. He said he agreed to sign over $353 a month of his $1,033 monthly disability pension for five years in exchange for $10,000 in cash up front. Those terms, including fees and finance charges, work out to an effective annual interest rate of more than 36 percent. After Mr. Govan belatedly did the math, he was shocked.

“It’s just wrong,” said Mr. Govan, who filed a federal lawsuit in February that raises questions about the costs of the loan.

Pitches to military members must sidestep a federal law that prevents veterans from automatically turning over pension payments to third parties. Pension-advance firms encourage veterans to establish separate bank accounts controlled by the firms where pension payments are deposited first and then sent to the lenders. Lawyers for retirees have challenged the pension-advance firms in courts across the United States, claiming that they illegally seize military members’ pensions and violate state limits on interest rates.

To circumvent state usury laws that cap loan rates, some pension advance firms insist their products are advances, not loans, according to the firms’ Web sites and federal and state lawsuits. On its Web site, Pension Funding asks, “Is this a loan against my pension?” The answer, it says, is no. “It is an advance, not a loan,” the site says.

The advance firms have evolved from a range of different lenders; some made loans against class-action settlements, while others were subprime lenders that made installment and other short-term loans.

The bankrupt firm in California, Structured Investments, has been dogged by legal challenges virtually from the start. The firm was founded in 1996 by Ronald P. Steinberg and Steven P. Covey, an Army veteran who had been convicted of felony bank fraud in 1994, according to court records.

To attract investors, the firm promised an 8 percent return and “an opportunity to own a cash stream of payments generated from U.S. military service persons,” according to the California Department of Corporations. Mr. Covey, according to company registration records, is also associated with Pension Funding L.L.C. Neither Mr. Covey nor Mr. Steinberg returned calls for comment. In 2011, a California judge ordered Structured Investments to pay $2.9 million to 61 veterans who had filed a class action.

But the veterans, among them Daryl Henry, retired Navy disbursing clerk, first class, in Laurel, Md., who received a $42,131 pension loan at a rate of 26.8 percent, have not received any relief.

Robert Bramson, a lawyer who represented Mr. Henry in the class-action lawsuit, said that pensioners too often failed to contemplate the long-term costs of the advances.

“It’s simply a terrible deal,” he said.
It certainly is a terrible deal. And these sharks peddling "pension advances," preying on financially vulnerable pensioners, should be prosecuted for loan sharking.

America's new pension poverty is a recurring theme on this blog and policymakers need to wake up and deal with a crisis in the making. Regulators need to be extremely vigilant as these firms peddling pension loans are sprouting up all over the United States. And as hard times hit retirees, more and more will be falling prey to these sharks, sending them deeper into pension poverty.

Most disturbing, it's as if we learned nothing from the whole sub-prime debacle. Here you have a classic example of yet another foray into sub-prime lending using pension loans. All that's missing is for banks and brokerages to collateralize all these loans and some rating agency to rate the different tranches. I'm being cynical but it never ceases to amaze me how the weak and vulnerable are continuously being preyed on.

Below, an ad on YouTube from "Rapid Pension Advances" peddling loan advances to pensioners and those receiving disability payments. Whenever I see these ads, I cringe in horror. Buyers beware, if it looks to good to be true, walk away and save the little money you have or risk losing it to unscrupulous sharks!



Friday, April 26, 2013

Teachers Put Hedge Funds in Detention?

Chris Tobe, founder of Stable Value Consultants, wrote an article for MarketWatch, Teachers put hedge funds in detention:
The Wall Street Journal reported last week that “the American Federation of Teachers listed 34 executives at hedge funds and other investment firms that help lead or make contributions to organizations with a hostile stance toward traditional defined-benefit plans.”

This is just the tip of the iceberg.

Many public pensions hold these hedge funds, such as the much maligned SAC Capital via a Hedge Fund of Funds. This is the case with the Kentucky Retirement System who owns SAC via the Blackstone Hedge Fund of Funds.

Rolling Stone's Matt Taibbi had highlighted Daniel Loeb of Third Point LLC (also listed by the AFT) in his blog article last week which caused an uproar and forced Loeb to withdraw from a scheduled speaking engagement at a Council of Institutional Investors conference.

The WSJ quoted Jay Rehak, president of the Chicago Teachers' Pension Fund. "They come to us with their hand out, and then they are stabbing us in the back."

This is not the first time that money managers have been called to the carpet for taking a hostile stance toward traditional defined-benefit plans. Blackstone strategist Byron Wien got in big trouble in 2010 for saying that retirement benefits were too generous.

Pete Peterson, a Blackstone co-founder, put millions behind think tanks that are hostile to DB plans and to an effort to cut Social Security benefits.

Record Currency management's (which did have Kentucky and is still with the Maryland Public plan) founder Neil Record is a leader in the United Kingdom in reducing Defined Benefit plans.

Pension politics continues to evolve and the next likely target is Private Equity — and as we all know from Bain Capital, is very likely to have the same issues.
Have to say, hedge funds and private equity funds should be frantically working behind the scenes to bolster defined-benefit plans. The institutionalization of the alternatives industry means the bulk of the $2.4 trillion managed by hedge funds is coming from large public pension plans.

Having said this, I don't agree with Chris Tobe's message above. I read Matt Taibbi's smear job on Daniel Loeb and thought it was sensational tabloid drivel. Loeb is arguably the best hedge fund manager alive and his fund has delivered outstanding returns to institutional clients which include many public pension funds.

Pete Peterson is the co-founder of Blackstone, one of the best alternatives fund in the world, but he retired a while back to focus on charities. True, the Peter G. Peterson Foundation is very much focused on reining in fiscal debt, and has proposed cuts to Social Security and other long-term entitlements (don't agree), but I can't find a single recommendation to abandon public defined-benefit plans. Most of the comments are just informational pieces pointing out the fiscal problems of state and local governments.

One thing I recommend to all hedge funds and private equity funds is to keep politics out of your business. Unions are growing increasingly frustrated by the constant attacks on defined-benefit plans and with good reason. Their members pay a lot  into these plans so they can enjoy the security and peace of mind that comes with a DB plan. The last thing they want to hear is some hedge fund or private equity manager who made it stinking rich by growing assets from their members' contributions publicly slamming DB plans.

And let's face it, hedge funds and private equity funds are in no position to slam anyone these days, especially the hand that feeds them. More articles are coming out shining a bad light on the hedge fund industry. Josh Brown wrote a  post on how hegde funds underperform more normal asset classes, stating the following:
Unfortunately, investors have plowed over $2 trillion dollars into the hedge fund complex under the misguided assumption that they'd be able to deliver alpha and absolute returns to juice performance. In actual fact, so-called "alternatives" have done the opposite for the vast majority of their investors.
And before you say "But what about what's his name?", bear in mind that the rare few hedge funds that have consistently posted great returns would never in a million years take money from you. And the odds of you identifying an emerging manager from the ground floor who becomes Paul Tudor Jones are about the same as you making out with Kate Upton in an outdoor shower on a Tahitian beach. There are amazing and talented fund managers out there - but even the fund of funds industry has been proven ineffective in terms of being able to sort them out from the rest.
There are excellent hedge fund managers out there, many of which I track every quarter, but Josh is right, most hedge funds are underperforming and the odds of identifying the next Paul Tudor Jones are slim to none. In fact, these are treacherous times for hedge funds and all active managers. Even great managers are struggling to deliver performance in this environment.

Had a conversation recently with a senior pension fund manager who invests with some of the world's best hedge funds. He told me that part of their due diligence is to look at the internal rate of return (IRR) and how it has evolved as assets grow. In his own words: "It's important to track the dollar-weighted return of these funds. We ask them data going back since inception. If a manager can't provide us with their IRR, we don't even look at them. Also, if  alpha is shrinking as assets mushroom, we flag it and review their performance."

This pension fund manager told me he read Simon Lack's book criticizing hedge funds, enjoyed many parts but he didn't agree with everything in the book. He thinks that hedge funds play an important part in an institutional portfolio and I agree. I'm also careful not to throw the baby out with bathwater when it comes to hedge funds as I think many commentators just do not understand their role in an institutional portfolio.

Hedge fund assets will only grow in the coming decade. A lot of the demand for hedge funds and other alternatives will be coming from Asia, which is why Paamco and other funds of funds are focusing their attention there.

Finally, today is my birthday so it's a good time to shamelessly plug my blog and ask many hedge funds, private equity funds, pension funds, big banks/ brokerages, unions, regulatory bodies and countless others who regularly read my comments to donate or sign up for a monthly subscription at the top right-hand side of the page.

I'm also looking into starting a consulting shop with a friend or joining an organization where I can continue doing what I love doing most, tracking pension fund investments and contributing positively to investment and asset allocation decisions across public and private markets. Please keep me in mind if you have any mandates for me. Wish you all a great weekend.

Below, Agecroft Partners Don Steinbrugge discusses hedge funds and his investment strategy with Deirdre Bolton on Bloomberg Television's "Money Moves." It's pretty much all about beta in Asia and elsewhere. Will be interesting to see if the facade of strength gives way this spring or if we get a rotation out of defensives into more cyclical sectors leveraged to global growth (pay attention to mining shares).

And Walkers Global Managing Partner Ingrid Pierce discusses start-ups and hedge funds with Deirdre Bolton on Bloomberg Television's "Money Moves."No doubt about it, breaking into the hedge fund world is getting harder than before, but if you think you have what it takes, go for it!


Thursday, April 25, 2013

How Australia Fixed a Retirement Crisis?

Dan Kadlec of Time Magazine reports, Mandatory Savings: How Australia Fixed a Retirement Crisis:
We can learn a lot about staying on top of our long-term financial security by studying the land down under.

Australia was among the earliest to get serious about financial education, establishing a financial-literacy foundation in 2005 — before the financial crisis. It also has a retirement system that is regarded as among the best in the world.

The U.S. is struggling on both fronts. We were early to formally embrace financial education, having established a Financial Literacy and Education Commission in 2003. But Australia has steamed ahead, requiring a personal-finance class for graduation throughout its school system. In the U.S., just 14 states require that such a course even be offered as an elective.

Increasingly, financial education is becoming a global initiative. The hope is that by raising the financial IQ of individuals around the world, the economy won’t fall victim to another financial crisis — at least not one caused by basic misunderstanding of things like mortgages and credit-card terms. It’s a long-term approach.

The real Aussie edge, though, may be a retirement system that “has achieved high individual saving rates and broad coverage at reasonably low cost to the government,”  according to new research from Julie Agnew for the Center for Retirement Research at Boston College. Australians do this through a three-pillar system that starts with private savings. The system also includes a safety net that resembles Social Security, though benefits are means-tested and disappear past a certain income threshold. In the U.S., means testing faces stiff opposition, though some argue that effectively it is already in place.

The key difference is Australia’s employer-based savings accounts, which resemble a 401(k). Employers are required to fund every worker’s account with 9% of pay, rising to 12% of pay in 2020. Over 90% of working Australians have savings in such an account. In the U.S., fewer than half of workers have money in a 401(k) or similar plan.

In her research, Agnew found that Australian plans are more likely to have automatic enrollment and contribution-escalation provisions, which are proven to boost participation and savings. Australian plans also include more advice and impose a fiduciary duty on anyone advising a plan participant. The country also has tighter restrictions on taking early distributions, known as leakage.

A mandatory employer-funded savings component is on the radar in the U.S. Alicia Munnell, director of the Center for Retirement Research, recently floated the concept as part of sweeping reform.
Retirement issues are a global concern. In one of the more unusual strategies for shoring up retirement security, the British food company Dairy Crest has transferred 44 million lb. of cheese to its pension. That sounds yummy. But something like the Australian system sounds better.
Dan Mitchell of the Cato Institute also praised Australia's private social security system, stating: "To be blunt, the Aussies are kicking our butts. Their system gets stronger every day and our system generates more red ink every day."

So is Australia the beacon of hope for America's 401(k) nightmare? I'm highly skeptical. While the U.S. retirement industry could learn from Australia's successes, I still maintain that the only enduring way to tackle the global retirement crisis will come when policymakers bolster defined-benefit (DB) plans, recognizing they're far superior to defined-contribution (DC) plans.

Sure, Australians are saving more for retirement but their savings are going to a defined-contribution plan which leaves millions vulnerable to the vagaries of public markets. When markets rise, people are happy but when they tank, they get anxious about their retirement. In other words, they don't have the security and peace of mind that comes with predetermined pension payments from a defined-benefit plan.

In Canada, I've long argued that it's time to enhance C/QPP for all Canadians. Last week, I praised the expert committee looking into Quebec's retirement system for proposing the adoption of a longevity plan to help those over 75 years old with a supplemental pension.

Nonetheless, even here there are disagreements among experts. Bernard Dussault, Canada's former Chief Actuary, shared the following with me yesterday:
If Quebec were to adopt a longevity plan, it shall be designed in a better fashion than what the Commission D'Amours (CDA) proposes. As designed, The CDA proposal is not viable and does not deserve to be identified as a longevity plan because:
  • while all current and future generations of contributors will pay the same uniform price for it, i.e. 3.3% of salary,
  • each successive generation of beneficiaries will receive the so-called longevity pension over a longer and longer period of time.
As longevity is expected to increase gradually for ever and at rates now proving to be higher than before, the promised CDA defined benefit will sooner than later become unsustainable.
The proposed plan could become a true longevity program only if the entitlement age (75 in the CDA proposal) were set to increase gradually each year (e.g. by 1 month). In that sense, the CDA proposal does not even conform with one of its own main guiding principles, i.e. inter-generational equity.
I'm not one to argue with Canada's former Chief Actuary. Bernard raises excellent points worth looking into as we study the pros and cons of  adopting this longevity plan.

Still, something needs to be done in Canada, the U.S., Australia and all around the world to bolster retirement systems and make sure future retirees can retire in dignity and security. Some countries are way ahead of others but pension systems all around the world are reeling after the crisis and policymakers need to address pension reforms sooner rather than later.

Below, pensions expert Ros Altmann discusses reforms to the U.K. pension system. There are two parts to this interview. As she says, the state pension will only provide a "bare minimum" and many people will need more to top it up.

Wednesday, April 24, 2013

Caisse Betting on Multi-Family Real Estate?

Arleen Jacobius of Pensions & Investments reports, Quebec pension fund invests in U.S. multifamily real estate:
Ivanhoe Cambridge — the real estate arm of the C$176 billion Caisse de Depot et Placement du Quebec — is snapping up multifamily real estate at a fast clip, and it's not done yet.

This month, Ivanhoe Cambridge bought into the $1.5 billion Equity Residential portfolio recently taken private by Goldman, Sachs & Co. and real estate manager Greystar Real Estate Partners.

Executives of Montreal-based Ivanhoe Cambridge believe the time is right to increase multifamily investments in the United States and the United Kingdom.

“Ivanhoe Cambridge believes in increasing its investment in the multiresidential segment in key markets and the U.S. is one in which we want to register growth this year,” said Sebastien Theberge, senior director, public affairs and communications at Ivanhoe Cambridge in an e-mail. “The economy is picking up and social-demographic trends are favorable, two key factors that will support the sector in the near future.”

The Equity Residential deal includes a portfolio of 27 high-quality multiresidential properties in high-performing submarkets in the U.S. Most properties in the portfolio were built in the 1990s and have strong existing cash flows. The partners will embark on a multiyear maintenance and renovation program for the properties. Mr. Theberge declined to provide terms of the transaction.

All together, Ivanhoe Cambridge has investments in 56 multiresidential properties located in major urban centers in Canada, the U.S. and the U.K.

“In the U.S., we are focusing on markets with strong, diversified employment bases, primarily New York, Boston, Washington, Los Angeles and San Francisco,” Mr. Theberge said in his e-mail. “In Europe, the focus is on Paris and London. Our London investments are through an alliance with Residential Land.”

In February 2012, Ivanhoe Cambridge — in partnership with Residential Land and Apollo Global Real Estate — bought four multiresidential buildings in prime central London. In December, Ivanhoe Cambridge acquired majority ownership interests in two multiresidential complexes in prime central London — one in South Kensington and the other in Belgravia.

Ivanhoe Cambridge's partnership gives it participation in any acquisition opportunity the partners come across that matches Ivanhoe Cambridge's investment criteria.
The Caisse has one of the best real estate teams among any institutional investor. If they're investing in this sector it's because they believe the economy and demographics are favorable going forward.

One thing that concerns me, however, is that some segments of the United States are very expensive. Bendix Anderson of National Real Estate Investor writes, Are Multifamily Prices Peaking in NYC?:
Sky-high prices for Manhattan apartment properties and rock-bottom low yields for investors may have reached the limit.

“The yield is down to the bare bones,” says Peter Schubert, managing director of capital markets for Transwestern. “I am calling the bottom.”

New York City’s clear strengths, including strong demand for rental apartments and a sharply limited supply of new apartments, are no longer enough to justify the prices paid by investors for top properties in top neighborhoods, according to Schubert, co-author of Transwestern’s “2013 Multifamily Housing Survey.”

Investors from all around the country are pouring money into New York City apartment properties. They are looking for an investment that yields more than Treasury bonds but that is still safe, even in our slow, uneven recovery. New York multifamily properties were resilient during the downturn, so they are attractive. “I’m talking to clients in Texas who say that their new mandate is to go and spend money in New York City,” says Schubert. “They have money burning a hole in their pocket.”
Low, low cap rates

Prices kept rising through the end of 2012. Average cap rates for apartment properties in Manhattan, which express their net operating income as a shrinking percentage of rising prices, fell to 3.9 percent in the fourth quarter. That’s more than a full percentage point below the year before, according to data firm Real Capital Analytics. “There is no cap rate compression left,” says Schubert.

Meanwhile, the average price per unit at apartment properties was well above $500,000, according to Real Capital Analytics. That’s high even for Manhattan.
Rent risk

Properties sold at low cap rates may have a difficult time growing their net operating incomes enough to justify their high prices. Expenses such as property taxes and utilities have been growing at three times the rate of inflation in the City.

Rent growth is also slowing. “We could endure a year or two of flat rent growth,” Schubert warns. Other market analysts see rent growth slowing already. Effective rent growth was just 0.1 percent over the first quarter of this year and actually shrank 0.2 percent in the fourth quarter of last year, according to Reis Inc. That’s in spite of a vacancy rate among institutional investment-quality apartments of just 1.9 percent in the first quarter. Usually, low vacancies mean higher rents. But rents still need to fit what residents can pay. “We may be seeing that rents are hitting the upper bound of what people can charge,” says Brad Doremus, vice president of research and economics for Reis.

Many investors are assuming rent growth will be much higher at the properties they buy in Manhattan. Even relatively conservative underwriting often assumes annual rent growth of 3 percent, Schubert says.
Big city risk

New York City real estate also carries unique risks. Nearly one-third of the City’s housing stock is restricted by rent stabilization laws. During the boom, investors bought dozens of rent-stabilized properties with plans to quickly raise the rents. Nearly all of these plans failed. Stuyvesant Town in Manhattan was just one high-profile property seized by lenders. Even if a buyer fully understands the local rent laws, those laws could always change. “It’s an evolving set of rules,” says Schubert.

For all these reasons, Schubert is urging his clients to look further afield from the core neighborhoods of Manhattan and risky “value-added” acquisitions of rent stabilized properties. Investors could look to other neighborhoods of New York City where values still have room to increase. “The best way to add value is to be ahead of the curve,” he says. “There will be more appreciation in these frontier neighborhoods.”
Some real estate investors who were burned badly during the downturn are now focusing elsewhere. The NYT reports of one investor who instead of buying prominent buildings in places like New York and Boston, is now buying residential complexes in secondary and tertiary markets like Greenville, S.C. and Maryville, Tenn.

But large institutions typically focus on primary markets, not tertiary markets. And while multi-family may be the place to invest, other sectors are much more vulnerable to structural changes taking place in our economy.

Dave Maney wrote an insightful comment on commercial real estate's fearsome future:
I wouldn't want to own most kinds of commercial real estate at today's valuations. Given the causes and direction of the radical restructuring that continues to grind through our economy, there's almost nowhere for demand for office and retail space to go but down.

Why? Because we don't have the same need to be near to each other to get things accomplished anymore.

Since the Industrial Revolution took hold 200-plus years ago, to make a product or perform a complex service, we had to gather in factories and office buildings. The need to be close to fellow workers was so critical and so vital that we literally started stacking them on top of each other in big cities, building skyscrapers that allowed thousands of employees to work together under the same very tall roof.

And in the world of retailing, we bought selections we made from what was on display on the shelves of a department store or big-box retailer.

But the Internet has begun to change the rules of proximity in significant ways. While many of us still gather in offices (fewer and fewer all the time in factories), the very nature of what it's like to work in those offices is different. Stop and think: Fifteen years ago, a typical office was an active, noisy place, with people walking purposefully about to converse with a co-worker, phones ringing with inquiries and orders, and lobbies full of visitors coming and going.

Now think about your most recent day in the office (or your attorney's or banker's office). What did you hear? Chances are ... nothing. Collaboration now happens largely in the digital world. Files are shared.

Multiple co-workers interact and move projects forward in virtual space. The phones are quiet because a company's information is online, so live inquiries are rarer. Orders get placed and paid for through the cloud.

The idea of "Putting a face to a name" used to be a huge reason for business travel. Now putting a face to a name involves pointing your browser to LinkedIn.

In short, the search box is becoming the human race's most fundamental organizing principle. We can find exactly what we want when we want it.

And unless we're trying to get served a stack of pancakes, we generally don't care where it's currently located. When collaboration is called for, we can find the very best collaborators on the planet offering us the lowest price for the services we need, and we can see them and talk with them and monitor their progress real-time all without ever once coming anywhere physically near them.

So here's your problem if you're a company owner or executive: You have lots of ways of getting things done. You can outsource, crowdsource, offshore, subcontract, use freelancing platforms — or you can hire employees and put them in your space.

But that will likely be both the most expensive and inflexible choice that your company can make.

Creating a physical space for a person to work in costs a lot of money — you can guesstimate $5,000 to $7,000 a year for a standard-sized manager's office in Class A space in downtown Denver. Because of the way most commercial real estate leases are structured, if you want office space, you're going to commit to paying for it for a very long time. You're locked in.

Now consider that we live in the most unpredictable and volatile economic climate we've seen in generations. Put yourself in the business owner's shoes: Do you want to stay lean and fast, or would you like to predict what you'll be needing and wanting four years from now?

Thinkers and investors much smarter than I (like Jeff Jordan from Silicon Valley's elite venture-capital firm Andreesen Horowitz) have written extensively about the coming destruction of the big-box retail and shopping mall business models courtesy of nimbly aggressive online retailers. Not just behemoths like Amazon.com, either.

Jordan cites specialty retailers that sell everything from tailored clothing to eyeglasses online and doesn't see a single skilled entrepreneur choosing to create a new retail brand exclusively in physical locations. He points out that the inherent financial leverage in real estate-based retailing models is devastating when sales and margins turn south, which is exactly what's happening to huge retailers such as Best Buy and J.C. Penney.

It's ultimately the same forces - search vs. proximity. Do I want what's handy, or do I want exactly what I want for the fewest dollars I can spend?

Am I right?

You don't have to take this argument to its extremes — that everyone will work out of their house or that all retailing will be done online — to know that the bloom is way off the rose in the commercial real estate world. Less demand means soft or weakening lease rates and increasingly squishy terms for tenants. Vacant retail space hurts remaining tenants and again puts downward pressure on both rates and terms.

No one said commercial real estate is going away. But I bet you can't create a long-term scenario where demand outstrips supply and investors win big.
As investors grapple with where to put their money to work in various geographies and real estate sectors, it's important to understand the risks in each market. The biggest risk of all for commercial real estate (and other asset classes) is a prolonged period of debt deflation.

Below, the world's best real estate investor, Tom Barrack of Colony Capital, discusses foreclosed housing and investment opportunities on CNBC. Listen carefully to his comments, very interesting.

Tuesday, April 23, 2013

Leo de Bever on Imagining a Better Future

Had a chance to speak with Leo de Bever yesterday morning. Leo is the President, CEO and CIO of the Alberta Investment Management Corporation (AIMCo) and one of the smartest people in the investment management industry.

Below, some bullet points from our conversation:
  •  AIMCo delivered 11.5% on their balanced fund for fiscal year 2013 which ended on March 31st. This represents 200 basis points value added above the policy (benchmark) portfolio which is excellent. The annual report will be made available in June.
  • Unlike Ontario Teachers' or HOOPP, AIMCo cannot leverage its portfolio using derivatives and repos. It's forbidden by Alberta's provincial law.  It's important to keep this in mind because looking at headline figures doesn't explain risks. Leo thinks intelligent use of leverage is fine but they can't do this at AIMCo and he jokingly told me: "this could change but by then the timing will be wrong."
  • We talked a lot about the global economy, monetary and fiscal and policy. He explained how monetary policy is raising the value of all assets as cheap money floods the system. "Problem is all the money is benefiting the banking system, corporations are hoarding record amounts of cash but the money isn't flowing into the real economy."
  • We talked about inefficient demand and the paradox of thrift. Leo thinks governments need to facilitate infrastructure spending to ignite demand and that the myopic focus on fiscal austerity will create more problems down the road.
  • We discussed rising inequality in the United States and elsewhere. He told me GDP is not capturing everything in the economy. In particular, human capital isn't being captured: "Take a company like Facebook. Probably used $100M in physical capital or less and they extracted $20B and more. Where did it go?"
  •  He also told me to read a book, Race Against the Machine, to understand how  the digital revolution is accelerating innovation, driving productivity and irreversibly transforming employment. 
  • But technology isn't all bad. Leo sees incredible innovations taking place in energy, healthcare and many other fields. 
  • He told me that on a recent trip to Palo Alto, he was amazed to see how universities are working closely with the private sector and venture capitalists to commercialize ideas. "We are lagging in Canada and this needs to be addressed. Canadian universities are not producing students with the skill sets that are needed by industry."
  • In terms of markets, we talked about bonds, stocks and the facade of strength. He still thinks that stocks will outperform bonds over the long-run but he notes the performance of stocks won't be spectacular.
  • In the unlisted markets -- private equity, real estate and infrastructure -- they look at deals that make sense and like to "invest between the cracks." 
  • AIMCo is looking to sell its stake in Place Ville Marie here in Montreal, most likely to the Caisse, the other major owner. The decision has nothing to do with Quebec but they think it's time to give another operator the opportunity to work the asset. "That's what makes a market."
  • Finally, we discussed benchmarks in private markets and compensation. Leo thinks benchmarks must reflect opportunity cost but he also told me that even "top quartile managers can underperform markets on any given year," so you need to make sure your compensation is competitive enough to attract and retain the right people to manage the unlisted assets which have all sorts of issues like J-curves and stale valuations.
  • But he did add that using different benchmarks in private markets (ie. one for performance and one for compensation) can create "organizational, behavioral and agency issues." You have to make sure your investment managers are aligned with the long-term targets of the pension plan.
I thank Leo de Bever for speaking with me and this brief comment does not do justice to the full extent of our conversation. I urge all my readers to take the time to listen carefully to a presentation  Leo gave on imagining a better future at the University of Alberta last February. Click here to view it, it's excellent.

Leo will be at the C.D. Howe Institute on Monday April 29 as part of the Toronto Roundtable Event delivering a similar speech: "Imagining a Better Future: Why Forecasts of a Mediocre Future are Probably Wrong."

Below, Steve Kroft of CBS 60 Minutes reports that technological advances, especially robotics, are revolutionizing the workplace, but not necessarily creating jobs.

Monday, April 22, 2013

New Brunswick's Pensioners Declare War?

The CBC reports, 'There will be war' over pension changes, retirees warn:
Opposition to proposed pension reforms continued to gather strength on Thursday afternoon as Finance Minister Blaine Higgs met with hundreds of angry retired civil servants in Moncton.

About 600 people attended the public information session about switching to the shared-risk model, including Betty Smith, a retired teacher and member of the Pension Coalition of New Brunswick.

"What they are doing is unacceptable, we will not accept it," said Smith. "There will be war in the province before this is over."

Under the provincial government’s reforms, the future pension risk would be shared by both sides.

Guaranteed cost-of-living increases will also be eliminated for pensioners and instead be dependent upon market performance.

'All we want is what we paid for — nothing more, nothing less.'—Betty Smith, retired teacher

Smith, who spent 12 years teaching and 33 years in the classroom, said she worked too hard to see her pension plan change.

"What they are doing is illegal, very illegal," she said.

"All we want is what we paid for — nothing more, nothing less. Shared-risk is great on a go-forward basis, not the way it's going now."

"We paid dearly for what we have today, and the money has been squandered by the governments. And they want to get more of our money. And we're not going to put up with it," Smith said.
Higgs 'embarrassed' about lack of consultations

The finance minister was also peppered with questions about a lack of communication and consultation on the changes.

Higgs, who is touring the province, visiting seven cities in four days, acknowledged their concerns and apologized to the crowd several times.

"I have not been involved in the process to this level til this point," he said. "I am embarrassed to be in this position at this time, where discussions were not held to the degree where they should have been."

Higgs was defensive, however, when it came to threats that his government will suffer consequences at the polls over the unpopular pension changes.

That type of threat has scared previous governments and put the province deeper and deeper into debt, he said.

"For me and for my colleagues, we didn't join this to just have this province to continue to spiral down this hole. We joined it to say can we start to recover."

Under the current plan, the risk of any market downturns is borne by the provincial government alone. Under the reforms, the risk would be shared by both sides.

The proposed model, unveiled last May by Premier David Award, also includes increased contribution levels and higher age of retirement phased in slowly over a period of time.

Government officials have previously said the pension changes would not cut the benefits in place for retirees.

But a government actuary at the Saint John meeting acknowledged cost-of-living increases will be eliminated for pensioners and instead be dependent upon market performance.

The Public Service Superannuation Act (PSSA), which covers employees who work directly for government departments and NB Power, currently has a $1 billion shortfall.

It included 13,441 pensioners as of March 31, 2012. Their average annual pension was $20,603.

A meeting was also held in Miramichi on Thursday night.

Meetings are also scheduled for:
  • Bathurst, April 19, 1 p.m.-3 p.m., Collège communautaire du Nouveau-Brunswick amphitheatre, Room 286C, 75 Youghall Dr.
  • Campbellton, April 19, 6 p.m.-8 p.m.: Collège communautaire du Nouveau-Brunswick gymnasium, 47 du Village Ave.
  • Edmundston, April 20, 1 p.m.-3 p.m.: Clarion Hotel, Banquet Room, 100 Rice St.
CBC also reports, Pension reforms for retirees not illegal, expert says:
A pension law expert says he doubts retired civil servants will be able to convince the courts that proposed pension changes in New Brunswick are a breach of contract.

"All contractual arrangements between employers and employees and retirees are governed by the Pension Benefits Act," said James Pierlot, who is based in Toronto.

"So the government does have the legal power to change how that functions. And indeed, to introduce shared-risk pension plans as it has done. So it that sense, no, there is no illegality here," he said.

Anger among pensioners has continued to grow this week as Finance Minister Blaine Higgs held a series of public meetings across the province to explain the changes.

Under the current plan, retired civil servants are sheltered by the provincial government from any risk of market downturns.

Under the reforms, however, the risk would be shared by both sides.

Guaranteed cost-of-living increases will also be eliminated for pensioners and instead, be dependent upon market performance.

Many pensioners have argued it's unfair for them to lose benefits they've already paid for.
Current employees hardest hit

Pierlot says it's understandable that retirees are upset about the changes, but they will be the least affected.

It is current employees who will bear the brunt of the new plan, he said.

"And the younger they are, the more modest their pensions are going to be going forward. They're facing later retirement ages, lower benefits, et cetera. Whereas any reductions or risks faced by retirees is considerably less."

Premier David Alward announced the government was overhauling the pension system last May, saying the current plan is not sustainable.

The new plan will see increased contribution levels and a higher age of retirement phased in. The targeted retirement age would be moved to 65 from 60 over a 40-year period.
James is right, there is nothing illegal being done here and younger employees will bear the brunt of the new plan. They will not enjoy the retirement benefits of current retirees.

Nonetheless, retirees are right to feel angry, betrayed and hoodwinked. There were no public consultations whatsoever and the cuts to their benefits were not explained to them properly.

Another thing worth looking into was whether their plan was properly managed over the last twenty years. That $1 billion shortfall no doubt got worse as interest rates hit record lows, but there were concerns that the plan wasn't being managed properly for years (many issues have now been addressed but the performance lagged their Canadian peers).

Why is it important to keep an eye on New Brunswick's pension war? Because some think New Brunswick has the answer to Canada's pension funding crisis and that shared-risk plans are the future and will  likely spread across Canada as their benefits become better known.

While I agree with shared-risk plans, which was one of the recommendations of the committee looking into Quebec's retirement plans, also think we need to look more closely at pension governance and improving the way these plans manage their investments and communicate their results.

The situation in New Brunswick is grim but hardly dire. The government bungled it up by not holding public consultations and can hardly be surprised by the backlash from retirees rightly concerned about cuts to their pension benefits, money which they paid into the plan for many years.

Below, angry civil service pensioners in Moncton tell finance minister reforms are 'illegal' and declare war over cuts to their pensions. Unfortunately, this scene will be playing out throughout Canada in the future which is why I urge finance ministers to bolster our retirement as soon as possible.

Update: CUPE official backs pension reforms despite protests.

Friday, April 19, 2013

Should Quebec Adopt a Longevity Plan?

Rhéal Séguin of the Globe and Mail reports, Panel proposes pension plan for elderly retirees in Quebec:
A new universal supplemental pension plan is one of the key proposals by a blue-ribbon panel to provide financial security for elderly retirees in Quebec.

A committee of experts examining the province’s underfunded retirement system recommended Wednesday that Quebec take the bold and innovative step of creating what it calls a “longevity pension” where, at age 75, retirees would receive an additional income.

As workers live longer and retire earlier, enormous pressure is being placed on existing private and public pension plans. Those managed by the Quebec Pension Plan alone are underfunded by $41-billion, the committee reported. The committee recommended that, to improve their solvency, the workers and employers need to restructure the plans over a five-year period.

The experts also called for the implementation of a voluntary retirement savings plan.

The Quebec government said it will hold public hearings and act quickly on some of the report’s recommendations.

“A bill [on a voluntary savings plan] was being prepared and will be tabled soon,” Premier Pauline Marois said in the National Assembly on Wednesday.

However, the government appeared less anxious to take a position on the committee’s longevity plan proposal. Ms. Marois invited the opposition parties to take part in a non-partisan debate next fall in seeking solutions to the serious financial problems facing the province’s retirement-income system.

In creating the longevity plan, the government should allow easier withdrawals from retirement savings, the committee recommended.

The committee confirmed that a growing number of workers were outliving their savings at a time when almost half of the four million workers in Quebec – or 47 per cent – have no group retirement plan. Their only source of income after retirement will be benefits from the Quebec Pension Plan and federal Old Age Security.

The longevity plan recommendation would be an additional way to require workers to contribute to another mandatory pension plan to ensure an adequate source of income in the latter years of their retirement.

“The status quo is not a solution,” said committee chairman Alban D’Amours, who was the former president and CEO of Desjardins Group. “The objective here is that everyone be given access to a reliable pension income.”

The proposed longevity plan would be fully funded by employer and employee contributions, and all workers – regardless of income – would be required to contribute. The plan’s cost was estimated to be the equivalent of 3.3 per cent of earnings shared equally between workers and employers up to a maximum contribution of $840 a year per employee.

Earnings at 75 years of age would be the equivalent of 0.5 per cent of earnings up to a maximum allowed by law. For instance, a young worker earning the maximum allowable income, $51,000, and who paid $840 a year into the plan, would receive $14,564 a year as a supplemental income at age 75.

The experts also concluded that while defined benefit plans provided the best protection at lower cost, several plans remained in serious financial difficulty. As many as 72 per cent of the plans had a degree of solvency of less than 80 per cent.

“Increasing life expectancy, early retirements, an aging population, the decrease in interest rates and financial market volatility have made the weaknesses blatantly obvious,” the report stated, adding that hopes of a market turnaround to correct the problem was an “illusion.”

The committee of experts recommended the government allow for more flexibility for negotiations between company management and employees to solve the financial problems facing the defined benefit plans. The objective the committee insisted on was to help workers plan their financial security in preparation for retirement.

“The longevity plan allows people to save more and it will cost a lot less than if we did nothing,” Mr. D’Amours said at a news conference. “Our entire pension system is coming under attack. If we do it [the longevity plan] today it is a savings plan. But if we do nothing, tomorrow it will become a tax.”

However, the business community expressed concerns that the new longevity plan amounted to a new tax on small and medium size companies. The Canadian Federation of Independent Business estimated the new plan could cost $5-billion a year – a heavy burden for many small companies and their employees to carry.
Kevin Dougherty of the Montreal Gazette also reports, ‘Longevity pension’ would cost working Quebecers $843 a year:
If proposals to fix the province’s ailing pension system become law, working Quebecers would pay $843 a year, and their employers would add an equal amount to fund a proposed new “longevity pension.”

And before the report was even presented Wednesday, Premier Pauline Marois said legislation to do just that is being prepared and would be presented soon.

Marois called for unanimity among all parties in the assembly, “to protect the retirement of those who have contributed all their lives to retirement plans and others who have not, who need more support.”

The longevity pension is the main recommendation in a 219-page report presented Wednesday by seven pension experts after 18 months of behind-the-scenes consultations and deliberations.

Benefits under the new plan would be paid starting at age 75 — on top of federal Old Age Security and existing Quebec Pension Plan benefits, adding as much as $14,564 a year to a pensioner’s income.

Quebecers are retiring earlier and living longer, putting unsustainable pressure on private pension plans.

The panel of experts was named by the Liberal government of Jean Charest in 2011 because private pension plans in the province have a shortfall, which has grown to $41 billion, between the money they have and the pensions they are committed to paying out.

But the panel, headed by Alban D’Amours, former head of Quebec’s Desjardins financial co-operative movement, broadened its focus to the restructuring of the province’s pension regime, looking 40 years ahead.

The looming problems are considerable.

The proportion of Quebecers working and paying taxes will drop to two working Quebecers for everyone over 65 by 2030.

As well, interest rates on investments average 2.3 per cent, far from the 10-per-cent-plus returns once promised by financial planners, touting, “Freedom 55” — the dream of stopping work 10 years before the usual retirement age.

Volatile financial markets suggest there is no respite ahead and Quebecers must make pension adjustments.

About 2.4 million working Quebecers have no private pension plan to supplement their government pensions.

The longevity pension would leave Quebecers with a 10-year period after the normal retirement age of 65 when they would have to either count on personal savings or continue working.

The committee makes no recommendation to raise the retirement age, but Luc Godbout, a Université de Sherbrooke tax expert and panel member, said too many Quebecers now claim their Quebec Pension Plan benefits at age 60 and their Old Age Security at 65, getting less than they could should they keep working and defer their government pensions.

By setting 75 as the age additional benefits would be paid, the committee sends a signal that there is no advantage to early retirement, and suggests that Quebecers save more before they retire.

“We are reinventing savings,” D’Amours said.

And while D’Amours stressed payments into the longevity pension are “not a tax,” Martine Hébert, Quebec vice-president of the Canadian Federation of Independent Business, called the new charge a “payroll tax” that would add to the burden on small businesses in the province, making them less competitive.

D’Amours said calling it a payroll tax is “a bad reading” of the plan, conceived to be 100-per-cent capitalized, meaning that everything paid into the plan will be paid out, without taxpayers contributing.

“It allows people to save more,” he said. “It allows small businesses to assume their responsibilities.

“And it will cost less than what we would have to pay eventually if nothing is done in 10 or 15 years, when the problem of longevity will be even more apparent.”

Without the longevity pension, pensioners with diminished resources would turn to government, seeking relief paid “with our taxes,” D’Amours said.

Yves-Thomas Dorval, president of the Conseil du patronat du Québec employers’ group, suggested the government could reduce other payroll taxes to ease the burden, but said overall the D’Amours report is positive.

“There are measures that will encourage people to work longer,” Dorval said.

He said contributions to pay the longevity pension would remove about $2 billion a year from the economy.

“That is a large impact,” Dorval said.“On the other hand, it is like a transfer for later because it is money that will be used later.”

While primarily intended to help Quebecers with no pension plan, the longevity pension would also ease some of the pressure on private pension plans.

The report’s authors explained that employers could adjust their private pension plans, reducing employees’ payroll pension deductions by a corresponding amount.

And the private plans would not duplicate the benefits of the longevity pension after age 75, easing the underfunding problem for company pensions.

The committee also proposed measures favouring negotiations to resolve the underfunding problem in a 15-year time frame.

Another proposal would allow an employer to unilaterally abolish secondary benefits, such as retirement at full pension before age 65.
The details of the report are available here on the Régie des rentes du Québec's website. The committee's presentation is available here (French only) and the full report is available here.

The Committee is composed of the following 7 volunteer members:
  • Mr. Alban D'Amours, Committee Chair; President and CEO of the Desjardins Group (2000-2008)
  • Mr. René Beaudry, actuary; Partner, Normandin Beaudry
  • Mr. Luc Godbout, tax specialist, Université de Sherbrooke
  • Mr. Claude Lamoureux, President and CEO, Ontario Teachers' Pension Plan (1990-2007)
  • Mr. Maurice Marchon, economist, HEC Montréal
  • Mr. Bernard Morency, Executive Vice-President, Caisse de dépôt et placement du Québec
  • Mr. Martin Rochette, lawyer; Senior Partner, Norton Rose 
I commend the work of all the members who produced this report and believe they are spot on with their recommendations. It's time Quebec gets serious about addressing problems in our retirement system.

The need to overhaul Quebec's retirement system is pressing. In an article earlier this week on Quebec's ailing pension system, Kevin Dougherty of the Montreal Gazette reported the following:
The Institut de la statistique du Québec estimates that at the end of 2012, private defined-benefit pension plans in Quebec had a total deficit of $40.6 billion. Also, 74 per cent of defined-benefit plans were only 80-per-cent solvent.

The problem affects both private and public-sector employees, as well as those with no pension plan except federal Old Age Security. The federal payout can be supplemented by the Canada Assistance Plan, and the more generous Quebec Pension Plan, funded by employee and employer contributions.

About 40 per cent of Quebecers have savings sheltered from the taxman in Registered Retirement Savings Plans, leaving 60 per cent of Quebecers with no retirement savings.

Now, Quebecers can claim a reduced pension, under the Quebec Pension Plan from age 60.

Quebec’s average retirement age in 2011 was 60.9 — compared with 62.7 in Ontario and the Canadian average of 62.3.

While Quebecers are living longer, retirement incomes are not always indexed to offset inflation.

Some employees, such as those who worked for once-solid companies like Nortel Networks and Abitibi, are not getting the pensions they were promised.

Quebec’s municipalities say they have a combined $5-billion deficit in meeting their obligations under defined-benefit pensions for civic employees — or about $100,000 for each employee.

Montreal Mayor Michael Applebaum has told the D’Amours committee that raising city taxes to cover pension deficits is not a foreseeable solution.

“It is a question of equity for Montrealers who, for the great majority, do not have a pension plan,” Applebaum said.

Éric Forest, president of the Union des municipalités du Québec, told The Gazette in an interview Monday that there is no single recipe to solve the problem, but he appealed to the government to “give us the tools” to work out agreements with public-sector unions.

The Conseil du patronat du Québec employers’ group told the D’Amours committee Quebec should consider raising the retirement age to 67 from 65, noting the finding of economist Pierre Fortin that since widespread public-pension plans began in Quebec in the 1960s, people are working 10 years less, on average, and draw pension benefits 20 years longer.

Conseil du patronat president Yves-Thomas Dorval said raising the retirement age is the easiest way to deal with the pension problem, while raising taxpayers’ contributions would have a negative impact, reducing investment and consumption spending, while holding down job creation and wages.

“It will touch everyone,” Dorval said.

And while some boomer-generation employees, in good health and with children still studying, are putting off retirement, most pension plans remain geared to retirement at 65, with early retirement at 55.

But Quebecers can expect to live much longer after that. The Institut de la statistique du Québec calculates that between 1980 and 2011, the life expectancy of Quebecers rose to 81.8 years from 75, with women living four years longer than men on average.

In Quebec between 1971 and 2011, the number of people over 65 doubled to 16 per cent of the total and will continue to rise to 28 per cent of Quebec’s population by 2051.

A study last year found that in the year 2000, there were five people working for everyone over 65 in Quebec, falling to four working to every one over 65 in 2010, and by 2030, there will be two people working for every Quebecer over 65.
In other words, longer life expectancy and demographics will place enormous pressure on our retirement system and it would be wise to adopt the committee's recommendations as soon as possible, ignoring the irrational complaints of the Canadian Federation of Independent Business.

A few things that I am wondering is who will manage this new longevity pension plan if it is adopted? The Caisse or a new fund? Also, why do we have so many underfunded public and private plans in Quebec? Why can't we just consolidate these plans and manage them with more rigor, transparency, adopting the best governance standards in the world?

But the message from this report is clear, we need to act now. Alban D'Amours is absolutely right, "the status quo is not a solution," it's just a downward path toward full-fledged pension poverty for millions of Quebecers.

Below, an RDI Économie interview with committee chairman Alban D’Amours from February 2013 (French only). Will embed more recent interviews as they become available.

Thursday, April 18, 2013

IMF Warns of Pension Fund Risk?

Ian Talley of the WSJ reports, IMF Sees Risk in U.S. Pension-Fund Strategies:
U.S. public pension funds and life-insurance companies are building up potentially dangerous levels of risky investments that could threaten their solvency, the International Monetary Fund warned Wednesday.

It is a gamble that could harm not only on pensioners and insurance customers, but also on the financial system, the IMF said in its Global Financial Stability Report.

Returns from traditional investments and contributions have dwindled during the recession. And as the Federal Reserve lowered interest rates to try to revive growth, those firms have been unable to match their funding levels with future liabilities.

For example, the IMF says public defined-benefit pension plans won't be able to fund nearly a third of their future obligations based on their current portfolios.

That funding shortfall has encouraged pension funds and insurance companies to bet on higher risk, and potentially higher-return, investments to meet those needs.

To be sure, the IMF says the Fed's actions are essential to reviving U.S. and global growth. But the cheap cash and low interest rates don't come without a cost.

The fund says that at the weakest pension funds, money mangers have boosted their holdings of alternative investments such as hedge funds and financial derivatives to about a quarter of their assets from virtually zero in the last 10 years.

Life insurance companies, meanwhile, have tried to compensate for the lower returns by renegotiating policy terms and getting rid of some insurance benefits. But there is a limit to what they can do, and so many insurance companies have bulked up on riskier investments too.

Most pension funds and insurance firms have cash on hand to weather near-term shortfalls, the IMF said.

"But a protracted period of low rates could depress interest margins further and erode capital buffers, potentially driving insurance companies to further increase their credit and liquidity risk," the IMF said.

The IMF said pension funds need to address their future funding shortfalls "without delay," through "restructuring benefits, extending pensioner's working years and gradually increasing contributions to close funding gaps."

At the same time, some insurance companies may need to get rid of some of their more costly products and restructure their investment portfolios to meet future needs.
Kevin Olson of Pensions & Investments also reports, IMF: U.S. public pension funds increasing risk to dangerous levels in search of yield:
U.S. pension funds, especially poorly funded plans, are increasing their risk exposure to dangerous levels in the current low-interest-rate environment, according to a report from the International Monetary Fund.

The Global Financial Stability Report states that vulnerabilities are growing in the U.S. credit markets while pension funds and insurance companies are moving into more risky assets.

“Reduced market liquidity could amplify the effects of any future increase in risk-free rates,” the report states.

Public DB plans have gone from fully funded in 2001 to a 28% shortfall at the end of 2012. In that same time period, weaker funded plans have increased their allocations to alternatives to 25% from virtually zero, which exposes plans to more volatility and liquidity risks, according to the report. Low interest rates have led plans to search for higher yields elsewhere.

“Low yielding assets may induce excessive risk taking in a search for yield, which may manifest itself in asset price bubbles,” the report states.

The IMF recommends pension plans engage in active liability management operations immediately, including restructuring benefits, extending working years and gradually increasing contributions to close funding gaps.

“An undesired buildup of excesses in broader asset markets is a potential risk over the medium term,” according to the report. “Asset reallocations of institutional investors to alternative asset managers, excess cash holdings by those asset managers, the decline in underwriting standards, and the sharp rise in bond valuations are all intertwined. Constraining those potential excesses is a financial stability imperative.”

You can read the details in the IMF's latest Global Financial Stability Report, entitled Old Risks, New Challenges, by clicking here for the PDF version.

Is the IMF right to warn U.S. public pension funds of the risks of plowing into alternatives which include real estate, private equity and hedge funds? Yes but this warning will fall of deaf ears. The reality is most U.S. public pension funds suffering from chronic deficits and still holding on to their rate-of return fantasy are increasingly betting on alternatives to get them out of their pension hole.

On Tuesday, went over the great pension derisking, explaining how U.S. corporate plans are implementing different strategies to either offload pension risk or significantly curtail it. It's worth noting that corporations are derisking their pension plans while public plans are taking on more risk in a low rate environment.

Nonetheless, one of the strategies corporations are using to derisk is to allocate more to alternative investments. And this is going on all over the world, not just the United States. Historic low rates are forcing pensions all around the world to take on more risk in illiquid investments.

So what? Rates are likely to remain low for quite a while and it could be a boon for alternative investments. Or it could be a major bust. While some hedge fund managers are making a killing on structured credit in the low rate environment, most are struggling in a market where the facade of strength is masking serious deflationary headwinds that could bring about a trend reversal.

Deflation, deleveraging are not good for markets or pensions. Shoving more money into private equity and real estate, taking on too much illiquidity risk, can seriously imperil the liquidity of the weakest public pension funds if another crisis hits.

Pensions and other institutional investors are hoping and praying that global central banks will keep pumping liquidity into the system to avert a protracted period of low rates. And central banks will oblige. That's why sovereign wealth funds, including China's CIC, are betting on a global recovery.

Hope they are all right but if we learned anything from 2008, it's to expect the unexpected and prepare for the worst. That is why Jim Keohane, president and CEO of the Healthcare of Ontario Pension Plan, warned my readers when going over their 2012 results that the "risks of not owning bonds is huge," especially for severely underfunded pension plans.

Why are U.S. bonds rallying? Several reasons. First, forced liquidation, margin calls are sending commodity and gold prices tumbling, intensifying investors' concerns on global growth. Second, every time there is a global crisis, investors seek refuge in U.S. bonds. Third, Japan's experiment is forcing Japanese insurers and pensions to look elsewhere for safe yield. Guess what they're buying as the Bank of Japan buys up JGBs, reducing supply of Japanese bonds? (stay long USD)

Below, José Viñals, Financial Counsellor and Director of the IMF's Monetary and Capital Markets Department, discusses old risks and new challenges from their latest Global Financial Stability Report.