Thursday, April 30, 2015

Ron Mock Sounds Alarm on Alternatives?

Arlene Jacobius of Pensions & Investments reports, Ontario Teachers CEO calls alternative investments ‘too expensive’:
Ontario Teachers’ Pension Plan, Toronto, is starting to step back from investing in alternative investments such as real estate and infrastructure because they are “too expensive,” said Ron Mock, president and CEO of the C$154.4 billion ($126.4 billion) pension fund, while speaking on a panel at the Milken Institute Global Conference in Beverly Hills, Calif., on Wednesday.

“There’s a lot of money crowded into the broadly defined alternatives space,” Mr. Mock said. “We find it too expensive. It’s time for us to step back.”

Instead, Ontario Teachers executives are investing “between the asset classes where we found the most interesting deals today,” he said.

For example, Ontario Teachers is an investor in the U.K. and Irish lotteries for their stable cash flows and high rate of return, which can be improved with technological upgrades, Mr. Mock said.

“(The lottery investment) is almost like an infrastructure asset,” he said.

Even though Ontario Teachers is being more cautious in its infrastructure investments, Canada’s eight pension funds are “dying to come into the U.S. to fund (the country’s) infrastructure needs” using direct investments, Mr. Mock said. “We are working with the government because there are impediments.”

But Mr. Mock said sovereign wealth funds and pension plans are untapped capital pools for global infrastructure.

Hiromichi Mizuno, executive managing director and chief investment officer of Japan’s ¥137 trillion ($1.15 trillion) Government Pension Investment Fund, Tokyo, also said on the panel that the pension fund has a 5% cap rather than a target allocation for alternative investments. This means Japan’s pension fund executives can invest in alternative investments opportunistically rather than try to meet a target allocation.
In order to better appreciate the context of Ron Mock's remarks, I highly recommend you read my overview of Teachers' 2014 results where he shared a lot of insights on their asset-liability approach to investing.

I've known Ron long enough to tell you he doesn't make big proclamations to get his name in the papers. He's been thinking long and hard of what increased competition from global pensions and sovereign wealth funds means for Ontario Teachers and other big investors.

And Ron is always thinking about risks that lurk ahead -- like 18 to 24 months ahead! I remember a time when he came over to the Caisse and talked about his investment approach in front of Henri-Paul Rousseau, Gordon Fyfe and others. On the plane ride over to Montreal, he had jotted some notes on a napkin which would form the basis of his strategy and he had forgotten the napkin in the conference room on the 11th floor. Gordon called me to go pick it up from the conference room and bring it to him outside as they shared a ride after the meeting (I didn't peek, I swear!).

So why is Ron Mock sounding the alarm on alternatives? Maybe he's worried that we are about to experience a significant shift in Fed policy which will undermine America's risky recovery and hurt real estate and infrastructure assets. Or maybe he's worried of global deflation which will be even more devastating to risk assets, especially illiquid alternatives. Or maybe he just thinks things are getting out of whack and this huge influx of sovereign wealth and pension money chasing yield at all cost is bidding up prices of private market investments to ridiculous levels.

I don't know exactly what he's thinking but he reads my blog regularly and he knows my thoughts as I've personally expressed them to him. I love what Tom Barrack, the king of real estate who cashed out before the crisis said at the time: "There's too much money chasing too few good deals, with too much debt and too few brains."

In January 2013, I openly questioned whether pensions are taking on too much illiquidity risk, and used insights from Jim Keohane, president and CEO of the Healthcare of Ontario Pension Plan (HOOPP) to make some points. Jim shared the following back then:
I find this whole discussion quite interesting. I agree with the commentary of the former pension fund manager. Private assets are just as volatile as public assets. When private assets are sold the main valuation methodology for determining the appropriate price is public market comparables, so you would be kidding yourself if you thought that private market valuations are materially different than their public market comparables. Just because you don’t mark private assets to market every day doesn’t make them less volatile, it just gives you the illusion of lack of volatility.

Another important element which seems to get missed in these discussions is the value of liquidity. At different points in time having liquidity in your portfolio can be extremely valuable. One only needs to look back to 2008 to see the benefits of having liquidity. If you had the liquidity to position yourself on the buy side of some of the distressed selling which happened in 2008 and early 2009, you were able to pick up some unbelievable bargains.
Moving into illiquid assets increases the risk of the portfolio and causes you to forgo opportunities that arise from time to time when distressed selling occurs - in fact it may cause you to be the distressed seller! Liquidity is a very valuable part of your portfolio both from a risk management point of view and from a return seeking point of view. You should not give up liquidity unless you are being well compensated to do so. Current private market valuations do not compensate you for accepting illiquidity, so in my view there is not a very compelling case to move out of public markets and into private markets at this time.
Interestingly, nothing has changed since Jim shared those comments. If anything, things have gotten much worse from a valuation perspective and risks are higher than ever now that the Fed is hinting it's ready to start raising rates if economic data improves.

But even if the Fed doesn't raise rates anytime soon, the advent of global deflation should give big investors enough worries to pause and think about their entire strategy toward alternatives. Is it time to stick a fork in private equity? Are hedge fund fees ridiculously high? Is real estate the mother of all alternatives bubble, ready to burst and wreak havoc on public pensions and sovereign wealth funds?

On that last question, Tom Barrack (yup, the same guy from above), came out at the Milken conference to warn of amateurs investing in riskier assets:
Too many investors have moved outside their areas of expertise as they seek higher returns, posing dangers for riskier assets, according to Colony Capital Inc. Executive Chairman Thomas Barrack Jr.

“Everybody is outside of their own asset class,” Barrack said in a Bloomberg Television interview Tuesday with Erik Schatzker and Stephanie Ruhle at the Milken Institute Global Conference in Beverly Hills, California. “When amateurs enter the marketplace for all of this, you are going to get an abundance of something and it is usually not good.”

Central banks globally have pushed investors into higher-yielding assets by reducing interest rates and purchasing bonds. The Standard & Poor’s 500 Index reached an all-time high on Friday and sovereign debt in Europe is trading at negative yields.

“Institutional investors that are in this endless search for yield are ignoring the risk peril of all the consequences of those things,” he said.

Investors with an abundance of liquidity have used real estate as a safe haven, Barrack, 68, said. Apartments in New York City and London are serving as a “safe deposit box” for foreign investors, he said. The influx of money, particularly from international players seeking less risk, has pushed up property values.

“Real estate has become the last bastion,” he said. “The liquidity in the world has created this flurry for solidity. If you do not think there is a bubble at that level, you are going to be mistaken.”
Little Experience

Capitalization rates, a measure of real estate investment yield that falls as prices rise, are being driven down by buyers with less experience in property investing, Sam Zell, the billionaire chairman of Equity Group Investments, said during a Global Conference panel discussion about real estate.

“Capital investment in the last 10 to 20 years is all about allocation,” said Zell, 73. “It’s not a whole bunch of amateurs, but a bunch of people that may not have a lot of experience in real estate, but with a whole lot of money.”

To protect themselves from possible future losses, real estate investors should look for “equity-type returns” in the capital stack, Barrack said during the panel discussion.

“Floating debt can choke and kill you quickly,” he said.
Stagnant Rents

While commercial-property prices have risen, office rents in most urban downtowns, with the exception of New York City, are effectively at the same levels as 20 years ago, Barrack said.

Including such expenses as leasing commissions, tenant improvements and property taxes, “if you effectuate down in current dollars, true office rents are about the same as in 1995,” he said in the television interview.

Colony Capital oversaw about $24 billion of equity before Barrack combined it with Colony Financial Inc. this year. His firm in recent years has owned Michael Jackson’s Neverland Ranch, invested in single-family rental homes and distressed mortgages.

“When the masses start entering the water and thinking they can navigate the waves, I get out,” said Barrack.
Got to love Tom Barrack, he just says it like it is. Real estate, which has long been touted as the best asset class, might have seen its best days ever as the future looks increasingly gloomy for a lot of reasons, especially if America's risky recovery falters next year.

Barbara Corcoran, founder at The Corcoran Group, talked about New York City real estate on Bloomberg, the lack of affordable housing in the city and why the market may be in a new bubble. She thinks things are fine but she's so blatantly talking up her business.

And it's not just New York. The same nutty thing is going on in London and other real estate hot spots around the world as the world's elite fight with global pensions and sovereign wealth funds for prime real estate assets. What a joke, this is definitely going to end badly and a bunch of amateurs are going to get their heads handed to them.

Below, Ron Mock, Ron Mock, president and CEO of the Ontario Teachers' Pension Plan, discusses Teachers' investment approach on Bloomberg television.

Also, André Bourbonnais, president and chief executive officer of the Public Sector Pension Investment Board, Winston Wenyan Ma, managing director and head of the North America Office at China Investment Corporation, Ron Mock, president and chief executive officer of Ontario Teachers Pension Plan, and Michael Sabia, president and chief executive officer of Caisse de dépôt et placement du Québec, participate in a panel discussion about Canadian pension plans and investment strategy. Bloomberg's Scott Deveau moderates the panel at the Bloomberg Canada Economic Series in Toronto.


Update: An astute private equity manager sent me this after reading my comment above:
These sweeping asset class statements are perhaps too broad, although no doubt like every asset class, valuations are high by historical standard. But whether this means an asset class issue or reflects an OTPP specific portfolio view deserves further thought. There are many ways to construct PE exposure, and not all portfolios share common attributes. That's why institutional PE performance is all over the map at any point in time.

As to whether there is more or less volatility in PE verses public markets, that's also more portfolio specific than the commentators note. There are huge variations in structures and types of underlying investments that make for many choices that are part of active portfolio management. Some portfolios are in fact less volatile and/or cyclical by design, others not.

In such a non-homogenous and flexibly defined area like PE, overall and average asset class attributes are not instructive as to merit or lack thereof of this style of investing. At the heart is whether one gets paid for illiquidity. At an average asset class level, this has probably not been the case for many years, it just takes a long time for this outcome to both surface and be understood.

The solution is that PE should be viewed as an execution business, not an allocation business. Through this lens, the opportunity for playing a role in a larger organization's portfolio context is cultural. Those with long term beliefs aligned with the reality of the activity will, as usual, do fine.
I thank this person for sharing these insights and agree with many of the points he raises. Still, when you are the size of OTPP, you can't help but making broad asset class observations and I think many big institutions should heed Ron Mock's warning and keep it in mind as they pile into alternatives.

Wednesday, April 29, 2015

America’s Risky Recovery?

Martin Feldstein, Professor of Economics at Harvard University, wrote a comment for Project Syndicate on America’s risky recovery:
The United States’ economy is approaching full employment and may already be there. But America’s favorable employment trend is accompanied by a substantial increase in financial-sector risks, owing to the excessively easy monetary policy that was used to achieve the current economic recovery.

The overall unemployment rate is down to just 5.5%, and the unemployment rate among college graduates is just 2.5%. The increase in inflation that usually occurs when the economy reaches such employment levels has been temporarily postponed by the decline in the price of oil and by the 20% rise in the value of the dollar. The stronger dollar not only lowers the cost of imports, but also puts downward pressure on the prices of domestic products that compete with imports. Inflation is likely to begin rising in the year ahead.

The return to full employment reflects the Federal Reserve’s strategy of “unconventional monetary policy” – the combination of massive purchases of long-term assets known as quantitative easing and its promise to keep short-term interest rates close to zero. The low level of all interest rates that resulted from this policy drove investors to buy equities and to increase the prices of owner-occupied homes. As a result, the net worth of American households rose by $10 trillion in 2013, leading to increases in consumer spending and business investment.

After a very slow initial recovery, real GDP began growing at annual rates of more than 4% in the second half of 2013. Consumer spending and business investment continued at that rate in 2014 (except for the first quarter, owing to the weather-related effects of an exceptionally harsh winter). That strong growth raised employment and brought the economy to full employment.

But the Fed’s unconventional monetary policies have also created dangerous risks to the financial sector and the economy as a whole. The very low interest rates that now prevail have driven investors to take excessive risks in order to achieve a higher current yield on their portfolios, often to meet return obligations set by pension and insurance contracts.

This reaching for yield has driven up the prices of all long-term bonds to unsustainable levels, narrowed credit spreads on corporate bonds and emerging-market debt, raised the relative prices of commercial real estate, and pushed up the stock market’s price-earnings ratio to more than 25% higher than its historic average.

The low-interest-rate environment has also caused lenders to take extra risks in order to sustain profits. Banks and other lenders are extending credit to lower-quality borrowers, to borrowers with large quantities of existing debt, and as loans with fewer conditions on borrowers (so-called “covenant-lite loans”).

Moreover, low interest rates have created a new problem: liquidity mismatch. Favorable borrowing costs have fueled an enormous increase in the issuance of corporate bonds, many of which are held in bond mutual funds or exchange-traded funds (ETFs). These funds’ investors believe – correctly – that they have complete liquidity. They can demand cash on a day’s notice. But, in that case, the mutual funds and ETFs have to sell those corporate bonds. It is not clear who the buyers will be, especially since the 2010 Dodd-Frank financial-reform legislation restricted what banks can do and increased their capital requirements, which has raised the cost of holding bonds.

Although there is talk about offsetting these risks with macroprudential policies, no such policies exist in the US, except for the increased capital requirements that have been imposed on commercial banks. There are no policies to reduce risks in shadow banks, insurance companies, or mutual funds.

So that is the situation that the Fed now faces as it considers “normalizing” monetary policy. Some members of the Federal Open Market Committee (FOMC, the Fed’s policymaking body) therefore fear that raising the short-term federal funds rate will trigger a substantial rise in longer-term rates, creating losses for investors and lenders, with adverse effects on the economy. Others fear that, even without such financial shocks, the economy’s current strong performance will not continue when interest rates are raised. And still other FOMC members want to hold down interest rates in order to drive the unemployment rate even lower, despite the prospects of accelerating inflation and further financial-sector risks.

But, in the end, the FOMC members must recognize that they cannot postpone the increase in interest rates indefinitely, and that once they begin to raise the rates, they must get the real (inflation-adjusted) federal funds rate to 2% relatively quickly. My own best guess is that they will start to raise rates in September, and that the federal funds rate will reach 3% by some point in 2017.
Martin Feldstein is an excellent economist and someone I take seriously but I humbly disagree with so many of the points he raises above and need to go over them in detail below.

First and foremost, I agree with Feldstein, the Fed is about to change course, and it will wreak havoc in markets. But unlike him, I'm in the Larry Summers/ Ray Dalio/ Jeffrey Gundlach camp and truly believe if the Fed starts raising rates anytime soon, it will be making a monumental policy mistake.

Importantly, Gundlach is right, this time is really different, and if the Fed starts raising rates, it will all but ensure another financial crisis and global deflation which will spread to America.

That brings me to my second point. Feldstein seems to think that bond yields are "artificially low" because of the Fed's "unconventional monetary policy." I happen to think that bond yields are at historic lows all around the world not because central banks are engaging in massive quantitative easing but because in the global titanic battle of inflation vs deflation, the latter is clearly winning.

When I read articles on how the euro area’s brush with deflation might be over before it even started, I can't help but cry. Who are we kidding here? Any macro 101 student will tell you this temporary blip in the eurozone's inflation is all about the sinking euro, it has nothing to do with the underlying structural economies of the eurozone which remain very weak.

In fact, surveys from the region's services and manufacturing sectors recently indicated the eurozone's economic recovery could be at risk of losing momentum:
Markit's composite flash April Purchasing Managers Index fell to 53.5 in April from 54.0 in March, below analyst expectations in a Reuters' poll for a reading of 54.4.

The headline index, which remained above the 50-mark that is consistent with expansion, is based on surveys of thousands of companies and viewed by analysts as a good gauge of growth.

"Disappointing overall but not disastrous," said Howard Archer, chief European economist at IHS Global Insight, in a note. "Euro zone manufacturing and services expansion unexpectedly moderated in April according to the purchasing managers, perhaps providing a reality check on the strength of the region's upturn."

Archer added that it remains to be seen whether the slowdown in business growth was mostly a correction after four months of improvement, or a sign that a pick-up in euro zone economic activity was levelling off.

Earlier on Thursday, Markit's German flash composite PMI fell to 54.2 in April from an eight-month peak of 55.4 in March. France's composite PMI, meanwhile, fell to 50.2 from 51.5 in March.

"We also had the reading from France and the French manufacturing and services PMI data has done what it does the best - disappoint investors to their core," said Naseem Aslam, chief market analyst at AvaTrade, in a note.
Again, all this talk of a eurozone recovery has more to do with the mighty greenback surging higher relative to all currencies, especially the euro, and less to do with the underlying structural economies.

But the U.S. dollar dropped to an eight-week low on Tuesday after an unexpectedly weak U.S. consumer confidence report for April, with investors growing cautious about a Federal Reserve meeting which could prove to be a major shift in policy:
That meeting could reinforce the view that the pace of U.S. interest rate increases would be slower than initially thought. The Fed is expected to keep interest rates on hold, but the main focus will be on the statement at the end of its policy meeting on Wednesday.

Worries that the U.S. economy is stalling, following a run of soft data, have seen the dollar lose 4 percent in the past six weeks as expectations of a rate rise in June have faded. But many still expect the Fed to lift rates in September.
I fully expect the Fed to hint that it's ready to start raising rates when it delivers its monetary policy comment later today. Risk assets will tank and there will be an uneasy period that will follow, making this a very hot and uncomfortable summer from a monetary policy perspective.

This is one reason why I don't agree with hedge funds that think now is the time to short the U.S. dollar. When there is heightened uncertainty in global financial markets, investors flock to good old U.S. bonds.

Another problem with Feldstein's comment above is that just like many others top American economists (and the Fed), he seems to think the U.S. economy operates in a vacuum and is totally insulated from global events.

Nothing can be further from the truth. The focus is once again on Greece where things are quickly reaching a boiling point. The only hope there is that 'Varoufexit' will mean no Grexit but with Tsipras in Dreamland, it is far from clear how things will play out there, especially since Syriza's failure could bring about political chaos in Greece.

But above and beyond Greece, which is nothing more than an endless distraction, the real worry is China. Another great economist, Nobel-laureate Michael Spence, wrote an excellent comment for Project Syndicate on China's slowing new normal:
The world’s two largest economies, the United States and China, seem to be enduring secular slowdowns. But there remains considerable uncertainty about their growth trajectory, with significant implications for asset prices, risk, and economic policy.

The US seems to be settling into annual real (inflation-adjusted) growth rates of around 2%, though whether this is at or below the economy’s potential remains a source of heated debate. Meanwhile, China seems to be headed for the 6-7% growth rate that the government pinpointed last year as the economy’s “new normal.” Some observers agree that such a rate can be sustained for the next decade or so, provided that the government implements a comprehensive set of reforms in the coming few years. Others, however, expect China’s GDP growth to continue to trend downward, with the possibility of a hard landing.

There is certainly cause for concern. Slow and uncertain growth in Europe – a major trading partner for both the US and China – is creating headwinds for the US and China.

Moreover, the US and China – indeed, the entire global economy – are suffering from weak aggregate demand, which is creating deflationary pressures. As central banks attempt to combat these pressures by lowering interest rates, they are inadvertently causing releveraging (an unsustainable growth pattern), elevated asset prices (with some risk of a downward correction, given slow growth), and devaluations (which merely move demand around the global economy, without increasing it).

For China, which to some extent still depends on external markets to drive economic growth, this environment is particularly challenging – especially as currency depreciation in Europe and Japan erode export demand further. Even without the crisis in major external markets, however, a large and complex middle-income economy like China’s could not realistically expect growth rates above 6-7%.

Yet, in the aftermath of the global economic crisis, China insisted on maintaining extremely high growth rates of 9% for two years, by relying on fiscal stimulus, huge liquidity injections, and a temporary halt in the renminbi’s appreciation. Had the government signaled the “new normal” earlier, expectations would have been conditioned differently. This would have discouraged undue investment in some sectors, reduced non-performing loans, and contained excessive leverage in the corporate sector, while avoiding the mispricing of commodities. Growth would still have slowed, but with far less risk.

In the current situation, however, China faces serious challenges. Given weak growth in external demand and an already-large market share for many goods, China cannot count on export growth to sustain economic performance in the short run. And, though support for infrastructure investment by China’s trading partners – especially through the “one belt, one road” policy – may help to strengthen external markets in the longer term, this is no substitute for domestic aggregate demand.

Investment can sustainably drive growth only up to the point when returns decline dramatically. In the case of public-sector investment, that means that the present value of the increment to the future GDP path (using a social discount rate) is greater than the investment itself.

The good news is that growing discipline seems to be pushing out low-return investment. And there is every reason to believe that investment will remain high as the economy’s capital base expands.

But, in order to boost demand, China will also need increased household consumption and improved delivery of higher-value services. Recent data suggest that, notwithstanding recent wage increases, consumption amounts to only about 35% of GDP. With a high household savings rate of around 30% of disposable income, per capita disposable income amounts to roughly half of per capita GDP. Expanded social-security programs and a richer menu of saving and investment options could go a long way toward reducing precautionary saving and boosting consumption. But what is really needed is a shift in the distribution of income toward households.

Without a concerted effort to increase households’ share of total income and raise consumption’s share of aggregate demand, growth of consumer products and services on the supply side will remain inadequate. Given that services are a significant source of incremental employment, their expansion, in particular, would help to sustain inclusive growth.

Another key challenge concerns China’s slumping property sector, in which construction and prices dropped rapidly last year. If highly leveraged developers are under stress, they could produce non-performing loans – and thus considerable risk – in both the traditional and shadow banking sectors.

Fortunately, Chinese households’ relatively low leverage means that the kind of balance-sheet damage that occurred in some advanced countries during the crisis, leading to a huge drop in demand, is unlikely, even if real-estate prices continue to decline. It also means that there remains some space for expanding consumer credit to boost demand.

That is not the only source of hope. Wages are rising, deposit insurance will be introduced, and deposit rates are being liberalized. Internet investment vehicles are growing. New businesses in the services sector – 3.6 million of which were started just last year – are generating incremental employment, thanks partly to a new streamlined licensing framework. And online platforms are facilitating increased consumption, while expanding market access and financing for smaller businesses.

China’s leaders should aim to accelerate and build upon these trends, rather than pursuing additional fiscal and monetary stimulus. Public investment is high enough; expanding it now would shift the composition of aggregate demand in the wrong direction. And, with the corporate sector already overleveraged, a broad-based expansion of credit is not safe.

Any fiscal stimulus now should focus on improving public services, encouraging consumption, and increasing household income. Accelerating the expansion of state-funded social security could bring down household savings over time. More generally, China must deploy its large balance sheet to deliver income or benefits that expand what households view as safely consumable income. Given that private investment responds mainly to demand, such measures would likely reverse its current downward path.

A further slowdown in China is a distinct possibility. China’s leaders must do what it takes to ensure that such a slowdown is not viewed as secular trend – a perception that could undermine the consumption and investment that the economy so badly needs.
I'm afraid that China's economy will experience a long deflationary spiral, and its citizens have moved from real estate speculation to speculating on stocks. The real concern is what happens when the China bubble bursts and spreads even more deflation throughout the world at a time when central banks are "normalizing" their respective policies.

One final thing on Feldstein's comment above. He raises a good point on low liquidity in the markets, one that Bryan Wisk at Asymmetric Return Capital discussed with me following my comment on the shift toward smaller hedge funds.

According to Bryan, investors are underestimating liquidity risk in this environment: "A lot of the big macro and quant funds you discuss on your blog are forced to trade in deep liquid markets or else they will get killed exiting anything remotely illiquid. This constrains their investment opportunities and is an example of why being too big can come back to really haunt you when markets seize and there are no bids for your offers."

In a nutshell folks, what Bryan is saying is that America's risky recovery is a lot riskier than most can possibly fathom. Our modern economies are inexorably tied to well functioning financial markets which provide credit to millions of small and large businesses. If this recovery falters or worse still, if the Fed begins raising rates too fast and another crisis hits, there will be huge economic and financial dislocations. At that point, America's Minsky Moment will come and it will be game over for decades, not a year like 2008.

Below, George Goncalves of Nomura predicts what the Fed will say and how it will impact the bond market, with CNBC's Jackie DeAngelis and the Futures Now Traders.

And CNBC's Rick Santelli discusses the latest action in the bond market, and the U.S. dollar, after soft GDP data.


Tuesday, April 28, 2015

Federal Budget Boosts Federal Pensions?

BNN reports, Federal budget promises to review pension investment rules:
The government says it will review a rule that prohibits federal pension funds from holding more than 30 percent of the voting shares of a company.

The Federal Budget said Canadian pension funds are among the most experienced private sector infrastructure investors in the world, but currently face limits on their investment activities.

The government plans to launch a public consultation “on the usefulness” of the current prohibition.

But Ian Russell, President of the Investment Association of Canada, tells BNN rolling back investment limits for pension funds will have big consequences.

“Those pension funds do not pay tax. So the dividends that flow from those investments would not be non-taxable,” said Russell. “Secondly, there is scope for a significant concentration of corporate Canada and voting control among these large tax-exempt pension funds.”

The rule covers large federal government pension plans, so amendments would not affect Canada’s major provincial pension plans such as the Caisse de dépôt et placement du Québec or the Ontario Teachers’ Pension Plan.

“Lifting the 30-percent rule is certainly something we would welcome and we will be participating in the public consultations,” said Mark Boutet, vice-president of communications and government relations for the Public Sector Pension Investment Board (PSP Investments), which invests on behalf of federal government employees.
I'm curious to see how these consultations will go but lifting the 30-percent rule would help Canada's large federal government pensions, which includes PSP Investments and CPPIB, to invest more of their assets funding private Canadian infrastructure projects.

Of course, if you're going to implement such a change, why limit it to big federal pensions? Why not allow all of Canada's large public and private pensions to enjoy the same investment opportunities as their federal counterparts? This would be the fair thing to do.

As far as reaction to the federal budget, CUPE's analysis blasted the Conservatives stating it was a dead giveaway to the rich and had this to say on retirement security and pensions:
The measures in this budget on retirement security will overwhelmingly benefit the wealthy with their private savings, while other changes they are considering will put the retirement savings of working Canadians at risk, with the introduction of ‘target benefit plans.’
  • Reduces the minimum amounts seniors must withdraw from their RRIFs after they reach age 71.
  • Increases the annual contribution limit for TFSAs to $10,000.
  • Considering changes to pension laws to allow federally regulated employers to establish target-benefit pension plans and to income tax laws to enable provinces to also establish target benefit plans.
While the change to RRIFs will help some seniors and is supported by seniors’ organizations, only half of all seniors have RRSPs or RRIFs, so this measure will largely benefit the few who are better off, while reducing tax revenues.

The real pension crisis is that 6 in 10 workers don’t have any workplace pension plan. Much better would be to improve the Canada Pension Plan (CPP) and Guaranteed Income Supplement (GIS) so all Canadians could depend on decent incomes in retirement. Labour has a fully-costed proposal to double CCP benefits, which is supported by provinces, pension experts, the NDP, and the Canadian public.

CUPE also called for the government to cancel its plan to increase the retirement age for Old Age Security (OAS) and the GIS to 67. These cuts will mean middle-class Canadians will lose about $13,000 in retirement income and nearly a quarter million future seniors per year could face poverty, all the while Conservatives provide huge tax cuts to the wealthy through TFSAs. The NDP has also committed to reversing this change and restoring the age of retirement to 65.

The Conservative government is intending to give the green light to federal jurisdiction employers to establish target benefit plans that will allow them to walk away from the pension promises they have already made. Workers and all those affected should also vigorously oppose this.

The budget also announced that Conservatives are considering changes to allow pension funds to own more than 30 per cent of the shares of a company. This is intended to facilitate further privatization of infrastructure investments through P3s and could increase the volatility of pension fund investments.
I agree with CUPE on some points, but totally disagree with it on others. Increasing the TFSA limit will predominantly help rich Canadians with high disposable incomes as they will tuck away more or their income into tax free savings but it will also help people with RRIFs shift assets into TFSAs.

Still, the net effect of this policy is to boost assets at Canadian banks, mutual fund companies and insurance companies. In other words, it's another dead giveaway to the financial services industry. It will boost the profits of the ultra wealthy Desmarais family, which owns mutual fund and insurance companies, but will do nothing to help average Canadians retire in dignity and security (only enhancing the CPP for all Canadians will achieve this goal).

Where I disagree with unions is their insistence on maintaining the retirement age at 65 when Canadians are living longer and working longer and their myopic and Marxist position that privatizing infrastructure is a terrible thing and will increase the volatility at Canada's large pensions.

This is utter nonsense and shows you unions don't want to share the risk of their plans or are clueless when it comes to longevity risk, managing assets and liabilities, and the important role Canada's large pensions play in terms of investing in infrastructure projects around the world. These private market investments have risks but because of their long investment horizon and steady cash flows, they offer important characteristics to pensions from a liability-hedging perspective.

There are many advantages of investing in Canadian infrastructure through P3s. It just makes sense as the risk of the projects will be shared by the private sector, but since these are Canadian projects, there is far less regulatory or legal risks than investing abroad and no currency risk, which is good for pensions hedging for Canadian dollar liabilities.

If you look around the developed world, you will see many cash strapped governments that have no funds to invest in much needed infrastructure projects. Canada is no different. Our large pension funds can play a key role here but only if the federal government allows them to invest more in domestic private infrastructure projects.

Are there tax implications to lifting the 30 percent rule? Sure there are but there are also big benefits. I find it abhorrent that a relatively rich and vast country like Canada has no high speed trains to connect our cities, not to mention our roads, bridges, ports and airports are a total disgrace and need major investments. Where is the money to fund such projects going to come from?

The Caisse's deal with the provincial government to handle some infrastructure projects offers a blueprint but the federal and provincial governments need to do a lot more to allow Canada's large pensions to invest in domestic infrastructure projects.

Of course, lifting the 30 percent rule will be met by vigorous opposition in corporate Canada because it's weary of giving our large public pensions more power to vote against their senor executives' excessive compensation packages. I happen to think this is a good thing and hope to see our large pensions torpedo any excessive compensation packages that aren't based on measurable long-term performance objectives.

Those of you who want to read more on the federal budget can read Mackenzie Investments' 2015 Federal Budget Bulletin. It covers the main points well and provides a good overview for individual investors.

As always, if you have anything to add on lifting the 30 percent rule, please email me at LKolivakis@gmail.com. I got to get back to trading these schizoid markets dominated by computer algorithms. Short sellers are ripping into biotech shares this week, similar to last year's big unwind. Just remember this, where there's blood, there's big opportunity. Below, a list of small biotech shares I'm tracking that are getting killed so far this week (click on image):



As I've repeatedly warned in the past, trading small cap biotechs isn't for the faint of heart. You can lose 30% on any given week, and sometimes a ton more in a single day (check out the 70% haircut Aerie Pharmaceuticals experienced after it announced phase III results that didn't meet expectations).

Public markets are volatile by their very nature but some segments are frighteningly volatile. This is another reason why Canada's large public pensions are increasingly shifting assets into infrastructure, real estate and other private markets. Why should they play a rigged game where they're destined to lose against big banks and big trading outfits? It makes more sense for them to invest in low volatility assets that provide stable cash flows over a very long investment horizon and where they have more control over their investments.

Below, the CBC reports that Canadian cities say they need $123 billion to update roads, public transit, and water systems and another $100 billion for new projects to meet growing demands (2013 report).

If there was ever a time to lift the 30 percent rule to boost infrastructure investments by our large pensions, it's now. Our infrastructure needs are growing and the federal government needs to do something about this dire situation or else Canada will look like a third world country in a decade (I'm grossly exaggerating but driving on Montreal's decrepit and congested roads really pisses me off!!).

Monday, April 27, 2015

A New Deal For Greece?

Greece's Finance Minister Yanis Varoufakis wrote a comment for Project Syndicate, A New Deal for Greece:
Three months of negotiations between the Greek government and our European and international partners have brought about much convergence on the steps needed to overcome years of economic crisis and to bring about sustained recovery in Greece. But they have not yet produced a deal. Why? What steps are needed to produce a viable, mutually agreed reform agenda?

We and our partners already agree on much. Greece’s tax system needs to be revamped, and the revenue authorities must be freed from political and corporate influence. The pension system is ailing. The economy’s credit circuits are broken. The labor market has been devastated by the crisis and is deeply segmented, with productivity growth stalled. Public administration is in urgent need of modernization, and public resources must be used more efficiently. Overwhelming obstacles block the formation of new companies. Competition in product markets is far too circumscribed. And inequality has reached outrageous levels, preventing society from uniting behind essential reforms.

This consensus aside, agreement on a new development model for Greece requires overcoming two hurdles. First, we must concur on how to approach Greece’s fiscal consolidation. Second, we need a comprehensive, commonly agreed reform agenda that will underpin that consolidation path and inspire the confidence of Greek society.

Beginning with fiscal consolidation, the issue at hand concerns the method. The “troika” institutions (the European Commission, the European Central Bank, and the International Monetary Fund) have, over the years, relied on a process of backward induction: They set a date (say, the year 2020) and a target for the ratio of nominal debt to national income (say, 120%) that must be achieved before money markets are deemed ready to lend to Greece at reasonable rates. Then, under arbitrary assumptions regarding growth rates, inflation, privatization receipts, and so forth, they compute what primary surpluses are necessary in every year, working backward to the present.

The result of this method, in our government’s opinion, is an “austerity trap.” When fiscal consolidation turns on a predetermined debt ratio to be achieved at a predetermined point in the future, the primary surpluses needed to hit those targets are such that the effect on the private sector undermines the assumed growth rates and thus derails the planned fiscal path. Indeed, this is precisely why previous fiscal-consolidation plans for Greece missed their targets so spectacularly.

Our government’s position is that backward induction should be ditched. Instead, we should map out a forward-looking plan based on reasonable assumptions about the primary surpluses consistent with the rates of output growth, net investment, and export expansion that can stabilize Greece’s economy and debt ratio. If this means that the debt-to-GDP ratio will be higher than 120% in 2020, we devise smart ways to rationalize, re-profile, or restructure the debt – keeping in mind the aim of maximizing the effective present value that will be returned to Greece’s creditors.

Besides convincing the troika that our debt sustainability analysis should avoid the austerity trap, we must overcome the second hurdle: the “reform trap.” The previous reform program, which our partners are so adamant should not be “rolled back” by our government, was founded on internal devaluation, wage and pension cuts, loss of labor protections, and price-maximizing privatization of public assets.

Our partners believe that, given time, this agenda will work. If wages fall further, employment will rise. The way to cure an ailing pension system is to cut pensions. And privatizations should aim at higher sale prices to pay off debt that many (privately) agree is unsustainable.

By contrast, our government believes that this program has failed, leaving the population weary of reform. The best evidence of this failure is that, despite a huge drop in wages and costs, export growth has been flat (the elimination of the current-account deficit being due exclusively to the collapse of imports).

Additional wage cuts will not help export-oriented companies, which are mired in a credit crunch. And further cuts in pensions will not address the true causes of the pension system’s troubles (low employment and vast undeclared labor). Such measures will merely cause further damage to Greece’s already-stressed social fabric, rendering it incapable of providing the support that our reform agenda desperately needs.

The current disagreements with our partners are not unbridgeable. Our government is eager to rationalize the pension system (for example, by limiting early retirement), proceed with partial privatization of public assets, address the non-performing loans that are clogging the economy’s credit circuits, create a fully independent tax commission, and boost entrepreneurship. The differences that remain concern how we understand the relationships between the various reforms and the macro environment.

None of this means that common ground cannot be achieved immediately. The Greek government wants a fiscal-consolidation path that makes sense, and we want reforms that all sides believe are important. Our task is to convince our partners that our undertakings are strategic, rather than tactical, and that our logic is sound. Their task is to let go of an approach that has failed.
I read Mr. Varoufakis comment and was unimpressed. For a bright guy, he conveniently misses what is truly ailing the Greek economy. I left this comment on Project Syndicate's site:
"The pension system is ailing." I would say the Greek pension system is on the verge of collapse. The jobs crisis doesn't help but an even bigger problem is the total lack of proper governance surrounding Greek pensions. Instead of creating something akin to the Canada Pension Plan Investment Board, Greece has allowed their pensions to slowly wither away, much like its economy which is in desperate need of major reforms. Of course, the biggest problem in Greece remains its grossly over-bloated public sector which Syriza will fight for tooth and nail until its leaders are forced to implement drastic cuts (one way or another, cuts are coming, especially if Greece leaves the euro and goes back to the drachma). Mr. Varoufakis knows this. Tsipras knows this. They are playing a dangerous game with no leverage. Greeks are only fooling themselves if they can't see past Syriza's dangerous lies. It's time for Greeks to take responsibility for years of economic failure and finally bring their economy into the 21st century by implementing much needed reforms to make it more competitive and open to foreign investors. Varoufakis laments that Greece needs a new deal but he fails to see the world has its own problems to deal with and if Greece doesn't reform, it will be left out, or worse, thrown back into the Dark Ages.
Now, I realize there is only so much you can cover in a short comment, but my main points are all there. Either Greece reforms its antiquated economy -- which is being held back by a grossly over bloated public sector supported by powerful unions, special interests groups which includes lawyers and pharmacists that don't want foreign competition, and a handful of ultra wealthy families milking the Greek economy dry -- or it will die of a painful death. And going back to the drachma will only make this death more painful, something that Greeks know all too well.

Greece's creditors know this all too well too. They've implemented a united strategy to squeeze its leaders until they yield. Mr. Varoufakis is already feeling the heat. At last week's rumble in Riga, his  counterparts lost patience with him, calling him an "amateur" who constantly lectures them but has implemented no serious reforms:
When Yanis Varoufakis warned his fellow euro-area finance chiefs of the dangers of pushing his government in Athens too far, Peter Kazimir snapped.

Kazimir, Slovakia’s finance minister, launched a volley of criticism at his Greek counterpart, releasing months of pent-up frustrations among the group at the political novice. They’d had enough of what they called the economics professor’s lecturing style and his failure to make good on his pledges.

The others at the April 24 gathering in Riga, Latvia, took their cue from Kazimir -- they called Varoufakis a time waster and said he would never get a deal if he persisted with such tactics. The criticism continued after the meeting: eight participants broke decorum to describe what happened behind closed doors. A spokesman for Varoufakis declined to respond to their descriptions.

“All the ministers told him: this can’t go on,” Spain’s Luis de Guindos said the following day. “The feeling among the 18 was exactly the same. There was no kind of divergence.” The others who provided an account of the meeting in interviews asked not to be named, citing the privacy of the talks.

Varoufakis’s isolation raises the stakes, which include a potential default and keeping the euro indivisible. After more than five years as a ward of the European Union, Greece is virtually out of cash. The aid pipeline is shut until Prime Minister Alexis Tsipras, elected Jan. 25 promising to push back against budget cuts, bends to EU policy demands.

Alluding to the political conflict, Varoufakis borrowed a line from a 1936 speech by U.S. President Franklin D. Roosevelt. “They are unanimous in their hate for me; and I welcome their hatred,” Varoufakis said on his Twitter account on Sunday. The quotation is “close to my heart (& reality) these days,” he wrote.
Looming Payments

The breakdown came as Greece heads into a week of heightening fiscal tension. The first of two International Monetary Fund payments is due on May 6 and the government still doesn’t know if it has enough money to pay pensioners and state employees this week.

Varoufakis sought to squeeze aid from the rest of the euro area accepting the full slate of EU demands, a gambit rejected by the group’s leader, Jeroen Dijsselbloem.

Varoufakis described the talks as “intense” and said his country is ready to make “big compromises” for a deal.

“The cost of no solution would be enormous not only for us but also for all,” he said.

Varoufakis cut a lonely figure on Friday morning as he prepared for the meeting. The 53-year-old academic walked with no entourage through the lobby of the Radisson Blu Daugava Hotel clutching a mobile phone and a newspaper.
Pension Stalemate

In remarks to the assembled ministers, he defended protecting public pensions, a key sticking point in the negotiations. He threatened to walk away from talks if creditors pushed too hard.

When Dijsselbloem invited the group to respond, he was greeted by silence. He asked again, and Kazimir spoke up.

Varoufakis’s refusal to accept the conditions of its creditors particularly riled the Slovakian because his government has slashed the budget deficit and cracked down on tax evasion. His position also may have fallen on deaf ears among his hosts in Riga.

Latvia’s economy shrank by more than a fifth in 2008 and 2009 when the country was led by Valdis Dombrovskis, now vice president of the European Commission and a participant in the Friday meeting. Dombrovskis pushed through some of the world’s harshest austerity measures -- equivalent to 16 percent of gross domestic product. The Greek economy has shrunk by about a quarter since 2008.
Photo Shoot

Political gaffes have afflicted Varoufakis from the outset. He offended the Italian government, a potential ally, when he said Feb. 8 their country was close to bankruptcy. Most famously, he posed for a photo spread in Paris Match magazine, showing the minister and his wife on their roof terrace overlooking the Acropolis in Athens.

For any European governments sympathetic to the plight of Greeks, the picture made it harder to justify additional aid to their voters. The episode also hurt Varoufakis’s credibility and gave other ministers an easy way to needle him.

After his comments to the meeting in Riga, Varoufakis was approached by France’s Michel Sapin, a Socialist.

“I told him I had read Philosophie Magazine,” Sapin said, alluding to Varoufakis’s academic style. “It’s better than Paris Match.”

Varoufakis has the backing of a majority of Greeks, according to an Alco survey published in Proto Thema newspaper. Some 55 percent of respondents said they had a positive view of him, compared with 36 percent who said they viewed him negatively.

Still, the schadenfreude in ministers’ reactions was leavened with concern about the consequences of the policy deadlock.
Calls for Plan B

Greece needs to begin paying monthly salaries to civil servants and retirees on Monday, and faces a string of obligations leading up to a $770 million IMF payment on May 12.

Tsipras tried to bypass the finance ministers last week, who have to sign off on any aid disbursement, to make his case directly to German Chancellor Angela Merkel and French President Francois Hollande at a summit in Brussels.

With the prospect of a default hanging over the session, Slovenia’s Dusan Mramor urged the group to consider a “plan B” to mitigate the fallout if negotiations fail. Others echoed his calls. In their public comments, EU Economic Commissioner Pierre Moscovici and De Guindos both said there was no plan B, while Dijsselbloem refused to comment on the prospect, saying it would only fuel speculation in the media.

“Any mention of a plan B is profoundly anti-European,” Varoufakis said in an interview with Euronews.

Before the session broke up and Dijsselbloem briefed the media, Varoufakis implored him to say that progress had been made toward a deal on releasing aid.

“There are still wide differences to bridge,” Dijsselbloem said, standing alongside European Central Bank President Mario Draghi, Moscovici, and head of the European Stability Mechanism Klaus Regling. “Responsibility mainly lies with Greek authorities.”
Varoufakis's troubles with his counterparts have reached a boiling point. The Wall Street Journal reports Greece has shuffled the team involved in bailout talks with the country’s international creditors, a senior government official said Monday, in a move that may reduce the influence outspoken Greek finance minister Yanis Varoufakis has on the slow-moving negotiations.

The FT also reports that Greece’s dire financial position is forcing eurozone authorities to look beyond Mr Varoufakis to Alexis Tsipras, prime minister, much like in February when Jeroen Dijsselbloem, the Dutch finance minister who chairs the eurogroup, brokered an extension of the current bailout program:
According to two eurozone officials, Mr Dijsselbloem phoned Mr Tsipras from Riga in an effort to mend fences after Friday’s feisty eurogroup meeting, where Mr Varoufakis was rounded on by his eurozone colleagues.

In a sign that Mr Varoufakis’s combative approach is prompting concern in Greece as well, a senior Athens official said the Riga meeting was likely to lead to him being sidelined as Mr Tsipras and his deputy Yannis Dragasakis take a more hands-on role.

Amid the acrimony, differences over a new list of reforms that is to be agreed by Athens were barely discussed at the meeting, putting off indefinitely a deal to unlock access to the funds left from Greece’s €172bn bailout.
I want you to remember the name Yannis Dragasakis because when it comes to Greek politics, he is the most powerful man in Greece and Tsipras listens to him very closely. It looks like Dragasakis has had enough of Varoufakis's "rock star personality" and this means the finance minister will be quietly pushed out of the negotiations with EU partners (my buddy predicted this a long time ago saying "Varoufakis is being used and he doesn't even know it").

Still, changing the players doesn't change the sticking points. Greece is on the verge of collapse and Nicholas Economides is right, at this point, only a miracle can save it from disaster. Unless Tsipras, Dragasakis and the rest of Syriza agree to some major reforms which will be unpalatable to most of the party's left-wing base, it's hard to see how any agreement will take place. Creditors are demanding major reforms and Tsipras and company keep saying they've done all they can, which is an outright lie but given their mission to stay in power as long as possible, this is their stance.

But Greeks are finally waking up to Syriza's dangerous posturing. In a comment in Naked Capitalism, Wolf Richter argues the Greek people just destroyed Syriza's strategy, noting the government's "extortion strategy" is quickly losing popular support:
The approval rating for the government’s strategy has plunged to a measly 45.5%, from 72% just last month, according to a new poll. A terrible cliff dive.

On a scale of 0 to 10, the administration got whacked in its details, earning 4.6/10 on the economy, 3/10 on immigration, 3.7/10 on crime-fighting and security, 4.2/10 on education, 5.5/10 on foreign policy and defense, 4.5/10 on public administration, and 4.4/10 on health.

Only 3% of the Greeks were confident their household finances would improve over the next 12 months, while 26.5% expected their situation to get worse, and another 15% were certain it would get worse.

How did they feel about a “Grexit” – and a return to the drachma? “Fear!” That’s what 56% said – up from 45.5% in March. Only 23% claimed they were indifferent, down from 26.5% last month. And just 9% thought there was no chance of it happening, down from 17% in last month.

Greece’s exit from the Eurozone and return to the drachma, of which it could print an endless amount to pay its bills and salaries and other schemes, would entail a vertigo-inducing devaluation, and all that comes with it.

The Greeks know how that program works. They have experienced the drachma. They see it as a tool by which the government tries to steal from them. They don’t trust their government with the administration of a currency any more than they trust their banks. And Greek parliamentarians don’t want the drachma either. They want their rich pensions to be paid in euros, not in devalued drachmas.

Thus, a Grexit is off the table as far as threats is concerned. It might happen, but it can’t be used as a threat to extort better terms from donor countries. The Greek game-theoreticians can evoke it all they want to, through leaks and on the record, and they can bandy about the threat of blowing up the world markets, but if they want to stay in power and if they want to face their people at home, they can’t go down that road.

Alas, all their negotiating partners know that too. The global financial markets know that. They all could digest a Grexit, but the Syriza government could not. Time to stop playing games and start talking in earnest. Or face some very, very angry folks at home.
I can only hope Greeks finally wake up and boot the clowns running the country out of office before it's too late, but my fear is that the damage Syriza has done is so severe that the endgame is coming no matter what and it won't be pretty. If Greeks thought austerity under Troika was bad, then they haven't seen anything yet. It will be much worse if Greece exits the eurozone and returns to the drachma (never mind what Nobel-prize winning economists claim).

And if Greece falls, no one wants their prints on the murder weapon, but the reality is every member of the eurozone will be responsible for this failure, especially Germany which has thus far profited the most off the euro crisis and endless Greek tragedy. It too will eventually feel the economic pain of others as its leaders were incapable of taking the leadership they had to in order to solidify this fragile union.

As far as the bigger picture, Greece's lose-lose game is yet another reminder that things aren't as solid as many economists and financial analysts claim. The global economy is a lot weaker than we think, and if the China bubble bursts, watch out, we're in for a prolonged period of global deflation. Ironically, this is why I don't agree with hedge fund managers who think it's time to short the mighty greenback.

In an environment of heightened global uncertainty, investors will flock to U.S. bonds, stocks and real estate to seek refuge but if deflation comes to America, there will be a lot more pain ahead as the mother of all carry trades unwinds. At that point, we won't be discussing a new deal for Greece, but a new deal for the world.

For now, all is calm as greenshoots are talking up global recovery. But mark my words, this is the calm before the storm, which is why I keep trading the liquidity rally focusing my attention mostly on tech and biotech stocks but very nervous about what happens if big investors start shorting the Fed.

Below, Yanis Varoufakis and Joseph Stiglitz discuss the eurozone crisis at the latest New Economic Thinking forum. Take the time to listen to their comments but keep in mind, the Greek economy is a beast that Stiglitz and Krugman fail to understand. Even Varoufakis fails to understand what truly ails the Greek economy and his antics cost him as he will be pushed out of negotiations.

Also, Constantine Michalos of the Greek Chamber of Commerce and Industry, recently discussed the best course of action to boost Greek business. Those of us who often travel to epicenter of the euro crisis know what Greece needs but my fear is that until Syriza is ousted and new, courageous leaders take the helm, the country will be mired in an endless depression.

There is an old Greek expression "Η Ελλάδα ποτέ δεν πεθαίνει" (Greece never dies), which we Greeks play on by saying "Η Ελλάδα ποτέ δεν πεθαίνει , αλλά πάντα κουτσαίνει" (Greece never dies but always limps along). It's time Greece's leaders stop playing the same narrow politics which have slowly but surely suffocated the Greek economy over the past 40 years and start thinking of how they will improve the opportunities for future generations who don't want to emigrate from Greece in search of a better life. 

Greece is the most beautiful country in the world but its leaders are hopelessly corrupt and dangerous demagogues who have never seen past their obsession of holding on to power at all cost. I look forward to the day when this vicious cycle is broken once and for all. That's a new deal for Greece those of us who love the country are all looking forward to as we anxiously watch this crisis unfolding. 


Friday, April 24, 2015

Big Pensions Against Big Payouts?

Euan Rocha of Reuters reports, Fresh opposition to Barrick Gold Corp’s executive pay structure from Canada’s largest pension fund manager:
The Canada Pension Plan Investment Board, the country’s largest pension fund manager, on Friday joined a slew of other investors opposing Barrick Gold Corp’s executive pay structure.

Toronto-based CPPIB said it plans to come out against the advisory vote on executive compensation that Barrick will be having at its annual shareholder meeting next week.

It also said it plans to withhold support from Brett Harvey, one of Barrick’s board members and the chair of its compensation committee. CPPIB own roughly 8.1 million Barrick shares, or less than a per cent of the company’s outstanding stock.

Last week, two smaller Canadian pension funds, the British Columbia Investment Management Corp (BCIMC) and the Ontario Teachers’ Pension Plan Board, said they plan to withhold support from Barrick’s entire board in light of their concerns with Barrick’s executive compensation package.

This marks the second time in three years that Barrick is facing heat over its executive pay. The company lost an advisory vote on its executive pay structure in 2013, prompting it to lay out a new compensation program last year. However, the company’s recent disclosure that Executive Chairman John Thornton was paid $12.9 million in 2014 unleashed fresh complaints.

Barrick contends that with its new pay structure, its senior leaders’ personal wealth is directly tied to the company’s long-term success.

But its detractors including well known proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis contend that Thornton’s pay is not clearly tied to any established and measurable long-term performance metrics.

Separately, CPPIB’s much smaller pension fund rival OPTrust also expressed its dismay with Barrick’s pay structure, stating that it also plans to come out against the advisory vote on the pay structure.

“Where it comes to Mr Thornton, we cannot easily discern any link between pay and performance … OPTrust has decided to also withhold votes from returning compensation committee members,” said a spokeswoman for the pension fund manager.

The investor outrage comes amid a growing outcry about large pay packages for senior executives at some Canadian companies.

Canadian Imperial Bank of Commerce lost its advisory vote on its executive compensation structure on Thursday, in the face of blowback over mega payments to two retired executives.
A quick look at Barrick Gold Corp's (ABX) five-year chart below tells me these investors are right to question executive pay at this company (click on image):


And it's not just Barrick. If you look at Canada’s top 100 highest-paid CEOs, you will find other examples of overpaid CEOs whose executive compensation isn't tied any established and measurable long-term performance metrics. It's not as egregious as the U.S., where CEO pay is spinning out of control no thanks to the record buyback binge, but it's getting there.

And Canada's big pensions aren't shy to vote against excessive compensation packages. Geoffrey Morgan of the Financial Times reports, CIBC shareholders vote down compensation-plan motion over CEO payout:
CIBC shareholders had their say on executive pay at the bank’s annual meeting Thursday and they let it be known they weren’t happy — voting down the bank’s resolution on its compensation plan.

Shareholders voted 56.9 per cent against the bank’s executive pay plan, but outgoing CIBC chairman Charles Sirois said that he didn’t believe the vote was a commentary “on our overall approach to compensation.”

“Based on feedback, we believe this year’s vote result on CIBC’s advisory resolution was significantly impacted by one specific item: the post-retirement arrangement provided to our former CEO,” Sirois said at the meeting in Calgary, his last with the bank before John Manley takes over as board chair.

CIBC’s former CEO, Gerald McCaughey, was paid $16.7 million this year when the bank accelerated his retirement date. Similarly, the lender paid former chief operating officer Richard Nesbitt $8.5 million when it also sped up his departure from the company.

Analysts and investors have criticized both severance packages.

“Our belief is that shareholders were using the say-on-pay vote to express their dissatisfaction with the severance packages,” CIBC spokesperson Caroline van Hasselt said in an interview.

The vote marks the first time a Canadian company has failed a say-on-pay vote since 2013, according to Osler, Hoskin and Harcourt LLP. Sirois said a special committee would review the results of the vote, which is non-binding.

Two of the banks’ larger shareholders have said as much. The Canada Pension Plan Investment Board, which owns 404,000 shares of CIBC, and the Ontario Teachers’ Pension Plan, with 220,000 shares, voted against the motion.

Teachers said it “did not support the structure of the post-employment arrangements [with McCaughey and Nesbitt], believing them to be overly generous and not in the best interests of shareholders.”

For the same reason, Teachers’ also withheld its votes for the company’s nominated slate of directors – all of whom were re-elected although two with significantly less support than their peers.

Luc Desjardins and Linda Hasenfratz were both re-elected with 86 per cent and 85 per cent support, respectively. By contrast, every other member of the 15-person board was elected or re-elected with more than 90 per cent support.

Hasenfratz chaired the committee that oversaw executive compensation matters, of which Desjardins was also a member.

“We cannot support the members of the Management Resources and Compensation Committee based on our concerns with the succession planning process and post-employment arrangements made to both Mr. McCaughey and Mr. Nesbitt,” a statement from Teachers’ reads.

The CPPIB declined a request for comment.

Despite their dissatisfaction with CIBC’s executive compensation, shareholders voted down three additional resolutions, put forward by Montreal-based Movement d’éducation et de défense des actionnaires, that would have altered the bank’s pay policies.

Shareholders voted more than 90 per cent against resolutions that aimed to close the gap between executive pay and that of frontline staff, rework the retirement benefits of all executives and restrict the use of stock options as compensation.
You might recall CIBC's former CEO Gerry McCaughey was warning about a retirement savings crisis in Canada and even said Canadians should have the choice to make additional, voluntary contributions to the Canada Pension Plan in order to avoid facing a significant decline in living standards when they retire. Of course, when it comes to his own retirement, Mr. McCaughey doesn't have to worry one bit. CIBC paid him a nice, cushy package.

Pensions are increasingly being bumped up at corporate Canada. BNN reports Air Canada has given chief executive officer Calin Rovinescu an enhanced pension that will almost double his retirement pay to $791,300 a year by age 65 if he remains at the airline for three more years:
The company said Mr. Rovinescu has helped shareholders by moving Air Canada “toward the goal of sustainable, long-term profitability. “For this reason, the board wanted to ensure that Mr. Rovinescu’s overall employment and pension arrangements are market competitive and that he continues to remain on as CEO for three more years,” spokesman Peter Fitzpatrick said.

Both of the new provisions are not covered under restrictions the federal government imposed on Air Canada in 2013, when it granted funding relief to give the airline more time to repay a $4.2-billion deficit in its pension plans. At that time, the government insisted Air Canada tie the level of bonuses and equity pay for executives to the level of pension plan repayments the company makes, saying it would ensure that executives were “part of the solution” at the airline.

There’s “no question” that the changes to Mr. Rovinescu’s compensation are designed to skirt the federal restrictions, said Jerry Dias, president of Unifor, the union that represents customer service agents and other Air Canada employees.

Mr. Dias said employees “gave up a ton” at Air Canada when the company filed for bankruptcy protection a decade ago and and on two other occasions when it sought to restructure.

“We’ve got some customer service agents that make slightly over minimum wage; it takes more than 10 years to get to the top rate and not everybody gets to the top rate,” said Mr. Dias, whose union is in negotiations now with Air Canada on a new contract.

“When I start to see the CEOs taking care of themselves very well as it relates to their pension plans, then it’s about time the workers get back some of the stuff that they had to give up.”

The company’s annual shareholder proxy circular says Mr. Rovinescu will have a pension of $791,300 a year at age 65, a 91-per-cent increase from $414,400 reported previously. Air Canada said the accrued liability for his pension was $7.3-million as of Dec. 31, up from $4.9-million at the end of 2013.
But union qualms aside, things are slowly but surely changing at Canadian banks. BNN reports that Canada’s new bank CEOs are making less money than their predecessors as banks cut salaries and reduce CEO pensions in the face of shareholder pressure to curb super-sized executive pay:
A report on bank CEO pay by Toronto compensation consulting firm McDowall Associates shows base salaries for the new CEOs of Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Toronto-Dominion Bank are all down 33 per cent compared with the outgoing CEOs’ salaries, while the base salary for the new CEO of Royal Bank of Canada is down 13 per cent compared with his predecessor.

Targeted total direct compensation – which includes grants of share units and stock options – is down between 11 per cent and 25 per cent for all four CEOs, the report shows. For example, the analysis shows Scotiabank CEO Brian Porter earned $8-million in total direct targeted compensation (excluding pension costs) in 2014, which is 25 per cent less than the $10.7-million that predecessor Rick Waugh earned in total targeted compensation in 2013.

Bernie Martenson, senior consultant with compensation firm McDowall Associates and previously vice-president of compensation at Bank of Montreal, said it is too soon to conclude that the banks have permanently lowered CEO pay because it is common for CEOs to get raises as they spend more time in the job.

But she said a number of current pay practices, including reducing the proportion of pay awarded in stock options, suggest overall pay is likely to be lower for the new CEOs over the long-term.

“You would naturally think there would be a difference between someone of long tenure and someone who is new in the role,” Ms. Martenson said.

“But I think the reduction of stock options in the last few years is starting to have an impact in terms of wealth accumulation. If you were to look out eight or 10 years for these new CEOs and compare the value of their total equity to that of their predecessors, I think it would be lower.”

Bank CEOs are still well compensated of course, but restraint is increasingly evident. Ms. Martenson points to the CEO pension plans at all four banks. Toronto-Dominion Bank CEO Ed Clark, for example, has the largest pension of departing CEOs at $2.5-million a year, while his replacement, Bharat Masrani, will have a maximum possible pension of $1.35-million a year when he retires.

At Scotiabank, Mr. Waugh’s pension plan was capped at a maximum of $2-million a year at age 63, while Mr. Porter is eligible for a maximum pension of $1.5-million available at 65. Royal Bank’s Gord Nixon had a $2-million maximum pension at 60, while his successor David McKay will have a maximum pension of $700,000 at 55, increasing to a final maximum of $1.25-million at 60.

Retired CIBC chief executive Gerry McCaughey had no cap on the size of his pension, but his pensionable earnings that formed the base for his pension calculation were capped at $2.3-million. His successor, Victor Dodig, has his annual pension capped at $1-million.

A number of shareholder groups – including the Canadian Coalition for Good Governance – have urged companies to reform pension plans because they create expensive funding obligations that last for decades.

Michelle de Cordova, director of corporate engagement and public policy at mutual fund group NEI Ethical Funds, said bank CEOs continue to have very generous pensions “that most people can only dream of,” but she sees a sense of moderation in the trends.

Ms. de Cordova, whose fund has lobbied the banks to curb their executive pay and link CEO pay increases to those of average Canadians, hopes the pay reductions in 2014 are not a temporary trend.

“It does suggest that there is some sense that the levels that pay and benefits had reached were perhaps too high, and boards have decided they need to do something about that,” she said. “I’d say they are still very generous arrangements, but it does seem that there is a sense that there needs to be some moderation, which is welcome.”

The report says all five of Canada’s largest banks have cut the proportion of stock options they grant their CEOs in recent years.

Banks previously decided how much equity they wanted to grant CEOs each year, and split the amount evenly between grants of stock options and grants of share units. In 2014, however, stock options accounted for 20 per cent of total new equity grants at the median for the five banks, while share units accounted for 80 per cent of new equity grants.

Ms. Martenson said banks faced pressure from regulators to reduce stock options following the financial crisis in 2008 because they were deemed to encourage executives to take risks by quickly pushing up the company’s share price to reap a windfall from quickly exercising options. Share units, which track the value of the company’s shares and pay out in cash, are considered less risky because they must be held for the long-term or even until retirement, creating incentives to build long-term growth.
Anyways, don't shed a tear for bankers. Having worked as an economist at a big Canadian bank a while ago, I can tell you there are still plenty of overpaid employees at Canada's big banks, and many of them are hopelessly arrogant jerks working in capital markets or investment banking. And the irony is they actually think they merit their grossly bloated payouts (their arrogance is directly proportional to their bonus pool!).

Those of you who want to read more on executive compensation in Canada run amok should read a paper by Hugh Mackenzie of the Canadian Center for Policy Alternatives, All in a Day's Work?. It's a bit too leftist for my taste but he definitely raises important points on tying CEO compensation to long term performance.

As far as Canada's large public pensions putting the screws on companies to rein in excessive executive compensation, I think this is a good thing and I hope to see more, not less of this in the future. Of course, the CEOs and senior managers at Canada's top ten enjoy some pretty hefty payouts themselves and sizable severance packages if they get dismissed for any other reason than performance.

But nobody is voting on their compensation, some of which is well deserved and some of which is just gaming private market benchmarks to inflate value added over a four year rolling period. Critics will charge these pensions going after big payouts as a case of the pot calling the kettle black. Still, I welcome these initiatives and hope to see other large pension and sovereign wealth funds join in and start being part of the solution to corporate compensation run amok.

Below, Ken Hugessen of Hugessen Consulting discusses trends in executive compensation (try not to fall asleep). All I know is I'm writing on overpaid CEOs, pension fund managers, hedge fund and private equity managers but nobody is paying me my fair share for all my hard work. And make no mistake, researching and writing daily blog comments on pension and investments is very hard work, especially when you're trading these schizoid markets to make a living!