Thursday, December 17, 2015

Canadian Pensions Betting On Energy Sector?

Allison Lampert of Reuters reports, Canadian pension fund PSP eyes energy sector amid oil slump:
The Public Sector Pension Investment Board, one of Canada's 10 largest pension fund managers, is considering entering the oil and gas sector, as weak crude prices create opportunities for long-term investors, said Chief Executive Andre Bourbonnais.

"It's one asset class we're looking into," Bourbonnais told media in Montreal on Tuesday. "We do not currently have the internal expertise really, so we're trying to look at how we're going to build it first."

Last week, the head of Healthcare of Ontario Pension Plan (HOOPP) expressed a similar sentiment, stating the prolonged weakness in energy prices is making valuations in the oil and gas attractive and revealed HOOPP is considering upping its investments in Canadian equities in response.

The interest mirrors that of larger Canadian pension funds such as Canada Pension Plan Investment Board (CPPIB) and Ontario Teachers' Pension Plan Board.

In June, Cenovus Energy (CVE.TO), Canada's second-largest independent oil producer, agreed to sell its portfolio of oil and gas royalty properties to Ontario Teachers' for about C$3.3 billion.

Bourbonnais, who joined PSP earlier this year from CPPIB, said he does not think oil prices have come close to hitting bottom.

"I think these markets have a ways to go," said Bourbonnais, who was previously global head of private investments at CPPIB, one of Canada's most-active dealmakers with over C$272 billion ($198 billion) in assets under management.

Montreal-based PSP, which manages about C$112 billion ($81.6 billion) in assets, mostly for Canada's public service, is also growing globally with the opening of offices in London in 2016 and Asia in 2017.

PSP is the 4th largest public pension fund manager in Canada behind CPPIB, Quebec's pension fund La Caisse de depot et placement du Quebec, and Ontario Teachers.

The fund is reviewing its hedging policy, given the current weakness in the Canadian dollar.

"We need to figure out what our hedging policy is going to be," Bourbonnais said. "Right now we have got a strategy that's hedging about half of our assets."
Interesting article for a few reasons. First, you'll notice how PSP's President and CEO, André Bourbonnais, is a lot more open to the media than his predecessor (he should also take the time to meet the world's most prolific pension blogger, especially since he's right in his own backyard).

Second, PSP has been very busy lately ramping up its global investments which now include a leveraged finance unit run out of its New York City office. I'm sure that team run by David Scudellari is going to be very busy in 2016 following the latest hiccup in credit markets.

[Note: Those of you who want to understand leveraged finance a lot better can pick up a copy of Robert S. Kricheff's A Pragmatist's Guide to Leveraged Finance, a nice primer on the topic which is available in paperback. There are a few other books on the topic I'd recommend but they're more technical and more expensive.]

Third, as I recently stated when I looked into why Japan's pension whale got harpooned in Q3, CPPIB gained a record 18.3% in FY 2015 and the value of its investments got a $7.8-billion boost from a decline in the Canadian dollar against certain currencies. By contrast, PSP Investments is 50% hedged in currencies which explains part of its underperformance relative to CPPIB in fiscal 2015. So, while I understand why PSP is "reviewing its hedging policy," it's a bit late in the game even if the loonie is heading lower (see below).

Fourth, and more interestingly, some of Canada's biggest pension funds are now starting to increase their investments in the oil and gas sector. Are they insane or are they also betting big on a global recovery and destined to be disappointed?

That will be the topic in today's version of Pension Pulse. What are my thoughts on the Canadian oil & gas sector? I agree with André Bourbonnais, I don't think oil prices have hit bottom yet and these markets have a ways to go (south). AIMCo's CEO Kevin Uebelein shared those exact same sentiments with me last month during our lunch here in Montreal and he even told me that AIMCo's Alberta real estate will be marked down but he sees opportunities opening up in that province's real estate in the next couple of years.

I personally have been short Canada since December 2013 when I talked to AIMCo's former CEO Leo de Bever on oil prices and the disaster that lies ahead. In fact, I got out of all my Canadian investments, bought U.S. stocks and told my readers the loonie is heading below 70 US cents back in January 2013. And now more than ever, I'm convinced negative interest rates are coming to Canada no matter what the new Liberal government does to buffer the shock.

[Note: As expected the Fed did raise rates by 25 basis points but the FOMC statement was dovish and somewhat eerily optimistic. Read my recent comment on the Fed's tacit aim and see what billionaire real estate investor Sam Zell said about the likelihood of a U.S. recession over the next 12 months. It's all about the surging greenback!!]

In stocks, I've been warning my readers to steer clear of emerging markets (EEM), Chinese (FXI), Energy (XLE), Oil Services (OIH), Oil & Gas Exploration (XOP), and Metals & Mining (XME) and/ or to short any countertrend rallies in these sectors. It's been a brutal year for these sectors and unless you're convinced that the global economy has hit bottom and is going to significantly surprise to the upside, you're best bet is to continue avoiding these sectors (or trade them very tightly as there will be countertrend rallies).

My investment approach and thinking is always governed by one major theme: DEFLATION. Are we truly at the end of the deflation supercycle?  I don't think so and keep referring to these six structural factors which explain why deflationary headwinds are here to stay for a very long time:
  • The global jobs crisis: Jobs are vanishing all around the world at an alarming rate. Worse still, full-time jobs with good wages and benefits are being replaced with part-time jobs with low wages and no benefits.
  • Demographics: The aging of the population isn't pro-growth. As people get older, they live on a fixed income, consume less, and are generally more careful with their meager savings. The fact that the unemployment rate is soaring for younger workers just adds more fuel to the fire. Without a decent job, young people cannot afford to get married, buy a house and have children.
  • The global pension crisis: A common theme of this blog is how pension poverty is wreaking havoc on our economy. It's not just the demographic shift, as people retire with little or no savings, they consume less, governments collect less sales taxes and they pay out more in social welfare costs. This is why I'm such a stickler for enhanced CPP and Social Security, a universal pension which covers everyone (provided governments get the governance and risk-sharing right).
  • Rising inequality: The ultra wealthy keep getting richer and the poor keep getting poorer. Who cares? This is how it's always been and how it will always be. Unfortunately, as Warren Buffett and other enlightened billionaires have noted, the marginal utility of an extra billion to them isn't as useful as it can be to millions of others struggling under crushing poverty. Moreover, while Buffett and Gates talk up "The Giving Pledge", the truth is philanthropy won't make a dent in the trend of rising inequality which is extremely deflationary because it concentrates wealth in the hands of a few and does nothing to stimulate widespread consumption.
  • High and unsustainable debt in the developed world: Government and household debt levels are high and unsustainable in many developed nations. This too constrains government and personal spending and is very deflationary.
  • Technology: Everyone loves shopping on-line to hunt for bargains. Technology is great in terms of keeping productivity high and prices low, but viewed over a very long period, great shifts in technology are disinflationary and some say deflationary.
All these factors are deflationary and bond friendly which is one reason why I dismiss any talk of a bond market bubble from gurus who clearly don't understand the bigger picture (the bond market is always right!).

Anyways, why am I continuously harping on deflation? Because it's the most important macro trend and it has the potential to disrupt the global economy for a very long time.

Importantly, when people talk about the slump in oil prices being driven only by supply factors, I can't help but wonder what planet they live on. The slump in oil and commodities is driven by excess supply and deficient demand and anyone who thinks otherwise is simply wrong.

I remember back in 2005, I was looking into commodities for PSP and attended a Barclays conference on commodities in London. Back then investors were enamored by "BRICS" and commodities and I remember thinking to myself the only thing missing from these conferences were cheerleaders with pom-poms.

It was such a joke but luckily I was able to convince PSP's board to stay away from commodities as an asset class and that decision saved them from huge losses (just ask Ontario Teachers which has been hemorrhaging money in its commodities portfolio in the last few years).

Anyways, back to Canadian pensions investing in the oil and gas sector. These pensions are long-term investors and they can invest in public and private markets. A lot of private equity funds are going to get killed on their large energy bets but they don't have the long investment horizon that Canada's top pensions have which is another reason I agree with those warning of PE's future returns.

Apart from private equity, however, Canadian pensions can play a rebound in oil & commodities via real estate buying up properties in Calgary and Edmonton (like AIMCo will be doing) or even in countries like Brazil and Australia.

And then, of course, they can just buy shares of public companies in oil & gas and commodities which have all been hit hard in 2015. But again, any private or public investment in energy is essentially a call on the global economy, and if Ken Rogoff is right, there a lot more pain ahead for commodity producers.

How bad are things for commodities? Bloomberg reports that one of the last metals hedge funds says China will bring more pain and if you look at the chart below that Sober Look tweeted, the selloff is relentless (click on image):

This is why even though I'm against passive investments in commodities, I think the best way to invest in this asset class in through active commodities managers. Reuters recently reported on how some oil traders are profiting handsomely from a crude price crash to near an 11-year low, even as it forces energy companies around the globe to slash costs and postpone projects.

Last December, Pierre Andurand of Andurand Capital wrote a great comment for my blog on where he saw oil prices heading. His energy-focused hedge fund Andurand Capital is up 8 percent in the year to Dec. 11 and given how poorly his competitors have performed, his performance is exceptional. Andurand is on record stating he sees oil prices below $30 a barrel (I agree with Goldman, see oil prices heading to $20 a barrel over the next two years which is why I'm still bearish on the loonie). 

What's my point with all this information? All these pension funds can invest in the oil & gas sector via a myriad of ways, including innovative technologies that Leo de Bever has been calling for, but also through active internal or external managers who deliver absolute returns.

The problem with big pensions is they need scale which is why they opt for large public and private investments instead of going to external commodity hedge funds, most of which are performing terribly anyways. Valuations are compelling, especially if you think a global recovery is in the offing next year, but there's a real risk these investments will take a lot longer to realize gains or even suffer huge losses, especially if global deflation materializes.

Those are my thoughts on this topic. If you have another view, let me know and I'll be glad to post it. Please remember to donate or subscribe to my blog on the top right-hand side and show your appreciation for my hard work and help support my efforts in bringing you the very best insights on pensions and investments.

Below, billionaire investor Sam Zell says the U.S. economy could go into a recession in the next year and that an expected Federal Reserve interest-rate increase is coming at least six months too late. I don't agree on his call that rates should have been increased six months ago but agree with him that the mighty greenback will wreak havoc on the U.S. economy and exacerbate the Fed's deflation problem.

Also, DoubleLine Capital co-founder and CEO Jeffrey Gundlach, discusses the conditions in the junk bond market compared to 2008, and when this market becomes an opportunity. Great interview, listen closely to what Gundlach especially on credit hedge funds that are down significantly and "that pressure will weigh on the junk bond market for some time to come."

Gundlach also joined CNBC's Fast Money to discuss the one thing traders should watch for after the Fed hike, his outlook on the rate hike and latest Fed action, stating there is a 1/3 chance of a U.S. recession in 2016 and the Fed won't follow through on dot projection.

All great insights from the reigning bond king and while I don't agree with his calls on the U.S. dollar or stocks, I certainly agree with him that even though the high yield blow-up won't crash markets, credit markets are vulnerable to further deterioration as oil prices slump and credit hedge funds get a wave of redemptions coming their way.

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