Thursday, March 31, 2016

Ontario Teachers' Gains 13% in 2015

Jacqueline Nelson of the Globe and Mail reports, Ontario Teachers’ Pension Plan posts 13% return in 2015:
Ontario Teachers’ Pension Plan’s 13-per-cent rate of return in 2015 was buoyed by growth in its private market assets, where investing conditions have grown increasingly challenging.

The pension plan, which supports 316,000 of the province’s teachers and retirees, earned $19.6-billion through all of its investments in a year peppered with deals – from toll roads to seniors’ housing.

“This was the year of the privates, whether it’s real estate, private equity or infrastructure,” Ron Mock, chief executive officer of Teachers, told a media briefing on Wednesday. He noted that just a few years ago, fixed income had been a similar bright spot for the portfolio.

Teachers’ private capital group posted a soaring 32.3-per-cent investment return in the 2015 calendar year. And infrastructure and real estate returned a collective 16 per cent in 2015. Each category exceeded the benchmark Teachers had set by a wide margin.

But the pension plan’s executives are now approaching these same sorts of assets with heightened vigilance.

“A lot of assets have seen unprecedented global competition for the time being. … We think prices are high, and there’s a risk the fund will not get compensated taking that risk going forward,” said chief investment officer Bjarne Graven Larsen, who joined the pension plan in February.

This attitude doesn’t mean the fund thinks asset prices are set to fall in the near future, Mr. Graven Larsen added, but indicates caution is required to ensure Teachers can add enough value to anything it buys to make up for the high prices those businesses and structures command.

Last year, Teachers completed a re-evaluation of its investment strategy with a special focus on how best to grow internationally. The review highlighted a need not only for outperforming benchmarks in different asset classes, but also for bringing those specialties together under a more unified strategy to boost total returns overall.

Teachers has created a new group called “portfolio construction” under Mr. Graven Larsen to look at possible risks across the global portfolio – from the implications of a British exit, or “Brexit,” from the European Union, to investment areas that should potentially be developed or receive more funding.

This effort to unify its asset classes comes as Teachers manages more capital than ever. The pension fund had $171.4-billion in assets under management, up from $154.5-billion in 2014.

The pension plan has steadily moved to oversee more of its investments, with 80 per cent of assets now managed internally by teams in Toronto, London and Hong Kong. Mr. Mock said these offices all performed well in 2015, and the pension plan was considering adding another base in South America.

The 2015 financial results included a 17.7-per-cent return in equities, with non-Canadian investments significantly outperforming those made in the country. The fund’s fixed-income portfolio, including bonds, had a one-year return of 5.9 per cent. Meanwhile, natural-resource investments were a dark spot, down by 1.3 per cent last year amid the commodity downturn.

Teachers ended last year 107-per-cent funded, with a surplus of $13.2-billion. That positions the plan to meet future pension liabilities over time, with money to spare.

With the ratio of active teachers to pensioners currently hovering at around 1.4 to one, the pension plan is paying out more in benefits than members are contributing. At the end of 2015, paid benefits reached $5.5-billion and new contributions stood at $3.3-billion.

Teachers has posted an annualized 10.3-per-cent rate of return since its founding as an independent organization in 1990. Since that time, pensions have been funded primarily through investment income. Only 21 per cent of assets have come from contributions from the province’s educators and government employer contributions in that time.
The Ontario Teachers' Pension Plan put out a press release, Ontario Teachers' earns 13.0% return for 2015:
Ontario Teachers' Pension Plan (Ontario Teachers') today announced a rate of return on investments of 13.0% for the year ended December 31, 2015, resulting in an increase in net assets to a record $171.4 billion from $154.5 billion at the end of 2014.

Investment earnings for the year were $19.6 billion, up from $16.3 billion in 2014. Measured against a consolidated investment benchmark of 10.1%, the plan's excess return of 2.9 percentage points resulted in $4.2 billion in value added. Since the plan's inception in 1990, total investment income has accounted for 79% of the funding of members' pensions, with the other 21% coming from member and government contributions.

"We are pleased with our Toronto, London and Hong Kong teams' performance this year," said Ron Mock, President and Chief Executive Officer. "This, in combination with the plan sponsors' 2008 adoption of condition inflation protection, which improved our investment risk tolerance, resulted in a successful year," he said.

Bjarne Graven Larsen, who assumed the Chief Investment Officer role on February 1, credits the plan's ongoing success to an evolving investment strategy with a global outlook. He noted: "Despite volatile market conditions, Ontario Teachers' global, diversified portfolio produced strong investment returns."

Ontario Teachers' continues to show strong performance in pension services, according to two independent, annual studies. The plan's Quality Service Index (QSI), which measures members' service satisfaction, was 9.1 out of 10 in 2015, and the plan was ranked second for pension service in its peer group and internationally.

Funding position
The plan had a preliminary funding surplus of $13.2 billion at January 1, 2016, the third surplus in as many years. It was 107% funded at the start of the year, based on current contribution and benefit levels.

2015 investment return highlights by asset class
The value of the plan's public and private equity investments totaled $77.5 billion at year-end, up from $68.9 billion at December 31, 2014. The investment return in the equities portfolio of 17.7% was ahead of the 14.7% benchmark.

Private Capital investments rose to $28.4 billion at year-end from $21.0 billion a year earlier. Private Capital's investment return was 32.3%, compared to the 18.1% benchmark.

Fixed Income had $69.1 billion in assets at year-end, compared to $65.6 billion at December 31, 2014. The one-year return of 5.9% was in line with the benchmark return of 6.0%.

Natural Resources investments were $10.2 billion at year-end, compared to $11.9 billion at December 31, 2014. The one-year return of -1.3% was ahead of the benchmark return of - 6.1%.

Real assets, a group that consists of real estate and infrastructure, had total assets of $40.6 billion at year-end, compared to $34.7 billion a year earlier. The real estate portfolio, managed by the plan's subsidiary Cadillac Fairview, totaled $24.9 billion in assets at year-end and returned 12.9%, exceeding the 8.0% benchmark. The infrastructure portfolio had $15.7 billion in assets at year-end, up from $12.6 billion a year earlier. Infrastructure's investment return of 21.4%, compared to the 14.3% benchmark.
You should download and read OTPP's 2015 Annual Report to gain better insights on the performance and operations at Teachers.

I had a chance to talk with Ontario Teachers' CEO Ron Mock late Wednesday afternoon to go over the 2015 results. Ron had a very busy day but was gracious enough to call me back and I thank him for doing so.

Below, I summarize some of the points from our discussion:
  • I began by congratulating him on these stellar results. Teachers outperformed all its large Canadian peers, including the Caisse, OMERS, AIMCo, and HOOPP. It also outperformed the average Canadian pension which returned 5.4% in 2015 (keep in mind, a big part of Teachers' relative outperformance comes from the clever use of leverage which others can't use).
  • More importantly and more crucially, Teachers' funded status improved to 107%, placing it just below HOOPP's 122% super-funded status. This is why I keep referring to HOOPP and OTPP as the two best pension plans in Canada and the world
  • The first thing that struck me from Teachers' 2015 results was the unbelievable performance of Teachers' Private Capital led by Jane Rowe. That group delivered 32.3% in 2015, trouncing its benchmark which gained 18.1% last year. 
  • Ron called it the "year of the privates" as Private Equity, Real Estate and Infrastructure all performed well, handily beating their respective benchmarks (which aren't that easy to beat). But he added: "We take a total portfolio approach. This year it was privates, three years ago, bonds kicked in for us."
  • On Private Equity, Ron told me they're focusing on "long-term value creation" which means good old fashion rolling-up-your sleeves PE, none of the financial engineering of the past where funds leveraged companies up to wazoo to bleed them dry as they pay themselves dividends. Teachers Private Capital has a long-term focus and a longer investment horizon than PE funds, giving it an advantage over its fund competitors. 
  • In terms of currency hedging, Ron told me that Teachers doesn't hedge currency risk, which helped with some investments, "but we had other investments in currencies that got hit" (probably in Brazil). So yes, FX gains added to our overall return but it wasn't the primary factor."
  • In terms of funds, I noted on my blog that Teachers sold stakes in global private equity funds in the secondary market. As I thought, this was to rejig the total portfolio to fund other investments like infrastructure. Ron confirmed this: "You got it, it's about looking at the total portfolio and investing in the best opportunities."
  • On the recent London City Airport consortium deal which I questioned on my blog, Ron had this to say: "We have deep expertise in airports. We can place a board quickly to monitor these investments and focus on value creation over a very long investment horizon. And our investment horizon for an asset like this isn't ten years, it's more like 20 to 30 years."
  • On the Maple Financial scandal which I also covered on my blog, Ron shared this: "I can't get into details as the investigation is still ongoing but we have pledged to repay dividends if the allegations are proven." But he added: "It's not a traditional operational screw-up like a hedge fund blowing up, it's more complex, an interpretation of [German] tax law." As far as whether Teachers took a writedown on this asset, Ron didn't say yes or no but he said "it's fully reflected in 2015's results."
  •  On Teachers' massive external hedge fund portfolio, Ron said 2015 was a "scratch year" for external hedge funds and internal absolute return trading activities. "In a volatile market like 2015, you wouldn't expect outperformance in these activities but they didn't dent the total portfolio either."
  • On Teachers' 107% funded status, Ron shared a few interesting tidbits with me. First, the discount rate set by the Board currently stands at 4.7%, one of the lowest in the world for any public pension, reflecting the fact that Teachers' is a mature plan paying out more in benefits than it receives in contributions and its members live a lot longer (bigger longevity risk attached to the plan). 
  • Ron told me the decision of what to do with the surplus (like fully restore inflation protection) lies entirely with the stakeholders of the plan, ie. the Ontario Teachers' Federation and the Ontario government. But he added: "They are very sophisticated and in the past, they didn't spend all of it but saved some for a rainy day, understanding these are very difficult markets and the focus must always be on the plan's sustainability." 
  • On that last point, Ron added this: "Our focus in on the long-term but we don't lose sight on short-term trends either because we are very path dependent. Our short-term is ten years and we always gauge the risks of a serious drawdown to the total portfolio. The last thing you want is to be piling on risk when you have a big drawdown." (this is why most US public pension funds are doomed). 
  • I also commended Ron for taking leadership role in implementing gender diversification at Teachers. I noted that Jane Rowe and Barbara Zvan were two of the highest paid officers at Teachers in 2015 (see compensation table below). Ron told me this: "It's important and I made a point to place Jennifer Brown, Rosemarie McClean and others in key positions. But beyond their gender, they are wickedly smart and highly ethical professionals who add value to our organization."
  • Lastly, a more philosophical question to a man who has experienced some harsh hedge fund lessons in the past and is now running one of the world's best pension plans. I asked Ron if he's happy and if he could have ever imagined being in the position he is right now. He told me: "I'm very happy, work with a great group of professionals, meet interesting people all over the world and I feel like there's a social purpose to what we're doing. I worry about aging demographics and people retiring with no pension. We do our part in ensuring a small subset of the population has their retirement needs addressed for the future."
That was a great way to end our conversation, one that should give many of you working at public pensions some food for thought in terms of why what you're doing is a part of something much bigger and much more important than your paycheck and bonus.

Once again, please take the time to carefully read Ontario Teachers' entire 2015 Annual Report. It is very well written and explains investments, operations, funded status and a lot more in great detail.

One thing I will bring up is executive compensation of senior officers (from page 30, click on image):

As you can see, Teachers' senior officers enjoy some generous payouts, a bit higher than what other large Canadian pensions pay their senior officers.

But I caution you to keep two things in mind: Teachers' four-year results are better than their large peers and people like Ron Mock, Barbara Zvan, Wayne Kozun and Jane Rowe have been there for a long time and they're delivering outstanding results. This compensation is explained in great detail in the Annual Report and it's in line with the results they produced.

Sure, Ontario's hard working teachers might be looking at these hefty payouts and questioning whether they're fair and need to be so excessive. I myself have done so on my blog on a few occasions but in the end, attractive compensation which is based primarily on long-term performance is part of good governance, and that's why Ontario Teachers sets the bar and has delivered outstanding results, ensuring the sustainability of the plan for years to come.

We should be openly discussing compensation at Canada's large pensions. I have no problem with an open, transparent discussion on compensation, but keep in mind the long-term results that come with this compensation. This money isn't given to them for free, they have to beat tough benchmarks to earn that compensation, so don't just look at compensation in a vacuum. Try to understand how it's determined and why these individuals are being paid top dollar. It's because they're producing stellar long-term results, ensuring the long-term sustainability of the plan and lowering its cost for all stakeholders.

On that last point, there is one chart I really like in the Annual Report, one that exemplifies Teachers' long-term performance (click on image):

When people ask me why I'm such a stickler for large, well-governed defined-benefit plans, I point out charts like the one above to make my case. If you're looking for a solution to the global retirement crisis, this is it, right there in that chart.

Below, Ron Mock, president and CEO of the Ontario Teachers’ Pension Plan, joins Bloomberg TV Canada’s Pamela Ritchie to discuss the plan's 39 percent stake in Brussels airport and how geopolitical risks impact the group’s investment strategy.

I also embedded another recent Bloomberg interview with Pamela Ritchie where Ron discussed Teachers' approach to global investments (this one is posted on Teachers' site). Lastly, I embedded a BNN interview with Ron Mock discussing Teachers' 2015 results.

Take the time to listen to all these interviews. Ron is a very smart guy and he's a genuinely good guy, which is why I thank him for taking the time to talk to me, going over Teachers' 2015 results.

Wednesday, March 30, 2016

Are Canadian Banks in Big Trouble?

Barbara Shecter of the National Post reports, TD expects ‘next shoe to drop’ on Canadian banks’ relatively low oil loan provisions:
Canadian banks are taking lower provisions for oil and gas related credit losses than their U.S. counterparts, prompting observers to dig into the reasons behind the trend.

Reserves related to oil and gas loans held by U.S. banks are four to five times higher than those held by the Canadian banks, according to analysts at TD Securities, who believe accounting treatments and interpretations are, at least in part, behind the striking difference.

In a note Tuesday, the TD analysts led by Mario Mendonca said loan quality within the portfolios could also be another reason, with historical loss trends suggesting Canadian banks are more conservative lenders.

Still, they said there is more to than that, including how aggressive each country’s regulators are, and interpretations under two different accounting regimes: U.S. Generally Accepted Accounting Principles (GAAP), and IFRS.

A close reading “reveals what we view as a material difference in loss recognition,” the analysts wrote.

Under U.S. GAAP, they said, a loan is impaired when it is probable a credit will be unable to collect on all amounts due, based on current information and events.

IFRS accounting considers a loan impaired based on “objective evidence” surrounding a financial asset or group of financial assets.

“We believe that either there is a very significant difference in the two accounting regimes or the standards are being interpreted in very different ways,” the TD analysts wrote.

In addition, they said U.S. banks are more likely than their Canadian counterparts to use a special form of provisioning known as a collective allowance because there is a greater acceptance in the United States of releasing these reserves in the future if conditions improve.

“In any event, the result is that the U.S. banks are likely to hold materially higher allowances on their oil and gas loans and, as they did post the financial crisis, release the collective allowances into earnings sometime in the future,” Mendonca and his team wrote.

Despite the differences, Canadian banks have begun to increase provisions for credit losses, reflecting the early impact of low oil prices.

The TD analysts said they expect “the next shoe to drop” in Canada when second-quarter results are posted this spring.

“Despite the recent move in oil, futures are flat year-to-date and prices are still down materially since the fall 2015 determinations,” they wrote. “This should result in further pressures on borrowing bases and the potential for covenant breaches.”

Combined with expected “prodding” from the Office of the Superintendent of Financial Institutions (OSFI), Canada’s key bank regulator, “we expect impairments and credit losses to climb,” the analysts said.
Canadian banks are already starting to put the screws on oil companies. Last week, Zero Hedge reported, A Glimpse Of Things To Come: Canadian Oil Company Liquidates Hours After Bank Demands Repayment.

It's no wonder Alberta's housing market is taking a beating after the historic plunge in oil prices. And as I wrote yesterday in my comment on shifting the focus on enhancing the CPP, I expect Alberta's woes to spill over to the rest of the country.

I've long been short Canada and despite the recent pop in oil prices and the loonie, I haven't changed my mind on that macro call. I fundamentally believe the worst is yet to come for Canada because my big picture outlook for global deflation hasn't changed.

And global deflation spells big trouble for all banks, not just Canadian ones. In fact, have a look at the U.S. Financial Sector ETF (XLF) and you will notice it's rising from its low in mid February but basically going nowhere as it's still below its 200-day and 400 day moving average (click on image):

Speaking at the Economic Club of New York on Tuesday, Federal Reserve Chairwoman Janet Yellen said that while the U.S. economy remains on track, the Fed still intends to pursue only a gradual increase in interest rates, stating global uncertainty justifies a slower path of rate increases.

I've already written about the sea change going on at the Fed, so none of this surprises me. Moreover,  Jeffrey Gundlach, the widely followed bond king who runs DoubleLine Capital, said on Monday that an interest-rate increase by the Federal Reserve in April is "inconceivable," given lower forecasts for first-quarter GDP growth.

What's worrying Janet Yellen? In my opinion, global deflation coming to America. The Fed is desperately trying to talk down the U.S. dollar, especially now that a profits recession has already hit the U.S. economy, threatening future employment gains (click on image): 

The latest strategic analysis from the Levy Economics Institute, Destabilizing and Unstable Economy, reveals that the US economy remains fragile because of three persistent structural issues: weak demand for US exports, fiscal conservatism, and a four-decade trend in rising income inequality. It also faces risks from stagnation in the economies of the United States’ trading partners, appreciation of the dollar, and a contraction in asset prices.

So here you have the U.S. economy slowing at a time when China, Japan and Europe remain mired in deflation, and we think little old Canada is going to do well in this environment? Sure, the lower loonie can help manufacturing exports, but if you ask me, many Canadian economists, especially bank economists, are way too optimistic on Canada's growth prospects going forward.

As far as Canadian banks, if you look at the BMO S&P/TSX Equal Weight Banks Index ETF (ZEB.TO), they too have performed better than their U.S. counterparts recently, basically bouncing up as oil prices rallied from their lows (click on image):

And when Canadian banks do well, the entire Canadian stock market does well (click on image):

But this countertrend rally won't be sustained as global deflation becomes more entrenched and as I've repeatedly warned you, use any spike in oil prices to short the loonie and lighten your position in energy and commodity shares.

I think what happened in Canada at the start of the year was a classic rotation into energy and commodity shares by global asset allocators who thought the loonie was cheap and these shares will bounce, which they did.

Now, if you're betting on a global recovery, you should continue buying Canadian banks, energy and commodity shares. If you think it's going to fizzle out in the second half of the year, stay away or sell these shares. This is all part of a global RISK ON/ RISK OFF trade that dominates markets.

When it comes to shorting Canada, however, I prefer shorting the loonie than Canadian banks. Why? Because every time they dip, all of Canada's big pension funds buy them and so do Canadian mutual funds. Canadian banks offer stable and attractive dividends, are well managed and they pass most of the mortgage risk from any potential housing crisis off to the Canada Mortgage and Housing Corporation (CMHC guarantees the bulk of the mortgages in Canada).

Still, a protracted global deflationary slump will present huge challenges to all global banks, including Canadian ones. This is why I agree with a buddy of mine who recommends Canadians buy shares of BCE in their retirement portfolio when they dip big, not now as they've run up too much as everyone chases dividends (click on image):

If you absolutely want to invest in Canadian banks, preferred shares are another option. One former colleague of mine loaded up on preferred shares of Canadian banks late last year as they got decimated. He rightly noted the risk/reward tradeoff at the time was much better than buying the common shares (read this article on preferred shares to understand why they got clobbered last year).

Finally, David Tavadian, founder of the Global Investment Strategy Institute (GISI), a new independent strategy & research firm based here in Montreal, sent me an interesting research paper on investing in U.S. relative to Canadian banks. You can contact David at and ask him to email you this Special Report which he co-authored with Jean Roy, professor of Banking & Finance at HEC Montreal. This report is excellent and well worth reading. 

Below, watch excerpts of Federal Reserve Chairwoman Janet Yellen speaking at the Economic Club of New York on Tuesday, warning that global uncertainty justifies a slower path of rate increases.  

I'm afraid the Fed and other central banks are realizing that there's little they can do to stem off the global deflation tsunami which is why markets are defying them right now. 

If global deflation sets in, the new negative normal will hit all countries, including Canada and the United States, placing huge pressure on all banks to deliver the return on equity (ROE) targets of the past.

Tuesday, March 29, 2016

Shifting the Focus on Enhancing the CPP?

Andy Blatchford of the Canadian Press reports, Next on the Finance Minister’s to do list: Get provinces to support a Canada Pension Plan expansion:
With his first budget behind him, rookie Finance Minister Bill Morneau seems comfortable in his new surroundings — he’s even quick to highlight the symbolism of the boardroom artwork at his department’s headquarters.

Morneau points to a series of framed pictures featuring etchings of $1 coins. The artist, he explains, flipped each of the loonies repeatedly to identify which might be considered the luckiest of the bunch.

That coin, now encased, also hangs from the wall.

“So, that’s the lucky loonie,” Morneau told The Canadian Press before a recent roundtable interview.

“We thought that was an appropriate piece of art for the Finance Department.”

Just days after tabling his maiden budget, good fortune seemed to be on the former Toronto businessman’s mind as he explained what his private-sector expertise brings to one of his next big tasks: enhancing the Canada Pension Plan.

One’s ability to retire in dignity is often driven “partially by luck,” said Morneau, who has advised Ontario Premier Kathleen Wynne on pensions.

There’s a role for government when someone in a private, defined-contribution plan — and who hasn’t saved enough — happens to retire at a time when the stock market’s down, he continued.

The Liberals repeated their support for strengthening the CPP in last week’s budget, which noted the dangers of things like failing private-sector pension plans and the risk that healthier Canadians could outlive their savings.

Until last fall, Morneau was executive chairman of the human resources firm Morneau Shepell, a company that describes itself as Canada’s largest provider of pension-administration technology and services.

He said he understands the financial challenges seniors face and that any CPP enhancement should be fully funded by those who will actually use it to avoid an “intergenerational wealth transfer.”

Morneau said he hopes to eventually get some consensus on enhancing the CPP, a goal outlined in the Liberal government’s election platform. Doing so would require the support of seven of the 10 provinces representing two-thirds of the country’s population.

The provinces and territories are scheduled to reconvene in June to continue talks that began in December on the polarizing subject of CPP reform. The aim is to reach a collective decision by the end of the year.

But it’s still unclear how much support the Liberals will garner, even though the provinces agreed in December to continue discussing the subject.

Wynne, for one, supports CPP expansion and plans to proceed with mandatory payroll deductions starting Jan. 1, 2017, for the new Ontario Retirement Pension Plan. That plan essentially mirrors the CPP for anyone who doesn’t already have a workplace pension.

Other big provinces like Quebec and British Columbia remain unconvinced. Quebec already has a public pension plan and B.C. has expressed concerns about the country’s fragile economy.

Saskatchewan has opposed CPP enhancement over worries about the negative consequences of the oil-price slide on the provincial economy.

But Morneau said he remains “cautiously optimistic” about the next round of CPP talks — an issue he’s unwilling to leave up to a simple toss of a coin.

“The devil is in the details, but there’s a recognition of the challenge that we face and there’s a recognition that CPP’s been a very effective vehicle over the last 50 years,” he said.
I certainly hope Bill Morneau convinces his provincial counterparts there is no better time than now (at least from a political standpoint) to expand the CPP.

The Liberals have already bungled up two things on retirement policy. First, they scaled back the TFSA limit, a dumb move which penalizes many Canadians with no pension whatsoever who are just trying to save for retirement. More recently, they scaled back OAS eligibility from 67 to 65 years old, making Canada the odd man out as far as global pensions are concerned.

Morneau concedes Canadians are healthier and living longer, so why not recognize longevity risk and leave OAS eligibility at 67? Answer: pure political pandering at its worst except now it's not the Harper Conservatives pandering to big banks and insurance companies, it's the Trudeau Liberals pandering to Canada's "working poor" (but implementing stupid policies in their name).

Now, the Trudeau Liberals have a golden opportunity to rally the provinces around a very important retirement policy -- perhaps the most important one in the history of Canada -- and get on to enhancing the Canada Pension Plan so more Canadians can retire in dignity and security and not be held hostage by the vagaries of global stock markets (if they're lucky enough to have saved anything for retirement).

Importantly, good retirement policy is good economic policy for the long-term. The more people retire in dignity and security, the better they can plan for retirement and spend accordingly. It all comes down to a theme I harp on in this blog, namely, rising inequality and deficient aggregate demand.

What about concerns from Quebec, British Columbia and Saskatchewan on oil and the economy? Let me address these concerns head on. Canada is going to face its worst economic crisis ever, ushering in negative rates here, but that is not a reason to avoid enhancing the CPP. Quite the opposite, that's a big reason to get on with bolstering the country's retirement system.

In fact, when I read Andrew Coyne's critique on the federal budget or that of John Ivison, I understand their concerns on spending but when they state Canada is not in a recession, they're either dreaming or completely delusional.

Let me give all you private sector economists, many of which are former colleagues of mine who I respect a lot, a word of advice. If you can't forecast trends in global stock, currency, commodity and fixed income markets, much like I regularly do on my blog, you have no business whatsoever trying to forecast where the Canadian economy is heading.

When I read articles on how New York's real estate market is headed for a crash, my mind immediately goes to Vancouver's red hot real estate market and how it's set to crash hard as house prices there hit new highs, no thanks to unscrupulous real estate agents preying on foreign buyers or worse still, helping them conceal their ill-gotten gains (a lot of black money is entering Canada and regulators are looking the other way).

But the same global pressures that are hitting New York and London's red hot real estate market are also going to hit that of Canada's. Add to this banks and hedge funds shedding thousands of high paying trading jobs, and you quickly realize that Vancouver and Toronto's real estate market are next in line to fall hard (in Montreal, Bombardier's woes is hurting this city's real estate market as many engineers lost their job).

And once Canada's real estate market implodes, I guarantee you Bank of Canada Governor Stephen Poloz will be going negative and not waiting to see what happens with federal spending on infrastructure. He might even move rates to negative a lot sooner if oil prices keep declining or crash.

In fact, my former colleague, Brian Romanchuk, wrote a very thoughtful comment on the radical status quo of the Canadian federal budget where he questions whether all this stimulus spending is going to make a difference once the Canadian housing market crashes (it won't but it's better than doing nothing!).

Brian ends his comment on this sobering note:
I fail to see anything in the budget that directly addresses the problems created by the two-tier labour market, and so there is no reason to expect the problems with persistent underemployment going away. This underemployment helps create the economic drag that has been diagnosed as "secular stagnation."
I've said this before and I'll say it again, Canadians live in Dreamland. They're either hopelessly delusional or they simply don't realize what's going on out in the global economy and how it's going to severely impact the Canadian economy (Albertans are the first to taste this bitter new reality).

And these problems aren't unique to Canada. Chronic underemployment or structural unemployment is threatening the U.S. economy too where a staggering 23% of Americans in their prime working years are unemployed. Worse still, those that are working aren't saving money enough for retirement and are making a dangerous retirement gamble on their future.

So, if the U.S. economy isn't in great shape (far from it), and China, Japan and Europe are mired in deflation, what are the prospects for a small open economy like that of Canada? I'm afraid they're not good and the worst is yet to come.

But don't use the poor economy as an excuse not to enhance the CPP for all Canadians. While volatile stock markets disproportionately impact the portfolios of individual Canadians, large, well-governed public pension funds like the Canada Pension Plan Investment Board relish at the opportunity to buy global public and private market assets at a discount.

Below, Finance Minister Bill Morneau says the government has an 'important role' to play in helping people save for retirement, highlighting three challenges the Liberals will be addressing.

Bill Morneau is absolutely right to shift the focus on to enhancing the CPP. It's now or never, period. If politicians squander a golden opportunity to enhance the CPP once and for all, they will be condemning another generation of Canadians to pension poverty.

Friday, March 25, 2016

Chicago's Pension Nightmare?

The Wall Street Journal reports, Chicago Pension Nightmare:
The hits keep coming for Chicago Mayor Rahm Emanuel. On Thursday the Illinois Supreme Court struck down the city’s pension reform, which required city workers to chip in more to their retirement plans, raised the retirement age and cut back on cost-of-living adjustments. But there may be a silver lining for the fiscal basket case known as Illinois.

The Illinois court said Chicago’s 2014 reforms violate a provision of the state constitution that bans diminishing existing pension benefits. This is legally debatable, but the court’s ruling wasn’t surprising since it had already knocked down state pension reforms signed by previous Governor Pat Quinn.

The ruling further limits Mr. Emanuel’s fiscal options as pension payments take an ever-growing share of city revenues. On Thursday the gracious souls at the Chicago Teachers Union announced a one-day walkout on April 1. The CTU isn’t allowed to strike until this summer, but CTU president Karen Lewis told her members not to worry: “What are they going to do, arrest us all? Put us all in jail? There’s not 27,000 spaces in the Cook County Jail right now.” Ah, she cares so deeply for the children.

The ruling may be better news for Illinois Governor Bruce Rauner, who has been trying to reform the state pensions amid a hostile Democratic legislature. The court said in its Chicago ruling that a reform would be constitutional if workers had a choice to go into a modified or lower-benefit structure.

Mr. Rauner has endorsed the outline of a plan created by state Senate President John Cullerton that would let workers choose between capping their pensionable salary and collecting more generous cost-of-living increases during retirement, or collecting slightly lower cost-of-living increases during retirement based on a higher pensionable salary.

Mr. Cullerton has since distanced himself from his own handiwork under union pressure, but something will have to give or Illinois and the City of Big Unfunded Pension Obligations will go broke.
John O'Connor of the Associated Press also reports, Illinois Supreme Court strikes down Chicago pensions plan:
The Illinois Supreme Court dealt another devastating blow Thursday to the state's impatient attempts to control ballooning public pension debt, striking down a law that would have cut into an $8 billion hole in two of Chicago's employee retirement accounts and leaving officials searching for new options to shore up an already wobbly program.

The city had hoped that by pointing to the steep increase in taxpayer-fueled contributions the law required it would be able to sidestep a widely expected ruling that the plan violated the Illinois Constitution's protection against reducing pension benefits.

But the court's unanimous finding in favor of pension participants who pointed to reduced future benefits and higher contributions sends the city back to the bargaining table.

Republican Gov. Bruce Rauner used the ruling the tout a proposal by Democratic Senate President John Cullerton that would offer workers a choice of future cost-of-living increases based on current salary, or lowered increases tied to future pay raises. The idea is, benefits already collected don't go away.

"We've got to stop changing and taking away peoples accrued pension benefits," Rauner said at a stop in Paxton, according to audio released by his office. "Let's propose changes for future work with 'consideration' so teachers or police officers or public places can choose different pensions for the future."

An expert on Illinois finances said it's time to amend the Illinois Constitution to make the pension protection language clear. Lawmakers vowed to keep trying.

To stave off insolvency by 2029, the law forced the city to significantly ramp up its annual contributions, but also cut benefits and required larger contributions from about 61,000 current and retired librarians, nurses, non-teaching school employees laborers and more.

Critics targeted the law from the start, in part because it addressed only two funds — civil servants and laborers. When including police and fire pension programs, the city's total liability was $20 billion — not counting a $9.6 billion shortfall in the Chicago Public Schools teachers' pension account. The City Council approved a $543 million property-tax increase last fall — to deal with shortages in police and fire funds.

The order came less than a year after the high court used the same reasoning to shoot down a separate pension bailout: the $111 billion deficit in state-employee retirement accounts.

And other cities are not far behind, facing similar shortfalls.

Laurence Msall, president of the Civic Federation, a Chicago-based tax policy and research group, suggested the iron-clad constitutional language threatens any proposal. He suggests a constitutional amendment that loosens its restrictions.

"We're not advocating for any specific plan," Msall said. "We're supporting the need for clarity in the constitution so those ideas can be legislated."

Chicago Mayor Rahm Emanuel, who inherited the crisis, disagreed with the ruling but pledged to re-convene negotiations on a new framework.

"My administration will continue to work with our labor partners on a shared path forward," the Democrat said in a statement.

The four unions representing the plaintiffs were more sanguine.

"This ruling makes clear again that the politicians who ran up the debt cannot run out on the bill or dump the burden on public-service workers and retirees instead," the unions said in a joint statement.
Margaret Cronin Fisk, Elizabeth Campbell, and Janan Hanna of Bloomberg also report, Chicago’s Plan to Overhaul City Pensions Dashed by Top Court:
Chicago’s plan to ease its $20 billion public-worker pension deficit was ruled illegal by the Illinois Supreme Court, a decision that the city warned may lead to the funds’ running out of money and worsen its financial strains.

The Chicago plan, passed in 2014, violates the Illinois Constitution, which bars the diminishing of public pensions, the court said Thursday. The finding upholds a lower court decision  from July and follows a similar ruling by the Illinois Supreme Court last May preventing changes to the state’s pension funds.

“It’s disappointing, but not unexpected,” said Paul Mansour, head of municipal research at Conning, which oversees $11 billion of state and local debt, including Chicago securities. “It will take longer to bring these costs under control absent the ability to enact common sense reforms that were negotiated.”

The city, the third-largest in the nation, shortchanged its pensions over the last decade, creating a shortfall that’s left it with a lower credit rating than any big U.S. city except once-bankrupt Detroit. Under the now void law, its projected annual payment of $886 million due this year to its four retirement funds was more than twice what it was a decade ago, spurring officials to adopt a record property-tax increase to ease the impact on the budget.

The ruling in the Chicago case impairs Mayor Rahm Emanuel’s efforts to pare a deficit that threatens the city’s solvency. The defeat leaves officials racing to devise new ways to shore up retirement system, though it will also save money in the short term because the overhaul required the city to boost contributions to its municipal and laborers funds. The two cover about 60,000 workers and retirees.

“My administration will continue to work with our labor partners on a shared path forward that preserves and protects the municipal and laborers’ pension funds, while continuing to be fair to Chicago taxpayers and ensuring the City’s long-term financial health,” Emanuel said in an e-mailed statement.

Workers hailed the decision for eliminating the risk that promised benefits will be scaled back. “Today’s ruling strengthens the promise of dignity in retirement for those who serve our communities, and reinforces the Illinois Constitution, our state’s highest law,” city unions said in a joint statement.

The court’s ruling comes almost 11 months after it unanimously struck down a 2013 law to alter Illinois’s retirement system, saying the changes to solve the state’s $111 billion pension shortfall violated constitutional protections of workers’ benefits. That holding led Moody’s Investors Service to cut Chicago’s credit rating to junk in May, citing the increased risk that the city’s law would also be thrown out.

Moody’s, which has a negative outlook on Chicago’s Ba1 rating, one step below investment grade, said it would continue to assess its plans to fix pensions in the wake of the ruling.
Ruling Expected

Before the ruling, Moody’s said the city could get hit with another downgrade if the court sided with unions and officials don’t develop and enact an alternate plan. Unlike cities such as Detroit, Chicago can’t file for bankruptcy protection to cut its debts because Illinois law doesn’t allow it.

There was little trading in Chicago bonds after the verdict, which investors had predicted would not go in the city’s favor.

The ruling was an “expected setback for the city,” said John Miller, co-head of fixed income in Chicago at Nuveen Asset Management, which oversees about $110 billion in munis, which includes Chicago debt. The city has a growing and diverse economy, he said, citing increasing corporate relocations and a rise in assessed valuations among other positives.

“They have time and they have strength to pull from,” Miller said. “I think other reform models that could pass muster are still being worked on. They tried one type, and that one type didn’t work, so they got to try another model.”

Chicago argued that its plan was different from the state version because it increased city funding of the municipal workers’ and laborers’ pension funds, essentially protecting benefits by ensuring the funds don’t go broke. The plans for fire and police retirees weren’t covered by the overhaul.

Accrued benefits shouldn’t be changed, Illinois Governor Bruce Rauner told reporters on Thursday. He reiterated the importance of his agenda, stalled in the Democrat-led legislature, to bolster the state economy through limits on unions and property tax relief.

“I’m not going to bail out Chicago, but our reforms structurally will allow Chicago to solve a lot of its own problems,” Rauner said.

The affected plans cut future cost-of-living raises. Lawyers for unions sued the city, arguing that any reduction in benefits was illegal. The court agreed.

“The statutory funding provisions are not a ‘benefit’ that can be ‘offset’ against an unconstitutional diminishment of pension benefits,” the opinion reads.

The city’s measures were intended to make the laborer and municipal worker pensions 90 percent funded by the end of 2055. The municipal workers’ pension was only 42 percent funded, and the laborers only 64 percent funded, at the end of 2014, city documents show.

Unfunded liabilities are increasing each day by an average of $2.48 million, city lawyers said in court papers. One fund will be out of money within 10 years, the other in 13, they said. The court rejected that as a justification for reducing benefits.

“To put it simply, in 10 years, the members of the Funds will be no less entitled to the benefits they were promised,” the opinion reads. “Thus the ‘guaranty’ that the benefits due will be paid is merely an offer to do something already constitutionally mandated by the pension protection clause.”

The case is Jones v. Municipal Employees Annuity and Benefit Fund of Chicago, 119618, Supreme Court of Illinois (Springfield).
In its editorial, the Chicago Tribune laments, Pension ruling another blow to Chicago taxpayers — and Emanuel:
The Illinois Supreme Court ruled unconstitutional another pension reform law on Thursday, this one affecting Chicago and splashing more red ink on fragile, debt-ridden city finances.

The court’s decision to toss Chicago’s pension reform law, which the Illinois legislature approved in 2014 as an attempt to rescue pension funds for municipal workers and laborers, was not a surprise. Nor is its ripple effect: As the opinion states and unarguable math attests, those two funds remain on track to go insolvent “in about 10 and 13 years, respectively.”

The court previously had twice ruled that an Illinois Constitution pension clause protects retirement benefits promised from a worker’s start of public employment. The law the justices rejected had required certain city of Chicago workers to pay more toward their pensions, scaled back cost-of-living increases upon retirement, and raised the retirement age. The court ruled that those changes violate the constitution’s provision that membership in any pension or retirement system “shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”

The decision repudiates Mayor Rahm Emanuel’s strategy for salvaging a vastly underfunded Chicago pension system that also covers public safety workers — police and fire — and Chicago teachers. Emanuel persistently has argued that because 28 of 31 unions affected by the 2014 reform law had agreed to it. Emanuel said that because the law would shore up the funds in the long run and thereby protect benefits for retirees, it would meet constitutional muster.

But the Supreme Court disagreed. In a 2015 ruling rejecting a pension reform law affecting state lawmakers, the justices faulted state lawmakers for not making adequate payments into their pension system. Thursday’s ruling similarly blamed city leaders for failing to make adequate payments into City Hall’s pension funds: “The pension code continued to set city contribution levels at a fixed multiple of employee contributions. This contribution level had no relationship to the obligations that the funds were accruing.” To rule in favor of the law would mean that the court would have to “ignore the plain language of the constitution.”

Translation: City and state politicians have known well that they were awarding pension benefits that Illinois governments cannot afford. Rather than properly fund pension systems, the politicians have spent on other priorities the tax revenues they should have set aside to fulfill all the generous retirement promises they made to their friends in public employees unions.

Justice Mary Jane Theis wrote the 5-0 opinion. Justices Anne Burke and Charles Freeman did not take part in the decision.

We supported this pension reform law, and the state law, for a number of reasons, including getting language before the courts for a decision. We now have it.

For city taxpayers, the impact of Thursday’s ruling is menacing. In essence the court is saying that the responsibility to deliver benefits the politicians have pledged to public workers falls on taxpayers’ shoulders. Barring some major reforms that do meet constitutional tests — or the long overdue government streamlining and cost-cutting that city and state pols chronically resist — taxpayers will have to bail out not only these pension funds for municipal workers and laborers, but also the similarly endangered funds for police officers, firefighters and teachers.

Add in taxpayers’ liabilities for Cook County workers, whose pension system is listing. Emanuel and Cook County Board President Toni Preckwinkle already have backed huge tax hikes to help address their respective pension shortfalls.

And don’t forget the underfunded pension systems for state workers, downstate teachers, university workers, retired lawmakers and some suburbs’ workers.

With the Supreme Court sticking to its rigorous interpretation of the pension clause — the justices even protected health care for retirees in a 2014 decision — there seems to be little room to extract from public workers that “shared sacrifice” the politicians love to talk about.

No, unless Illinois pols institute massive reforms to the cost of governance, taxpayers can expect to bear the brunt of the pension crisis our elected officials have created in their name.

The taxation required to support the huge enterprise of Illinois government already is monumental — and now it’s likely to grow. Blame decades of mismanagement at all levels of representation.

Borrowing to pay for operating expenses has been the path to ruin. This new City Hall obligation comes on top of billions of borrowing throughout city, county and state governments.

As you prepare to vote in the November general election, remember: Piling debts upon debts can no longer be the way Illinois and Chicago operate.
Piling debts are going to keep piling in Chicago. Progress Illinois reports, Chicago Takes Out $220 Million Loan For Pension Payments:
The city of Chicago borrowed $220 million for a police and fire pension payment due by the end of the year.

The city took out the loan with a 3 percent interest rate in order to have the pension funds ready by a state-mandated March 1 deadline, officials said Monday.

Chicago Mayor Rahm Emanuel's 2016 budget included a $588 million property tax hike for police and fire pensions and school construction. Still, the mayor's spending plan depends on the state for pension funding changes, which have cleared both legislative chambers but have not yet been sent to Republican Gov. Bruce Rauner. The governor has called for the Chicago pension to bill to be included "as part of a larger package of structural reform bills."

The pension funding changes would give the city more time to make its pension payments, cutting pension costs due this year by $219 million.

With the pension changes in place, the state could return the $220 million it borrowed from its $900 million short-term credit line.

In other pension-related news, the Illinois Supreme Court is expected to hand down a decision Thursday regarding Chicago's 2014 overhaul of its Municipal and Laborers pension funds.

Last July, a Cook County Judge deemed the city's pension overhaul unconstitutional. The city appealed the lower court ruling to the Illinois Supreme Court.

The Cook County judge's ruling against Chicago's pension measure was guided by a May decision from the Illinois Supreme Court involving a state pension reform law.

The state's high court struck down the state pension measure on the grounds that it violated the Illinois Constitution's pension clause, which states that contractual pension benefits cannot be reduced.
Chicago's pension nightmare has come full circle. As Zero Hedge rightly notes, the countdown for insolvency begins for Chicago's pensions. This pension problem has been festering for years not just in Chicago but in the entire state of Illinois which has one of the worst funded state plans.

What are my thoughts? I've been warning all of you that U.S. public pensions are doomed and the worst ones are at the city and local levels. These unfunded public pension liabilities are going to crush taxpayers through higher property taxes and make it increasingly more difficult for people to afford homes in the United States, not that they are affordable right now.

And while I understand the state's high court ruling -- after all, Chicago mismanaged its pensions for decades, failing to top them up so they it can spend lavishly and foolishly elsewhere -- I am increasingly worried that public sector unions fail to understand that unless they agree to adopt a shared risk model and agree to some pension reforms, their city will go the way of Greece and Detroit where the bond market extracted a pound of flesh from public pensions.

[Update: $10 billion of Chicago's debt was just downgraded to one level above junk.]

In other words, Illinois' Supreme Court can interpret the law any way it wants, in the end it's the bond market which will impose drastic cuts to public pensions because already stretched taxpayers aren't in a position to bail out grossly mismanaged public pensions.

I've gone through this already when I discussed New Jersey's COLA war:
In the U.S., you don't have such shared risk plans at state pensions, which is why you see massive confrontations on public pensions and terrible solutions to the state pension crisis (like shifting out of defined-benefit into defined-contribution plans).

So who is going to win New Jersey's COLA war? I don't know. I feel for a lot of public sector employees getting screwed but the reality is New Jersey and other U.S. states are already screwed when it comes to their pension promise and unions and politicians will need to agree on very difficult cuts to shore up these public pensions. You can only kick the can down the road so far before the chicken comes home to roost.

One thing I do know, however, is that defined-contribution plans are not the solution to America's ongoing retirement crisis. We can debate COLAs but there's no debating that bolstering defined-benefit plans is the best way to bolster a country's retirement system. You just need to get the governance right and introduce a shared-risk model at public pensions like New Brunswick did to tackle its pension deficit.
What is important for all of you to keep in mind when I discuss Chicago's pension nightmare, U.S. public pensions being doomed, Europe's pension problem or the $78 trillion global pension disaster is that the global pension crisis is deflationary and it will be with us for a long time.

Let me explain this further. When it comes to unfunded public pensions, either you increase the retirement age and contributions or you cut benefits or you ask taxpayers to bail them out. That last option is political suicide but let's say politicians are able to ram this through.

What do all these options mean? Less spending for the economy by consumers and less spending on much needed infrastructure projects. And less personal spending on goods and services as well as less government spending on goods, services and infrastructure is very deflationary. Period.

Below, CBS Chicago reports on the Illinois Supreme Court's decision to strike down the Emanuel administration’s attempt to bail out the severely underfunded pension systems for city workers and laborers, placing more pressure on taxpayers to top up these funds.

Get ready, Chicago's pension nightmare will spread throughout the world and there will be no resurrecting pensions from the dead.

On that happy note, wish many of you a Happy Catholic Easter (our Greek Orthodox Easter is in May) and I wish you all a nice long weekend. I'll be back on Tuesday.

Thursday, March 24, 2016

Ontario Teachers' Brussels Connection?

Barbara Shecter of the National Post reports, Ontario Teachers’ Pension Plan owns 39% stake in terror-targeted Brussels Airport:
The terrorist attack in Brussels on Tuesday morning hit close to home for the Ontario Teachers’ Pension Plan.

The pension fund owns 39 per cent of the Brussels Airport, a stake acquired in 2011. Two bombs went off at the airport while another exploded at a busy metro station. The combined death toll reached at least 30, and more than 200 were injured.

“We are deeply saddened and shocked by the tragedy in Brussels and our thoughts are with all of those that have been affected,” said a statement posted on the Canadian pension fund’s website.

It added that Teachers’ is “in close contact with Brussels Airport and the Belgium Government,” and that the pension fund is “providing whatever support we can.”

Deborah Allan, a Teachers’ spokesperson, said there would be no further comment Tuesday.

Other shareholders in Brussels Airport include Macquarie European Infrastructure Funds and the Belgian State.

Teachers’ holds the airport stake in its infrastructure and natural resources portfolio, alongside stakes in Bristol Airport, Birmingham Airport, and Copenhagen Airports, the largest airport in Scandanavia.

The Canadian pension plan also has a stake in High Speed 1, the 109-kilometre high-speed railway connecting London to the Channel Tunnel.
Ontario Teachers' has a large portfolio of infrastructure assets that includes many European airports. Most recently, along with AIMCo, OMERS, and Kuwait's sovereign wealth fund, it bought London City Airport.

I questioned that deal, stating the premium they paid was outrageous but one senior Canadian pension fund manager who didn't bid on this asset told me: "You can't always look at infrastructure valuations as I've seen assets that look cheap and turn out to be terrible investments and others that look expensive and turn out to be great investments. It really all depends on their long-term strategic plan for this asset."

This comment, however, isn't about valuations or the Brusssels airport as an asset (I know it well and think it's a great asset). It's about another risk that comes along with infrastructure assets, namely, security risk associated with the scourge of terrorism.

If I was an owner of any any major infrastructure asset that terrorists can potentially strike, I would be sitting down with my infrastructure team to review security operations.

Admittedly, if you start thinking about airport security or security on a subway, bus or train, it can drive you mad because many of these are "soft" targets that terrorists can easily strike.

In the case of Brussels airport, we know the carnage happened outside the security perimeter where people were waiting in line to check in their bags.

Right now, there are many fingers being pointed at who is to blame for the Brussels attacks. Reuters reports one of the attackers in the Brussels suicide bombings was deported last year from Turkey, and Belgium subsequently ignored a warning that the man was a militant, Turkish President Tayyip Erdogan said on Wednesday.

The Haaretz reports that Belgian security services, as well as other Western intelligence agencies, had advance and precise intelligence warnings regarding the terrorist attacks in Belgium on Tuesday.

If this is the case, clearly security agencies need to accept their responsibility in this tragedy. Who else dropped the ball here? Some are pointing the finger at ICTS, a firm run by former Israeli intel operatives who run the security at Brussels airport:
ICTS was established in 1982 by former members of Shin Bet, Israel's internal security agency and El Al airline security agents, and has a major presence around the world in airport security including operations in the Netherlands, Germany, Spain, Italy, Portugal, Japan and Russia. ICTS uses the security system employed in Israel, whereby passengers are profiled to assess the degree to which they pose a potential threat on the basis of a number of indicators, including age, name, origin and behavior during questioning
Signs of the Times states this isn't the first time that ICTS has come under scrutiny for possible security lapses. But when I read absurd nonsense like "it seems that the conditions are being created whereby the events of Nazi Germany may well repeat, only this time with Muslims in the position of the Jews," I tune off and question the angle of this "investigative reporting" (only fools would state or believe such rubbish).

When it comes to airport security or any security, I would hire an Israeli firm run by former Shin Bet operatives in a second. Not that they can guarantee the security of passengers but these people are highly trained specialists who know what to look for when it comes to possible terrorist threats.

After Paris and Brussels, it's easy to point fingers but the reality is security agencies across the world are stretched thin as governments cut back on their spending. This places more pressure on Ontario Teachers and others that own infrastructure assets to review their security measures to ensure the well-being of passengers as well as the security of all their infrastructure assets.

When thinking of infrastructure assets, experts often cite liquidity risk, currency risk, political and regulatory risks but rarely cite terrorism as a risk. Maybe they should start talking about this risk because terrorism isn't going away, it's only going to get worse.

Below, Pini Schiff, Israel's former airport security chief says the Brussels attacks should be a "wake up call" for European countries to reassess airport security protocol. I tried to embed this clip but couldn't turn off the autoplay. You can watch it here.

Mr. Schiff thinks Europeans are 40 years behind Israel in terms of airport security but others aren't convinced that Europe is ready to adopt Israel's approach to security.

Also, the terror attack in Brussels has exposed a major weak spot in airport security - cars and people are not screened until they reach security machines deep inside terminals. Counter-terrorism expert Tony Roman of Roman and Associates is calling for a change."Cars at the terminal, a bomb could be in them and we can lose a lot of people," he told IE. He added: "We have to move security away from the terminal. It is a minor inconvenience for a lot of protection."

Tony Roman also appeared on CNBC with Israeli security expert and AR Challenges CEO Rafi Sela to discuss airport security and the terror attacks in Brussels. See their discussion below.

Lastly, discussing the future of security at airports worldwide in the aftermath of the Brussels attacks with Alan Diehl, former FAA and NTSB investigator. Get ready for more sweeping changes at airports.

Unfortunately, this is the new normal and we better get used to it. There will be new devices to detect explosives favored by terrorists but the reality is security protocols across all airports will need to be reassessed in light of the tragic events at Brussels.

Wednesday, March 23, 2016

AIMCo Returns 9.1% in 2015

Benefits Canada reports, AIMCo returns 9.1% in 2015:
Alberta Investment Management Corporation (AIMCo) has reported a 9.1% rate of return on its total assets under management for the year ending December 31, 2015.

The pension fund earned more than $1.5 billion of active value-add return above benchmark and overall investment income of $7.5 billion on total assets under management of $90.2 billion.

“I am very pleased with the terrific year of performance, especially against a backdrop of change and extreme volatility across the markets,” said Kevin Uebelein, chief executive officer. “AIMCo’s investment teams remained disciplined and focused on the long term, taking well-measured active risk positions, in-line with our investment strategies and our clients’ established needs.

“That steady hand approach, and the support of the entire organization, allowed us to identify, and act upon, value-generating opportunities across all major asset classes. This result is further evidence that the ‘Canadian Model’ of public asset management is one that very well serves the needs of the public.

“During these times of intense challenge for Alberta, it is especially gratifying to be able to deliver more than $1.5 billion of over-performance against our benchmark returns, which represents a best-ever performance figure for AIMCo.”

Detailed performance information will be available in AIMCo’s annual report to be released in June 2016.
Matt Scuffham of Reuters also reports, Canada's AIMCo records 9.1 percent rate of return in 2015:
Canada's Alberta Investment Management Corp (AIMCo) said it performed better in 2015 than in any year since its inception in 2008, with investments in real estate and infrastructure outperforming benchmarks.

AIMCo achieved an overall rate of return of 9.1 percent and a 10.1 percent rate after stripping out government and specialty fund clients for managing short and medium-term fixed income assets and for liquidity management.

AIMCo, which manages pension and government funds for the oil-rich province of Alberta, said overall investment income was C$7.5 billion ($5.75 billion) from total assets under management of C$90.2 billion. The performance exceeded its investment benchmark by over C$1.5 billion, it said.

AIMCo said investment teams in public equities, infrastructure, private equity and real estate all significantly outperformed their market benchmarks.

Like other Canadian pension funds, AIMCo has invested in real estate and infrastructure as an alternative to low-yielding government bonds.

"This result is further evidence that the 'Canadian model' of public asset management is one that very well serves the needs of the public," said Chief Executive Officer Kevin Uebelein.
AIMCo put out a press release on its results which you can read here. In its press release, AIMCo emphasizes the 10.1% return for the Balanced Fund, which is more representative when comparing it to its large Canadian peers, and it states the following:
AIMCo’s strong results in 2015 were the outcome of contributions from across the organization. Investment teams in Public Equities, Infrastructure, Private Equity and Real Estate all significantly outperformed their market benchmarks, while Money Market & Fixed Income, Mortgages and Private Debt & Loan performed equally well, providing stable value-add through difficult market conditions.
I had a chance to discuss these results with Dénes Németh, Director, Corporate Communication at AIMCo. Unfortunately, Kevin Uebelein, AIMCo's CEO, wasn't available but I realized that it wouldn't have been a fruitful discussion because the a detailed discussion of these results would require me to analyze the details from the Annual Report which only comes out in June.

I like the fact that AIMCo reports its calendar year and fiscal aggregate numbers. This makes it easier to compare its performance to its large Canadian peers.

But I find it unacceptable that AIMCo and a few other large Canadian pensions make their annual report public after releasing results. The Caisse and OMERS do this and it drives me crazy. At least the Caisse publishes a lot more detail on its performance when it releases it in February.

To be fair to these organizations, there are all sorts of reasons as to why they can't make their annual reports available at the time of reporting their results. Leo de Bever, AIMCo's former CEO, told me: "The fiscal release is constrained by provincial reporting issues: AIMCo ultimately consolidates in part with the provincial accounts, and we could not release before they do."

So what do I think of AIMCo's 2015 results? They are great. AIMCo handily beat the 5.4% average return of other large Canadian pension funds which defied market volatility last year and it even performed better than its peers like OMERS, HOOPP and the Caisse (AIMCo's Balanced Fund returned 10.1% in 2015 vs the Caisse which returned 9.1%).

While I wasn't able to get details of individual portfolios, Dénes Németh did tell me that AIMCo's Balanced Fund gained 10.1% vs 8% for its benchmark in 2015 and over the last four years, it gained 11.8% vs 10.6% for its benchmark. This would explain the $1.5 billion in active value-add return above benchmark last year.

It's also impressive that this performance was generated in Public Equities and Private Markets like Real Estate, Private Equity and Infrastructure. I commend both the Caisse and AIMCo for generating active value-add in Public Equities which is one reason why they both outperformed OMERS and HOOPP.

Of course, being an astute pension analyst, I asked Dénes two simple questions: "Does AIMCo hedge currency risk and what is the weighting of private market assets in its portfolio?"(see my coverage of HOOPP's 2015 results to understand why I asked these questions).

Dénes replied: 
"With respect to the questions below, I prefer not to respond as doing so would only provide insight toward one element of many that contribute to the successful outcomes achieved by our investment teams in 2015. My concern is that without the full story, which as I have explained will come in June, your readers may put more weight on these single factors than the overall effort that led to the strong results. I hope you will understand."
Of course I understand and while it's fair to point this out, it's equally fair for me to ask these questions as a large part of AIMCo's outperformance in 2015 is explained by these two factors.

In fact, I downloaded AIMCo's 2014 Annual Report where I was able to get answers to all these questions and a lot more. If you want to get details on its investments and benchmarks governing every investment portfolio, take the time to read AIMCo's 2014 Annual Report.

For example, here are the benchmarks governing each investment portfolio (click on image from page 33 of the 2014 Annual Report):

I'm not going to discuss the merits of each benchmark but for the most part, they're excellent benchmarks that properly cover the risks of each portfolio (we can debate whether they should add a liquidity and leverage premium on the benchmark for PE and whether this benchmark has too much beta in it but benchmarks for private markets aren't simple).

Now, to answer my question, roughly 25% of AIMCo's assets were in Private Markets as of December 31st 2014 and I expect that figure stayed the same or marginally increased in 2015. Also, there is a note that states "For balanced funds, notional exposures and Client-directed currency derivatives are not included in asset class calculations."

In fact, Leo de Bever shared this with me on AIMCo's currency hedging policy:
"This has been a big debate in the pension industry. Some hedge, some don’t, some go 50-50 as a measure of ignorance. AIMCo tended to hedge fixed income because it was a US substitute for Canadian fixed income, but most listed equities were unhedged where FX markets were liquid to make that efficient."
So, private market weights and currency gains had a material impact on overall performance in 2015. When you add to this outperformance in Public Equities which are unhedged, it was a great year for AIMCo.

Unfortunately,  I cannot share more specifics with you until AIMCO's 2015 Annual Report is released in June. Just go to the website and you will find it here (AIMCO really needs to revamp that annoying flash website and make it cleaner and easier to find information and download PDF and HTML information).

As far as compensation, once again, I cannot provide you with details until the 2015 Annual Report is available but AIMCo pays its top brass in line with what other large Canadian pensions pay (click on image from page 69 of AIMCO's 2014 Annual Report):

AIMCo's CEO Kevin Uebelein just started working last year so I expect to see his compensation increase and Dale MacMaster assumed the role of CIO and is doing an outstanding job, so I expect his compensation to increase too.

Going forward, I also expect AIMCo is going to have a tough time with its Real Estate holdings in Alberta and this was expressed to me in a lunch meeting I had with Kevin Uebelein back in November (read some of those details here).

I also asked Dénes Németh about the London City Airport deal which AIMCo took part in with Ontario Teachers, OMERS and Kuwait's sovereign wealth fund but he told me they are bound by the Consortium's confidentiality clause.

It's too bad because I questioned that deal, stating the premium they paid was outrageous, and would love if Kevin Uebelein, Michael Latimer or Ron Mock can share more on why this is such a great asset at that valuation and more importantly, what is their long-term strategic plan for this asset?

Of course, one senior Canadian pension fund manager who didn't bid on this asset told me: "You can't always look at infrastructure valuations as I've seen assets that look cheap and turn out to be terrible investments and others that look expensive and turn out to be great investments. It really all depends on their long-term strategic plan for this asset." Ok, fair enough, let's hope they know what they're doing with this London airport.

Below, Leo de Bever, AIMCo's former CEO and now chairman of Oak Point Energy, joins Bloomberg TV Canada's Pamela Ritchie to discuss why innovation is not happening at a fast enough pace among Alberta's high-cost energy producers to help them cope with the low oil-price environment.

Good interview, listen to Leo's comments and his dire warning as I think many Canadians are delusional about where oil prices and the loonie are headed (a brutal reality check is coming).