Friday, May 31, 2013

NYC Pension Chief Faces Huge Hurdles?

Martin Z. Braun and Henry Goldman of Bloomberg report, NYC Pension Chief Seeks $500,000 Managers Not Wall Street:
New York City’s $140 billion retirement system pays Wall Street money managers about $360 million a year, the only one of the 11 biggest U.S. public-worker pensions that refuses to manage any assets internally. Larry Schloss, the city’s chief investment officer, says the practice must end.

Schloss, 58, points to Ontario’s C$130 billion ($126 billion) teachers’ pension fund, which has returned an average 9.6 percent annually on its investments since 2003 -- 1.6 percentage points better than New York’s funds. The Canadian system reaped those gains mostly without paying outside asset managers. Schloss says the same in-house approach could work in New York.

“I’m not looking for John Paulson,” said Schloss, who earns $224,000 a year, referring to the billionaire hedge-fund manager. “I’m just looking for a VP at MetLife (MET) who makes 500,000 bucks.”

The 38 staff members in the city comptroller’s Bureau of Asset Management oversee five funds for police, firefighters, teachers, school administrators and civil-service workers. They get paid an average of $100,000 a year, less than the median base salary of a first-year Harvard MBA graduate. They farm out asset management to more than 300 firms.

Investing directly means the Toronto-based Ontario Teachers’ Pension Plan doesn’t have to pay outside managers 2 percent of assets they oversee, plus 20 percent of profits, the typical fees for hedge funds and private-equity and real-estate firms. It also gives Ontario Teachers’ more control over investments, Chief Executive Officer Jim Leech said in a telephone interview.
Losing Money

Among New York’s outside arrangements is a $60 million investment by four pensions in a real-estate fund sponsored by Colony Realty Partners, a Boston-based private-equity firm that oversees $3.2 billion. The fund has lost 15.5 percent since 2006, while Colony has reaped $7.7 million in fees, according to the comptroller’s office.

Last year, three city pension funds paid more than $1.2 million in fees on a $160 million investment in a real-estate fund co-sponsored by Fisher Brothers, a New York-based property investor and Morgan Stanley (MS), the New York bank. The fund has returned 0.3 percent since 2004. Another 2004 real-estate investment with Tishman Speyer Properties LP returned 58.8 percent.
California Compensation

Emily Margolis, a spokeswoman for Colony, did not respond to e-mailed and telephoned requests for comment. Suzanne Halpin, a spokeswoman for Fisher Brothers and Matt Burkhard, a Morgan Stanley spokesman, declined to comment.

Managing money internally and paying staff higher salaries and bonuses isn’t always a formula for success. The California Public Employees’ Retirement System, the largest U.S. pension, manages almost two-thirds of its assets, including 83 percent of stocks and 91 percent of bonds. Chief Investment Officer Joseph Dear received $522,540 in compensation in 2011.

Yet its 6.1 percent average annual return for the 10 years ending June 30, 2012 is 1.1 percentage point less than that of the Pennsylvania Public School Employees’ Retirement System. The Pennsylvania fund manages only 26 percent of assets internally and paid Chief Investment Officer Alan Van Noord $269,302 in 2011.

New Jersey’s $75.3 billion pension manages 73 percent of its assets in-house, the most among the 11 biggest U.S. public funds. The system returned 6.4 percent for the 10-year period ending June 30, 2012.
‘Way Ahead’

New York City will pay $8 billion this year toward retirement benefits, a cost that has risen more than fivefold since 2002. That’s why Ontario Teachers’ presents a model, Schloss says.

“They’re way ahead,” Schloss said in an interview in his seventh-floor office in the Municipal Building, which houses more than 2,000 employees across from City Hall. The former global head of private equity at Credit Suisse First Boston (CSGN), Schloss was hired by Comptroller John Liu in 2010 to increase returns and reduce costs.

The Ontario fund employs a staff of investment managers earning an average of C$720,000 a year to increase assets worldwide. Their investments include ownership of Toronto Eaton Centre and other shopping malls, a stake in Seoul-based Kyobo Life Insurance Company, and a 30 percent interest in Copenhagen’s international airport.
Managing Managers

In New York, there’s plenty of talent and it’s “ridiculous” that the city won’t pay enough to hire it, Schloss said. A plan to manage a portion of assets internally, with compensation levels benchmarked to New York City insurance companies, endowments and pensions, hasn’t gained traction with fund trustees, he said.

“We’re not really in the asset-management business,” Schloss said. “We manage managers.”

Bringing Ontario’s approach to New York may be a challenge. While the city’s retirement system has about 60 cents of assets for every $1 in obligations, union officials say they’re wary of tinkering with it.

“Why would you try to dismantle a system that’s performing well?” said Greg Floyd, president of Teamsters Local 237, which represents 24,000 city employees. Floyd sits on the board of the city’s $46 billion civil-employees’ pension. Pension-fund trustees have to approve raising investment staff salaries and authorize internal asset management.
Reduced Fees

There’s “a yearning” among union trustees to manage assets in-house, though “we are never going to be able to pay private-industry salaries to work in government,” said Manhattan Borough President Scott Stringer, a labor-backed Democrat running for comptroller who’s favored to win. Liu, also a Democrat, is running for mayor. His term expires Dec. 31.

“When you get a new comptroller, you get a new chief investment officer,” Schloss said. “It’s not good for performance to have a system where your senior staff turns over every four years.”

The Ontario fund, which also has offices in London and New York, manages more than 80 percent of its assets in-house and is 97 percent funded. By contrast, the total market value of the assets of 109 U.S. state pension plans last year was 69 percent of projected liabilities, according to Wilshire Associates, a Santa Monica, California-based consulting firm.

What sets Ontario Teachers apart is governance and compensation, Leech said.
Wall-Street Caliber

The fund paid its 250-person investment staff C$180 million last year. The workers aren’t government employees, meaning their salaries aren’t subject to civil-service rules. High salaries and bonuses attract Wall Street-caliber talent, Leech said. About 35 percent of assets are in so-called alternatives such as private equity, real estate, and hedge funds.

“We compete with KKR,” said Leech, referring to the private-equity firm founded in 1976 by Jerome Kohlberg, Henry Kravis and George Roberts. “You don’t want to go into that game with a second-stringer.”

The Ontario fund has a nine-member independent board that sets policy and delegates day-to-day management to the professional staff. New York’s five funds have 58 trustees spread across several unions and political jurisdictions.

Two years ago, Mayor Michael Bloomberg and Liu unsuccessfully proposed overhauling management of the five pensions to create a system more like Ontario Teachers’. The mayor is the founder and majority owner of Bloomberg News parent Bloomberg LP.
Accounting Background

The five boards were to be pared down to a single 12-member body that would set investment policy. Asset management would have been separated from the comptroller’s office to insulate it from politics.

Instead of union officials and political appointees, Ontario Teachers’ board members are chosen for their backgrounds in business, finance, economics and accounting. Only one board member is a former teacher.

“What does a kindergarten teacher know about investing?” said Leech.

When Schloss was chosen to oversee the city’s pensions in 2010, Liu described the funds’ structure in a press release as a “cluster$&*$.” Schloss persuaded trustees to increase the investment staff to 38 from 22. The pensions added hedge funds, opportunistic fixed income and leveraged loans to the mix of investment possibilities.
Pay Obstacle

To an inexperienced staff he added Barry Miller, a former managing partner at Nottingham Capital Management, to oversee private equity. He hired Seema Hingorani, former research director at Pyramis Global Advisors to oversee hedge funds. Both earned $175,000 annually. Miller resigned to join Connecticut-based private-equity firm Landmark Partners, the Wall Street Journal reported on May 21.

“We wanted to hire a number of people but couldn’t because of compensation,” Schloss said.

Asset management staff are required to live in New York City unless they get a waiver. Obtaining one involves multiple agencies and City Hall approval, said Matt Sweeney, a spokesman for the comptroller’s office.

The median sales price of a two-bedroom condominium in Manhattan was $1.6 million in the first quarter of 2013, according to appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate.

“It’s just really hard to say, ‘Hey, come work here for $100,000 and you have to live in the five boroughs,” he said.
I sympathize with Larry Schloss and other U.S. pension chiefs who are struggling with similar issues. It is simply mind-boggling that compensation for staff managing billions of public employees' retirement funds is so low, especially for people living in New York City.

Jim Leech, President and CEO of Ontario Teachers' Pension Plan, is right, what sets their fund apart is governance and compensation. That governance model has spread to other large Canadian pension funds and it's the reason why they're able to attract and retain high calibre professionals to manage public and private market assets in-house. 

Now, we can debate whether the Canadian model is full of hot air and whether Ontario Teachers' can really compete with the KKRs of this world, but there is no denying that they have top-notch professionals managing public and private market assets. Teachers pays their staff well and senior managers like Neil Petroff, their CIO responsible for active management, and Ron Mock, their next president and CEO, enjoy a very attractive and competitive compensation (short-term + long-term comp) but they're brilliant, deliver outstanding results and they can easily earn more moving to the private sector. I can say the same thing about other senior pension fund managers at large Canadian pension funds. They are paid extremely well but they deliver results.

Stakeholders need to realize that managing pensions is a huge responsibility and when you read how poorly many U.S. pension fund managers are compensated, you realize they got the governance all wrong. Instead of overhauling governance and compensation, hundreds of millions in fees are being paid to external managers, all part of the secret pension money grab feeding Wall Street. Some funds are worth paying fees, most are not, and good chunk of assets should be managed in-house.

In my last comment, I discussed the ideas of Theodore Economou, CEO of Cern Pension Fund, who thinks pensions should think more like global macro hedge funds. Mr. Economou emphasizes the importance of cutting-edge risk management, proper governance and how funds that cannot replicate Cern's model in-house should consider farming out their entire pension portfolio to a top hedge fund management company and negotiate hard on fees.

This might sound extreme but when you look at the obstacles Larry Schloss and many of his peers face in the United States, you wonder how long can they go on with the current governance model which presents serious challenges and risks sinking their pensions into a deeper hole. Will it take another financial crisis for stakeholders to realize that governance and compensation need to be overhauled at most U.S. public pension funds?

Below, Lawrence Schloss, New York City's chief investment officer and deputy comptroller for pensions, talks about the city's pension fund strategy and investment in real estate, private equity and hedge funds. Schloss spoke with Deirdre Bolton on Bloomberg Television's "Money Moves" (December, 2012).

And Joseph Dear, chief investment officer for the California Public Employees' Retirement System (CalPERS), talks about investment strategy, corporate governance and the impact of pharmaceutical companies' business interests on CalPERS' health-care costs. Dear spoke with Willow Bay at the Milken Institute 2013 Global Conference in Los Angeles in early May.


Thursday, May 30, 2013

Should Pensions Think Like Macro Funds?

Margie Lindsay of Hedge Funds Review reports, Cern Pension chief urges others to ‘think like global macro hedge funds’:
CEO of the Cern Pension Fund Theodore Economou says pension funds should use the techniques of the best global macro hedge fund managers to control risk and volatility while producing absolute returns.

Pension funds should use the sophisticated risk management tools used by the best hedge funds to lower volatility and achieve better returns, says Cern Pension Fund CEO Theodore Economou.

Cern invests its entire Sfr4 billion ($4.1 billion) pension fund as if it were a large global macro hedge fund. "We manage towards an absolute return target," says Economou. "We believe our model can and should be replicated by pension funds with the same goals as Cern because we think the model represents an answer to the industry's challenges."

For those funds not able to replicate the Cern model, Economou advocates turning over the entire pension fund portfolio to a top hedge fund management company.

If the hedge fund industry works together with pension funds, he believes it has the potential to grow five or 10 times larger than it is today.

Economou made the comments at the European Single Managers Awards 2013 held in London, where Cern Pension Fund was given the award for outstanding contribution to the hedge fund industry by an institution.

Earlier in a video interview he said he believes the hedge fund industry can "come to the rescue of the pension fund industry". He believes the disciplined risk management of hedge funds allows them to control risk while at the same time delivering smooth returns. "This is exactly what pension funds need to do."

Risk management combined with flexibility in allocating assets under the overall objective of preserving capital needs to be embedded in the entire process, he says.

"I believe passionately the Cern model provides an ideal response to the challenge pension funds are facing," says Economou.

The Cern governance model is designed to accommodate a dynamic and flexible asset allocation process, which Economou believes is essential in order for pension funds to avoid losses and meet returns in the long term with minimum volatility.

"The Cern process starts with addressing what really matters to trustees: what losses can be accepted; what is the investment return objective; and what are the constraints in terms of liquidity and permitted instruments? Only after setting these boundaries does the portfolio get built to meet those objectives."

Economou has taken the traditional process and "turned it on its head". "The fact is that the traditional model is failing to deliver," he says.

In his view in order for a pension fund to be more conservative it needs to be less traditional and throw out the 60%/40% stocks/bonds model.

Over the three years since Cern's switch from the traditional model to implement Economou's ideas, the fund has "multiplied the efficiency of taking risk and converted it to return by a factor of 10. It is bringing this risk awareness in the process that has had the most impact."
A report on the full interview with Theodore Economou will be published in the June issue of Hedge Funds Review. Mr. Economou is very sharp and highly respected in the pension fund industry. He ranks among the top 100 influential asset managers in aiCIO's Power 100, a list which includes CEOs and CIOs of well known Canadian and international funds. aiCIO provided this profile on him:
At 14 years of age, Economou witnessed something that would shape his approach to risk forever. In 1979, he and his family were based in Tehran, the Iranian capital, when the Shah was overthrown, prompting the Islamic Revolution. The country changed overnight and Westerners—along with many others—had to leave immediately. Panic was everywhere—except for Economou’s household.
“My father had already made plans to leave,” he says. “He had gathered information from a network of contacts, not just the official channels, and had known something was about to happen. We didn’t even miss a day of school.” The experience of an entire society changing so rapidly made him realize that it paid to be prepared for any eventuality, not just what you suspect could happen. “It doesn’t mean you have to be pessimistic—this mindset applies equally to seizing opportunities—but you need to be in a situation where you are ready and can react.”
Almost three years on from joining the CERN pension, the lessons he learned in Tehran are evident. The model he introduced to the fund in 2009—which had lost 19% of its value a year earlier—aims to manage risk, preserve capital, and achieve the highest quality absolute returns. This, of course, is a simplistic outline of what Economou, a trained engineer, presented to scientists at one of the world’s finest research organizations. “It helped to speak the same language,” he says. “I explained we were targeting efficiency and control in the same way that they were. We would just deal with investments while they dealt with fundamental particles.”
As reported by aiCIO back in 2010, Cern is revolutionizing risk management:
Despite misguided and so far unfounded concerns, the European Organization for Nuclear Research's (CERN) Large Hadron Collider has not created a black hole that, in turn, has swallowed earth and humanity. If it had, what the European scientific institute famous for smashing together sub-atomic particles did with its employee pension fund would be relatively meaningless. However, since we are all still here, the risk management and portfolio overall currently under way in Geneva matters—for the system's thousands of pensioners, as well as for other capital pools willing to learn from CERN's innovations.

First, an introduction to CERN's team. Theodore Economou is the organization's pension Chief Executive Officer and is potentially the nicest man in investment management. A close second for this title might be his Chief Investment Officer, Gregoire Haenni. They are the types that apologize profusely for even minor incidents of tardiness. They are exceedingly well mannered, as only two non-Americans can be. Together, they comprise the brain trust of the $4 billion pension system, and the work they are doing—focusing on portfolio reconstruction and proprietary risk modeling—is appropriately suited to an institution with multiple Nobel Prize recipients on staff.

“Essentially, what I found when I arrived in October 2009 was a very traditional portfolio that any pension CIO would recognize,” Economou says on a phone call with aiCIO following his October appearance at the aiCIO Summit in London, England. “It was 60% risk assets, including real estate, and 40% bonds. The fund did a strategic asset allocation study every three years, followed by tactical allocation moves, with the fund taking fairly large single bets, such as bets on currency.” Economou, who ran the ITT pension system in New York City before moving to Switzerland, thought it was time for a new approach. “We are in the process of changing it from this legacy, return-based approach, to a risk-based one,” he says. “It's an absolute-return approach to the entire fund—with a key term being ‘liability-aware'.” This last term, Economou notes, means that the fund can be cognizant of its liabilities without being “slavishly tied” to liability-driven investing (LDI). “There is this religious discussion about LDI, but the reality is that it confuses actuarial losses with real cash losses,” he says. “I don't think it's acceptable. What this means is that, if you offset your liability with an asset, particularly a swap, if something happens to interest rates and your liability goes down, it's great—but in an LDI world, your assets also go down the same amount.”

Hand in hand with this allocation overhaul, Economou and Chief Investment Officer Haenni also are looking to retool the fund's risk management procedures—and this is where the truly innovative work is being done. “We look at risk management as two processes,” Economou says. “One: the overall risk management process, showing us the acceptable risk constraints. This tells us what the size of the sandbox we can play in is, and this is a process where we involve an external risk manager.” The metric presently used to measure this risk is conditional value-at-risk-based (CVar), which Economou views as “not a perfect measure, but you need to start somewhere.” (Volatility is not risk, Economou stresses time and time again; the loss of capital is the risk). The result of this first process of risk management is that the fund's board knows whether the risks being taken lie within previously agreed upon guidelines.

The reason Haenni was hired earlier this year was not so much to create this 30,000-foot view of potential problems, but to provide an expertise in portfolio-level risk management modeling. If the first risk management process is about the size of the sandbox, Haenni's work is about how to maximize the fun in the sandbox. “I was asking around about what the best risk management system for portfolio construction was,” Economou says. “That's how I got in touch with him.” Haenni, it turns out, has spent his academic and professional career working on risk modeling. An extension of his PhD thesis at the University of Geneva, this model first went with him to Swiss asset manager Pictit, where he spent a decade refining the system. He now finds himself and his model in Geneva.

The model itself is a sight to behold. Its entire goal is to “illustrate risk and make it actionable,” according to Economou, by answering two questions: how manager x should behave, and how, put together, all managers behave relative to each other. The system looks at 20 dimensions of correlation that, when presented visually, are distilled into three dimensions, making it both more intuitive and easier to act upon. Once this analysis has been done, Economou and Haenni have another process they apply. “The second part is top-down, a macro-view approach,” Economou says. “We don't pretend that we can call the market— that's borderline delusional. People spend hundreds of millions trying to do this, and we can't argue that we can compete with these folks, but what we can do is identify different market regimes, different areas of risk that are excessive, and we can hedge.” In essence, this two-man team is attempting to identify market regimes and position their portfolio appropriately. It's not forecasting. It's identifying risk.

“We refer to it as a capital preservation philosophy,” Economou notes, echoing Benjamin Graham's mantra that to win, the first thing you have to do is not lose. “Losing money is not okay. The traditional approach of running money—the 60/40 strategic asset allocation regime we had here at CERN—is focused on performance versus an index.” There is an assumption in this framework, Economou and Haenni believe, that the index, over time, will meet a fund's needs. “We don't view this assumption as appropriate,” Economou adds. “Market cycles can be very long—look at Japan. And boards don't always understand volatility.” Put another way: They are not bullish on world markets, and they've designed a systematic approach to investing that (they hope) will allow them to act successfully upon this belief.

Of course, Economou and Haenni can't go it alone. Their board, as at any other pension fund, must approve changes to asset allocation and risk controls. “Our board has been superb,” Economou says, noting that an institution that draws upon more than 10 countries for funding and houses some of the brightest minds in the world will naturally produce high-quality board members. Relying on Netherlands-based consultant Ortec Finance to confirm that the new asset allocation fits within the risk scope that the board finds comfortable, the fund has been “very receptive to the changes” Economou and Haenni are implementing. Alongside spending the summer “programming liability risk—our benchmark—into the model so that any incremental manager's risk impact can be identified,” Economou and Haenni worked hard to educate their board on the new paradigm. “It was a success,” notes Economou. “They understand, and they are happy with the ideas underlying the changes. There is a difference between ‘conservative’ and ‘traditional.’ Most boards are ‘conservative'—as they should be—but that doesn't mean 60/40 is ‘conservative.’ Investment boards and executives need to disassociate these two terms—and ours seems to be doing this.”

The inevitable stressful periods, the team knows, are yet to come. “The real test is when markets are up 20% and we're below that,” Economou says. “We have told the board that we look at it as ‘how much have we left on the table on the upside to protect the downside.’ I think they'll be with us in this scenario, due to the usual mantra: education, education, education.”

This could all be for naught, of course. Similar to its pre-2009 pension structure (which, Economou stresses, wasn't wrong— it just needed to be updated) CERN's particle collider is running at only half power due to an explosion in 2007. Yet, by 2013, it is expected to be firing sub-atomic fragments around its 17-mile loop at nearly their full speed—after which, if skeptics are to be believed, none of us will be here to see how either experiment turns out.
Cern Pension Fund's latest annual information meeting 2012 is available here. As you can read, their objective is to achieve the actuarial return objective of 3% over inflation (5% long term), with the lowest possible level of risk at all times. Since 2009, they've implemented the following significant changes:
  • Reduced equities, replacing with alternatives
  • Increased bonds, reducing cash
  • Reduced index strategies, replacing with asymmetric strategies
  • Reduction of risk of real-estate portfolio
Should pensions 'think like global macro hedge funds'? I absolutely agree with Mr. Economou,  pensions need to use sophisticated risk management tools used by the very best hedge funds to lower volatility and achieve better returns.

In my blog, I cover various approaches different pension funds use. HOOPP did it again last year, gaining 17% in 2012. HOOPP's president and CEO, Jim Keohane, told me that they run their fund like a multi-strategy hedge fund and their culture and LDI approach are the cornerstone of their success. They manage assets internally, practice tight risk management and they're always thinking outside the box, taking intelligent risks like their long-term option strategy on the S&P 500 which paid off handsomely in 2012.

Ontario Teachers' Pension Plan gained 13% in 2012. They manage absolute return strategies internally but also have a large allocation to external hedge funds. Ron Mock, who will succeed Jim Leech as President and CEO in 2014, is running one of the world's best funds of hedge funds at Teachers and heading their fixed income operations. Ron knows absolute return strategies better than most of the best hedge fund managers and I gurantee you he will be working closely with top global macro and multi-strategy hedge funds to reduce volatility and increase returns. At Teachers, they don't just invest in hedge funds and private equity funds, they leverage these relationships significantly to improve their overall returns.

CPPIB gained 10% in FY 2013 and the Caisse de dépôt gained 9.6% in 2012. Canada's two largest pension funds engage in absolute return strategies internally and are big investors in external hedge funds, including top global macro funds. They are also very active in private markets, heavily investing in private equity, real estate and infrastructure. The shift to private markets is their strategy to lower volatility and increase returns at their funds.

But increasing allocations to private markets means locking up funds for many years and smaller pension funds do not have the resources or liquidity profile of a CPPIB or PSP Investments, which recently bought Hochtief's airports unit, and can't take on more illiquidity risk. Even large funds like Ontario Teachers' and the Caisse have to manage liquidity risk more carefully after the 2008 crisis. Teachers shifted most of their hedge funds to a managed account platform and are managing liquidity risk a lot tighter after the crisis.

Getting back to global macro hedge funds, their performance has been surprisingly poor given the influence of macroeconomic and political events on all asset classes since the financial crisis, but as RoRo becomes less dominant, global macro strategies could return to form in 2013.

When it comes to hedge funds and private equity funds, choose your partners carefully, and this doesn't always mean investing with the big brand names. Often times it's worth cultivating relationships with small or mid-sized funds with established track records where you can work more closely with senior managers to improve your internal processes at your pension fund.

Mr. Economou's idea of farming out the entire pension fund portfolio to a top hedge fund company if you cannot adopt the Cern governance model might sound extreme, but as pension funds struggle to obtain their actuarial target return relying on the traditional 60/40 stocks/bonds model, this approach is worth considering. Most underfunded mature pension plans simply cannot afford to relive another 2008, it will kill them. The focus has to shift to tighter risk management and bringing risk awareness back in the process.

Below, Theodore Economou, CEO of the Cern Pension Fund, discusses why pension funds should use the techniques of the best global macro hedge fund managers to control risk and volatility while producing absolute returns. Great interview, well worth listening to his comments.

Wednesday, May 29, 2013

The Decline of Dutch Pensions?

Norma Cohen and Matthew Steinglass of the Financial Times report, Yawning deficits force Dutch pension funds to cut payouts:
Marianne Keestra, a former teacher in the Dutch city of Haarlem, has seen her monthly pension payments cut, and she knows who she blames – her former employer.

“The government stuck their hand in the pension pot,” says Ms Keestra, 71. “And they never paid it back.”

For years, the Dutch government and many businesses systematically underfunded their employee pension plans, relying on high investment returns to make up the shortfall.

Now, a combination of record low rates, sluggish economic growth and lives that last far longer than anyone imagined even a decade ago have resulted in yawning deficits. At the end of 2012, the funds were €30bn short of what is needed to cover promised benefits.

For the Dutch, the cutbacks are the first ever in a nation which has the second largest “defined benefit” system in Europe. But defined benefit provision, under which pensioners are guaranteed a portion of their salary for as long as they live, is unravelling under the pressure of the financial crisis and ensuing recession.

In April, under orders from the Dutch central bank, 66 of the country’s 415 pension funds started cutting their payouts. The average cut is around 2 per cent of the monthly benefit, but that figure conceals a wide range.

ABP, Ms Keestra’s fund and also the country’s largest with 2.8m participants, has cut payments by 0.5 per cent, but smaller funds such as those for barbers and meat packers are cutting pension payouts by 7 per cent or more.

The loss of income to pensioners has dealt a further blow to a Dutch economy that has already shrunk 1 per cent over the past year and is suffering from record-low consumer confidence levels. Meanwhile, anger over the cuts has bolstered the fortunes of the 50Plus party, which won election to the Dutch parliament for the first time last year on promises to defend the interests of pensioners.

While the woes of Dutch pension schemes are far from unique, the Netherlands stands out because its laws allow employers to cut benefits under certain circumstances.

Dutch pension schemes are among the most tightly regulated of any in Europe or North America. By law, they must hold sufficient assets to cover 105 per cent of promised benefits, unlike those elsewhere allowed to run huge deficits. In addition, they have no leeway in setting the parameters that determine estimates of liabilities, such as expected investment returns or the number of years retirees will draw benefits.

Moreover, unlike the US, UK and many other countries, the Netherlands does not operate a pension insurance scheme to pay benefits to the underfunded schemes of insolvent employers. The fallout from the failure of a company or industry-wide scheme could be devastating, which explains why the rules are so tough.

In 2007, Dutch schemes held assets covering 152 per cent of promised benefits. But that fell to 102 per cent last year due to low interest rates – which have the effect of making liabilities balloon – and sharp falls in stock and property markets.

“The law says that accrued benefits can only be reduced if it is the last resort and if it is needed to meet their minimum requirement of 105 per cent,” says Wichert Hoekert, an Amsterdam-based consultant at actuaries Towers Watson.

But Dutch pension funding requirements are less strict than they once were. Last September the parliament, under pressure from older voters, approved new rules that allow pension schemes to use a higher rate to gauge the pace at which inflation will erode liabilities.

This has lowered liabilities, and funding targets. The sector as a whole now has a coverage ratio of 105 per cent under the new rules, but just 101 per cent under the old rules, according to an analysis by Aon Hewitt.

Some Dutch analysts criticise the new rules as gimmickry that will weaken the plans. “Tweaking the discount rate is just a bookkeeping trick to bring down liabilities,” said Bas Jacobs, an economics professor at Erasmus University. While figures using the new discount rate show the pension sector as a whole has just enough assets to meet its liabilities, Mr Jacobs said he “wouldn’t be surprised if the pension plans actually had a shortfall of €100bn-€200bn”.

There are arguments that employers benefited from schemes, too. Hefty investment returns during the 1990s allowed many to avoid putting any cash in at all for years.

In addition, Dutch tax rules allowed employers to offer early retirement, reducing payrolls and improving corporate profitability. As at 2007, a quarter of Dutch retirees were below the age of 60. Early retirement has proved extremely expensive for defined benefit schemes, especially as longevity has risen sharply. On average, Dutch men aged 65 can expect to live for another 18 years as of 2011, up from just 15.5 years a decade earlier.

As equities markets have improved, the pensions funds’ problems have grown less severe. The funds now have €1.07tn in assets, up from €831bn at the end of 2011, and administrators say that once the current round of cuts is complete at the end of the year every plan will meet its minimum coverage ratio.

But for Ms Keestra, that does not settle the story. “It’s not just the benefit cuts. I haven’t seen a cost-of-living increase in years,” she said.

Resuming full indexing for inflation would require the coverage ratio to rise to 135 per cent, and Dutch administrators are making no promises.
On Monday, I wrote about how OMERS is considering a proposal to reduce pension payouts. Now Dutch pension funds are considering cutting payouts to deal with their yawning deficits (and France is next in line).

The fact that these once mighty pensions are now forced to consider cutting pension payouts speaks volumes of the ongoing global pension crisis. The Dutch pension system is one of the strongest in the world with some of the largest and best pension funds. Pensions are tightly regulated to make sure the coverage ratio is adequate to meet promised benefits.

A few weeks ago, Richard Evans of the Telegraph wrote a comment, Superiority of Dutch pensions called into question:
Millions of Dutch pensioners – held up as the envy of their British counterparts by campaigners three years ago – have been forced to endure cuts to their pensions because of funding shortfalls in some of their schemes.

A total of 66 Dutch pension funds have been forced to cut pensions because of funding gaps, figures from the Dutch central bank show. The cuts average 1.9pc.

In all, 2 million active pension scheme members face cuts, on top of 1.1 million who are already receiving their pensions and 2.5 million "sleepers" (members who have changed jobs without taking their pension rights with them), European Pension News reported.

The development has sparked a lively debate among British pension experts about the merits of the Dutch scheme.

In 2010, David Pitt-Watson, a former chairman of Hermes Focus Asset Management, said British pensions "should go Dutch". In an article for The Daily Telegraph, he wrote: "If a typical British and a typical Dutch person save the same amount of money for their pension, the Dutch person will end up receiving at least 50pc more income in their retirement than the Briton. There is no trick here. It's just that the Dutch have an efficient architecture for their savings. We do not."

He said the Dutch system enjoyed economies of scale thanks to large schemes that covered a number of firms. These schemes can pay pensions from investment income instead of relying on annuities.

But responding to the recent cuts, John Lawson of Aviva said: "Dutch charges are not cheaper, nor are equities a one-way bet."

Henry Tapper of First Actuarial said the cuts should be put in "a little perspective". He said: "The Dutch system works rather like the with-profits system. Current Dutch pensions have been shown by David Pitt-Watson and others to be producing about 39pc more than our 'guaranteed pensions' [from annuities] in the UK."
Despite the pension cuts, I don't question the superiority of Dutch pensions and think that anyone who does is simply ignorant or ill-informed. The Dutch are years ahead of most other countries in terms of providing adequate retirement income to a large portion of their population. Their DB plans are still the envy of the world.

Is their retirement system perfect? Of course not but when you compare it to the alternatives being touted in other countries, it is far superior in terms of providing adequate coverage and it's tightly regulated. Their new rules that lowered liabilities and funding targets are questioned by Dutch academics but those rules are still more stringent than what you see in the rest of Europe or North America.

But there are cracks in the once mighty Dutch pension system and the vultures are circling. Mark Cobley of Financial News reports that UK insurer Legal & General is preparing to enter the €800bn Dutch pension fund market to buy out schemes from companies that want to close them:
These transactions, known as pensions or bulk-annuity buyouts, originated in the UK, where many companies are closing old-style final salary pension funds to new joiners, and no longer want to run them.

About £30bn worth of such deals have been done in the past five years, involving hundreds of companies and more than half a million UK pensioners, according to pensions advisers Lane Clark and Peacock.

Tom Ground, head of bulk purchase annuities and longevity insurance at Legal & General, said: “We have an existing presence in the Netherlands and all the licenses to write annuity business. It’s our intent to do bulk annuities, but quite when is more questionable. We are still working out our strategy.”

He added: “There is an established market there; quite an attractive market. It is the obvious next market to go to after the UK and Ireland.”

The Dutch pension fund sector is Europe’s second-largest behind the UK, but due to the prevalence of large, industry-wide pension funds still open to new joiners, few buyouts have been done. Deals that have been done mostly involved local insurers such as Aegon.

However, consultants say the appetite of Dutch insurers for such deals is waning, opening the door to foreign players. A recent report on the buyout market from Lane Clark and Peacock said: “There are signs that some of the [domestic] players are reducing their appetite as they look to preserve capital and generate higher profit margins. In contrast, insurers from other jurisdictions are now considering entering the Dutch market.”

Legal & General announced its first non-UK deal in April, taking on a €136m annuity book from Irish life insurer New Ireland Assurance.
It's terrible that companies are looking at closing defined-benefit plans but given the environment of record low rates and sluggish economic growth, pension risk transfers will be a booming business for global insurers. They will profit, companies will breath easier but pensioners will bear the brunt of these changes.

This is why I think it's time we expand C/QPP in Canada and address serious deficiencies that plague our retirement system. Our large public pension plans are among the best in the world and we need to bolster them and make them part of the solution to meet the retirement needs of our aging population.

Below, an APG All Pensions Group corporate video. APG and PGGM are global leaders in the pension fund industry and represent what I see as part of the solution to the Dutch and global pension crisis.

APG All Pensions Group corporate movie from Edenspiekermann on Vimeo.

Tuesday, May 28, 2013

Caisse Unloading European Properties?

Frederic Tomesco of Bloomberg reports, Caisse de Depot Sells Europe Properties Amid ‘Dark Night’:
Caisse de Depot et Placement du Quebec is selling some of its European property and redeploying proceeds in assets such as infrastructure while the euro-area economy shrinks, Chief Executive Officer Michael Sabia said.

About 20 percent of the Caisse’s C$18 billion ($17.5 billion) of real estate assets are in Western Europe, according to its 2012 annual report. Canada’s largest public pension-fund manager oversaw net assets of about C$176 billion at the end of last year, including C$6.31 billion in infrastructure such as toll roads and a stake in London’s Heathrow Airport.

“We are selling real estate assets in Europe,” Sabia said in an interview yesterday at the Bloomberg Canada Economic Summit in Toronto. “Real estate pricing among top quality, platinum-quality assets -- the pricing is quite good, and we are trying to benefit from that and in some other asset categories as well, where selectively asset prices are high.”

The euro-area economy contracted 0.2 percent in the first three months of 2013, data from the European Union’s statistics office showed last week. That extended the recession in the zone to a sixth quarter.

While stressing “it’s the right time to be counter-cyclical in Europe,” Sabia said he and his investment team will approach investing in the region with extreme caution. The Caisse had 7.2 percent of its total assets in the euro region at year-end, according to its annual report.
‘Dark and Foggy’

“There’s a dark night going on in Europe, a dark and foggy night where bad things come out of trees and bite you,” Sabia said. “It’s a pretty scary place. In Europe there are investments to be made, and I think it’s possible to be successful there but there’s no place in the world, other than maybe emerging markets, where the word selectivity is fundamentally important.”

Sabia didn’t specify which European properties the Caisse is planning to sell.

On May 7, the Caisse’s Ivanhoe Cambridge real-estate unit sold the Paris building that houses the headquarters of Vivendi SA to French insurer Assurances du Credit Mutuel. Terms of the deal weren’t disclosed.

In addition to infrastructure, cash from asset sales may be reinvested in distressed debt or “situations where a current shareholder needs to liquidate an asset,” Sabia said. “We are trying to, in effect, help build our future by trying to benefit frankly from some of the issues and difficulties that other institutions in Europe have right now.”
Private Equity

Sabia, 59, said in January that the Caisse plans to add C$10 billion to C$12 billion in what it calls less-liquid investments in the next two years. The fund manager seeks to have about 30 percent of its assets in private equity, real estate and infrastructure by the end of 2014, up from 25 percent, the CEO said at the time.

Real estate was one of the best performing asset classes for the Caisse last year, returning 12.4 percent. The pension fund manager’s overall return was 9.6 percent.
Real estate has been one of the best performing asset classes for the Caisse ever since it was introduced in the early 80s which is why it plans to increase its holdings over the next two years, along with those of other illiquid asset classes like private equity and infrastructure.

So why is the Caisse selling some of its European real estate assets? As Michael Sabia said, the pricing for top quality assets is quite good and they want to benefit from the environment where selectively asset prices are high.

Does this mean the Caisse is scaling back its real estate portfolio? Not at all, and let me clarify some of the figures being thrown around, including some I've quoted on my blog because it gets confusing. The consulting firm bfinance wrote an interesting comment, Investors show renewed interest in commercial real estate, where it stated the following:
Some of the world’s largest pension funds and SWFs are showing renewed interest real estate, with Canada’s C$160bn (now $176B) Caisse de Dépôt et Placement du Québec saying it intends to increase its real estate allocation from C$30bn to C$40bn during the next 18months.

This will make Caisse one of the world’s largest property investors, as pension funds despair of the low yields on bonds. In January, it completed a £265m deal with private equity group TPG to buy the Woolgate Exchange building in the City of London, but it plans to allocate the bulk of its new property spending to the US and China, where it will build a portfolio of shopping centres.
If you look at the Caisse's latest annual report, the allocation to real estate as of December 31st, 2012 is 10.3%, or C$18 billion of total net assets of  $176.2 billion. The Caisse does plan to increase its holdings of less liquid asset classes by C$10 billion to C$12 billion over the next two years but that includes real estate, private equity and infrastructure.

From Ivanhoé Cambridge's 2012 activity report, you will see the fair value of their real estate assets and real estate investments at the end of 2012 was C$30.3 billion and $C4.5 billion respectively, but those figures include debt and partnerships with other funds and are not net asset values reported in the annual report.

Mixing up net and gross assets leads to confusion in some articles. On a gross basis, Ivanhoé Cambridge does manage over $30 billion and this will grow significantly over the next couple of years, cementing the Caisse's position as one of the most influential real estate investors in the world. In terms of market influence, the fair market value reported, which is gross assets and includes partnerships, is what articles often discuss. In terms of reporting results, however, it's net assets that count.

The $10 billion increase in real estate assets over the next 18 months in the bfinance comment refers to gross assets and is in line with what was reported in an article Nicolas Van Praet of the National Post wrote back in April, Ivanhoe Cambridge clinches US$1.5-billion housing deal, its largest ever:
Ivanhoe Cambridge has pulled the trigger on its largest ever housing deal, joining partners in a slate of multi-residential properties in the United States worth US$1.5-billion.

Ivanhoe said it bought into a portfolio of 27 residential properties containing 8,010 units in all with partners including investment banking firm Goldman, Sachs & Co. and apartment operator Greystar Real Estate Partners. The assets are located in Washington, D.C. and northern New Jersey, South Florida, the San Francisco Bay area, southern California, Phoenix and Denver. Goldman and Greystar bought the properties from Equity Residential with Ivanhoe investing later.

Ivanhoe, the real estate arm of the Caisse de dépôt et placement du Québec, plans to spend an estimated $10-billion on new property as it speeds up asset purchases over the next 18 months. Half of that amount could be deployed in the United States, Ivanhoe global investments president Bill Tresham told the Financial Post in an interview in February.

The club deal announced Tuesday is one of Ivanhoe’s largest investments of the past few years and its largest ever in the multi-residential asset class. Its share of the agreement was not disclosed.

The company is slowly divesting assets including hotels to focus on residential units, office buildings and shopping centres where returns are more predictable. Real estate values in the United States are about 80% of their peak before the last recession whereas values in Canada are at record highs, Mr. Tresham said.

“The number one goal for us geographically is to have more capital invested in the United States,” he said. “We’re finally this year mobilized to really get it done.”

Ivanhoe said the partners have agreed to launch a multi-year maintenance and renovation investment program for their new assets. Most of the income-producing housing were built in between 1990 and 2000 and are located in key U.S. suburban markets.

The high price of Canadian real estate means sellers are getting top dollar for their investments as they move to deploy cash elsewhere.

Ivanhoe’s ownership partner in Montreal’s Place Ville Marie office tower, Alberta Investment Management Corp., is seeking to unload its stake in the building. Under their partnership, Ivanhoe is believed to have the right to match any offer AIMCo receives.
I've covered the Caisse's investments in U.S. multi-family real estate and stated that even though some markets are pricey, they believe the economy and demographics are favorable going forward and I agree.

The focus on U.S. real estate is understandable given the recovery is well underway there. Europe is back from the brink but it's still a mess and the risk of a prolonged downturn remains high, especially in periphery economies, but core economies are also slowing.

Nonetheless, insitutional investors are increasingly looking at European real estate and bfinance notes there has been a "flood of money from SWFs, private equity groups and large pension funds targeting assets in London, Paris and Munich, with a sharp swing towards industrial property." This is leading to yield compression and rising risks in some markets:
... experts warn of yield compression as the flood of money into some areas, whether geographic (London, Paris, Frankfurt) or strategy specific (core, inflation-linked long lease), is creating far greater risk on capital invested down the line than investors may realise in their quest for short term cash yield.

In some areas, the flood of money has compressed yields to extremely low levels. For example, long lease, inflation-linked real estate with quality tenants, such as supermarket operators, have dropped below 5%, and even as low as 4.25%. Furthermore, the terms of the leases on such properties have weakened.
The compression in yields in some European markets and sectors is surely one of the reasons the Caisse is taking advantage of the "flood of money" to unload selective assets in the euro region. That's what makes a market, buyers and sellers.

Other Canadian pension funds continue to invest heavily in hot European markets. Ed Hammond of the FT reports the Queen’s property company  has teamed up with one of Canada’s largest pension funds in a £320m deal that underlines the burgeoning relationship between big business and aristocratic ambition:
The Crown Estate, which manages an £8bn property empire on behalf of the sovereign, will work with Ontario Municipal Employees Retirement System on a 270,000 sq ft development of shops, restaurants and offices in St James’s, the central London heartland of the UK hedge fund industry.

The deal marks the latest in a trio of lucrative joint ventures the Crown Estate has entered into with foreign investors. The company is among a handful of large, predominantly London-based landed estates, to have abandoned the traditional business model for hereditary property portfolios by swapping passive rent collection for active asset management.

Under the terms of the deal with Oxford Properties, the real estate division of Omers, the Crown Estate will use the investment to fund a phase of its £1bn overhaul of the St James’s Market area.

The deal, to be announced this week, marks a rare opportunity for an outside investor to gain access to a large area of commercial property in the tightly controlled West End.

Demand for office space in St James’s and Mayfair has risen sharply in the past two years, with rents among the highest in Europe. Average prices in the West End reached £92.50 a square foot at the end of last year, compared with £55 a square foot in the City of London.

As well as co-investor, the Crown Estate will act as development manager on the project.

One of the reasons for seeking a funding partner for the project is that the Crown Estate is not allowed to be in debt. In 2011, it sold a 25 per cent stake in Regent Street for £450m to Norges Bank Investment Management, Norway’s NKr4tn ($720bn) oil fund. The company is also working on a £100m project in London with the Healthcare of Ontario Pension Plan.

The Queen has no powers to liquidate assets belonging to the Crown Estate and cannot buy or sell properties, but she is entitled to a modest slice of the company’s revenues. Under an agreement struck between King George III and the government in 1760, the portfolio was managed by the Crown on behalf of the state, with surplus revenue going to the Treasury. In turn, the Treasury made a fixed annual payment to the monarch.

The agreement was overturned in 2011, however, and replaced with the Sovereign Grant Act, under which the Queen will this year receive 15 per cent of the Crown Estate’s revenues.

In addition to the West End estate, the Crown Estate owns 106,000 hectares of farmland, 14 regional shopping centres and most of the seabed to the 12 nautical mile territorial limit.
St Jame's Market area is flourishing again after the 2008 crisis and many of the world's best hedge funds and private equity funds operate in that area. If the boom in alternative assets continues, the overhaul of that area will be extremely lucrative for Crown Estate and OMERS.

Below, Hans Vrensen, global head of research at DTZ, talks about commercial real estate in London and investment opportunities outside of the U.K. capital. He spoke May 16 with Bloomberg's Neil Callanan in London.

And Bruce Ratner, executive chairman of Forest City Ratner Cos., talks about the New York City real estate market. Speaking with Tom Keene, Sara Eisen and Scarlet Fu on Bloomberg Television's "Surveillance," Ratner also talks about his bid to rehabilitate Nassau Veterans Memorial Coliseum in Uniondale, New York and talks about how the runup in NYC condo prices is 'unnerving'.


Monday, May 27, 2013

OMERS To Reduce Pension Payouts?

Barbara Shecter of the National Post reports, OMERS considering proposal to reduce pension payouts:
Faced with a $10-billion pension-funding deficit, one of Canada’s largest pension funds is considering a drastic proposal that would reduce benefits paid to retiring workers — or force them to work years longer for the same retirement income.

The Ontario Municipal Employees Retirement System (OMERS) Sponsors Corporation, which determines benefits and contribution rates for one of the largest pension operators in the province of Ontario, is mulling a change that would reduce the key figure used to calculate how much money an employee will receive each year in retirement.

A decision on the proposed change to the formula, which would take effect in 2015, is expected by the end of June.

OMERS is an umbrella organization for more than 900 employers and their workers in the province, including paramedics, transit workers, firefighters, police and city workers. It represents almost 429,000 active and retired members.

Changes to the pensions overseen by OMERS are considered annually, but this year’s proposal to reduce the “multiplier” rate at which workers rack up retirement payouts — to 1.85% from 2% — is “more drastic,” according to Simon Archer, a pension specialist at law firm Koskie Minsky LLP in Toronto.

“This is the one that made my eyebrows go up,” he said after looking at the proposals. “Usually plans try not to touch that if they can avoid it.”

Mr. Archer said workers who are close to retirement would see little change, while new employees would be hit the hardest.

A sustained period of low interest rates has made pension promises more expensive for companies, forcing them to raise the amount of money both the employer and employees pay into pension plans, or reduce benefits.

OMERS had a deficit of $7.3-billion at the end of 2011, and already tried to remedy the growing problem by phasing in contribution rate increases over the past three years. At the same time, plan costs have been rising as members age.

There are legal impediments to reducing any benefits that have already been accrued by workers under a plan, but benefits based on future work — including by newly hired employees — are fair game, said Mr. Archer.

The new pension formula at OMERS would be applied to all earnings above a certain threshold beginning in 2015. In order to go into effect at all, it will require approval by two-thirds of the board of the OMERS Sponsors Corporation. The 14 members of the board include an equal number of employer and employee representatives.

Three of the employer representatives proposed the formula change, according to documents posted on the OMERS Sponsors Corp. website. The “key rationale” behind the request for the plan change includes the funding deficit, and the fact that contribution rates are already at an all-time high, the documents say, adding that these factors are “putting a significant strain on members and their employers at a time when our economy is also under stress.”

If the proposal is accepted, it will not affect retirement benefits accrued for work done through the end of 2014. The documents note that the impact on lower-income earners would be reduced because the new formula would be applied only to earnings above the maximum earnings level calculated in the Canada Pension Plan.

In addition, the change would give workers more room for RRSP contributions and they could still receive 70% of their pre-retirement income if they were willing to work longer — 38 years instead of 35 — to build up the additional benefit.

Individual plan members do not get to vote on the proposal, but John Pierce, vice-president of public affairs at OMERS, said feedback or input from them can lead to amendments or even withdrawal of any suggested pension plan changes.

This year’s OMERS proposals, which also include curbs on indexing for inflation and a delay in early-retirement eligibility, appear to address some of the concerns raised in a recent survey by global human resources consultant AON Hewitt. It suggested that Canadian pension plan sponsors have been slow to react to changing demographics and other challenges to pension sustainability.

Awareness of the trends “does not seem to have spurred plan sponsors into addressing long-term sustainability strategies as they struggle with short-term financial pressures and regulatory requirements,” AON Hewitt said in the survey released in early May.
Martin Mittelstaedt of the Globe and Mail also reports, Proposal before OMERS would require employees to work longer to get full pension:
Ontario municipal pension fund giant OMERS has received a proposal from some of its employer members to increase the amount of time it would take for workers in the plan to gain a full pension from 35 years to 38 years.

The proposal will be voted on at the end of June, but would require significant backing from union representatives at the Ontario Municipal Employees Retirement System to be approved.

Under the proposal – made by representatives from the Electricity Distributors Association, the Association of Municipalities of Ontario and the City of Toronto – the so-called multiplier of 2, now used to calculate when a person would be entitled to full benefits, would be cut to 1.85 starting in 2015.

“This is just one of the proposals that has been tabled,” John Pierce, vice-president of public affairs at OMERS, said Friday. He declined to predict whether the measure had enough support to be approved.

OMERS has an annual process of reviewing benefits and pension fund premium payments.

The pension fund has previously had proposals from employers to end inflation protection enjoyed by members, but the requests have not been approved because of the need for benefit reductions to pass with two-thirds support. Votes at the plan are divided equally between employers and worker representatives, making it difficult to get the needed support to approve cuts, which are usually anathema to union members.

OMERS, like many pension plans, is under-financed because of low interest rates and flagging stock market returns, and currently has a deficit of just under $10-billion. OMERS said it is about 86 per cent funded and expects the deficit to be eliminated gradually over the next 10 to 15 years.

The employer groups making the proposal said in a note that the because of the funding deficit, “contribution rates are currently at an all-time high putting a significant strain on members and their employers, at a time when our economy is also under stress.”

They said the change would involve only a small pension reduction for those close to retirement age and would be “not material” for them, while having “an immediate impact on funding.”

Currently, a full pension at OMERS is equal to 70 per cent of a person’s top five years of income. With the current multiplier, it would take 35 years to earn that amount. Those working fewer years receive a lesser amount based on multiplying their years of service by the multiplier of two.
I already covered this topic when I went over OMERS' 2012 results. Was a bit harsh on them but their results are in line with what other large Canadian pension funds posted last year. On the plan's deficit, I agreed with Patrick Crowley, OMERS' CFO, it's not something to worry about short-term. Moreover, OMERS is fully transparent and provides a fact sheet on the plan's funding status with details on a plan to return the plan to fully funded status. More information is available here, including a detailed document on OMERS' funding strategy.

Unfortunately, the media likes blowing pension plan deficits way out of proportion. An 86 per cent funded status is not a disaster, it's well within the norm and can be addressed. Ontario Teachers' Pension Plan is 97 per cent funded, which is negligible and hardly worth worrying about. Yes, plan members are living longer and demographic shifts are introducing longevity risk, but a rise in real interest rates will significantly reduce future liabilities.

Importantly, when it comes to pensions, the most important thing to keep in mind is future liabilities are predominantly impacted by the rise and fall of real interest rates. A steep decline in interest rates will widen pension deficits but a rise in rates will lower deficits (in financial lingo, the duration of liabilities is bigger than the duration of assets, so even if investment gains are strong, it won't be enough to make a dent in the deficit if real rates keep falling).

Having said this, common sense should also come into play when looking at pension sustainability and implementing sensible reforms. There is no guarantee that interest rates will rise significantly over the next decade. In fact,  they can stay low for a long time, especially if a deflationary Japan like slump engulfs the developed world. While echoes of a bond bubble make headlines, some fear we are already in a protracted period of low growth and risks of deflation remain high (slump in commodities might be a harbinger of future deflation).

Also, if people are living longer, then why not introduce measures to have them work longer before receiving a full pension? There is nothing set in stone that pension rules can never be revised. In particular,  shared risk between employers and employees is becoming the new norm and New Brunswick may indeed be the future of Canada's pension reforms.

As far as investments, OMERS took a decision a long time ago to shift a majority of their assets into private markets. They are not alone. CPPIB's long-term strategy is to increase its weighting in private markets and the Caisse plans to increase its global real estate holdings over the next 18 months, cementing its reputation as one of  the best institutional investors in an increasingly popular asset class.

Unlike others, however, OMERS prefers managing its private market assets in-house. There is some debate on whether the Canadian model is full of hot air, especially in private equity, but this does not apply to real estate and infrastructure. OMERS launched a giant infrastructure fund last year and they are internationally recognized for their expertise in direct  infrastructure investments. Canadian pension funds are world leaders in direct infrastructure deals, the most recent deal being PSP Investments' acquisition of Hochtief's airports unit for $1.4 billion.

Nevertheless, no matter what strategy is adopted in private markets, relying on investment gains alone to sustain future pension payouts is simply not a credible long-term strategy. Plan deficits are often blown out of proportion but plan sponsors need to revise their pension policies and look into adopting sensible proposals which will ensure the long-term sustainability of their defined-benefit pensions. This may include cutting cost-of-living adjustments, increasing contribution rates, extending the period of work to reflect demographic shifts and adopting a shared risk model which has worked well for Ontario Teachers', HOOPP and CAAT.

In short, there are no guarantees when it comes to the future of defined-benefit pensions. I'm a huge proponent of bolstering DB pensions and expanding C/QPP but also realize the structural shifts taking place in the world are raising the costs of these public pensions, and if reforms aren't implemented, these changes can jeopardize their future sustainability. When it comes to the pension promise, it's always best to plan ahead for unforeseen scenarios. Now more than ever, employers and unions need to work together to ensure the sustainability of defined-benefit plans.

Below, parts 1 and 2 of the Waterloo Pensions Debate (Waterloo Ontario, Dec 04, 2012), a heated debate between Fair Pensions For All, OMERS and CUPE. It is long but worth looking at. Listen to these presentations with a skeptical ear as there is a tremendous amount of scaremongering by those claiming to represent Canadian taxpayers. Their agenda is to dismantle DB plans and replace them with DC plans, effectively exacerbating pension poverty for all Canadians.


Friday, May 24, 2013

Can Hedge Funds Survive Bernanke?

James Greiff of Bloomberg reports, Can Hedge Funds Survive Bernanke?:
You have to wonder how long an industry that underperforms the broader market will stay around.

Goldman Sachs Group Inc. published a chart today comparing the performance of hedge funds that invest in equities with the major stock-market indexes. Based on Goldman's research, the average hedge fund is up just 5.4 percent so far this year. During the same period, the Standard & Poor's 500 Index has risen 15.4 percent, and the average mutual fund has gained 14.2 percent (click on image below).


This kind of subpar showing surely can't sit well with investors who shell out as much as 20 percent of their gains to the fund manager, who also collects a fee that can be as much as 2 percent of the assets under management.

There could be any number of explanations for why hedge funds have done so badly. Goldman says many hedge funds bet against stocks such as Johnson & Johnson, expecting them to fall. They rose instead.

Then there's the lack of volatility. Hedge funds often profit from discrepancies in prices between related assets, and these tend to shrink during calm periods in financial markets.

Based on one of the most widely watched measures of stock-market volatility, the VIX Index, we're in the equivalent of the horse latitudes. The VIX recently registered a read of about 13, compared with a high of almost 90 at the peak of the financial crisis in October 2008 and more than 40 in the summer of 2011, when worries peaked that Greece might exit the euro monetary union. The VIX has been a snore this year, bouncing between 12 and 18.

The biggest reason for the market tranquility might be the Federal Reserve's repeated assurances that it will maintain zero interest rates and provide monetary stimulus until the economy recovers, and unemployment ebbs.

That may just account for the recent flurry of stories about how much hedge-fund managers hate Fed Chairman Ben Bernanke. He's putting them out of business.
I take these articles on hedge funds with a grain of salt. Sure, most hedge funds are under-performing the broader market but that's hardly surprising since stocks have soared again this year and hedge funds are not long-only mutual funds (they too are under-performing equity indexes). Also, many hedge funds didn't read the macro environment right in the last few years and their bearish stance has cost them a lot of performance.

More importantly, the majority of hedge funds are not  worth paying 2 & 20 in fees. With or without Ben Bernanke, hedge fund Darwinism will continue to impact the industry. The institutionalization of the industry means that only the very best funds will be able to meet the increasingly stringent demands of institutional investors. 

It's also worth keeping in mind that while L/S equity hedge funds are struggling, fixed income hedge funds are growing. In fact, Bloomberg reports that hedge funds are bulking up on bond trading:
As banks abandon debt trading, hedge funds that bet on bonds and loans are pulling in money from investors and hiring traders. Debt-focused hedge funds drew $41.4 billion from pension plans, wealthy individuals, and other investors in 2012, the most since 2007, according to data from Hedge Fund Research. They managed a total of $639.7 billion as of March 31, HFR data show, surpassing stock-trading hedge funds, with $638.7 billion.

Regulators are demanding that banks curb proprietary trading—betting with their own money—and hold more capital to back riskier investments. That’s allowed hedge funds to expand in businesses the banks are leaving, including distressed-debt trading and fixed-income arbitrage, a strategy that seeks to exploit short-term price differentials. “Hedge funds are playing in asset classes where they previously hadn’t played,” says Jason Rosiak, head of portfolio management at Pacific Asset Management.

Hedge funds specializing in debt trading are still minnows compared with Wall Street’s largest houses. BlueCrest Capital Management, Pine River Capital Management, and Millennium Management, three of the fastest-growing funds, have combined assets of about $67.6 billion, according to people with knowledge of the matter who asked not to be identified because the information is private. JPMorgan Chase’s (JPM) corporate and investment bank had an average of $413.4 billion in assets designated for trading in the first quarter.

Still, the hedge funds are growing rapidly, luring bankers from JPMorgan, Deutsche Bank (DB), Barclays (BCS), Bank of America (BAC), and others. BlueCrest doubled its New York staff in the two years through December, while Pine River increased its global workforce by a third in 2012. Millennium expanded its staff by 32 percent, to 1,250 people, last year. James Staley, the JPMorgan executive who was once seen as a candidate to run the company, quit in January to join $13.6 billion hedge fund firm BlueMountain Capital Management. “There’s a continuous brain drain on Wall Street,” says Rosiak.

One reason for banks’ retreat is the 2010 Dodd-Frank Act’s Volcker Rule, which seeks to curb proprietary trading. While the Volcker Rule hasn’t taken effect because regulators are still working out the details, some banks have closed proprietary trading desks.

Hedge funds, which are considered part of the less regulated “shadow-banking” system, are not subject to the rule. The idea behind regulators’ push to move debt trading from banks to hedge funds is to transfer the risk “into relatively small repositories that will be relatively insignificant if they fail,” says Roy Smith, a finance professor at New York University’s Stern School of Business. “The regulatory posture in the U.S. and in Europe is unequivocal. They want to transfer risk to the shadow-banking system.”

Yet moving risk to hedge funds does not make it go away. In 1998 hedge fund Long-Term Capital Management lost more than $4 billion after a debt default by Russia, mostly as a result of a fixed-income arbitrage strategy. The Federal Reserve was so concerned about the impact that it arranged a bailout paid for by banks. “If the hedge fund firms fail,” says Smith, “the real question is, to what degree will the market suffer from it?”

The bottom line: Debt-focused hedge funds now manage $639.7 billion, just topping stock-trading hedge funds, which have $638.7 billion.
I've already covered bankers jumping ship to hedge funds. The growth of debt hedge funds has been fueled in large part by the Fed's quantitative easing which has revived structured credit strategies. Just how well these funds will perform in the future remains to be seen now that bonds hear bubble echoes.

Also, the Fed isn't the only central bank engaging in massive quantitative easing.  I've discussed the seismic shift in Japan and how Abenomics revived global macro funds. But shorting the yen and going long Japanese equities has become a crowded trade and some are worried that Japan is the new Apple.

I don't know. All I know is that the tsunami of liquidity keeps propelling risk assets higher, making nervous investors even more nervous. Some old time traders think it's time to throw out your playbook, reminding us that even though the bears are right to look at the weak macro backdrop, bull cycles often don’t make any sense at all.

I've been warning my readers of a melt-up in stocks for the longest time and think multiple expansion will continue despite rumblings of a Fed pullback. Will a rotation occur out of defensives into cyclical sectors or will defensives be the new bubble? That remains to be seen. All I know is that as long as the music keeps playing, risk assets will go higher, forcing many funds to keep dancing despite their fears of what happens when the music stops.

Finally, I didn't go over top funds' activity in Q1 2013. Those of you who want to look into their top holdings can refer to the links in my Q4 2012 comment. Be careful, however, as the data is lagged and many of the top holdings are way overbought on a weekly basis and others are just languishing and not participating in the broader rally.

Below, Commonfund Hedge Fund Strategies Group CEO Nick De Monico discusses hedge funds and his investment strategy with Deirdre Bolton on Bloomberg Television's "Money Moves."

Thursday, May 23, 2013

Ontario Teachers' Shifts Focus to Asia?

Armina Ligaya of the National Post reports, Ontario Teachers’ Pension Plan to open Hong Kong office:
The Ontario Teachers’ Pension Plan says it will open up an office in Hong Kong within months, as it pushes to increase their exposure to emerging markets from 15% to 20%.

Jim Leech, the chief executive of the largest-single profession pension plan in Canada, says the plan on Tuesday received notification that it received the appropriate licensing to open an office in Hong Kong to cover Asia.

“We will be opening up a Hong Kong office in the next couple of months, with some feet on the street there,” he said in remarks at Bloomberg’s Canada Economic Summit Tuesday. “And I think that signals what we’re doing. Most projections show something like 70 to 80% of world trade are going to be intra-Asian trade, and that’s where wealth is going to be created, and that’s where we’ve got to be to be able to take advantage of it.”

The plan, which had net assets of $129-billion as of Dec. 31, 2012, invests and administers the pensions of 303,000 active and retired teachers in Ontario.

But as more teachers retire and the number of teachers in the workforce dwindle, the plan is facing a demographic crunch and is becoming more risk-averse in its investments, said Mr. Leech.

There are 1.4 working teachers for every retired teacher — more than 2,900 of which are over the age of 90, he added.

As such, they have shifted their exposure to equities from 65% about 15 years ago to about 45% range today.

“We’ve just slowly been dialing it back, simply because we can’t afford the volatility,” said Mr. Leech.

In turn, it has shifted towards investments in infrastructure, real estate and emerging markets.

The plan’s view is Europe, as an investment market, has been “dead for a long time,” he said. And in the U.S., while there has been anecdotal evidence of a renaissance, Mr. Leech does not anticipate big growth.

“So, maybe we can get a couple points, 2.5 points growth out of the U.S., over a longer period of time, so that really just leaves you with the emerging markets,” he said.
Ontario Teachers' put out this press release:
Ontario Teachers' Pension Plan (Asia) Limited, a subsidiary of Ontario Teachers' Pension Plan, has been granted regulatory approval by the Hong Kong Securities and Futures Commission to conduct regulated activities, including dealing in securities, advising on securities, and asset management (Types 1, 4 and 9 regulated activities).

"I am pleased to confirm that our Asia subsidiary and its proposed responsible officers have received formal approval for these licences," said Jim Leech, President and Chief Executive Officer of Canadian-based parent Ontario Teachers' Pension Plan (Teachers'). "Asia has long been a region of interest to Teachers'. We look forward to continuing to build relationships with local partners and exploring new direct, co-investment and fund investment opportunities in the market."

The Asia office will be located in Hong Kong and staffed by local and Canadian equities staff from the fund's private capital and public equities departments. This office will be the fund's second major regional office. Teachers' European, Middle East and Africa regions private capital office opened in London in 2007.
Ontario Teachers' isn't the only (or the first) large Canadian fund opening up an office in Hong Kong. If you refer to the interview with Mark Wiseman, CPPIB's president and CEO, at the end of my comment on CPPIB's FY 2013 results, you will see the first foreign office they opened was in Hong Kong, not New York or London.

Does it make sense for these large funds to open offices in Asia and elsewhere? Yes and no. They can easily invest in large public and private market funds that already have offices in Asia but the truth is there are advantages to having eyes and ears on the ground to explore all opportunities in direct, co-investment and fund investments, as well as cultivate relationships with large Asian pension and sovereign wealth funds in the region.

As far as dialing back risk to deal with their demographic crunch, Teachers' has been shifting out of public equities into real estate, private equity and infrastructure over the last 15 years to dampen volatility but it also recently announced it is absorbing more investment risk. And while investing in emerging markets is volatile, there is no question that over the long-term this region will grow while the developed world struggles with low growth and high debt.

Finally, there was another article that caught my attention. Barry Critchley of the National Post reports that debt financing by pension funds is a steadily growing business:
One day after OPB Finance Trust raised $250-million of nine year debt at 2.90%, more information has emerged about the borrowings by some of the country’s leading public sector pension funds. For instance:

— According to DBRS, the total debt outstanding for OMERS is about $4.43-billion. That debt has been issued by three different entities: OMERS Realty Corp., OMERS Realty CTT Holding and OMERS Realty CTT Holding 2. In numbers provided by DBRS, the total debt for PSP Capital Inc., the financing arm for the Public Sector Pension Investment Board is about $11.8-billion. That debt has been issued through one entity, PSP Capital Inc.

— According to FTSE TMX Global Debt Capital Markets Inc. the entity that manages and publishes the country’s debt indexes, debt issues from five public sector funds have found a home in the all government index.

Of the five, Cadillac Fairview Finance Trust, a unit of Ontario Teachers Pension Plan Board, has three issues in that index: $1.25-billion (with a 3.24% coupon and a maturity date of Jan. 25 2016); $750-million (4.31% and Jan. 25, 2021); and $600-million (3.64% and May 9 2018.) Among the others the Caisse de depot’s CDP Financial Inc. has one issues that’s included ($1-billion, 4.60% and July 15, 2020); OMERS Realty Corp. ($200-million, 4.74% and June 4 2018); OMERS Realty CTT Holding ($170 million, 4.75% and May 5 2016) and OPB Finance Trust ($350-million, 3.89% and July 4, 2042). For its part PSP Capital has two issues included ($700-million, 2.94% and Dec. 3, 2015) and ($900-million, 2.26% and Feb. 16, 2017.) All those issues with the exception of OPB Finance Trust are AAA-rated OPB is split rated: AAA/AA(high). And all the issues are guaranteed by the pension fund.

So what’s the point of all the debt financing? When Cadillac Fairview last raised capital it explained it in these terms. “The Trust will lend the proceeds of the Offering to one or more of the entities comprising the real estate portfolio of Ontario Teachers’ Pension Plan Board referred to as the Cadillac Fairview Group.” In addition the release said that Cadillac Fairview Finance Trust “is a special purpose trust established under the laws of the Province of Ontario. The activities of the Trust are limited to the borrowing of funds from time to time, lending funds to the Cadillac Fairview Group, and holding funds in cash and cash equivalents and other ancillary activities.”

In an early 2013 ratings report by Moody’s Investor Services, it was stated that PSP Capital, a wholly owned subsidiary of the Public Sector Pension Investment Board (PSPIB). PSPIB “uses this subsidiary to add a moderate degree of leverage to increase the return of its investment portfolio by issuing medium term notes and commercial paper.”
You might wonder why large Canadian pension funds are engaging in debt financing but if the conditions are right to issue debt and they have the AAA balance sheet to borrow cheaply, why not borrow to fund investments? The increase in leverage is moderate and hardly something to be concerned about.

Below, Reorient Financial Markets' Uwe Parpart discusses the outlook for the Chinese economy and Federal Reserve monetary policy with Susan Li, John Dawson, Rishaad Salamat and David Ingles on Bloomberg Television's "Asia Edge."