Friday, October 30, 2015

The Quiet Screwing of America?

Suzanne Woolley of Bloomberg reports, You're About to Get Too Expensive for Your Pension Plan:
The federal budget deal could speed the long, lingering death of old-fashioned defined-benefit pension plans, in which employers reward years of service by providing a guaranteed stream of income in retirement.

The deal could affect any pre-retiree in a former employer's pension plan by increasing the per-head premiums that plan sponsors must pay to the Pension Benefit Guaranty Corp. If it goes through as written, every person in a plan will get more expensive at the stroke of a pen.

Employers are already deeply concerned about the extent and uncertainty of future pension liabilities and are trying to shed them. The proposed increase in the budget legislation would push even more pension plans to manage costs any way they can, including reducing participant head count, said Alan Glickstein, a senior retirement consultant with Towers Watson.

The budget deal calls for a 22 percent hike, spread out over three years, in flat-rate, single-employer premiums paid to the PBGC, which acts as a backstop to a company's pension liability should the company become insolvent. Those premiums will already have risen from $31 in 2007 to $64 in 2016; by 2019 they will reach $78.

An increasingly common way companies get rid of those liabilities is by offering participants a chance to take their pensions all at once, as lump sums based on the present value of their future benefits. After strong years for such offers in 2013 and 2014, the activity rose dramatically in 2015, said Matt McDaniel, who leads Mercer’s U.S. defined-benefit risk practice.

More lump-sum deals aren't good news for employees, about 40 percent to 60 percent of whom take the deals. Most who take lump sums of less than $50,000 cash those retirement funds out rather than roll them into an IRA, paying income tax and a 10 percent penalty if they aren't at least 59½. While it depends on individual circumstances, it usually makes more financial sense to leave the money in the plan and have it trickle out during retirement.

Perversely, the premium hikes could wind up hurting, not helping, the Pension Benefit Guaranty Corp., because they may not fully offset shrinking head count in pension plans. Benefit consultants are frustrated. "This has nothing to do with pension policy, but is simply a device to raise revenue," said Towers Watson's Glickstein. Higher premiums "would be a factor that causes a move away from these plans, and the whole point of the PBGC is to strengthen the employer pension system, so it's kind of ironic."

A statement by the Erisa Industry Committee, an association that advocates for the employee benefit and compensation interests of large employers, said it was "outraged." Its Oct. 27 statement quoted the committee's president as saying that "even the PBGC’s own analysis does not call for an increase in premiums on single-employer defined benefit plans. PBGC premium increases like the one announced today do nothing to encourage single-employers to continue defined benefit plans or improve benefits for retirees; in fact, the increases only work to further weaken the private retirement system.”

In response to the criticism, an Obama administration official spoke with Bloomberg BNA's Pension & Benefits Daily, telling David Brandolph that with the underfunding in the PBGC's single-employer program, "the proposed premium increases are necessary to ensure that PBGC will be able to pay retiree benefits when pension plans fail. Even with these changes, premiums would likely remain a relatively small percentage of a company's annual pension contribution and a tiny fraction of total compensation costs." The official noted that the increases take effect over three years to allow companies to plan for the new costs.
Last week, I ripped into Blackstone's Tony James and his solution to America's retirement crisis and followed up with a comment looking at why there shouldn't be four or more views on DB vs DC plans but only one view which clearly explains the brutal truth on DC plans.

This week, Congress and the Senate just passed a budget and debt deal that they'll be sending to President Obama which will make it harder for companies to offer defined-benefit pensions. And this is all happening less than a year after Congress effectively nuked pensions.

What is going on in the United States of pension poverty is a real travesty. I call it the quiet screwing of America where corporations flush with cash buy back their shares to pad the outrageous compensation of their top brass while they put off hiring and much needed investments and now Congress made it easier for them to justify their decision to cut defined-benefit plans for their employees.

Not surprisingly, both Democrats and Republicans joined forces to pass this bill, which goes to show you when it comes to corporate interests, there's no divisive politics, just a bipartisan, unified front to pander to their corporate and Wall Street masters.

This week I learned that some 8,737 UPS retirees could soon see their pension checks cut as they receive their pensions from the cash-strapped Central States Pension Fund (see my previous comment on Teamsters' pension fund). A month ago, CBC reported that employees of the decommissioned Hub Meat Packers in Moncton will see their pensions slashed by as much as 25 per cent.

In an equally disturbing example, the Washington Post reports on how military veterans are scrambling to sell their pensions through pension advance schemes in an effort to make ends meet, a huge mistake which will squeeze them into pension poverty.

Meanwhile, according to a new study, the 100 top U.S. CEOs have as much saved for retirement as 50 million Americans, thanks in large part to special savings plans that their employees don’t receive:
The Center for Effective Government found that the 100 biggest nest eggs of corporate chiefs added up to $4.9 billion, or 41 percent of what American families have saved for retirement. David Novak, the former CEO of Yum Brands, the company that owns Taco Bell, Pizza Hut and KFC, had the largest nest egg, worth $234.2 million, or enough money to provide an annuity check of about $1.3 million a month starting at age 65.

By contrast, almost three in 10 Americans approaching their golden years have no retirement savings at all, the study said, and more than half between 50 and 64 will have to depend on Social Security alone, which averages $1,233 per month.

Aside from fatter paychecks, CEOs get two other perks to help them grow their retirement funds faster than their employees can. Companies and business groups argue that CEO retirement packages are tied to executive performance and necessary to be able to attract top executives.

Special Pensions

More than half of Fortune 500 CEOs receive supplemental executive retirement plans (SERPs), a type of tax-deferred defined-benefit plan for the C-suite. These plans have come under heat from shareholders as expensive and unnecessary.

CEOs enjoy these plans even as companies eliminate regular defined-benefit plans for employees. Only 10 percent of companies provide defined-benefit pension plans, covering just 18 percent of private sector workers, according to the Bureau of Labor Statistics. In the early 1990s, more than a third of private sector workers had pension plans.

Executive Tax-Deferred Compensation Plans

Almost three-fourths of Fortune 500 companies offer their senior executives tax-deferred compensation plans. Unlike 401(k) plans offered to regular workers, these special plans have no limits on annual contributions. That allows CEOs to invest a lot more in their retirement than everyday Americans. For example, last year, 198 CEOs running Fortune 500 companies were able to invest $197 million more in these plans because they were not hamstrung by limitations on defined compensation plans, the study found.

American workers over 50 can contribute only $24,000 a year to 401(k) plans, while younger employees have an $18,000 limit.
This is the new pension normal. CEO compensation which includes lavish pensions is soaring to obscene levels while companies are looking to slash pension costs, offloading them to insurers or employees, or if they go belly up, pensions become the problem of some cash-strapped government pension agency which backstops pensions and slashes benefits.

While this is going on pretty much everywhere, at least in Canada there's talk of enhancing the Canada Pension Plan. In the U.S., there's a dangerous shift in pension policy which will come back to haunt the country as social welfare costs skyrocket and pension poverty soars, placing more pressure on an ever growing debt problem.

What is the solution to the U.S. retirement crisis? I stated my thoughts last week when looking at the DB vs DC debate:
In short, I believe that now is the time to introduce real change to Canada's retirement system and enhance the CPP for all Canadians.

I'm also a big believer that the same thing needs to happen in the United States by enhancing the Social Security for all Americans, provided they get the governance right, pay their public pension fund managers properly to manage the bulk of the assets internally and introduce a shared risk pension model in their public pensions.

It's high time the United States of America goes Dutch on pensions and follows the Canadian model of pension governance. Now more than ever, the U.S. needs to enhance Social Security for all Americans and implement the governance model that has worked so well in Canada, the Netherlands, Denmark and Sweden (and even improve on it).

And some final thoughts for all of you confused between defined-benefit and defined-contribution plans. Nothing, and I mean nothing, compares to a well-governed defined-benefit plan. The very essence of the pension promise is based on what DB, not DC, plans offer. Only a well-governed public DB plan can offer retirees a guaranteed income for the rest of their life.  

What are the main advantages of well-governed DB plans? They pool investment risk, longevity risk, and they significantly lower costs by bringing public and private investments and absolute return strategies internally to be managed by well compensated pension fund managers. DB plans also offer huge benefits to the overall economy, ones that will bolster the economy in tough times and reduce long-term debt.

In short, there shouldn't be four, five or more views on DB vs DC plans. The sooner policymakers accept the brutal truth on DC plans, the better off hard working people and the entire country will be over the very long run.
You'll forgive me if I keep beating the same drum on this topic but it's absolutely crucial that policymakers around the world get their pension policy right.

On Friday morning I received an email telling me that the Canada Mortgage and Housing Corporation (CMHC), a major Canadian Crown corporation, was reverting back to defined-benefit plans for all their employees after shifting new employees into DC plans back in 2012.

The person who sent me that email is a pension authority who shared this with me: "Hopefully, some others will come to same conclusion that a risk shared DB is the most cost effective way to provide a secure retirement and will follow their example."

He's absolutely right which is why I'm hoping to see Canadian and U.S. policymakers move toward enhancing and bolstering defined-benefit plans for all their citizens (see my last comment on breaking Ontario's pension logjam).

Lastly, I discussed inequality in a recent comment of mine looking at which bond bubbles worry the Fed. I think it's shameful that our society values overpaid hedge fund managers and CEOs and does little to fight for the rights of our most vulnerable, including the poor, the disabled and the elderly who are increasingly confronting pension poverty.

Below, take the time once again to listen to this classic 2003 exchange between then congressman Bernie Sanders and Fed Chairman Alan Greenspan. Unfortunately, over a decade since that exchange, the quiet screwing of America continues unabated and both Republicans and Democrats are to blame.

Update: Read my follow-up  comment on America's pension justice to gain more insights on the quiet screwing of America and why the country is headed down the wrong path when it comes to bolstering its retirement system.

Thursday, October 29, 2015

Breaking Ontario's Pension Logjam?

Adam Mayers of the Toronto Star reports, How a 30-minute chat with Trudeau broke Ontario’s pension logjam:
Justin Trudeau came to town Tuesday and managed to achieve, in a 30-minute meeting with the premier, what 18 months of effort had previously failed to do.

Trudeau removed one of the biggest obstacles to the progress of Ontario’s retirement pension plan, namely the issue of how to the collect the premiums and keep track of what is owed in payments.

It’s an unexciting piece of bureaucratic process, but it’s also absolutely vital. If the government can’t keep accurate records, the plan will fail.

This missing piece is one reason why there’s been little visible movement in the past year on the Ontario Retirement Pension Plan (ORPP). The plan's outline is this: The ORPP is coming in 2017, starting with larger employers. The plan is aimed at those Ontarians who lack a company pension plan; at its best, it will replace about 15 per cent of income to maximum earnings of $90,000, or $13,500 a year. It will be in addition to a Canada Pension Plan payment.

The ORPP couldn’t easily move ahead without federal co-operation, and the Harper Conservatives offered none.

Trudeau unlocked the jam Tuesday by making a promise to Wynne. According to Wynne’s spokesperson Zita Astravas, Trudeau said that once he takes office, he will direct the Canada Revenue Agency and departments of finance and national revenue to work with Ontario officials on the registration and administration of the ORPP, The Star’s Robert Benzie reported.

This is the same pension-administration help that Ottawa had extended to Quebec and Saskatchewan, but denied to Ontario.

This week’s news is important because it means the ORPP can move ahead on its own, while Ontario participates in talks to expand the CPP. The Ontario plan hedges against the fact that expanded CPP talks will fail, but if they succeed, the province’s effort isn’t wasted because its plan would be folded into the improved CPP.

Nothing has so far been said about CPP talks. But at a campaign stop in Toronto, Trudeau said he’d get going with the provinces within 90 days of becoming prime minister.

That gives him until Jan. 17 to make good on his promise, a tight schedule given the long list of things on the new government’s plate. But given Trudeau’s nod to Wynne just a week after winning the election, the odds have improved that the CPP will be high on the new finance minister’s list.

Polls show that Canadians are worried about retirement security and support a better national pension plan. They trust the CPP, seeing it as well run and reliable. They often quibble with the amount they are paid, but that’s a political decision, not something the CPP Investment Board controls.

Research carried out by the Gandalf Group for the Healthcare of Ontario Pension Plan (HOOPP) in the middle of the election campaign confirms that Trudeau and Wynne are moving with public opinion.

The research looks at attitudes toward workplace pensions, and in particular defined benefit pension plans. These plans are on the retreat in the private sector, but still widely available in the public sector.

Among the findings:
  • 77 per cent support increasing CPP costs and benefits;
  • 54 per cent say any contribution changes to the CPP should be mandatory;
  • 70 per cent support the idea of the ORPP to increase pension benefits;
  • 74 per cent said higher pension contributions are a form of savings, and an investment in the future. Only 20 per cent saw the higher premiums as a tax, which is how the Conservatives painted the cost of a better CPP.
In a world of economic uncertainty and powerful global forces, stronger public pensions protect workers against forces outside their control. After a decade of inaction and small thinking, it seems the will is there to do something. All that remains is finding the way.

ORPP at a glance
  • It will be mandatory for 3 million Ontarians without company pensions.
  • Contributions begin in 2017, with larger employers going first.
  • Modelled after CPP. Has survivor benefit, but is not transportable. There is no opt out.
  • Workers and employers each contribute 1.9 per cent of earnings up to a maximum annual income of $90,000.
  • At its best, the pension aims to replace 15 per cent of income.
  • The fund would collect $3.5 billion a year, which would be invested at arm’s length.
Source: Ontario Ministry of Finance
What are my thoughts on all this? Go back to read last week's comment on real change to Canada's pension plan following the Liberals' sweeping victory. There, I critically examined the Liberals' pension policy but unequivocally supported any effort to enhance the CPP even if I think the Canadian economy is on the verge of a serious recession:
My regular readers know my thoughts on the Canadian economy. I've been short Canada and the loonie for almost two years and I've steered clear of energy and commodity shares despite the fact that some investors are now betting big on a global recovery. I think the crisis is just beginning and our country is going to experience a deep and protracted recession. No matter what policies the Liberals implement, it will be tough fighting the global deflationary headwinds which will continue wreaking havoc on our energy and commodity sectors and also hurt our fragile real estate market. When the Canadian housing bubble bursts, it will be the final death knell that plunges us into a deep recession.

Having said this, I don't want to be all doom and gloom, after all, this blog is called Pension Pulse not Greater Fool or Zero Hedge. I'd like to take some time to discuss why I think the new Liberal government will be implementing some very important changes to our retirement system, ones that will hopefully benefit us all over the very long run regardless of whether the economy experiences a very rough patch ahead.

Unlike the Conservatives led by Stephen Harper who were constantly pandering to Canada's financial services industry, ignoring the brutal truth on DC plans, both the Liberals and the NDP were clear that they want to enhance the CPP for all Canadians, a retirement policy which will curb pension poverty and bolster our economy providing it with solid long-term benefits.

Of course, as always, the devil is in the details. Even though I agree with the thrust of this retirement policy, I don't agree with the Liberals and NDP that the retirement age needs to be scaled back to 65 from 67. Why? Because Canadians are living longer and this will introduce more longevity risk to Canada's pension plan.

But longevity risk isn't my main concern with the Liberals' retirement plan. What concerns me more is this notion of voluntary CPP enhancement. I've gotten into some heavy exchanges on this topic with Jean-Pierre Laporte, a lawyer who founded Integris, a firm that helps Canadians invest for their future using a smarter approach.

Jean-Pierre is a smart guy and one of the main architects of the Liberals' retirement policy, but we fundamentally disagree on one point. As far as I'm concerned, in order for a retirement policy to be effective, it has to be mandatory. For me, any retirement policy which is voluntary is doomed to fail. Jean-Pierre feels otherwise and has even written on what forms of voluntary CPP enhancement he's in favor of.

There are other problems with the Liberals' retirement policy. I disagree with their stance on limiting the amount in tax-free savings accounts (TFSAs) because while most Canadians aren't saving enough, TFSAs help a lot of professionals and others with no pensions who do manage to save for retirement (of course, TFSAs are no substitute to enhancing the CPP!).

More importantly, Bernard Dussault, Canada's former Chief Actuary shared this with me:

"Unfortunately, there is a major flaw in the Liberal Party of Canada's resolution regarding an expansion of the Canada Pension Plan, which is that their proposal would exclude from coverage the first $30,000 of employment earnings.

Indeed, although the LPC's proposal would well address the second more important goal of a pension plan, which is to optimize the maintenance into retirement of the pre-retirement standard of living, it would completely fail to address the first most important goal of a pension plan, which is to alleviate poverty among Canadian seniors."
I thank Bernard for sharing his thoughts with my readers and take his criticism very seriously.

Let me be crystal clear here. I don't think the Liberals can afford to squander a golden opportunity and not introduce mandatory CPP enhancement for all Canadians. Anything short of this would be a historical travesty and it would dishonor Pierre-Elliott Trudeau's legacy and set us back decades in terms of retirement and economic policy. 

Why am I so passionate on this topic? Because I've worked at the National Bank, Caisse, PSP Investments, the Business Development Bank of Canada, Industry Canada and consulted the Treasury Board of Canada on the governance of the public service pension  plan. I've seen first-hand the good, the bad and ugly across the private, public and quasi-public sector. I know what makes sense and what doesn't when it comes to retirement policy which is why I was invited to speak on pensions at Parliament Hill and why the New York Times asked me to provide my thoughts on the U.S. public pension problem.

I've also put my neck on the line with this blog and have criticized and praised our largest public pension funds but one thing I know is that we need more defined-benefit plans covering all Canadians and we've got some of the very best public pensions in the world. Our top ten pensions are global trendsetters and they provide huge benefits to our economy. That's why you'll find a few pension fund heroes here in Canada.

Are the top ten Canadian pensions perfect? Of course not, far from it. I can recommend many changes to improve on their "world class governance" and make sure they're not taking excessive and stupid risks like they did in the past. The media covers this up; I don't and couldn't care less if it pisses off the pension powers.

But when thinking of 'real change' to our retirement policy and economy, we can't focus on past mistakes. We need to focus on what works and why building on the success of our defined-benefit plans makes sense for bolstering our retirement system, providing Canadians with a safe, secure pension they can count on for the rest of their life regardless of what happens to the company they work for.

In my ideal world, we wouldn't have company pension plans. That's right, no more Bell, Bombardier, CN or other company defined-benefit plans which are disappearing fast as companies look to offload retirement risk. The CPP would cover all Canadians regardless of where they work, we would enhance it and bolster its governance. The pension contributions can be managed by the CPPIB or we can follow the Swedish model and create several large "CPPIBs". We would save huge on administrative costs and make sure everyone has a safe, secure pension they can count on for life.
I stand by my comments and even though I'm happy to see it's full steam ahead on the ORPP, I would prefer to see full steam ahead on enhancing the CPP (and QPP here in Quebec). Only that will propel Canada to the top spot in the global ranking of pension systems.

It's important to educate Canadians on the the huge advantages of well-governed defined-benefit (DB) plans. These include pooling investment risk, longevity risk, and significantly lowering costs by bringing public and private investments and absolute return strategies internally to be managed by well compensated pension fund managers who are also able to invest with the very best external managers as they see fit, making sure alignment of interests are there. DB plans also offer huge benefits to the overall economy, ones that will bolster the economy in tough times and reduce long-term debt.

In short, there shouldn't be four, five or more views on DB vs DC plans. The sooner policymakers accept the brutal truth on DC plans, the better off hard working people and the entire country will be over the very long run.

All this to say that I don't really care if the Liberals won the federal election and Kathleen Wynne is happy and embracing Justin Trudeau. I take all these political grandstanding photo ops with a grain of salt. It's time to get down to business and let me assure the Liberals in Ottawa and Queen's Park in Toronto there's a hell of a lot work ahead and if they screw up this historic opportunity to significantly bolster our national retirement system, future historians will not be kind to them.

But when discussing enhancing the CPP, there are a lot of issues that need to be properly thought of including whether the federal government wants to give the new pension contributions to CPPIB or direct them to a new entity. There's also the issue of pension governance and I think it's high time we stop patting each other on the back here in Canada and get to work on drastically improving pension governance at Canada's top ten pensions.

In particular, it's time to remove the Auditor General of Canada from auditing our large public pensions (it's woefully under-staffed and lacks the expertise) and either have OSFI, which already audits private federally regulated pension plans, or better yet the Bank of Canada audit our large pubic pensions and keep a much closer eye on all their investment and operational activities.

I've long argued that we need to perform comprehensive operational, performance and risk management audits at all our large public pensions. These should be performed by independent and qualified third parties to make sure that the governance at these pensions is indeed "world class" and the findings of these audits which can be done once every two or three years must be made public.

Some of Canada's public pension plutocrats will welcome my suggestion, others won't. I couldn't care less as I'm not writing these lengthy blog comments to pander to them or anyone else. I speak my mind and I've seen enough shenanigans in the pension fund industry to know that when it comes to pension governance, we can always improve things, even in Canada where we pride ourselves on being leaders on governance. For me, it's all about transparency and accountability.

If you have anything to add to this debate, feel free to email me at I don't pretend to have the monopoly of wisdom when it comes to pensions and investments but I think I'm doing my part in educating people on the real issues that matter most when it comes to their retirement security.

Below, watch Bernie Sanders tell Alan Greenspan, in 2003, that Americans are not living the way that Mr. Greenspan imagines they are (I thank my brother for sending me this classic clip). Also, Sen. Bernie Sanders asked a panel of experts to contrast the United States health care system with single-payer one in Canada.

Whether or not you love Bernie, you have to admire his chutzpah. He nailed the 'maestro' and he nailed the key points on why single-payer health care is a better system (even if it's far from perfect). I think Bernie would totally be in favor of enhancing the CPP in Canada and possibly enhancing Social Security in the United States (provided they get the governance right) where the solutions to America's retirement crisis being peddled are outrageous and shortsighted.

Of course, when enhancing the CPP or Social Security, you've got to get the governance right and make sure transparency and accountability are the pillars of any changes to the retirement policy.

Wednesday, October 28, 2015

CPPIB Goes Bollywood?

Barbara Shecter of the National Post reports, CPPIB adds Mumbai to list of global offices, commits to stake in Cablevision:
The Canada Pension Plan Investment Board has opened an office in Mumbai to support and expand on $2 billion of investments made in India since 2010.

The new Mumbai office joins a list of seven international hubs including London, Hong Kong, New York and Sao Paulo. As with the others, the office in India will allow the pension giant’s management team to develop local expertise and partnerships, and will provide access to investment opportunities that “may not otherwise have been available,” said chief executive Mark Wiseman.

He noted that Canada’s largest pension has already made investments in the country in segments including infrastructure, real estate and financial services.

These include a 3.9 per cent stake in Kotak Mahindra Bank, India’s third-largest private sector bank by market capitalization, and a US$332-million investment in L&T Infrastructure Development Projects, the unlisted subsidiary of India’s largest engineering and construction company.

On Tuesday, the same day the new Mumbai office was announced, CPPIB issued a separate announcement saying it would take a US$400-million stake in U.S. cable operator Cablevision Systems Corp.

Toronto-based CPPIB is teaming up with a group of investors, including funds advised by BC Partners and BC European Capital IX, to provide 30 per cent of the equity in Altice’s proposed acquisition of Cablevision, one of the largest cable operators in the United States with millions of customers in greater New York.

The transaction is expected to close in the first half of 2016, subject to regulatory approvals.
Euan Rocha of Reuters also reports, Canada's CPPIB opens office in India to scout for opportunities:
The Canada Pension Plan Investment Board, one of the country's largest pension fund managers, opened an office in Mumbai on Tuesday as it scouts for investment opportunities on the Indian subcontinent.

CPPIB, which has already committed to invest more than $2 billion in India, sees its long investment horizon aligning with the financing needs of India's economy.

The Toronto-based fund owns a nearly 4 percent stake in Kotak Mahindra Bank, one of the largest private sector banks in India. It has also committed to investments in infrastructure projects in India, office buildings, and to providing structured debt financing to residential projects in major Indian cities.

"The opening of an office in Mumbai allows CPPIB to develop local expertise, build important partnerships and access investment opportunities that may not otherwise have been available," CPPIB head Mark Wiseman said in a statement.
You can read CPPIB's full press release on opening an office in India here. This is all part of CPPIB's long-term strategy to invest in public and private markets in emerging markets.

Why invest in India? There are plenty of reasons. In June 2010, Goldman Sachs Asset Management put out a nice little white paper, India Revisited, which made a solid case for investing in the country based on an advantageous demographic profile, a growing middle class, a healthy financial system, low levels of private and corporate leverage, conservative regulations and a domestically driven economy which insulated India from the worst effects of the 2008 global economic crisis.

Of course, there are plenty of pitfalls investing in India too. According to a 2008 NRI guide going over the advantages and disadvantages of investing in India, corruption is rampant in that country:
India, despite its enormous manpower, is facing a shortage of qualified skilled professionals due to lack of adequate public education system. The wage rates, hence, are going higher and higher eroding the cost advantage that has served India for a decade now.

Infrastructure is another field where India has to pull up its socks. Foreign investors, in their day-to-day course of business deal with PIO. But when these foreign investors come to India, they witness inadequate and not up-to-the-mark airports, seaports, roads, power grids, communication system and facilities, health care and education.

If India has to become a superpower, her government has to work with full commitment and dedication in all the fields mentioned above. Indirection, uncertainty and revisiting settled issues eternally characterise business negotiations in India.

Corruption is another huge predicament that has to be minimised as much as possible if India is to become an apple of the investors’ eyes. The Indian courts have huge backlog of more than 27 million cases, with many cases taking more than a decade to get solved! Unfriendly labour laws, difficulty in getting patent rights, and various other legal and ethical challenges add to India’s affliction. What officials put forth is not exactly how the true picture is.

India, no doubt, is a tough place to do business. But all said and done, we cannot deny the fact that India is a strong contender for the post of ‘economic superpower of the future’ and its strategic location works in its favour abundantly. We at believe that the ginnie has been let out of the bottle and soon the world would realize the potential of the Indian financial markets: including both stock markets and mutual funds. And if the challenges are taken care of, then it is a heavenly abode for all investors.
The ginnie has been let out of the bottle which is why CPPIB and other large global investors like Norway's massive sovereign wealth fund are investing more in India.

In my opinion, however, the real opportunities in India lie in private, not public markets which gives CPPIB a big advantage over other investors. Anyone can invest in iShares MSCI India (INDA) which pretty much tracks the iShares MSCI Emerging Markets ETF (EEM). But a large investor like CPPIB can invest in real estate, infrastructure and private equity deals in that country, opening the door to a lot more lucrative investment opportunities.

Does CPPIB need to open up offices in various regions of the world? There, I'm a little more skeptical. CPPIB, Ontario Teachers and others love opening up offices to have "boots on the ground" but I prefer PSP's approach of partnering up with the right partners in various countries to find the very best opportunities in public and private markets (I always ask myself a simple question: Do we really need to open up offices around the world or are we better off sourcing opportunities through partners?).

It's also worth noting that investing in emerging markets via public or private markets carries a whole set of unique risks, including more volatility and currency risk.

Last October, I questioned CPPIB's risky bet in Brazil and pointed out that while this makes sense over the long run, the fund will deal with volatility and huge currency losses over the short run (the Brazilian economy has gotten clobbered as China's growth and demand for commodities has slowed and even though CPPIB doesn't need to sell its Brazilian assets, their valuations are not immune to public market and currency woes).

One area where CPPIB can help India is in bolstering its antiquated pension system which ranks dead last in Mercer's global ranking of pension systems.

As far as CPPIB's cable deal, you can read its press release here. It basically partnered up with BC Partners, one of the best private equity funds in the world, to co-invest alongside it and join forces with Altice, in the latter's acquisition of Cablevision:
Altice, the European cable and telecoms group which last month announced it will buy US cable television company Cablevision for $17.7bn including debt, said on Tuesday that the two would take a 30 per cent stake in the company for around $1bn.

Altice, known for being acquisitive, has previously bought rivals in France, the US and Israel. Following the announcement of the Cablevision deal it announced a new equity capital raising exercise of around €1.8bn.

From the announcement:
Altice N.V. (Euronext: ATC, ATCB) today announced that funds advised by BC Partners ("BCP") and Canada Pension Plan Investment Board ("CPPIB") have entered into a definitive agreement to acquire 30% of the equity of Cablevision Systems Corporation (NYSE: CVC) (for approximately $1.0 billion).

Together with the recent Cablevision debt financing and the Altice equity issuance, the acquisition of Cablevision is fully funded.
The cable wars are heating up everywhere, especially in the U.S., and this is a good long term deal as long as they didn't overpay for it and get regulatory approval.

Below, Martin Sorrell, CEO of WPP, says that while he remains an unabashed bull on BRICS, there’s reason to be particularly positive on India.

Also, David Zaslav, Discovery Communications CEO; Barry Diller, IAC/InterActiveCorp and Expedia, Inc. Chairman and Senior Executive; and Les Moonves, CBS chairman & CEO, discuss viewing television a la carte. They also weighed in on the relationship between content and distribution providers. This was a fascinating discussion with media titans.

Lastly, economist and former Labor Secretary, Robert Reich, explains why your cable bill is so high. Reich is right, there's not enough competition in cable and internet service providers and that's all because of  politics. You might have noticed your Netflix rate creeping up. This is only the beginning. Get ready for more price increases in this industry which is dominated by a few key players.

Tuesday, October 27, 2015

Which Bond Bubble Worries Her Most?

Jeff Cox of CNBC reports, Junk bond market betting big against Fed rate hike:
Traders have been using junk to bet against the possibility that the Federal Reserve will raise interest rates anytime soon.

Exchange-traded funds that track high-yield bond indexes have been the beneficiaries of a cash surge in recent weeks as market participants figure the central bank probably won't raise rates in 2015, and it could be well into 2016 before anything happens.

In just the past week alone, three bond-related ETFs pulled in $2.4 billion. Two are focused on high-yield, or junk, bonds, according to, despite repeated warnings on Wall Street that the segment of the market is headed for the rocks.

The iShares iBoxx $ Investment Grade Corporate Bond, the iShares iBoxx $ High Yield Corporate Bond and the SPDR Barclays High Yield Bond have been hugely popular.

During October, the group has pulled in $6.6 billion, with the two junk funds attracting about $4.3 billion of the total.

By contrast, in August, when the market was still anticipating that the Fed might raise its key interest rate in September, the two high-yield funds lost a net $344 million.

Since then, a sputtering economy and lackluster inflation have changed Wall Street's perception of when the central bank's Federal Open Market Committee will enact its first hike since taking its funds rate to zero in late 2008. Traders now put just a 7 percent chance of a rate move at Wednesday's FOMC meeting and a 36 percent probability for the final one of the year in December, according to the CME's tracking tool. Current expectations are for a March 2016 hike, with a 59 percent chance.

The Fed's rate posture is critical to the bond market because yields and prices move in opposite directions. A Fed hike would be expected to trigger responses across credit markets, driving rates higher and eating into bondholder principle.

Moreover, corporate America has been dependent on low rates to finance the trillions of debt issuance it has taken on during the era of zero interest rate policy, or ZIRP. The $8.1 trillion in net outstanding debt has grown by 8.4 percent in 2015.

The quality of that debt has eroded as well, making high yield particularly sensitive to rate increases and the possibility for an elevated level of defaults.

Ratings agency Moody's reported Monday that the rolls of "potential fallen angels," or issuers with investment-grade debt currently in danger of becoming junk, swelled by 17 in the third quarter, while no companies fell into the opposite category, called "potential rising stars." It's just one measure by which bond quality has declined, another being the continuing erosion in covenants, or the conditions companies must meet to their bondholders.

Still, ETF buyers are willing to take a shot at the market, believing that in addition to the Fed staying dovish with rates the default level will remain low.

In addition to junk funds, the ETF market in general has been flocking to fixed income. The Vanguard Intermediate-Term Bond fund also was in the top 10 over the past week in terms of flows, taking in $484.5 million, while the iShares Core U.S. Aggregate Bond ETF pulled in $416.8 million, according to and FactSet.
In my last comment I went over Mercer's global ranking of top retirement systems and referred to the latest Absolute Return Letter, The Real Burden of Low Interest Rates, where Niels Jensen explains why low rates are here too stay making it more difficult for all pensions to generate the returns they need to cover their liabilities.

Today I'm going to discuss one of my favorite subjects, the (not so) scary U.S. bond market that all these gurus have been warning us about. This includes hedge fund titans Paul Singer and Carl Icahn, as well as the maestro Alan Greenspan who also sounded the alarm on bonds.

My regular readers already know my stance on all these "dire warnings" on the "bond bubble." I ignore them for the simple reason that I don't see an end to the deflation supercycle and think the era of low growth, low inflation/ or deflation and low returns is here to stay for a very long time.

And while Bridgewater's Ray Dalio is worried about the next downturn (he should be more concerned about his funds' lackluster performance), central banks are very busy saving the world, coming up with new tricks like negative interest rates and even buying municipal bonds to mitigate the ravages of deflation and spur growth (wait till the Bank of Canada starts buying provincial bonds).

In other words, there won't be any bursting of any U.S. bond bubble. The Fed has a serious deflation problem to contend with, especially after China's Big Bang, and it knows it would be making a monumental mistake if it raises rates anytime soon. This shift in focus from domestic to international  concerns represents a sea change at the Fed, one that we better all get used to.

Are there unintended consequences to maintaining rates so low for so long? Of course, central banks are fueling a property bubble all around the world as rates remain at historic low levels. They are also exacerbating inequality as low rates favor financial speculation, rewarding overpaid hedge fund managers but punishing savers. Record low rates also force pensions to take on more risk to make their return target by investing in hedge funds and private equity funds, providing elite managers with a perpetual source of funds and making them obscenely wealthy in the process.

Zero interest rate policies (ZIRP) also fuel inequality via the buyback bubble. As rates remain at historic lows, companies are incentivized to borrow big and plow that money right back into a share repurchase program, allowing them to literally manipulate earnings-per-share so their CEOs and top brass can keep inflating their bloated compensation without having to hire new workers or invest in capital, equipment and research and development.

No wonder dividends and stock buybacks are on track to hit a new high this year and could top $1 trillion for the first time, according to Michael Thompson, managing director of S&P Capital IQ Global Markets Intelligence:
Companies have been increasing their buybacks and dividends to please investors for years. Total payouts from S&P 500 companies surged 84% in the past decade to $934 billion in 2014, from $507 billion in 2005, according to a report by S&P Capital IQ.

While getting cash is great for investors, there's two sides to the thank-you's that companies are giving out.

On one hand, they can be a healthy sign that reflects a company's confidence in its future and willingness to share the cash its business is generating. But increasingly they're seen as a gimmick to distract investors from problems like struggling sales growth and lack of ideas in how to invest its cash.
This is a structural problem that is worth paying closer attention to because as companies plow cash into share repurchase programs, rewarding investors and mostly their top brass, they're not doing their part to invest in human and physical capital.

All this fuels inequality and rising inequality concerns me from a social and economic point because it exacerbates long-term structural unemployment and is very deflationary.

[Note: Those of you who want to delve deeply into the issue of inequality should pick up Thomas Piketty's The Economics of Inequality, Tony Atkinson's Inequality: What Can Be Done?,  Joseph Stiglitz's The Great Divide and Robert Reich's Saving Capitalism: For the Many, Not the Few.

I would also recommend Piketty's Capital in the Twenty-First Century but it's way too long and technical even if it's a masterpiece on the subject of inequality. I found Atkinson's book to be a particularly excellent read as he offers policymakers ideas on tackling rising inequality not simply by taxing the rich but also through tackling poverty.]

But while rising inequality concerns me and academic economists, it doesn't concern the Fed and other central banks which are there to respond to the needs of the financial and corporate elites. And to be fair to the Fed, even if it did raise rates, it would end up crushing the over-indebted masses which are struggling to pay off their credit card bills and the mortgage on their overvalued homes. 

Lastly, while all the focus is on the U.S. bond bubble, Bloomberg's Lianting Tu recently reported, If You Thought China's Equity Bubble Was Scary, Check Out Bonds:
As a rout in Chinese stocks this year erased $5 trillion of value, investors fled for safety in the nation’s red-hot corporate bond market. They may have just moved from one bubble to another.

So says Commerzbank AG, which puts the chance of a crash by year-end at 20 percent, up from almost zero in June. Industrial Securities Co. and Huachuang Securities Co. are warning of an unsustainable rally after bond prices climbed to six-year highs and issuance jumped to a record. The boom contrasts with caution elsewhere. A selloff in global corporate notes has pushed yields to a 21-month high, and credit-derivatives traders are demanding near the most in two years to insure against losses on Chinese government securities.

While an imminent collapse isn’t yet the base-case scenario for most forecasters, China’s 42.2 trillion yuan ($6.7 trillion) bond market is flashing the same danger signs that triggered a tumble in stocks four months ago: stretched valuations, a surge in investor leverage and shrinking corporate profits. A reversal would add to challenges facing China’s ruling Communist Party, which has struggled to contain volatility in financial markets amid the deepest economic slowdown since 1990.

“The Chinese government is caught between a rock and hard place," said Zhou Hao, a senior economist in Singapore at Commerzbank, Germany’s second-largest lender. "If it doesn’t intervene, the bond market will actually become a bubble. And if it does, the market could crash the way the equity market did due to fast de-leveraging.”

The slide in stocks is one reason why corporate bonds have done so well, prompting a 91 percent jump in issuance last quarter. Many investors who sold shares during the Shanghai Composite Index’s 38.4 percent drop from its June high have plowed the proceeds into debt, viewing the market as a haven given its history of almost negligible defaults. Five interest-rate cuts since November have also fueled gains as the People’s Bank of China seeks to revive growth with lower borrowing costs.

Yields on top-rated corporate notes due in five years have declined 79 basis points, or 0.79 percentage point, this year to 4.01 percent. The yield premium over similar-maturity government securities has dropped to 97 basis points, near the lowest since 2009.

By contrast, the yield on corporate notes globally has increased 26 basis points to 2.92 percent. Credit-default swaps on China’s sovereign debt jumped to a more than two-year high of 133 basis points in September and were last at 113 basis points.

Risks Rise

A reversal in the bond market would do more damage to China’s economy than the drop in shares and exacerbate capital flight from the biggest emerging market, according to a worst-case scenario projected by Banco Bilbao Vizcaya Argentaria SA. The Spanish lender more than doubled its first-quarter profit by selling holdings in a Chinese bank.

“The equity rout merely reflects worries about China’s economy, while a bond market crash would mean the worries have become a reality as corporate debts go unpaid," said Xia Le, the chief economist for Asia at Banco Bilbao. "A Chinese credit collapse would also likely spark a more significant selloff in emerging-market assets.”

For all the concerns about a bond rout, default levels in China have so far been remarkably low, thanks in part to government-orchestrated bailouts for troubled firms. Just four companies have defaulted on onshore bonds, including Shanghai Chaori Solar Energy Science & Technology Co., which became the first to renege on its debt in 2014.

Government Firepower

China has the wherewithal to stave off a crisis in its credit markets, according to Ken Hu, chief investment officer for Asia-Pacific fixed income at Invesco Ltd. "Unlike most other emerging-market countries, China has high domestic saving rates, little government debt, healthy fiscal balances, strong trade and current account surpluses, and most of its corporate debts are domestic," he said.

Policy makers went to unprecedented lengths to combat the tumble in share prices, including compelling state-owned firms to buy equities and preventing major stockholders from selling. The Shanghai Composite rose 1.27 percent on Friday, its second straight day of advance after a week-long national holiday.

A recovery in the equity market could be the trigger for a selloff in bonds as money managers liquidate their holdings to catch the rally in stocks, according to Thomas Kwan, the Hong Kong-based chief investment officer at Harvest Global Investments Ltd., whose Chinese unit offers funds through the Qualified Domestic Institutional Investor program.

Warning Signs

The risk of a downward spiral in debt prices has increased after investors took on leverage to amplify their returns, according to Ping An Securities Co. The monthly volume of bond repurchase agreements -- a form of borrowing used by investors to increase their buying power -- has jumped 83 percent from January to 39 trillion yuan in September, according to data from the Chinamoney website.

About 16 percent of companies on the Shanghai stock exchange lost money in the past 12 months, double the proportion last year, and the number of firms with debt levels twice their equity has doubled to 347 since 2007. Profits at Chinese industrial companies sank 8.8 percent in August from a year earlier, the biggest decline since the government began releasing monthly data in 2011.

Baoding Tianwei Yingli New Energy Resources Co., a maker of solar components, could become the latest Chinese company to default on local-currency notes after its parent said it’s unlikely to meet a deadline next week on a 1 billion yuan bond.

“Global investors are looking for signs of a collapse in China, which itself could increase the chances of a crash,” Commerzbank’s Zhou said. “This game can’t go on forever."
Indeed, investors betting big on a global recovery have not been rewarded and continue getting hammered as energy and commodity prices head lower as everyone nervously awaits news out of China.

This is why I even though I agree with those who say the possibility of rate hike this year shouldn't be ignored, I wouldn't bet on it and would only worry about it next year once we see clear signs that a global recovery is well underway. And if for any reason a global recovery doesn't materialize, I would expect the Fed to start talking about more QE or even negative rates if deflation fears spread to America.

All this to say that even though the Fed is cognizant of all these supposed bond bubbles, it won't be a factor to worry about in the next few months. The October surprise I discussed earlier this month remains my base case scenario for the near term.

Below, CNBC Finance Editor Jeff Cox breaks down what investors should expect from the Fed in the coming weeks and months. I agree with him that the "ghost of 1937" weighs heavily in the Fed's decision and that bank stocks matter a lot more than economic data.

But with deflation fears reigning, I don't see any huge run-up in financial shares (XLF). And while China may be dumping Treasuries, U.S. banks are scooping them up as the ultimate carry trade continues unabated. Fun times and as long as the music doesn't stop, neither the Fed nor you should worry about any bond bubble anywhere in the world.

Update: The Federal Reserve kept interest rates close to zero for yet another meeting but said it would focus on its “next meeting” in mid-December on whether to raise interest rates. Like I said above, I wouldn't ignore the possibility of rate hike this year but I wouldn't bet on it.

Monday, October 26, 2015

2015 Global Ranking of Top Pensions

Chris Flood of the Financial Times reports, Global ranking of top pension funds:
Denmark and the Netherlands are the only two countries with pension systems that could be regarded as “first class”, according to a comprehensive global pensions study.

The two countries rank first and second in the Melbourne Mercer Global Pension Index, which measures the health of the pension systems in 25 countries to assess whether they will be able to deliver adequate future provision.

The report, produced jointly by Mercer, the consultancy, and the Australian Centre for Financial Studies in Melbourne, says that big reforms are required to improve the pension systems of some of the world’s most populous countries, including China, India, Indonesia and Japan.

Japan, Austria and Italy score poorly in the report. They have high levels of government debt, inadequate pension assets and ageing populations, finds the study.

David Knox, senior partner at Mercer, says: “There is no easy solution, but the sooner action is taken, the better. Reforms take time and good transition arrangements are required, as implementing new policies might stretch over 10 or even 20 years.”

Pension systems in other advanced economies including the US, Germany, France and Ireland were also found to face large risks that could endanger their long-term health.

The UK’s score was marked down following the recent removal of the requirement for retirees to buy an annuity that would provide a guaranteed income until death. Even Australia’s highly regarded pension system, ranked third in the report, could be improved by requiring part of any retirement benefit to be taken as an income stream, rather than a single lump sum, the report finds.

The report shows average years in retirement have risen from 16.6 in 2009 to 18.4 in 2015. Mercer forecasts this will increase to 19.2 by 2035.

Only Australia, Germany, Japan, Singapore and the UK have raised their state pension age to counteract increases in life expectancy.

“Living to 90 and beyond will become commonplace. More countries should automatically link changes in life expectancy to the state pension age,” says Mr Knox. The Netherlands has already taken this step.

Amlan Roy, head of pensions research at Credit Suisse, the bank, adds: “It is necessary to get rid of fixed retirement ages.”

Mercer also recommends that governments make greater efforts to ensure older workers remain active. Participation rates among workers aged 55 to 64 differ considerably, from 77 per cent in Sweden to just 40 per cent in Poland. The pace of improvement in activity rates for older workers has also varied significantly over the past five years.

Mr Roy says: “Unsustainable promises on pensions have been made the world over and will have to be renegotiated in response to increasing longevity.”

He points out that pensioners aged 80 and above represent the fastest-growing cohort globally and annual healthcare costs for this group are around four times higher than the rest of the population.

This raises great concerns for younger people. Mr Knox says: “Most civilised governments will offer retirement benefits to the poor and infirm but some young people are asking if there will be any state pension provision by the time they retire.”
You can download and read the 2015 Melbourne Mercer Global Pension Index report here. The overall index value for each country’s pension system represents the weighted average of the three sub-indices below (click on image):

According to the report:
The weightings used are 40 percent for the adequacy sub-index, 35 percent for the sustainability sub-index and 25 percent for the integrity sub-index. The different weightings are used to reflect the primary importance of the adequacy sub-index which represents the benefits that are currently being provided together with some important benefit design features. The sustainability sub-index has a focus on the future and measures various indicators which will influence the likelihood that the current system will be able to provide these benefits into the future. The integrity sub-index considers several items that influence the overall governance and operations of the system which affects the level of confidence that the citizens of each country have in their system.

This study of retirement income systems in 25 countries has confirmed that there is great diversity between the systems around the world with scores ranging from 40.3 for India to 81.7 for Denmark.
Indeed, there is great diversity between countries but it doesn't surprise me that Denmark and the Netherlands lead the world when it comes to their national pension system. Both ATP and APG went back to basics following the 2008 financial crisis. ATP runs their national pension like a top hedge fund and is actually doing much better than most top hedge funds. The Netherlands has an unbelievable pension system which is why I've long argued the world needs to go Dutch on pensions.

What do the Netherlands and Denmark have in common? They have strict laws governing the pension deficits of their public and private pensions and if things go awfully wrong, these pensions are mandated by law to take action to return to solvency. This and the fact that they have long ago introduced a shared risk  pension model is why these two countries have the world's best pension systems.

It is worth noting, however, that while Denmark and the Netherlands have the best pension systems, the world's best pension plans and pension funds are here in Canada where you will find your fair share of pension fund heroes who get compensated extremely well for delivering outstanding results (some say outrageously well but they are delivering the long term results).

The report raises the issue of longevity risk, a theme I've covered in detail on this blog. While I don't think longevity risk will doom pensions, I do think that common sense dictates if people live longer, the retirement age should be adjusted accordingly to make sure these pensions are sustainable. This is why I don't agree with the Liberals and NDP proposal to scale back the retirement age in Canada to 65 from 67, but do agree with them that we need to finally introduce real change to Canada's retirement system and enhance the CPP for all Canadians.

As far as the United States, there are new solutions being discussed to tackle a looming retirement crisis but I'm not impressed as these proposals only benefit large alternative investment shops charging huge fees and Wall Street which makes a killing in fees serving these large funds.

Moreover, there shouldn't be four views on DB vs DC plans, there should only be one view which clearly explains the brutal truth on DC plans and why well-governed DB plans are far superior in terms of performance and offer big benefits to the overall economy too.

What about Australia and its superannuation schemes which are government mandated DC plans? That country came in third in the global ranking, ahead of Canada. As I've stated in the past, while Australia does a great job covering all its citizens, we don't need pension lessons from Down Under. I would recommend an enhanced CPP over any Australian superannuation scheme any day.

And how about Sweden? It placed high again in the global rankings but there's a pension battle brewing there. In fact, Chris Newlands of the Financial Times reports, Swedish pension chief executives condemn reforms:
The heads of the four largest pension funds in Sweden have written an open letter to the government condemning proposed changes to the country’s public pension system.

The letter is an embarrassment for the Swedish finance ministry, which said in June it would close one of the country’s five state pension funds and shut down the SKr23.6bn ($2.7bn) private equity-focused fund, known as AP6, to cut costs.

The funds, which were set up to meet potential shortfalls within the state pension system, have long been criticised for producing lacklustre returns and for their expensive management structure.

But the chief executives and chairmen of four of the funds have called the changes “short term” and “politically motivated” and said the overhaul would have a negative impact on investment performance, which would ultimately harm pensioners.

It is the strongest rebuttal yet of the government’s proposals for reform and the first time there has been a public, co-ordinated response from AP1, AP2, AP3, and AP4, which manage $142bn of pension assets.

The group attacked the proposals for lacking a proper assessment of costs.

The heads of the four funds wrote in the letter: “During the reorganisation, planned to start in 2016 and continue for almost two years, there is a risk that the AP funds will lose their focus on long-term asset management, which will have a negative effect on results.

“If this were to lead to even a 0.1 per cent decrease in returns this would amount to about SKr1.2bn.”

Per Bolund, Sweden’s financial markets minister, previously rejected the suggestion that the proposals could jeopardise Sweden’s pension framework. He told FTfm in August: “That is exaggerated. We would never suggest something that would harm the pension system.”

The AP funds were originally split into several smaller groups due to fears that one large scheme would become too dominant an investor in Sweden and too much of a political temptation.

The four funds fear the government’s plan to also create a national pension fund board to determine return targets and the investment strategy of the remaining funds would revive the threat of political interference.

“The proposed governance of the funds is unclear and bureaucratic,” they said. “The proposals to establish a national pension fund board and the ability for the government to have an influence . . . will present the prospect of short-term political micromanagement.”
I'm not sure what exactly is going on in Sweden but if they choose to amalgamate these public pension funds into one national pension fund, they better get the governance right (ie., adopt CPPIB's governance which is based on Ontario Teachers' governance and what most of Canada's top ten use).

In my recent comment on real change to Canada's pension plan, I stated the following:
In my ideal world, we wouldn't have company pension plans. That's right, no more Bell, Bombardier, CN or other company defined-benefit plans which are disappearing fast as companies look to offload retirement risk. The CPP would cover all Canadians regardless of where they work, we would enhance it and bolster its governance. The pension contributions can be managed by the CPPIB or we can follow the Swedish model and create several large "CPPIBs". We would save huge on administrative costs and make sure everyone has a safe, secure pension they can count on for life.
I am paying close attention to developments out of Sweden to gauge why the Swedish finance ministry is proposing to reform the pension system and to amalgamate these funds (contact me at if you have any information on this).

At the bottom of the global pension ranking, I noticed India and South Korea. Don't know much about India's pension system but South Korea’s National Pension Service (NPS), which oversees US$430 billion (RM1.84 trillion) in assets, is understaffed and struggling to generate higher returns.

Lastly, take the time to read the latest Absolute Return Letter, The Real Burden of Low Interest Rates. Niels Jensen explains why low rates are making it more difficult for all pensions to generate the returns they need, placing pressure on many of them which are already chronically underfunded.

Jensen looks at the funded status of UK, US, and German pensions and notes the following:
Some countries have begun to take action. Sweden, Denmark and the Netherlands have all permitted the local pension industry to use a fixed discount factor of 4.2%, and in the U.S. the regulator now allows the industry to use the average rate over the last 25 years when discounting future liabilities back to a present value.

Although initiatives such as these have the effect of reducing the present value of future liabilities and thus the amount of unfunded liabilities overall, they do absolutely nothing
in terms of addressing the core of the problem – low expected returns on financial assets in general and low interest rates in particular.
He's right, pensions better prepare for an era of low returns and if my forecast of a protracted period of global deflation materializes, it will decimate pensions and all the massaging and tinkering of discount rates won't make an iota of a difference. In fact, at that point, even central banks won't save the world.

Below, CCTV reports thousands of people rallied in Athens over the tax hikes and pension cutbacks included in the cash-for-reforms deal. The Greek pension system is in such dire straights that nobody is bothering to cover it. Still, if you ask me, Greece remains the very best place to retire in the world as long as you don't rely on the Greek government for your pension.

Friday, October 23, 2015

Four Views on DB vs DC Plans?

Nick Thornton of Benefitpro reports, DC vs DB: 4 views on new EBRI data (h/t, Pension Tsunami):
This week’s new data from the Employee Benefits Research Institute adds a new dimension to the vital question of the country’s retirement readiness.

In the report, researchers show that often, 401(k) plans can do a better job of replacing income in retirement than defined benefit plans can.

The report simulates savings outcomes for workers currently age 25 to 29, with at least 30 years of eligibility in a 401(k) plan.

It measures how often replacement rates of 60, 70, and 80 percent can be achieved by workers in four income quartiles if they participate in a 401(k) plan, compared to those levels of income replacement rates for participants in defined benefit plans.

When measured against a 60 percent income replacement rate, traditional pensions beat 401(k) for all workers, except those in the highest income quartile.

But as replacement rates are increased, 401(k) participants fare better, according EBRI.

Under the 70 percent replacement rate, workers in the top two income quartiles do resoundingly better than their counterparts in defined benefit pension plans.

Only 46 percent of workers in the second-highest income quartile can expect to replace 70 percent of income from a defined benefit plan, compared to 75 percent who contribute to a 401(k) plan.

When benchmarking against an 80 percent income replacement rate, workers in the top two income quartiles stand little chance of replacing as much income with traditional pension benefits, whereas 61 percent of workers in the second highest income quartile will be able to do so with distributions from a 401(k), and 59 percent of the best-paid workers will be able to do so through 401(k) savings, according to the modeling.

The take away: traditional defined benefit plans seem better for lowest income workers, especially the lower the income replacement rate.

Many 401(k) proponents will no doubt see the new data as supportive of their core argument: that participating in a defined contribution plan throughout the lion’s share of one’s working life will reap sufficient savings for a secure retirement.

Of course, others will disagree. Here is a look at four stakeholder views on the question of 401(k)’s efficacy, or inadequacy, in preparing the country for retirement.

Daniel Bennett, Managing Director, Advanced Pension Strategies

Bennett’s Southern California-based advisory provides specialized pension and tax-advantaged solutions for small employers.

He has real issues with EBRI’s new report. For starters, he says it’s based on generous return assumptions—the study uses an average annual return of 10.9 percent in 401(k) plans, which the institute tracked in plans between 2007 and 2013.

He also questions the validity of a 401(k) assessment that assumes 30 years of contributions, as EBRI’s report does.

Bennett tells BenefitsPro he is not partial to a defined benefit option to a 401(k), or vice versa, but he does admit to having a bias for small businesses.

“My field experience strongly indicates that 401(k)s are very deficient in providing positive retirement outcomes for anyone, owner and worker alike, in all but the largest firms and even then typically only for the higher wage earners,” said Bennett.

Selling 401(k) plans to the small business market is a “loss leader” for firms like Bennett’s.

He says providers are not incentivized to service the market, given the thin margins. He thinks the Department of Labor’s “draconian” fiduciary proposal will only make matters worse.

Defined contribution plans are part of the solution, he says, but don’t expect him to be in the camp that says 401(k)’s superiority is an open and shut case.

“Retirement Income outcomes are really the only thing that matters,” believes Bennett. “So when I read studies assuming 30 years of contributions and 10.9 percent growth rates, I can only sit there and scratch my head wondering what these guys are smoking.”

“They need to get out of the ivory tower and down in the trenches with me to see what is really happening,” he added.

Tony James, President and COO, Blackstone

A leader of one of world’s biggest private equity firms went on CNBC this week and said that the retirement crisis facing savers in their 20s and 30s will ultimately lead to a breakdown of the country’s financial structure.

“If we don't do something, we're going to have tens of millions of poor people and poverty rates not seen since the Great Depression,” James told CNBC.

He advocated a government-mandated Guaranteed Retirement Account system, of the kind famously recommended by labor economist Teresa Ghilarducci almost a decade ago.

Private equity firms like Blackstone have been trying to break into the 401(k) market for several years, with little documented success to date.

While James’ comments to CNBC were made outside the context of the EBRI report, he clearly would take issue with its assumptions.

He said 401(k)s typically earn 3 to 4 percent, while pension plans, which James said have an average allocation of 25 percent to alternative investments such as ones his firm manages, yield closer to 7 and 8 percent.

"The trick is to have these accounts invested like pension plans, so the money compounds over decades at 7 to 8 percent, not at 3 to 4," said James.

Economic Policy Institute

The self-described non-partisan think tank advocates on economic issues affecting low- and moderate-income Americans (Teresa Ghilarducci sits on its board, as do several of the country’s largest labor leaders).

This week it published its own report, claiming in 2014, “distributions from 401(k)s and similar accounts (including Individual Retirement Accounts (IRA), which are mostly rolled over from 401(k)s) came to less than $1,000 per year per person aged 65 and older.”

“On the other hand, seniors received nearly $6,000 annually on average from traditional pensions,” according to EPI’s blog post.

Its post was also independent of EBRI’s new study.

“Though 401(k) and IRA distributions will grow in importance in coming years, the amounts saved to date are inadequate and unequally distributed, and it is unlikely that distributions from these accounts will be enough to replace bygone pensions for most retirees, who will continue to rely on Social Security for the bulk of their incomes,” according to the institute.

Peter Brady, Senior Economist, Investment Company Institute (ICI)

The ICI, a trade group representing the interests of the mutual fund industry (Blackstone is a member), also works with EBRI to coordinate data on 401(k) savings rates.

Brady published a post, also independent of EBRI, calling to question the Economic Policy Institute’s defense of defined benefit plans.

“EPI has it wrong,” writes Brady. Its analysis is “highly misleading” for the following reasons, he argues.
  • It’s using unreliable data. Its source, the Bureau of Labor Statistics’ Current Population Survey (CPS), has consistently undercounted the income that retirees receive from employer-sponsored retirement plans and IRAs.
  • It’s backward looking. The people whose income it’s measuring, today’s retirees, haven’t enjoyed the benefits of today’s well-developed 401(k) system.
  • It’s gotten the math wrong. EPI’s analysts simply mishandled the data in ways that minimized the value of 401(k) plan and IRA distributions.
Unlike Peter Brady who represents the mutual fund industry, I don't question the non-partisan Economic Policy Institute or its findings that 401(k)s are a negligible source of retirement income for seniors.

In fact, maybe Brady is right for the wrong reasons. I would reckon the EPI has gotten the math wrong by overestimating the retirement income from 401(k)s which have been a monumental failure contributing to the ongoing retirement woes of millions of Americans getting crushed by pension poverty.

That is where I agree with Blackstone's Tony James. 401(k)s are not the solution to America's retirement crisis but neither is his idea of a government-mandated Guaranteed Retirement Account system which invests like U.S. pension funds getting eaten alive by hedge fund, private equity fund and real estate fund fees. James's solution is great for the Blackstones of this world and Wall Street, but it won't bolster America's retirement system, which is why I ripped into it in my last comment.

Moreover, Daniel Bennett, Managing Director of Advanced Pension Strategies is right to question the new data from the Employee Benefits Research Institute. It's based on unrealistic return assumptions which are even worse than the ones U.S. public pension funds use as they chase their rate-of-return fantasy foolishly believing they will achieve a 7-8% bogey in a deflationary supercycle which won't end any time soon.

Let me add a fifth and sobering view to this debate between DB vs DC plans, one which I've already covered in a previous comment of mine on the brutal truth on DC plans. In that comment, I noted the following:
Take the time to read the research report by the Canadian Public Pension Leadership Council. The research paper, Shifting Public Sector DB Plans to DC – The Experience so far and Implications for Canada, examines the claim that converting public sector DB plans to DC is in the best interests of taxpayers and other stakeholders by studying the experience of other jurisdictions, including Australia, Michigan, Nebraska, New York City, Saskatchewan and Texas and applying those lessons here in Canada. I thank Brad Underwood for bringing this paper to my attention.

I'm glad Canada's large public pension funds got together to fund this new initiative to properly inform the public on why converting public sector defined-benefit plans to private sector defined-contribution plans is a more costly option.

Skeptics will claim that this new association is biased and the findings of this paper support the continuing activities of their organizations. But if you ask me, it's high time we put a nail in the coffin of defined-contribution plans once and for all. The overwhelming evidence on the benefits of defined-benefit plans is irrefutable, which is why I keep harping on enhancing the CPP for all Canadians regardless of whether they work in the public or private sector.

And while shifting to defined-contribution plans might make perfect rational sense for a private company, the state ends up paying the higher social costs of such a shift. As I recently discussed, trouble is brewing at Canada's private DB plans, and with the U.S. 10-year Treasury yield sinking to a 16-month low today, I expect public and private pension deficits to swell (if the market crashes, it will be a disaster for all pensions!).

Folks, the next ten years will be very rough. Historic low rates, record inflows into hedge funds, the real possibility of global deflation emanating from Europe, will all impact the returns of public and private assets. In this environment, I can't underscore how important it will be to be properly diversified and to manage assets and liabilities much more closely.

And if you think defined-contribution plans are the solution, think again. Why? Apart from the fact that they're more costly because they don't pool resources and lower fees --  or pool investment risk and longevity risk -- they are also subject to the vagaries of public markets, which will be very volatile in the decade(s) ahead and won't offer anything close to the returns of the last 30 years. That much I can guarantee you (just look at the starting point with 10-year U.S. treasury yield at 2.3%, pensions will be lucky to achieve 5 or 6% rate of return objective).

Public pension funds are far from perfect, especially in the United States where the governance is awful and constrains states from properly compensating their public pension fund managers. But if countries are going to get serious about tackling pension poverty once and for all, they will bolster public pensions for all their citizens and introduce proper reforms to ensure the long-term sustainability of these plans.

Finally, if you think shifting public sector DB plans into DC plans will help lower public debt, think again. The social welfare costs of such a shift will completely swamp the short-term reduction in public debt. Only economic imbeciles at right-wing "think tanks" will argue against this but they're completely and utterly clueless on what we need to improve pension policy for all our citizens.

The brutal truth on defined-contribution plans is they're more costly and not properly diversified across public and private assets. More importantly, they will exacerbate pension poverty which is why we have to enhance the Canada Pension Plan (CPP) for all Canadians allowing more people to retire in dignity and security. These people will have a guaranteed income during their golden years and thus contribute more to sales taxes, reducing public debt.   
In short, I believe that now is the time to introduce real change to Canada's retirement system and enhance the CPP for all Canadians.

I'm also a big believer that the same thing needs to happen in the United States by enhancing the Social Security for all Americans, provided they get the governance right, pay their public pension fund managers properly to manage the bulk of the assets internally and introduce a shared risk pension model in their public pensions.

It's high time the United States of America goes Dutch on pensions and follows the Canadian model of pension governance. Now more than ever, the U.S. needs to enhance Social Security for all Americans and implement the governance model that has worked so well in Canada, the Netherlands, Denmark and Sweden (and even improve on it).

And some final thoughts for all of you confused between defined-benefit and defined-contribution plans. Nothing, and I mean nothing, compares to a well-governed defined-benefit plan. The very essence of the pension promise is based on what DB, not DC, plans offer. Only a well-governed public DB plan can offer retirees a guaranteed income for the rest of their life.  

What are the main advantages of well-governed DB plans? They pool investment risk, longevity risk, and they significantly lower costs by bringing public and private investments and absolute return strategies internally to be managed by properly compensated pension fund managers. DB plans also offer huge benefits to the overall economy, ones that will bolster the economy in tough times and reduce long-term debt.

In short, there shouldn't be four, five or more views on DB vs DC plans. The sooner policymakers accept the brutal truth on DC plans, the better off hard working people and the entire country will be over the very long run.

Below, my favorite older clip where CBS editor-in-chief Eric Schurenberg explains why the great 401(k) experiment has failed.  If you ask me, America's 401(k) nightmare isn't over and it will get worse until U.S. policymakers radically transform their retirement system by enhancing Social Security and adopting Canada's successful public pension governance and shared risk models.

And Nicole Musicco, MD and new head of APAC at the Ontario Teachers' Pension Plan, discusses the fund's portfolio diversification. Listen carefully to her comments and you'll understand why most of the world's pension fund heroes are here in Canada.

I wish you all a great weekend and remind you to please contribute to this blog via PayPal at the top right-hand side. Institutional investors are kindly requested to subscribe using one of three options. If you have anything to add to this debate, feel free to contact me at