Tuesday, December 9, 2014

Canada Finds Key to Pension Fund Investing?

Ian Austen of the New York Times reports, Canada Finds Key to Pension Fund Investing:
This is pension fund investing, Canadian style: lower management costs, freedom from political meddling and nonexistent funding shortfalls.

Such success is a goal that has eluded many public pension funds in the United States.

It is a model that has moved the major Canadian pension plans largely out of government debt in search of higher returns. That has sent them on a shopping spree of sorts of global corporate buyouts, infrastructure and real estate.

Canada has several benefits that have opened the door for pension funds to invest the way they please. The funds are generally free of government and union interference. They tend to look at the long term. And the salaries of pension fund officials resemble those of bankers, rather than bureaucrats. Perhaps most distinctive, however, is how the funds view themselves.

“We’re not a pension plan,” said Mark Wiseman, the president and chief executive of the 234 billion Canadian dollar, or $204 billion, Canada Pension Plan Investment Board, which manages the holdings of the obligatory national pension plan. “We’re an asset management business, an investment business.”

Last month, a group led by a real estate unit of the Caisse de Dépôt et Placement du Québec, which manages public and government worker pension funds in that province, bought a Manhattan office tower from the Blackstone Group in a private deal reportedly worth $2.25 billion. That was on top of a $280 million deal for two Seattle office towers.

Just over a year ago, Mr. Wiseman led a successful $6 billion bid to acquire Neiman Marcus and Bergdorf Goodman. The Fairmont Banff Springs Hotel in Alberta is owned by Omers, the plan for municipal workers in Ontario.

It is an approach that has delivered solid returns. The Ontario Teachers’ Pension Plan, a fund that manages 140 billion Canadian dollars in investments and the one that established the Canadian model, has a surplus of 5 billion dollars. It has generated an average return of 10.2 percent over the last 24 years.
“The teachers and the province and the first chairman and C.E.O. of this all agreed that we are going to run it like a business — full stop,” said Ron Mock, the president and chief executive of Teachers’, as the Ontario plan is known. “We were built for success.”

Mr. Mock said that this year, Teachers’ investments will contribute 76 cents of every dollar added to the fund, with its members and the government splitting the remaining 24 cents. While agreement is widespread that Canada’s direct investment, hands-off fund model has worked, introducing it elsewhere often can be an insurmountable task. As New York mayor, Michael R. Bloomberg was thwarted in his 2011 effort to merge five teachers’ pension funds in the city as a step toward creating a Canadian-style system.

Keith Ambachtsheer, who retired last year as director of the Rotman International Centre for Pension Management at the University of Toronto, was part of a group formed by the Ontario government in the late 1980s to reform its teachers’ pension plans. The key to making the new system work, he said, was an agreement that while the plan’s directors would be appointed by the teachers’ union and the province, its members would be selected based on their background in finance.

The practice continues. “This is not an organization that has a lay board,” Mr. Mock, the president, said. “We don’t have amateurs on our board.”

The other critical factor was the decision to avoid eroding the fund by outsourcing investments to firms like private equity shops and hedge funds. As a result, Teachers’ built its own in-house expertise. That meant that it had to be prepared to offer multimillion-dollar compensation packages.

Ashby Monk, the executive director of the global products center at Stanford University, said that salaries paid by many funds outside Canada were limited by law. Or their boards fixate on small amounts of employee compensation “and ignore that they’ve just written a $100 million check to Wall Street” for management services.

Mr. Wiseman estimates that the cost of outsourcing a $10 billion infrastructure investment is at least $200 million a year. By contrast, he said, the Canada Pension Plan board’s in-house infrastructure group, which has offices globally, can do the job for about $51 million.

In a country where public sector salaries are closely scrutinized, the idea of highly paid fund managers was initially not an easy sell. But the financial success of the Teachers’ fund made it largely a nonissue for those that followed its model.

To attract entry-level employees, most of the Canadian funds will match offers from Wall Street. That practice does not continue for the top officers. Jim Leech, who retired last year as Teachers’ president and chief executive, received total compensation of 8.5 million Canadian dollars. While stratospheric by the standards of Canadian public institutions, it is a small fraction of what senior executives on Wall Street, particularly in private equity, can earn.

But Mr. Wiseman said that the Canada Pension Plan Investment Board and other Canadian funds had some other lures. Working for the fund frees top officers from competing for capital and allows them to focus on investing. The fund’s size and global scope are additional attractions, he said.

But what surprised him the most, he said, was the fund’s purpose: providing pensions to Canadians outside Quebec (Caisse provides for those in Quebec).

“They are proud that they are investing and making money not just for some nameless, faceless shareholder or making some rich guy richer,” he said. “For most people who are investors, their work is really kind of hollow.”

With the exception of the Caisse, which has a mandate to develop Quebec’s economy as well as generate returns, none of the other major Canadian funds are used as economic engines and they make most of their investments abroad.

“The Canadian funds are allergic to that notion,” said Mr. Monk, who has advised the Alberta Investment Management Corporation. While that has the advantage of minimizing investments that are driven by political demands, he contends that it sometimes blinds the Canadian funds to lucrative opportunities at home. Funds with development mandates in Singapore and South Africa, he said, generally outperform their Canadian counterparts.

Like money managers worldwide, Mr. Wiseman and Mr. Mock acknowledges that finding investments in a world awash in money is becoming increasingly difficult. But they also were adamant that their long time horizons (some Canadian funds view infrastructure as a 50- to 70-year investment) and size give them advantages over competing bidders.

“In areas like infrastructure, yes there’s more competition for $1 billion deals,” Mr. Wiseman said. “But we can do $3 billion deals.”

Politics and history, Mr. Ambachtsheer said, will make it difficult for countries like Norway, which are moving toward adopting more of a Canadian-style fund system.

For Canada, however, he said the biggest potential danger was becoming complacent because of the system’s success.

“Don’t get too smug about this,” he said. “Anything can fail.”
I'm glad the American media is giving more credit to Canada's top ten but reporters should also discuss the brutal truth of defined-contribution plans and openly acknowledge that the United States of Pension Poverty is heading down the wrong path when it comes to bolstering the retirement system for millions of Americans getting crushed by pension poverty.

Even in Canada, the winds are changing fast as a new crisis emerges threatening the country's public finances and risking to hurt many social programs. The Harper government wants to increase the TFSA contribution limit to $10,000 but all this will do is fuel more income inequality and leave most people fending for themselves in savage markets (the big drop in Canada's TSX is only the beginning of prolonged agony).

As far as the article above, I've already discussed why Canadian pension funds are trendsetters and how they take the long, long view but I take this stuff with a grain of salt. Why? Because I know too much on the good, the bad and downright ugly at Canada's large public pension funds, and it's extremely difficult to impress me.

The one key area which I keep harping on is pension governance. I think Canadians funds are way ahead on this front (for the most part) and that is why they are able to do a lot more direct deals and co-investments with general partners. And as I wrote in my recent comment on New Jersey's pension GASBing for air, U.S. public pensions have got to get the governance and compensation right:
Compensation is part of pension governance and if you ask my expert opinion, CalPERS' compensation is fair and accurately reflects the market, their performanc and their ability to attract and retain professionals to manage billions. The only thing I would change is base it on four-year rolling returns, like they do at Canadian public pension funds.

All this hoopla on compensation at U.S. public pension funds is totally misdirected. I happen to think most U.S. public pension fund managers are grossly underpaid, just like I think some Canadian public pension fund managers are grossly overpaid (read my comment on PSP's hefty payouts and the subsequent ones on its tricky balancing act and its FY 2014 results which were likely padded by skirting foreign taxes).

Getting compensation right is critical to the long-term health of any public pension fund but supervisors of these funds should make sure they're paying their senior investment staff properly based on benchmarks that truly reflect the risks they're taking. I believe in paying people for performance, not for taking dumb risks to trounce their silly benchmark (that contributed to Caisse's ABCP disaster which the media is still covering up). 
In other related news on Canadian public pension funds, Barbara Shecter of the National Post reports, CPPIB overhauls operating structure, bids farewell to senior officer:
The Canada Pension Plan Investment Board has reorganized its management structure so fewer people report directly to Mark Wiseman, the chief executive.

An internal memo obtained by the Financial Post also details the planned departure of John Butler, senior managing director and general counsel, who will leave Canada’s largest pension investment manager by the end of the year.

In the memo discussing a three-part organizational change, Mr. Wiseman says CPPIB’s board approved an “evolution” of the organization’s investment framework and compensation last month that is intended “to better align incentives with an increased focus on total return.

It will involve changes to processes involving portfolio management, risk, performance, and governance, which will demand “tight coordination” and will be overseen by a newly formed committee, Mr. Wiseman said.

The CEO’s direct reports will be reduced to seven from 10, with the head of the legal department now reporting to chief financial officer Benita Warmbold, and the chief talent officer and the senior managing director of public affairs and communications reporting to chief operations officer Nicholas Zelenczuk.

The move to simplify the reporting structure was driven by the growing “breadth and complexity of each function” within the CPPIB, according to Tuesday’s memo.

“Put simply, having all our core services, in addition to all our investment departments, international, and total portfolio management report into one individual (the CEO) – is not the optimal design in terms of management efficiency,” Mr. Wiseman wrote.

“I plan to establish a regular recurring meeting with our core services leaders to continue my direct involvement as CEO in these critical functions,” he said.

In the memo, Mr. Wiseman said Mr. Butler approached him earlier this year to speak about “the next stage of his career.” It then became clear “that his plans to depart could mesh well with the timing of the [other] organizational changes” under way.

CPPIB will conduct a search for a successor to Mr. Butler, who joined in 2003. In the meantime, Matt Cockburn from Torys will be retained as acting interim general counsel, Mr. Wiseman said.

The CPPIB is a professional investment organization that invests assets of the Canada Pension Plan not needed to pay current benefits.
Good move, there were way too many people reporting to Mark Wiseman and I think they can simplify it even more. In my comment on CalSTRS' shift to internal management, I wrote:
According to Reuters, Debra Smith, the new chief operating investment officer, will oversee the fund's Investment Operations, Branch Administration, and a new unit comprised of Compliance, Internal Controls, Ethics and Business Continuity. And as stated in the WSJ article above, Smith will report to the investment committee twice a year, giving her a direct line to board members.

Pay attention here folks because this is a great move from a pension governance perspective. I've always argued that the head of risk and head of operations at public and private pension funds should report directly to the board of directors, not the CEO or CIO. If there is a disagreement on operational or investment risks being taken, the board can listen to the arguments and decide if the risks are worth taking.

I've also long argued that whistleblowers need to be protected and whistleblower policies need to be beefed up at all public pension funds so that employees who witness shady activity can safely report it without worrying about being fired. If some senior manager is accepting bribes from an external fund manager or from a big vendor peddling the latest most expensive software, there should be a way to detect and report this fraud.

Finally, go back to read my comment on why U.S. pension funds are going Canadian. The reason is simple. It makes sense to manage assets internally, saving on fees and having more control over your investments. CalSTRS isn't the first big state pension fund to do this (Wisconsin is) and it won't be the last.

Of course, to really go Canadian, U.S. public pensions have to pay their senior investment staff big bucks and they have to separate politics from their entire governance process. When I read articles on how John Buck Co., a real-estate investment firm whose executives contributed substantially to the campaign of Chicago Mayor Rahm Emanuel, has earned more than $1 million in fees for managing city pension money, I shake my head in disbelief. This is Chicago-style politics at its worst. No wonder Illinois is a pension hell hole
There you have it, my thoughts on whether Canada truly has found the key to pension fund investing. We do a lot of great things up here but there is no doubt in my mind that we need to strive to do a lot more to improve transparency and pension governance, incorporating best practices from around the world.

Below, Christopher Ailman, chief investment officer of the California State Teachers' Retirement System, talks about the outlook for financial markets and Federal Reserve policy in 2015, and asset allocation for his pension fund. He speaks with Erik Schatzker on Bloomberg Television's "Market Makers."

As I stated recently, while the Caisse and others are souring on debt, I'm not bearish on bonds because the deflationary boom can turn into a bust. And while global markets are melting down because of oil, I think the biggest risks for stocks are pretty much accounted for now and this is just another big correction, not the start of another stock market crash (except for energy, it's crashing and will stay low for years).

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