Friday, October 31, 2014

BoJ's Halloween Surprise?

 Leika Kihara and Tetsushi Kajimoto of Reuters report, Japan's central bank shocks markets with more easing as inflation slows:
The Bank of Japan shocked global financial markets on Friday by expanding its massive stimulus spending in a stark admission that economic growth and inflation have not picked up as much as expected after a sales tax hike in April.

BOJ Governor Haruhiko Kuroda portrayed the board's tightly-split decision to buy more assets as a preemptive strike to keep policy on track, rather than an admission that his plan to reflate the long moribund-economy had derailed.

But some economists wondered if pushing even more money into the financial system would be effective as long as consumer confidence continues to worsen and demand remains weak.

"It's clearly a big surprise given Kuroda's repeated insistence that policy was on track and assorted politicians have been warning about the negative side of a weak yen currency," said Sean Callow, a currency strategist at Westpac.

"We salute the BoJ for admitting that they weren't going to reach their goals on inflation or GDP, though we do note that the new policy equates to about $60 billion of quantitative easing per month. This perspective does raise the question of just how much impact monetary policy is having."

The jolt from the BOJ, which had been expected to maintain its level of asset purchases, came as the government signaled its readiness to ramp up spending to boost the economy and as the government pension fund, the world's largest, was set to increase purchases of domestic and foreign stocks.

"We decided to expand the quantitative and qualitative easing to ensure the early achievement of our price target," Kuroda told a news conference, reaffirming the BOJ's goal of pushing consumer price inflation to 2 percent next year.

"Now is a critical moment for Japan to emerge from deflation. Today's step shows our unwavering determination to end deflation."

Kuroda said the BOJ's easing was unrelated to major portfolio changes by the Government Pension Investment Fund (GPIF) also announced on Friday, but the effect of the day's two major decisions means that the central bank will step up its buying of Japanese government bonds, offsetting the giant pension fund's increased sales of them.

The BOJ's move stands in marked contrast with the Federal Reserve, which on Wednesday ended its own "quantitative easing," judging that the U.S. economy had recovered enough to dispense with the emergency flood of cash into its financial system.

In a rare split decision, the BOJ's board voted 5-4 to accelerate purchases of Japanese government bonds so that its holdings increase at an annual pace of 80 trillion yen ($723.4 billion), up by 30 trillion yen.

The central bank also said it would triple its purchases of exchange-traded funds (ETFs) and real-estate investment trusts (REITs) and buy longer-dated debt, sending Tokyo shares soaring and prompting a sharp sell-off in the yen.

Kuroda said that while the economy continues to recover, plunging oil prices, slowing global growth and weak household spending after the tax hike were weighing on price growth.

"There was a risk that despite having made steady progress, we could face a delay in eradicating the public's deflation mindset," he said.

Before Friday's shock decision, Kuroda had been relentlessly optimistic that the unprecedented monetary stimulus he unleashed 18 months ago would succeed in bolstering an economic recovery and ending 15 years of falling prices.

But the world's third-largest economy has sputtered despite the BOJ's asset purchases and earlier government spending.

Most economists polled by Reuters last week had expected the central bank to ease policy again but not so soon. A majority had expected it to move early next year.

The bank's previous failed effort to defeat deflation via quantitative easing (QE) in the five years to 2006 failed.


Still, Economy Minister Akira Amari called the BOJ's easing a timely move, saying the decision was related to but separate from Prime Minister Shinzo Abe's looming decision on whether to raise the sales tax again next October, which would help rein in hefty government debt but risk a further economic blow.

In a semiannual report, the BOJ halved its growth forecast for the fiscal year to March to 0.5 percent. It trimmed its CPI forecast for fiscal 2014 and 2015, but still expects to meet its inflation target within the two years it originally set out.

"This is very significant because it reasserts Kuroda's leadership over the policy board, which was beginning to show open dissent," said Jesper Koll, director of research at JPMorgan Securities.

"It recognizes what we have known, that the real economy has been weaker than expected, weaker than forecast, and reasserts that Kuroda thinks they can do something about this."

The benchmark Nikkei stock index .N225 spiked to a 7-year high on the BOJ bombshell and closed up 4.8 percent. The yen tumbled, with the dollar climbing to 110.91 yen, its highest since 2008, from 109.34 before the announcement.

"It’s easy money, so financials, banks and securities, and real estate stocks stand to benefit further," said Masayuki Doshida, senior market analyst at Rakuten Securities.

In a reminder of the challenges the central bank faces, data earlier on Friday showed annual core consumer inflation was 1 percent when stripping out the effect of April's tax hike, half the BOJ's target.

Household spending fell for a six straight month in September from a year earlier, while the job-availability rate eased from its 22-year high in August.

Also on Friday, a Japanese government panel overseeing the GPIF approved plans for the fund to raise its holding of domestic stocks to 25 percent of its portfolio from the current 12 percent.

The $1.2-trillion GPIF is under pressure from Abe to shift funds towards riskier, higher-yielding investments to support the fast-ageing population, and away from low-yielding JGBs.

With Abe set to decide in December whether to raise the sales tax next year to 10 percent from 8 percent, voices are growing for him to delay the planned fiscal tightening, given the economy's weakness.

Isamu Ueda, a senior official in Komeito, the junior party in Abe's coalition, said on Friday it would be difficult to press ahead with plans to raise the tax next year.

"I think conditions are severe for (raising the tax) next October," Ueda told reporters after a meeting of Komeito's economic revival council, which he heads.
The surprise decision by the Bank of Japan to engage in more quantitative easing prompted a huge rally in global equities and at this writing, U.S. stock futures are up sharply.

So what is going on? Despite unprecedented monetary and fiscal stimulus, Japan is still trying to slay its deflation dragon and Europe and the United States better be paying attention because this could very well be their future.

Interestingly, the Fed ended its quantitative easing program a couple of days ago and if you read the FOMC statement, it was somewhat hawkish, which makes me wonder if the Fed is on track for making a huge policy blunder.

Importantly, I think the Bank of Japan is right to be worried and the Fed is too complacent about contagion risks emanating from the euro deflation crisis, taking away the punch bowl too soon. The doves on the Fed, like James Bullard, understand the dangers of deflation spreading to the U.S. and why it's important to leave the door open for more QE down the road, but he's not a voting member. Charles Plosser and Richard Fisher, two of the hawkish presidents on the FOMC, voted to end QE but they will be replaced early next year and this could change the tenor of debate within the U.S. central bank's policy-setting committee.

I wrote my thoughts on Fed policy last Friday, emphasizing this:
...the biggest policy mistake the hawks on the FOMC are making is ignoring global weakness, especially eurozone's weakness, thinking the U.S. domestic economy can withstand any price shock out of Europe. If eurozone and U.S. inflation expectations keep dropping, the Fed will have no choice but to engage in more QE. And if it doesn't, and deflation settles in and markets perceive the Fed as being behind the deflation curve, then there is a real risk of a crisis in confidence which Michael Gayed is warning about. Perhaps this is the real reason why big U.S. banks are loading up on bonds (not just regulatory reasons).
It's also interesting to read how Japan's giant pension fund, the GPIF, is unloading JGBs to buy domestic equities but the BoJ is snapping them up to keep rates low (central banks are more powerful than giant pension funds). 

What does all this mean for the markets? Global risk assets will continue to rally and we will await the news from the European Central Bank to see if it finally starts engaging in massive QE. Morgan Stanley and Goldman Sachs are warning that European QE, while fully priced in, is neither imminent nor likely. If that's the case, then expect the Fed to stand ready to engage in more QE down the road, especially if inflation expectations keep dropping despite massive global monetary stimulus. 

Former Federal Reserve Chairman Alan Greenspan is right to warn of market turmoil as QE unwinds, but I don't think he understands the real danger in the global economy, namely, a protracted period of debt deflation. BoJ Governor Kuroda is way ahead of his global counterparts but he's fighting a losing battle. No matter what monetary authorities do, deflation and deleveraging are coming, and that will scare everyone next Halloween. 

Below, Marc Lasry, Avenue Capital chairman & CEO, explains how his hedge fund was able to profit from banks and Europe's "structural issues." Lasry also explains why he likes energy plays now, but he prefers playing the credit side than investing in energy stocks (I wouldn't touch energy or commodity stocks until you get a better sense of where inflation expectations are heading).

One thing Lasry said that I really liked (not in clips below) was when the risk-free rate was at 4%, distressed debt investing was expected to deliver 20% annually (5x the risk-free rate) but with rates at 0.25%, investors are happy with low to mid-teen returns, recognizing the "risk parameters have changed" and you have to take on a lot more leverage to obtain these returns. Smart guy which is why he's one of the best distressed debt investors in the world. Happy Halloween!

Thursday, October 30, 2014

Oversized Hedge Fund Egos?

Alexandra Stevenson and Julie Creswell of the New York Times report, Bill Ackman and His Hedge Fund, Betting Big:
William A. Ackman, the silver-haired, silver-tongued hedge fund mogul, gestured out the window of a 42nd-floor conference room at Pershing Square Capital Management in Midtown Manhattan. The view was spectacular, but Mr. Ackman’s arm extended not downward, toward the vibrant fall foliage of Central Park, but skyward toward the top of a glittering glass building just around the corner on 57th Street.

He was pointing toward One57, a new 90-story, lavish hotel and condominium building described by one critic as “a luxury object for people who see the city as their private snow globe.” Specifically, Mr. Ackman was referring to the penthouse apartment. Named the Winter Garden, for a curved glass atrium that opens to the sky, it is a 13,500-square-foot duplex with an eagle’s-eye view of the park.

And it will belong to Mr. Ackman. When the sale closes, the reported $90 million price would be the highest ever paid for a Manhattan apartment. It is, he explained, “the Mona Lisa of apartments.” Never will there be another like it.

But Mr. Ackman, 48, doesn’t intend to live there. He lives at the Beresford, off Central Park, with his wife and daughters. The Winter Garden is just another investment opportunity for him and a few others. “I thought it would be fun,” he said, “so myself and a couple of very good friends bought into this idea that someday, someone will really want it and they’ll let me know.” Maybe he will hold some parties there in the meantime.

Whether it’s a top-of-the-world apartment, an attack on a company or even his annual vacations with friends (the next trip is Navy SEAL training), Bill Ackman does everything big.

And this may be his biggest year yet. Overseeing more than $17 billion, his hedge fund is up 32 percent in a year when many other hedge funds are just breaking even. He recently completed a public offering of stock in Europe of part of Pershing Square, and while the shares are trading below the offering price, he still raised $2.7 billion that he can use to make more big bets. He’s also a driving force behind one of the biggest — and certainly the most controversial — potential mergers of the year: Valeant’s $53 billion hostile takeover bid for Allergan, the maker of Botox.

His critics agree that he’s big. They say he stands out for his big mouth and oversize ego, an accomplishment in the hedge fund world. (Even back in high school, his tennis teammates presented him with a T-shirt that read: “A closed mouth gathers no foot.”) Others warn that his fund has a risk of blowing up. His portfolio is made up of bets on less than a dozen companies. (The Allergan stake alone made up 37 percent of his fund earlier this fall, according to filings.) That means when things go bad, they can go really bad. That’s what happened when his $2 billion bet on Target through a separate fund lost 90 percent of its value at one point.

He has wagered $1 billion that Herbalife, the nutritional supplement company, will fail. So far, that bet hasn’t panned out, and even one of his closest advisers has called his theatrics on the subject — including a teary, three-hour rant this summer in front of nearly 500 people — a mistake.

But on that crisp fall morning at Pershing Square, Mr. Ackman was uncharacteristically taciturn. Reserved, even. Or maybe he was just a bit annoyed.

When asked if he has had to make bigger, riskier bets as his fund has grown, he answered, a bit petulantly: “We certainly have to make bigger investments, that’s definitely true. But not riskier investments.” Asked about failures, like the Target bet, he sighed deeply. “Target was a bad investment,” he said, “but out of 30 investments, I don’t know of another investor with as high a batting average.”

He certainly has an enviable long-term record: His funds, excluding the Target and four other separate funds, have returned 21 percent net of fees over 10 years, annualized. He has achieved it by going on the offensive. Mr. Ackman’s role as an activist hedge fund investor is to persuade other shareholders that he knows how to run companies better than current management does. This involves research, argument and, perhaps most important, a sensitivity to how every pronouncement and gesture will be perceived.

“I was angry at Carl Icahn for many years, as you know,” Mr. Ackman said of the longtime activist investor, when asked if he holds grudges. He swiped at his eye and added, lest the movement be misinterpreted: “My eye is tearing. It’s not emotion. I have a clogged tear duct.”

His attention to detail and persuasive powers will be especially important come December, when Allergan shareholders hold a special meeting. Mr. Ackman will urge them to replace a majority of the company’s board and to pave the way for approving the takeover by Valeant.

It’s a high-stakes move. And Mr. Ackman is all in for a big win. He is intensely competitive about everything, from memorizing two-letter words for Scrabble games to, as it turns out, owning apartments.

“It’s one of a kind,” he said of his trophy penthouse. “By the way,” he added, nodding down the street where other luxury towers are expected to be built, “these other buildings are not going to be as good.”

Commanding the Room

All successful people have stories to tell about what allowed them to achieve fabulousness. There is usually a moral. In the story that Mr. Ackman likes to tell, the moral is this: Never doubt Bill Ackman.

During his freshman year at Harvard, Mr. Ackman happened to read the application essay of the guy in the room next door. It was about why he hated Smurfs. Mr. Ackman thought it was really good, and an idea formed. He would write a book on how to write a college essay, drawing on examples and interviews with Ivy League admissions officers. On the advice of a family friend, he broadened his book to include information on college admissions and sent it off to publishers. The rejection letters piled up. He dropped the idea.

Later, two guys from Yale wrote a similar book called “Essays That Worked,” which would be featured in a New York Times article.

“I suffered extreme psychological torture,” Mr. Ackman recalled. The advice that the family friend gave, he added, had been bad. “I said, the next time I have a really good idea, I’m not going to listen just because someone is older than me.” Mr. Ackman continued, “It’s not going to stop me from going forward.”

Fresh out of Harvard Business School in 1992, Mr. Ackman went to work for his father, Lawrence Ackman, at his commercial real estate brokerage firm, Ackman-Ziff. But the young man was impatient. After just one week, and shrugging off advice that he first work for a veteran hedge fund manager, Mr. Ackman convinced his Harvard buddy David P. Berkowitz to start a hedge fund.

Cobbling together $3 million, the two started Gotham Partners. In a tiny office, they pored over corporate filings, hunting for undervalued companies. In 1998, Gotham started a hostile proxy fight against a small Ohio real estate holding company, First Union Real Estate Equity and Mortgage Investments. It took months of tussling before Gotham prevailed.

At Gotham, Mr. Ackman developed the methods he would use again and again. He went after big targets and took his battles into the public arena. Those techniques proved especially useful when he had sold short a company’s stock, betting on a collapse on the stock price.

His first foray into activist short-selling was in the spring of 2002, when he released a 48-page, scrupulously researched paper criticizing the management and reserve levels of the Federal Agricultural Mortgage Corporation. By that fall, Farmer Mac’s stock had tumbled, producing a quick win for Gotham, which had sold the agency’s stock short.

Mr. Ackman’s next short target, in late 2002, was the bond insurer MBIA, which he argued had backed billions of dollars of risky financing. It was a bet that would take years, hours of presentations to credit agencies and regulators, and a Wall Street financial crisis in 2007 before eventually paying off when MBIA’s stock started to collapse. Mr. Ackman’s bet was a huge success, netting just over $1 billion. But Gotham’s days were numbered.

Over the course of several years, Mr. Ackman struggled to right the troubled First Union, including an attempt to merge it with a failing golf operator that Gotham also owned. Investors started to voice concern. When a judge’s decision about the merger in late 2002 went against Gotham, the partners decided to wind down. The once highflying fund was done.

More than a decade later, Mr. Ackman accepts partial responsibility for Gotham’s demise. The problem, he said, was not its investments, which he argues ultimately paid off, but rather the strategy of investing in real estate, which was hard to sell quickly when investors wanted their money back. “I made a couple of strategic mistakes that, had I had more perspective, I wouldn’t have made,” he said.

About a year after Gotham closed, Mr. Ackman reappeared with a new fund, Pershing Square, and a $50 million seed investment from the Leucadia National Corporation. There would be a new focus: activist investing.

At Gotham, he learned that he needed research and a story. At Pershing, he perfected the skill of telling that story to an audience of shareholders, corporate directors and the news media.

“He’s trying to create a theatrical setting where it’s not about the words, it’s about the dynamic, the action,” said J. Tomilson Hill, chief executive of Blackstone Alternative Asset Management, an investor in Pershing Square.

He charged quickly out of the gate, persuading Wendy’s to divest itself of the Canadian chain Tim Hortons. Then he got McDonald’s to sell some of its restaurants and buy back shares. It became clear that when Pershing Square announced a stake in a company, something big was going to happen, and the stock moved.

“Bill commands a room. He’s a tall guy, a good-looking guy. He draws all eyes to him when he speaks,” said Damien Park, the founder of Hedge Fund Solutions, which consults on activist campaigns but has not worked with Mr. Ackman. “Also, his ideas aren’t usually incremental in nature — asking a company to distribute cash or clean up a balance sheet. They’re usually quantum changes in a company.”

That was true of his 2007 mark on Target. In just two weeks, he raised $2 billion for a special fund to invest in just one stock. He wanted Target to sell its credit card business and restructure its real estate holdings. Target sold off part of its credit card business, but management disagreed with his real estate plan. Over the course of two years, Mr. Ackman waged a $10 million campaign to replace board members with himself and four others.

When shareholders voted against him in the spring of 2009, the defeat stung more than his reputation. By then, losses amounted to as much as 90 percent, and many investors in the special Pershing Square fund, including the fellow activist investor Daniel S. Loeb through his Third Point hedge fund, had asked for their money back.

Mr. Ackman suffered another black eye a few years later with J. C. Penney. He won a seat on its board in 2011 and handpicked Ron Johnson, the head of Apple’s retail stores, to turn around the troubled retailer. But the efforts were botched; the company went from being profitable to losing $1.4 billion in 2013. Mr. Ackman resigned from the board in the summer of 2013, selling his stake at an estimated loss of $473 million.

“Every time I see him,” said Mr. Hill at Blackstone, “I say: ‘Bill, do me a favor. Stay away from retail.’ ”

Still, Mr. Ackman notched two of his biggest hits — General Growth Properties and Canadian Pacific — over the same period, helping to offset the reputational and financial losses from Target and J. C. Penney. Pershing estimates that Mr. Ackman’s original $65 million investment in General Growth, which operated commercial properties and has been restructured into three businesses, is now worth $3.3 billion. In Canadian Pacific, Mr. Ackman has so far tripled the value of his original investment after replacing the board and forcing through a turnaround.

His defenders argue that anyone with a fund as large as Pershing is going to have the occasional blunder. “In this business, if you don’t make mistakes, you’re either a liar or you don’t take many swings at the ball,” said Leon Cooperman, the founder of the hedge fund Omega Advisors.

Always a Competition

Last year, Mr. Ackman and some friends took a scuba-diving trip off the coast of Myanmar. The sun was warm, the ocean calm, but even in this idyllic setting, Mr. Ackman felt compelled to devise a competition he could win. After surfacing from each dive, he checked his air gauge against everyone else’s, to see who had used the least amount of oxygen while diving. Using less oxygen suggested less stress, thus proving who was least rattled under water. Mr. Ackman really, really likes to win.
Continue reading the main story

“When we lost at tennis, always, on some fundamental level, he regarded it as an aberration,” recalled Michael Grossman, his tennis partner in high school.

Mr. Ackman had an upper-middle-class upbringing in the New York suburbs, and he recalls plenty of rough-and-tumble arguments at home with his parents and sister. “Let me win?” Mr. Ackman recalled. “That doesn’t exist in my house. No one lets anyone win. Fight to the death.”

And if, at times, that means putting his fund and reputation at risk, so be it.

“I think he is just prepared to live with the scrutiny and the calumny heaped upon his head,” said William A. Sahlman, one of his professors at Harvard Business School.

This year, Mr. Ackman made a rare move. It began with a meeting in early February between him and J. Michael Pearson, the chief executive of Valeant. Five days later, Mr. Pearson expressed his interest in buying Allergan, the maker of Botox, and sought Mr. Ackman’s help, according to Valeant’s regulatory filings. Mr. Ackman agreed and began buying shares in Allergan through a unique partnership with Valeant later that month, eventually building a $4 billion stake in the company. By April, Mr. Ackman and Valeant had gone public with a bid for the company worth $47 billion. It went hostile.

“A hedge fund getting together with another company to buy out a competitor?” said Alan Palmiter, a business law professor at the Wake Forest University School of Law. “That’s definitely unusual. I can’t recall ever seeing a hedge fund being part of an industry takeover.”

Allergan had stronger words for Valeant and Mr. Ackman. It rejected the deal and warned shareholders that Valeant would squeeze the company for profit and skimp on research. In a federal lawsuit, Allergan contended that the Valeant-Ackman partnership was an “improper and illicit insider-trading scheme hatched in secret by a billionaire hedge fund investor.” The S.E.C. is now investigating. Pershing Square denies the accusations.

The short-seller James S. Chanos, who predicted the fall of Enron, has called Valeant’s accounting aggressive and joined the fight — against Mr. Ackman.

While Mr. Ackman drew support from big Allergan shareholders — including T. Rowe Price and Pentwater Capital Management, and proxy advisers like Glass Lewis — for a special shareholder meeting in December to vote on a new board, the clash has intensified. In early October, Mr. Ackman provided a sometimes testy deposition for the Allergan lawsuit. (After confirming that he had given depositions “a number” of times before, Mr. Ackman added, “I love depositions.”)

Neither side shows signs of backing down ahead of the shareholder vote. In court filings, Valeant and Pershing have accused Allergan of providing false information about Valeant to shareholders. Allergan said last week that it saw no evidence to support those claims. Valeant and Pershing, meanwhile, have raised their offer twice and have signaled they might raise it again in the next few weeks, to $60 billion.

‘A Sad Performance’

For three hours on a sunny day this past July, Bill Ackman ranted. He raved. He brought up comparisons to Enron. To the Mafia. To the Nazis. He cried.

He did this in front of an audience of nearly 500 people in a Midtown Manhattan auditorium. He had billed this as the “most important” presentation of his career, promising that it would be the “death blow” against Herbalife, the nutritional supplement club that he has bet against.

It seemed to have the opposite effect. Throughout the jaw-dropping exhibition, Herbalife’s stock rose higher, ultimately closing the day up 25 percent.

The presentation was so over the top that other hedge fund investors, friends and even members of Pershing Square’s own advisory board quickly labeled it a mistake. “It was one of the few times that I felt sorry for Ackman, a guy who makes more in a day than I make in a year,” said Erik M. Gordon, a professor at the Ross School of Business at the University of Michigan. “It was a sad performance, and it was, minute by minute, calling into question his judgment and credibility.” Mr. Ackman’s theatrical sense had gone wrong; later, he told Bloomberg News that the presentation “was a P.R. failure.”

Others feared the bet itself, which at one point totaled 10 percent of Pershing’s assets. At least one investor had already redeemed his money.

“I’m sure we had some redemptions from people who were nervous about Herbalife,” Mr. Ackman said in the Pershing conference room.

The head of a firm that invests in hedge funds, speaking on condition of anonymity because he might someday invest with Mr. Ackman, said: “There are two schools of thought on Herbalife. Bill thinks this is an outright fraud that will be convicted. To take that big a bet for your fund and your investors, I think it’s foolish.”

Even before the “death blow” presentation, Mr. Ackman had restructured his bet against Herbalife. After discussions with investors and his advisory board, he reduced Pershing’s exposure by 60 percent. But he has spent $50 million just on research and legal fees for his campaign against the company.

“Some of us might be surprised by how much he ventured — how much he got into it — but I don’t think there is anybody on the board who thinks that this is now a mistake,” said Martin Peretz, one of Mr. Ackman’s professors at Harvard, who was an early investor in Gotham and serves on Pershing’s advisory board. (Members of the advisory board each received 1 percent of the firm.) That Herbalife’s share price has fallen 34 percent this year helps, he added. Still, Mr. Ackman’s position will start making money only if Herbalife stock falls roughly another 9 percent.

The Federal Trade Commission and the S.E.C. have opened inquiries into Herbalife and its practices — in no small part because Mr. Ackman lobbied regulators and lawmakers to encourage investigations. The S.E.C. is also looking at Pershing Square and some of the investors who took the other side of the bet.

Some hedge fund executives wonder whether Mr. Ackman has lost his perspective on Herbalife, allowing it to become a personal vendetta.

“I think Bill has gotten very angry about what Herbalife is doing, and the presentation made it very clear that it’s personal to him,” said Whitney Tilson, a hedge fund manager and a longtime friend of Mr. Ackman. “He wants to be vindicated for his personal reputation as well.”

Mr. Ackman argues that he maintains plenty of rational distance. When asked if he could absorb any new information that might change his thesis against Herbalife, he first nodded curtly. Certainly, yes.

But, unable to stop himself, he fell into a familiar refrain. “There’s nothing actually that could prove that Herbalife is not a pyramid scheme,” he said. “There’s nothing.”

Maybe Mr. Ackman is capable of changing his mind. Or maybe not. As for Herbalife, he finished heatedly, “That’s a bad example.”
This article provides a great profile of a well-known hedge fund titan. I track Bill Ackman's Pershing Square and many other top funds every quarter (next one will be out in a couple of weeks). Ackman's fund is having a great year, which is why he's leading the pack in 2014. But as I keep warning my readers, beware of investing in the hottest hedge funds.

As far as egos, there is no doubt Ackman has a huge ego and it often comes back to bite him in the ass, making some of his investors extremely nervous. The sad public display of hedge fund cannibalism didn't make him or Carl Icahn look good. In fact, it turned many people, especially those in the Jewish community, completely off which is why they wisely simmered down and made up.

What else does the article show us? Great investors invest with conviction and they're not afraid to take very concentrated bets. They will lose on some big bets but win on most which is why they typically outperform the S&P500 over a long period.

Ackman's fund has hit a few home runs, offsetting his big flops. Two of his biggest hits — General Growth Properties (GGP) and Canadian Pacific (CP) — helped to offset the reputational and financial losses from Target (TGT) and J. C. Penney (JCP).

I must admit, I always thought J.C. Penney was a dud and openly questioned why so many top hedge fund managers, including Soros, jumped on that bandwagon in the third quarter of 2013 (Soros cut his losses in the subsequent quarter). As far as Herbalife (HLF), I continue to steer clear from it as I never bought their products and don't have an opinion on the company. As far as Valeant Pharmaceuticals (VRX), Ackman might be right but I wouldn't bet against Jim Chanos, the man who exposed Enron as a fraud.

In another story related to oversized hedge fund egos, Bloomberg's Christie Smythe reports, Bridgewater Sues Ex-Employees Who Founded Rival Convoy:
Bridgewater Associates LP, the $160 billion hedge-fund firm founded by Ray Dalio, sued two former employees who started competitor Convoy Investments LLC, claiming they exaggerated their previous roles with Bridgewater to win clients.

Convoy founders Howard Wang and Wenquan Wu, who Bridgewater said served in “low-ranking roles” in client services and information technology, have tried to pass themselves off as “former key figures,” according to the firm’s complaint accusing the two of violating laws against false advertising.

“Rather than promote their new venture honestly, defendants elected to trade off of Bridgewater’s hard-earned reputation,” the Westport, Connecticut-based firm said in the Oct. 21 complaint in Manhattan federal court.

Wang had publicized that he personally “managed” multibillion-dollar portfolios and helped oversee the $70 billion All Weather fund, while Wu billed himself as helping oversee various “critical components” of the company’s operations systems, Bridgewater said.

After being confronted about misleading claims, Wang and Wu took down only some of their statements from Convoy’s website, and then “mysteriously” hid the bulk of the site behind a password, Bridgewater said. The Convoy founders also submitted exaggerated claims in an application for a trademark for the new firm, according to the complaint.
Ambitions Hidden

While they had agreed to disclose their post-employment plans, Wang and Wu didn’t tell the firm that they were planning to start a competitor, Bridgewater said. The men “kept their competitive ambitions hidden,” telling Bridgewater they were “traveling, ballroom dancing” or passively advising friends and family about their investments, according to the complaint.

A representative of New York-based Convoy who wouldn’t provide a name said in an e-mail that the lawsuit claims are “baseless.”

“We believe this is a case of a giant hedge fund using its weight to scare ex-employees from becoming competition, particularly because we believe our low fee and pro bono approach is disruptive to the established industry model,” the representative said.

Bridgewater is seeking damages and a court order stopping the men from allegedly engaging in false advertising.

The case is Bridgewater Associates LP v. Convoy Fund LP, 14-cv-8413, U.S. District Court, Southern District of New York (Manhattan).
I'm keeping a close eye on this case for two reasons. First, if Bridgewater is right and these former employees are misrepresenting their experience at the fund to garner assets, then kudos to Bridgewater for exposing them.

But if this isn't the case, then I give all the credit to the founding partners of Convoy Investments for standing up to the 'Bridegewater bullies' and starting a new hedge fund with much lower fees than the established industry norm. They aren't the first fund to think of drastically chopping fees and they won't be the last.

In the hedge fund world, you won't find a bigger ego than Ray Dalio even though he will vigorously deny this claiming his critics don't understand Bridgewater's unique culture and 'radical transparency.'

I'm not a critic of Ray Dalio or Bridgewater but I have raised concerns on their size and performance in the past and some of the deals they entered with public pension funds. I was one of the first in Canada to invest in Bridgewater back in 2002 and met Ray Dalio roughly ten years ago when Gordon Fyfe and I visited their office. I even confronted him on why deflation and deleveraging is the endgame, irritating him to the point where he blurted out: "Son, what's your track record?" Fyfe got a real kick out of that response.

I like Ray and think Bridgewater is a top global macro fund which produces outstanding research to back their positions. But let there be no mistake, it's Ray's shop and he rules it with an iron fist. He will claim otherwise but look at the facts. How many Bridgewater "cubs" or "tigers" are there out there? Why haven't there been more former Bridgewater employees starting up their own fund? The evidence speaks for itself and Bridgewater's reaction to this new venture sends a strong message to any of their employees thinking of starting a new fund, "We will squash you like a bug!".

There is something else that irks me a lot. All these overpaid hedge fund gurus collecting huge fees on the billions they manage have catapulted into the Forbes' list of billionaires. Dalio is now the richest person in Connecticut with an estimated net worth of $14.3 billion (do the math...when managing over $100 billion, that 2% management fee really kicks in, making Dalio obscenely rich). Kudos to him, he's come a long way since starting his fund in a small Manhattan apartment in the mid-70s.

But when a hedge fund manager's net worth is roughly 10% of the assets he manages, I start worrying that his ego will get the better part of him and whether he's spreading enough of his enormous wealth to all his employees. What else worries me? As I've stated before, that 2% management fee should be scrapped for alternative investment funds managing billions because it turns most funds into large, lazy asset gatherers (not the case for Bridgewater but this is a legitimate concern).

As always, I welcome your feedback and if Ray Dalio or Bill Ackman have anything to say, they can contact me directly ( There are a lot of egos in finance, especially in the hedge fund industry, and that's not always a bad thing. But all these overpaid hedge fund gurus owe their enormous wealth to teachers, police officers, firefighters and other public servants working hard to make an honest living. I wish they'd recognize this and publicly thank them once in a while.

Below, Daniel Posner, chief investment officer of Opportunistic Credit at Golub Capital, and Columbia University’s Fabio Savoldelli discuss how hedge funds were impacted by volatility, the recent market selloff and where Gloub Capital is finding value. They speak on “Market Makers.”

And Skybridge Capital Senior Portfolio Manager Troy Gayeski discusses the performance of hedge funds, Fed policy and his outlook for the economy on “Bloomberg Surveillance.”

Wednesday, October 29, 2014

CPPIB's Risky Bet on Brazil?

Guillermo Parra-Bernal of Reuters reports, Canada's CPPIB to invest $396 mln in Brazil real estate:
Canada Pension Plan Investment Board (CPPIB) plans to invest about 1 billion reais ($396 million) in commercial property in Brazil, a few months after the Toronto-based pension fund opened an office in São Paulo.

In a statement released late on Monday, CPPIB said the investments include the purchase of warehouses, land and stakes in development projects in the logistics and retailing industries, adding to the fund's portfolio of more than 100 properties in Latin America's largest economy.

The move brings CPPIB's real estate commitments in Brazil to over $1.8 billion. Since 2009, CPPIB has bought real estate in Brazil to profit from rising demand for corporate and distribution facilities.

The Canadian giant, one of the world's biggest pension funds with more than $212 billion in assets under management, opened an office in Brazil in February to gain on-the-ground presence and business connections before tapping complex, sizeable investment opportunities. CPPIB's São Paulo office focuses primarily on investments in Brazil, Chile, Colombia, Mexico and Peru.

"Brazil remains a key market for CPPIB over the long term and we will continue to seek attractive investment opportunities through our existing partnerships with top-tier local partners while we continue to build our local presence in Sao Paulo," Peter Ballon, head of CPPIB's real estate investment in the Americas, said in the statement.

CPPIB will pay 507 million reais for 30 percent in a joint venture with Singapore's Global Logistic Properties Ltd. , the world's No. 2 owner of industrial properties, to run 32 logistics properties in São Paulo and Rio de Janeiro, the statement added.

Another 231 million reais were committed to GLP Brazil Development Partners I, a real estate investment vehicle in which Global Logistic Properties has a 40 percent stake and CPPIB a 39.6 percent stake.

CPPIB also pledged to spend 159 million reais to buy a 25 percent stake in a São Paulo logistics project alongside Cyrela Commercial Properties SA.

The fund also paid 100 million reais for a 33.3 percent stake in the Santana Parque Shopping mall, which is jointly run by partner Aliansce Shopping Centers SA, the statement added. CPPIB has a 27.6 percent in Aliansce, a shopping mall operator.

In a separate statement, the pension fund announced that Rodolfo Spielmann was named general director and leader of CPPIB's operations in Latin America. Spielmann, a former Deutsche Bank AG banker and a Bain & Co executive in Brazil for the past 14 years, started at the fund on Oct. 20.

CPPIB has committed $5.6 billion to investments in Latin America.
The Canadian Press also reports, CPPIB raises real estate commitments in Brazil to $2B, citing the figures in Canadian dollars:
The Canada Pension Plan Investment Board (CPPIB) has announced a combined $445 million of investments in logistics and retail assets in Brazil in a string of moves that bring its real estate commitments in the South American giant to more than $2 billion.

“Since making our first real estate investment in Brazil in 2009, CPPIB has become one of the largest investors in the sector with ownership interests in logistics, retail, office and residential assets or developments,” Peter Ballon, managing director and head of real estate investments — Americas, said in a release Monday.

“Over the past 10 months we deepened relationships with our key partners to commit additional equity in high-quality real estate assets that are important additions to our diversified Brazilian portfolio.”

The latest investments include $226 million in a joint venture with Global Logistic Properties to invest in a portfolio of 32 logistics properties that GLP previously acquired from BR Properties S.A. CPPIB will have a 30 per cent ownership stake in the joint venture. Logistics properties include warehouses, distribution facilities and the like.

Meanwhile, the CPPIB has committed an additional $103 million to GLP Brazil Development Partners I, an existing joint venture that is owned 40 per cent by GLP, 39.6 per cent by CPPIB and 20.4 per cent by the Government of Singapore Investment Corp. The additional capital will be used to acquire a strategically positioned land parcel in Rio de Janeiro comprising 3.8 million square feet of buildable area.

It has also committed $71 million to acquire a 25 per cent interest in a new logistics development project alongside longtime partner Cyrela Commercial Properties. Called Cajamar III, the development will comprise more than 2.7 million square feet of leasable area located on the outskirts of Sao Paulo.

And the CPPIB is acquiring a 33.3 per cent interest in Santana Parque Shopping for $45 million. Aliansce Shopping Centers, an existing partner, also owns a 33.3 per cent interest in the 280,000 square foot regional shopping centre in Sao Paulo.

“Brazil remains a key market for CPPIB over the long term and we will continue to seek attractive investment opportunities through our existing partnerships with top-tier local partners while we continue to build our local presence in Sao Paulo,” Ballon said.

Canada Pension Plan Investment Board is a professional investment management organization that invests the funds not needed by the Canada Pension Plan to pay current benefits on behalf of 18 million Canadian contributors and beneficiaries.
Soon after the news of this Brazilian transaction broke out, the critics came out swinging. Canada's Business News Network invited Jim Doak, President and Managing Partner of Megantic Asset Management, who said he was "suspicious" and "had a bad feeling about this." He questioned the valuations of illiquid investments and said he's "smelling ego here" and the CPPIB is taking on serious foreign country risk (watch the entire BNN clip here).

I don't know where BNN finds these people to comment on pension fund deals but this guy sounds like Andrew Coyne when he railed against the CPPIB in his comment on Ontario's new pension suckers. In fact, take a look at this snapshot I took on my computer from the BNN interview (click on image):

You'll see other clips with a negative spin on the CPPIB and their "expensive" and "complex" operations. Of course, they don't mention how CPPIB's governance is one of the best in the world and how they have been very careful investing in private markets in this environment, fully cognizant that deals are pricey.

Now, let me share my thoughts on this Brazilian real estate deal. From a timing perspective, this deal couldn't come at a worse time. Why? Because the Brazilian economy remains in recession and things can get a lot worse for Latin American countries which experienced a boom/ bust from the Fed's policies and China's over-investment cycle. This is why some are calling it Latin America's 'made in the USA' 2014 recession, and if you think it's over, think again. John Maudin's latest, A Scary Story for Emerging Markets, discusses how the end of QE and the surge in the mighty greenback can lead to a sea change in the global economy and another emerging markets crisis.

Mac Margolis, a Bloomberg View contributor in Rio de Janeiro, also wrote an excellent comment this week on why the oil bust has Brazil in deep water, going over the problems at Petroleo Brasileiro (PBR). A look at the one-year chart shows you a bit of how bad things are (click on image below):

You can say the same thing about Brazilian mining giant, Vale, which has also been pummeled in the last few months (click on image below):

The re-election of President Dilma Rousseff didn't exactly send a vote of confidence to markets as she now faces the challenge of delivering on campaign promises to expand social benefits for the poor while balancing a strained federal budget. President Rousseff says the Brazilian economy will recover and the country will avoid a credit downgrade but that remains to be seen.

Having said all this, CPPIB is looking at Brazil as a very long-term play, so they don't care if things get worse in the short-run. In fact, the Fund will likely look to expand and buy more private assets in Brazil if things do get worse. And they aren't the only Canadian pension fund with large investments in Brazil. The Caisse also bought the Brazilian boom and so have others, including Ontario Teachers which bet big on Eike Batista and got out before getting burned.

Are there risks to these private investments in Brazil? You bet. There is illiquidity risk, currency risk, political and regulatory risk but I trust CPPIB's managers weighed all these risks and still decided to go ahead with big investment because they think over the long-run, they will make significant gains in these investments.

My biggest fear is how will emerging markets act as QE ends (for now) and I openly wonder if big investments in Brazil or other countries bound to oil and commodities are worth the risk now.  Also, the correlation risk to Canadian markets is higher than we think. My only question to CPPIB's top brass is why not just wait a little longer and pick these Brazilian assets up even cheaper?

But I already know what Mark Wiseman will tell me. CPPIB takes the long, long view and they are not looking at such deals for a quick buck. As far as "egos at CPPIB" that Mr. Doak mentions in the BNN interview, I can't speak for everyone there, but I can tell you Mark Wiseman doesn't have a huge ego. If you meet him, you'll come away thinking he's a very smart, humble and hard working guy who's very careful about the deals he enters.

Below,  Reuters' Yiming Woo reports that Brazil's leftist President Dilma Rousseff narrowly re-elected in a vote that split along the country's social class and geography. I can't comment on President Rousseff except to say she will have big battles ahead, but I can tell you that Brazil is a great country with a bright future. Just like Neymar, it will rise and flourish again but the recovery could take a lot longer than CPPIB and others anticipate.

Tuesday, October 28, 2014

The United States of Pension Poverty?

Ted Kedmey of TIME reports, This Is the Scariest Number Facing the Middle Class (h/t, @HOOPPDB):
The average middle class American has only $20,000 in retirement savings, according to a new survey that shows large swathes of the public are aware of those shortfalls and feeling anxious about their golden years.

Wells Fargo surveyed more than 1,000 middle class Americans about the state of their savings plans. Roughly two-thirds of respondents said saving for retirement was “harder” than they had anticipated. A full one-third of Americans said they won’t have sufficient funds to “survive,” a glum assessment that flared out among the older respondents. Nearly half of Americans in their 50s shared that concern.

But perhaps the most startling response came from the 22% of Americans who said they would prefer to suffer an “early death” than retire without enough funds to support a comfortable standard of living.
Let's take a closer look at the Wells Fargo survey which finds saving for retirement is not happening for a third of the middle class:
Saving for retirement is a formidable challenge for middle-class Americans, with 34% not currently contributing anything to a 401(k), an IRA or other retirement savings vehicle, according to the fifth annual Wells Fargo Middle-Class Retirement study. Forty-one percent of middle-class Americans between the ages of 50 and 59 are not currently saving for retirement. Nearly a third (31%) of all respondents say they will not have enough money to “survive” on in retirement, and this increases to nearly half (48%) of middle-class Americans in their 50s. Nineteen percent of all respondents have no retirement savings. On behalf of Wells Fargo, Harris Poll conducted 1,001 telephone interviews from July 20 to August 25, 2014 of middle-class Americans between the ages of 25 and 75 with a median household income of $63,000.

Sixty-eight percent of all respondents affirm that saving for retirement is “harder than I anticipated.” Perhaps the difficulty has caused more than half (55%) to say they plan to save “later” for retirement in order to “make up for not saving enough now.” For those between the ages of 30 and 49, 59% say they plan to save later to make up retirement savings, and 27% are not currently contributing savings to a retirement plan or account.

Sixty-one percent of all middle-class Americans, across all income levels included in the survey, admit they are not sacrificing “a lot” to save for retirement, whereas 38% say that they are sacrificing to save money for retirement.

“Saving for retirement isn’t easy. It requires sacrifice, and it’s not something people can push off and hope to achieve later in life. If people in their 20s, 30s or 40s aren’t saving today, they are losing the benefit of time compounding the value of their money. That growth can’t be made up later, so people have to commit early in life to make savings a regular discipline year after year – it is the only way most people will achieve their financial goals to carry them through retirement,” said Joe Ready, director of Institutional Retirement and Trust.

While a majority of middle-class Americans say that they are not sacrificing a lot to save for retirement, 72% of all middle-class Americans say they should have started saving earlier for retirement, up from 65% in 2013. When respondents were asked if they would cut spending “tomorrow” in certain areas in order to save for retirement, half said they would: 56% say they would give up treating themselves to indulgences like spa treatments, jewelry, or impulse purchases; 55% say they’d cut eating out at restaurants “as often”; and 51% say they would give up a major purchase like a car, a computer or a home renovation. Notably, fewer people (38%) report that they would forgo a vacation to save for retirement.
What Have They Saved?

According to the survey, middle-class Americans have saved a median of $20,000, which is down from $25,000 in 2013. Middle-class Americans across all age groups in the study expect to need a median savings of $250,000 for retirement, but they are currently saving only a median amount of $125 each month. Excluding younger middle-class Americans who may be earning less money, respondents between the ages of 30 and 49 are putting away a median amount of $200 each month for retirement, whereas those between the ages of 50 and 59 are putting away a median of $78 each month for retirement.

Twenty-eight percent of all age groups included in the survey report that they have a written financial plan for retirement. That number is slightly higher, 34%, for those between the ages of 30 and 39. People with a written plan for retirement are saving a median of $250 per month, far greater than the median $100 per month that is being saved by those without a written plan.

“People who have a written plan for retirement are helping themselves create a future on their own terms, with a foundation built on saving, and hopefully, investing.As evidenced by the difference in monthly savings amounts for those with a written plan and those without, it is clear that a plan makes a sizeable difference,” added Ready.
The Power of the 401(k)

Middle-class Americans value the 401(k) as a way to create a retirement nest egg. Seventy percent of respondents have a 401(k) or equivalent plan available to them through their employer, and a majority of them (93%) are currently contributing to their plans. Approximately 67% of those in a plan contribute enough to maximize their company’s 401(k) match, and the median contribution rate for those between the ages of 30 and 59 is 7%.

Eighty-five percent of those with access to a 401(k) or equivalent plan from their employer affirm they “wouldn’t have saved as much for retirement” if they did not have a 401(k). Moreover, 90% say the 401(k) or equivalent plan “makes it easy to save for retirement.”

“The 401(k) makes a significant difference for people in that it gives them the ability to save in a regular, systematic way. It conditions people to think that saving money is paying themselves first and is just as important as paying day-to-day bills,” said Ready.

Examining retirement savings by age, the median amount saved by those in their 40s is $40,000, for those in their 50s is $20,000, and those in the age range of 60 to 75 is $25,000. The median amount saved by those who have access to a 401(k) plan is much higher than that saved by those without access to a plan, particularly for those who are younger. Middle-class Americans between the ages of 25 and 29 with access to a 401(k) plan have saved a median of $10,000 versus a median of zero savings for those without access. Respondents between the ages of 30 and 39 with access to a 401(k) have saved a median of $35,000 versus those without access who have saved a median of less than $1,000, and those between the ages of 40 and 49 with access to a 401(k) have saved a median of $50,000 versus the $10,000 saved by those without access.

Having access to a 401(k) also seems to positively impact a sense for what is possible. More than half (58%) of non-retirees without access to a 401(k) plan say “it is not possible” to pay bills and “still” save for retirement, compared to a third (32%) of those who have access to a plan, but say they can’t save and pay bills at the same time.

Those who have access to a 401(k) are more likely to say they would give up certain expenses, big purchases or expenditures like eating out in order to save for retirement, at a rate approximately 10 percentage points higher than those without access to a 401(k).
The Retirement Picture

Across all age groups, almost half (48%) of non-retirees are not confident that they will have saved enough “to live the lifestyle they want” in retirement. This lack of confidence jumps to 71% for non-retirees between the age of 50 and 59.

A quarter of all middle-class Americans say they “get depressed” when thinking about their financial life in retirement. However, the rate of those who feel down about retirement increases to one in three for those in their 40s and 50s. In a new survey question, 22% of the middle class say they would rather “die early” than not have enough money to live comfortably in retirement.

Working longer or into traditional retirement years appears to be a predicted reality for a third of middle-class Americans who say they will need to work until they are “at least 80 years old” because they will not have enough retirement savings, holding steady from a year ago. Half of those in their 50s say they will need to work until age 80. In another new question asked this year, a quarter (26%) of middle-class Americans say working into their 80s is something they plan to do even if it’s not a financial necessity.

The majority (70%) of middle-class Americans do not think Social Security will be their primary funding source for retirement, but the perception varies greatly for those based on age. Almost half (46%) of non-retirees in their 50s think Social Security will be their primary source of income, as do 56% of non-retirees between the ages of 60-75.
I guarantee you Social Security will be the primary source for retirement funding for the majority of middle class Americans. America's new retirement reality is grim and unfortunately the retirement crisis isn't sparking new thinking.

Instead, Americans are offered more of the same. If you read the Wells Fargo survey, it extolls the virtues of 401(k)s as a savings plan but neglects to mention America's 401(k) nightmare which is actually still going on even if the stock market bounced back since the crisis.

For example, during the summer, Bloomberg reported on how retirees suffer as $300 billion rollover boom enriches brokers. And Ron Lieber of the New York Times recently reported on combating a flood of early 401(k) withdrawals (h/t, Suzanne Bishopric):
This week, the Internal Revenue Service announced that people under age 50 in 401(k) and similar workplace retirement plans will be able to deposit up to $18,000 in 2015, an increase of $500 from this year. Those 50 and over can toss in as much as $24,000, a $1,000 increase.

Which is all fine and dandy for the well-heeled and the frugal. But one of the biggest problems with these accounts has nothing to do with how much we can put in. Instead, it’s the amount that so many people take out long before they retire.

Over a quarter of households that use one of these plans take out money for purposes other than retirement expenses at some point. In 2010, 9.3 percent of households who save in this way paid a penalty to take money out. They pulled out $60 billion in the process; a significant chunk of the $294 billion in employee contributions and employer matches that went into the accounts.

These staggering numbers come from an examination of federal and other data by Matt Fellowes, a former Georgetown public policy professor who now runs a software company called HelloWallet, which aims to help employers help their workers manage their money better.

In a paper he wrote with a colleague, he noted that industry veterans tend to refer to these retirement withdrawals as “leakage.” But as the two of them wrote, it’s really more like a breach. And while that term has grown more loaded since their treatise appeared last year and people’s debit card information started showing up on hacker websites, it’s still appropriate. Millions of people are clearly not using 401(k) plans as retirement accounts at all, and it’s a threat to their financial health.

“It’s not a system of retirement accounts,” said Stephen P. Utkus, the director of retirement research at Vanguard. “In effect, they have become dual-purpose systems for retirement and short-term consumption needs.”

How did this happen? Early on in the history of these accounts, there was concern that if there wasn’t some way for people to get the money out, they wouldn’t deposit any in the first place. Now, account holders may be able to take what are known as hardship withdrawals if they’re in financial trouble. Moreover, job changers often choose to pull out some or all of the money and pay income tax on it plus a 10 percent penalty.

The breach tends to be especially big when people are between jobs. Earlier this year, Fidelity revealed that 35 percent of its participants took out part or all of the money in their workplace retirement plans when leaving a job in 2013. Among those from ages 20 to 39, 41 percent took the money.

The big question is why, and the answer is that leading plan administrators like Fidelity and Vanguard don’t know for sure. They don’t do formal polls when people withdraw the money. In fact, it was obvious talking to people in the industry this week and reading the complaints from academics in the field that the lack of good data on these breaches is a real problem.

Fidelity does pick up some intelligence via its phone representatives and their conversations with customers. “Some people see a withdrawal as an opportunity to pay off debt,” said Jeanne Thompson, a Fidelity vice president. “They don’t see the balance as being big enough to matter.”

Or their long-term retirement savings matter less when the 401(k) balance is dwarfed by their current loans. Andrea Sease, who lives in Somerville, Mass., is about to start a new job as an analytical scientist for a pharmaceutical company. She was tempted to pull money from her old 401(k) to pay down her student loan debt, which is more than twice the size of her balance in the retirement account. “It almost seems like they encourage you,” she said, noting that the materials she received from her last retirement account administrator made it plain that pulling out the money was an option. “It’s an emotional thing when you look at your loan balance and ask yourself whether you really want to commit to 15 more years of paying it, and a large sum of 401(k) cash is just sitting there.” So far, she’s keeping her savings intact.

Another big reason that people pull their money: Their former employer makes them. The employers have the right to kick out former employees with small 401(k) balances, given the hassle of tracking small balances and the whereabouts of the people who leave them behind. According to Fidelity, among the plans that don’t have the kick-them-out rule, 35 percent of the people with less than $1,000 cashed out when they left a job. But at employers that do eject the low-balance account holders, 72 percent took the cash instead of rolling the money over into an individual retirement account.

This is unconscionable. Employers may meekly complain about the difficulty of finding the owners of orphan accounts, but it just isn’t that hard to track people down these days. Whatever the expense, they should bear it, given its contribution to the greater good. Let people leave their retirement money in their retirement accounts, for crying out loud.

Account holder ignorance may also contribute to the decision to withdraw money. “There is a complete lack of understanding of the tax implications,” said Shlomo Benartzi, a professor at the University of California, Los Angeles, and chief behavioral economist at Allianz Global Investors, who has done pioneering research on getting people to save more. “And given that we’re generally myopic, I don’t think people understand the long-term implications in terms of what it would cost in terms of retirement.”

In fact, young adults who spend their balance today will lose part of it to taxes and penalties and would have seen that balance increase many times over, as the chart accompanying this column shows.

But Mr. Fellowes of HelloWallet, interpreting the limited federal survey data that exists, says he believes that people raid their workplace retirement accounts most often because they have to. They are facing piles of unpaid bills or basic failures of day-to-day money management. Only 8 percent grab the money because of job loss and less than 6 percent do so for frivolous pursuits like vacations.

What can be done to change all of this? Mr. Benartzi thinks a personalized video might be even more effective than a boldly worded infographic showing people the money they stand to lose. He advises a company called Idomoo that has a clever one on its website aimed at people with pensions. If you want to see the damage that an early withdrawal could do, Wells Fargo has a tool on its site.

Fidelity has recently begun calling account holders to talk to them about cashing out, and it has found that people who get on the phone are a third as likely to remove some of their money as they are if they receive written communication. Here’s hoping more people will get such calls when they leave for another job.

Mr. Fellowes has a bigger idea. Given that so many people are pulling money from retirement savings accounts for non-retirement purposes, perhaps employers should make people put away money in an emergency savings account before letting them save in a retirement account. It’s a paternalistic solution, but some of the large employers he works with are considering it.

It’s surprising that regulators haven’t taken more notice of the breaches here. The numbers aren’t improving, but more and more people are relying on accounts like this as their primary source of retirement savings. “This is a problem that industry should solve,” said Mr. Benartzi, pointing to the unsustainability of tens of billions of dollars each year leaving retirement accounts for non-retirement purposes.

He says he thinks that there’s a chance that a company from outside the financial services industry could come in and solve the problem in an unexpected way before regulators take action. “If we don’t solve it, someone is going to eat our lunch, breakfast and dinner and drink our wine too.”
Forget a company from outside the financial services industry coming in to solve the problem. My solution is to bolster defined-benefit plans for all Americans, not just public sector workers, and have the money managed by well-governed public pension funds at a state level.

I emphasize well-governed because a big part of America's looming pension disaster is the mediocre governance which has contributed to poor performance at state pension funds. I edited my last comment on the Pyramis survey of global investors to include this comment:
The other subject I broached with  Pam is how the governance at the large Canadian public pension funds explains why they make most of their decisions internally. Public pension fund managers in Canada are better compensated than their global counterparts and they are supervised by independent investment boards that operate at arms-length from the government.
Of course, good governance isn't enough. States need to introduce sensible reforms which reflect the fact that people are living longer and they need to introduce some form of risk-sharing in these state pension plans.

As far as 401(k)s, RRSPs, and other forms of defined-contribution plans, you know my thoughts. They might help people save but the brutal truth is they're not pension plans with guaranteed benefits to help people retire in dignity and security. This is why despite their existence, America's new pension poverty keeps growing.

It's high time U.S. policymakers start tackling the domestic retirement (and jobs) crisis. It's time to move beyond public sector pension envy and go Dutch on pensions, introducing a major overhaul of the retirement system which will provide adequate retirement income for all Americans. There will be major resistance but the benefits of defined-benefit plans far outweigh the costs.

Moreover, the real cancer of pensions is that the status quo is a surefire path to destruction. As more and more companies exit defined-benefit pensions, they leave millions of workers fending for themselves in these crazy markets. It's a looming disaster which will severely impact the United States of Pension Poverty and unless policymakers address this issue, it will come back to haunt the country (in the form of increased social welfare costs and lower government revenues).

Below, Ray Martin of CBS News discusses why you shouldn't use your 401(k) as a piggy bank. And Robert Shiller, Case-Shiller Index co-founder and Yale University professor of economics, discusses the recent trend of slow home price gains and the surplus in housing.

Monday, October 27, 2014

Surge in Confidence Among Global Funds?

Digital Journal reports, Pyramis survey reveals surge in confidence among world's largest institutional:
Confidence has returned among institutional investors worldwide, according to a new survey by Pyramis Global Advisors.

Nine in ten (91%) pension plans and other institutional investors believe they can achieve target returns in five years, significantly higher than the 65 percent reported in 2012, according to the 2014 Pyramis Global Institutional Investor Survey, which includes 811 respondents in 22 countries representing more than USD$9 trillion in assets.

"After years of strong equity returns and below average volatility, institutional investors want to keep their winning streak going," said Pam Holding, chief investment officer, Pyramis. "Our global survey shows that while the outlook on volatility varies greatly by region, institutions worldwide largely agree that they can continue to grow their portfolios and improve funded status."

Significant Regional Differences

The Pyramis survey identifies regional differences across such topics as: expectations for market volatility, perspectives on alternatives, investment objectives and investment opportunities.

Market Volatility Expectations

Outside the U.S. and Canada, volatility expectations over the long term are quite low with a decrease in the frequency of boom/bust cycles expected in Asia (91%) and Europe (79%). Only seven percent of U.S. institutions expect volatility to decrease, while 42 percent expect an increase in volatility. This trend continues across North America with only 10 percent of Canadian plans expecting a decrease in volatility, while 60 percent foresee an increase.

While market volatility remains a top concern in Europe and Asia, U.S. institutions are expressing less worry about capital markets than years past. Europe also remains concerned about a low return environment, while Asia is focused on regulatory and accounting changes and Canada is focused on risk management. The top concern for U.S. plans is current funded status (28%), with a majority of pensions intending to improve it.

Perspectives on Alternatives

While the use of alternative investments is still rising rapidly in the rest of the world, use of liquid and illiquid alternatives appears to be slowing among U.S. institutions.

Among respondents planning an allocation increase to illiquid alternatives over the next one to two years, Asia leads the way with 79 percent, followed by Europe (57%) and the U.S. (22%).

When asked which investment approaches are most likely to underperform over the long term, 31 percent of U.S. respondents cite hedge funds as least likely to meet expectations. Risk factor investing is expected to be the biggest disappointment among Canadian, European and Asian plans.

When asked specifically about the fees associated with alternative investments, only 19 percent of U.S. plans surveyed say hedge funds and private equity are worth the fees, as compared to 91 percent in Asia and 72 percent in Europe.

"U.S. plans are currently reevaluating the complexity, risks and fees associated with hedge funds," said Derek Young, vice chairman of Pyramis Global Advisors. "Our survey suggests that U.S. institutions are preparing to move back to a more traditional, back-to-basics portfolio."

Investment Objectives

On average, primary investment objectives among global institutions lean toward growth, but results vary considerably by geography. Asian institutions are overwhelmingly focused on growth, with 64 percent listing capital growth as the primary investment objective. For plans in the U.S., funded status growth is the primary investment objective, but levels differ among public plans (62%) and corporates (37%). Plans in Europe are primarily focused on preservation, while Canadian institutions are equally focused on preserving and growing their funded status.

Investment Opportunities

A global view of the survey results shows plans are seeking investment opportunities over the medium term predominantly in emerging Asia. However, a regional breakdown reveals a geographic tilt. Seventy-one percent of plans in Asia cite emerging Asia as the top medium-term growth prospect. U.S. and Canadian plans favor North America (34%) and emerging Asia (32%). European plans favor North America (33%), emerging Asia (21%) and developed Europe (19%).

For additional materials on the Pyramis survey, go to

About the Survey
Pyramis Global Advisors conducted its survey of institutional investors in the summer of 2014, including 811 investors in 22 countries (191 U.S. corporate pension plans, 71 U.S. government pension plans, 48 non-profits and other U.S. institutions, 90 Canadian pension plans, 283 European and 128 Asian institutions including pensions, insurance companies and financial institutions). Assets under management represented by respondents totaled more than USD$9 trillion. The surveys were executed in association with Asset International, Inc., in North America, and the Financial Times in Europe and Asia. CEOs, COOs, CFOs, and CIOs responded to an online questionnaire or telephone inquiry.

About Pyramis Global Advisors
Pyramis Global Advisors, a Fidelity Investments company, delivers asset management products and services designed to meet the needs of institutional investors around the world. Pyramis is a multi-asset class manager with extensive experience managing investments for, and serving the needs of, some of the world's largest corporate and public defined benefit and defined contribution plans, endowments and foundations, insurance companies, and financial institutions. The firm offers traditional long-only and alternative equity, as well as fixed income and real estate debt and REIT investment strategies. As of June 30, 2014, assets under management totaled nearly $215 billion USD. Headquartered in Smithfield, RI, USA, Pyramis offices are located in Boston, Toronto, Montreal, London, and Hong Kong. Outside of North America, Fidelity Worldwide Investment is the sole distributor of Pyramis' institutional investment products.

About Fidelity Worldwide Investment
Fidelity Worldwide Investment is an asset manager serving retail, wholesale and institutional investors in 25 countries globally outside North America. With USD $290.1 billion assets under management as of June 30, 2014, Fidelity Worldwide Investment is one of the world's largest providers of active investment strategies and retirement solutions. Institutional clients benefit from the breadth of our investment platform, which combines our own product range and through a subadvisory agreement, the capabilities of Pyramis Global Advisors.

Pyramis, Pyramis Global Advisors and the Pyramis Global Advisors A Fidelity Investments Company logo are registered service marks of FMR LLC.
Interestingly, confidence levels varied significantly. Janet McFarland of the Globe and Mail reports, Canadian pension funds most pessimistic about future market upheavals:
Canadian pension funds are the most pessimistic in the world about coming market upheavals, reporting in a new global pension survey they anticipate market bubbles and crashes will become more frequent in the future.

A survey of 811 pension fund managers by Pyramis Global Advisors, the pension asset management division of financial giant Fidelity Investments, shows Canadians are concerned about future market volatility, while fund managers in Europe and Asia strongly believe market volatility will decrease in the long term.

“It really is polar opposite,” said Derek Young, the U.S.-based vice-chairman of Pyramis.

The survey, conducted in June and July, found 60 per cent of Canadian pension fund managers believe that over the long term, “volatility is increasing and market bubbles/crashes will become more frequent,” while 42 per cent in the U.S. agreed with the statement. However, only 4 per cent of pension managers in Europe and 5 per cent in Asia agreed volatility is increasing.

In Asia, by contrast, 91 per cent said they believe volatility is decreasing and market crashes will become less frequent, while 79 per cent in Europe supported that statement. Just 10 per cent in Canada and 7 per cent in the U.S. said they believe volatility is decreasing.

The survey included 90 Canadian pension funds representing about 25 per cent of all pension plan assets in Canada, Pyramis said.

Mr. Young said he believes the findings reflect the broader global focus of Canadian pension funds, saying funds in other regions are often more inward-looking and focus more on their regional markets. They may have responded based on a consideration of their own local economies, while Canadian pension funds may have been assessing the volatility more broadly in all major markets, he said.

“I do believe that Canada has a very unique and global perspective compared to most countries,” Mr. Young said.

Bill Hatanaka, chief executive officer of OPTrust, which manages pension assets for Ontario government workers who are members of the OPSEU union, said the relatively small size of Canada’s markets on a global scale means pension funds are forced to take a global investing approach and are “sensitized” to the potential for a variety of scenarios to create volatility.

“Our resource-based economy and its inherently cyclical nature has helped us to become more comfortable with anticipating volatility from economic cycles and events,” he said.

Leo de Bever, chief executive officer of Alberta Investment Management Corp., which manages $75-billion of pension and other assets for the Alberta government, said he finds the views of European and Asian fund managers surprising, because “it seems reasonable to assume – as the Canadians did – that historically low volatility could not last.”

“We had not seen a correction in a while, so it was bound to happen some time,” Mr. de Bever said.

The fact equity markets have been so volatile this fall suggests the Canadian respondents may have had an accurate view in June about the likelihood of future boom and bust cycles, Mr. Young said.

“The Canadians were definitely positioned the appropriate way in terms of their thought processes, and certainly that expectation matched up with reality,” he said.

The survey also found that fund managers around the world are more optimistic about the chances of meeting investment return goals over the next five years compared with two years ago when the survey was last conducted.

In 2014, 91 per cent of fund managers globally said they are comfortable they will achieve their annualized returns over the next five years, an increase from 65 per cent. In Canada, 96 per cent believe they can meet their goals, up from 60 per cent in 2012.

Although the survey was conducted before equity markets declined sharply this fall, Mr. Young said he believes the greater confidence is still likely prevailing because “these are long-term investors and we are asking about five-year views.”

Julie Cays, chief investment officer at the Colleges of Applied Arts and Technology (CAAT) Pension Plan in Ontario, said many pension plans have lowered their return assumptions in recent years because interest rates remain low, which helps build confidence the targets can be met.

She said a major reason for concern about future volatility is the huge amount of liquidity the U.S. Federal Reserve has provided in recent years to stimulate the U.S. economy, which she said is an experiment that’s never been tried on such a scale before.

“We don’t really know what the effect of all this liquidity and all these low rates is really going to be over the long term, and I think people are nervous about that,” Ms. Cays said.

Mr. de Bever sees reasons for optimism about returns in future years, saying while many assets are now fully valued, companies are still finding productivity gains and maintaining strong profit margins.

“That’s likely to be true longer term, although one can make a case that the easy gains have been made for now,” he said.
On Friday afternoon, I had a conference call with Pam Holding, chief investment officer at Pyramis, and we discussed these results. I thank Charles Keller for setting this call up.

A few things struck me about the survey. First, as discussed above, there is a significant divergence in views on concerns of future market volatility, with Canadian plans being the most pessimistic (click on image above). Derek Young of Pyramis is right, Canadian funds are more global in their investments which provides them with a unique global perspective on markets.

Some of the largest Canadian pensions funds, like the Caisse, have been publicly warning of global headwinds, and others have privately expressed similar concerns to me. And Julie Cayes is right, the unprecedented liquidity the Fed has provided to stimulate the U.S. economy (and shore up global banks' balance sheets) is an experiment that has never been tried on such a scale before. It could turn out ugly, especially if deflation creeps into the U.S. economy and the market loses faith in the  Fed.

I've been warning my readers for the longest time that deflation is coming and those that are ill-prepared will suffer grave consequences. The Canadian funds are right to be worried, which is why they'll be better prepared when the next big downturn hits global markets (some more than others).

This brings me to the findings of the survey on alternatives. Interestingly, the exuberance on alternatives among U.S. pension funds has simmered down a lot. I think a lot of large U.S. pension funds are asking some very tough questions on alternative investments, with the first one being: "Where's the beef?".

All those huge fees enriching overpaid hedge fund and private equity "gurus" that have become large, lazy, glorified asset gatherers focusing more on marketing to collect that all important 2% management fee no matter how lousy their long-term and short-term performance is (when managing billions, management fees should be scrapped!!).

It's a travesty which is why I'm not surprised CalPERS dropped a hedge fund bomb last month and got out of hedge funds altogether. As this survey shows, other large institutions are beginning to understand the hedge fund myth, openly questioning whether these investments are worth the fees. Of course, assets keep plowing into them despite their lousy performance.

To be fair, I know there are many excellent hedge funds that are worth the fees but it's becoming increasingly harder to identify them. The reality is U.S. public pension funds never took their hedge fund investments as seriously as some of the large Canadian funds (Ontario Teachers, Caisse, etc). They followed the advice of their useless investment consultants who shoved them in funds of funds instead of hiring a dedicated team to oversee these investments (I used to invest in hedge funds, it's not an easy job! Just ask Ron Mock who ran one of the best funds of funds in the world and still suffered harsh hedge fund lessons).

I recently learned that CalPERS is shifting out of hedge funds to invest more in real estate:
The nation's largest public pension is bullish on real estate. The California Public Employees Retirement System plans to increase its $26 billion of commercial real estate investment by $7 billion, or 27%, according to The Wall Street Journal. The move follows the fund's decision to liquidate its $4 billion invested in hedge funds and to stop putting money into hedge funds.

But this time around Calpers will be investing in safer real estate—fully leased office towers and apartments in big cities. It is also investing almost exclusively through real estate funds that manage separate accounts created for Calpers, which offers more control. In the past, Calpers had invested in speculative real estate like shopping malls.
I'm glad CalPERS is investing in safer core real estate as opposed to leveraged opportunistic real estate but this shift in illiquid alternatives isn't without significant risk. There are too many pension funds taking on too much illiquidity risk and this can come back to haunt them, especially in a deflationary environment (not to mention prices are insane right now, making it that much tougher finding deals because everyone is plowing into real estate).

I will end by thanking Pam Holding and Charles Keller at Pyramis for discussing the results of their 2014 global survey. It should be noted this survey was conducted over the summer before the Fall selloff but it still contains very useful and interesting information.

I also wanted to bring to your attention that Pam's team at Pyramis has developed low-volatility products for institutional investors who are not quite sure about how to properly de-risk their plan or just want less beta in their portfolio. I urge you to contact Pyramis Global Advisors if you have questions regarding these products (In Canada, contact Chris Pepper at

The other subject I broached with  Pam is how the governance at the large Canadian public pension funds explains why they make most of their decisions internally. Public pension fund managers in Canada are better compensated than their global counterparts and they are supervised by independent investment boards that operate at arms-length from the government.

Finally, Anthony Scaramucci, founder and co-managing partner of SkyBridge Capital, recently sat down with Steve Forbes to talk about his vision for hedge funds, the activist investing boom and why he got fired — and rehired — at Goldman Sachs. A video and transcript of their conversation is available here. Take the time to listen to this interview.

Mr. Scaramucci sure knows how to talk up hedge funds, which isn't surprising given it's his bread and butter, but I would take some of what he says with a grain of salt. Also, the S&P was down 37% in 2008, not 62% as he states, but I'll give him a break there. His claim that CalPERS got out of hedge funds "at the bottom" might turn out to be true but he totally misses the point as to why they got out.

Below, an older CNN interview where Scaramucci says despite the negative press on hedge funds, he can pick winners. I wish him and other funds of funds in that game the best of luck. If my prediction is right, another wave of destruction will hit funds of funds hard.