Friday, February 10, 2017

Much Ado About CPPIB's Quarterly Results?

Jacqueline Nelson of the Globe and Mail reports, Volatile markets shake CPPIB results:
The Canada Pension Plan Investment Board reported a decline in Canada Pension Plan assets to $298.1-billion in its third fiscal quarter, as a major drop in North American fixed income markets hampered investment results.

CPPIB, which manages the Canada Pension Plan investment portfolio, said Friday that the $2.4-billion decrease in assets through the quarter ended Dec. 31 was caused by a swell in CPP payments made to cover benefits at the end of the calendar year that exceeded the $1.7-billion in investment income the fund produced. The investment portfolio’s return in the quarter was 0.56 per cent, after factoring in all costs.

“The fund’s modest return this quarter reflects the largest quarterly decline in North American fixed income markets since CPPIB’s inception coupled with the Canadian dollar strengthening against most major currencies except for the U.S. dollar, partially offsetting gains in our public equity portfolio,” said Mark Machin, CEO of the CPPIB, in a statement.

The end of 2016 and the election of U.S. president Donald Trump brought broad declines to the bond market, projecting investor expectation of inflation and economic growth in the U.S. CPPIB also takes the strategic position not to not to hedge its investment portfolio against currency fluctuations, which means foreign exchange changes can generate big gains or losses.

Mr. Machin has cautioned in recent months to expect more short-term volatility in the fund’s investment results, as the pension fund adjusts its approach to risk in a way it expects will lead to higher long-term gains. So far, in the nine months of CPPIB’s current fiscal year, the fund has produced a 6.9 per cent investment return, after factoring costs.

The CPPIB said that it expects to see more CPP contributions flow into the CPP Fund during the first part of the 2017 calendar year, which will help to make up payments exceeding contributions at the end of 2016. The fund noted that it receives more contributions annually than it pays out.

On the investment front, the pension fund was highly active in the quarter, particularly in real estate. CPPIB invested in student housing, office buildings and retail. The fund also sold a large stake in a Manhattan office tower.

“Income was generated across investment programs and our teams continue to invest in assets in line with our long-term objectives to deliver solid results,” Mr. Machin added.

The breakdown of CPPIB’s investment portfolio shifted only slightly in the quarter. Equity investments made up 56 per cent of assets at the end of December, and 22.1 per cent of assets are in fixed-income investments such as bonds. Infrastructure and real estate assets made up the remaining 21.9 per cent.

CPPIB reported a 10-year annualized return of 4.8 per cent after factoring inflation, which exceeds the standard set by Canada’s Chief Actuary.
Barbara Shecter of the National Post also reports, CPP Fund assets fall below $300 billion, hit by the biggest decline in fixed income markets in its history:
A decline in North American fixed income markets and seasonal cash outflows cause net assets of the CPP Fund to dip below $300 billion.

The fund, which had assets of $300.5 billion at the close of the second quarter, ended the third quarter on Dec. 31 with assets of $298.1 billion.

The investment portfolio delivered a net investment return of $1.7 billion, or 0.56 per cent after all costs, while Canada Pension Plan cash outflows in the quarter were $4.1 billion.

“The Fund’s modest return this quarter reflects the largest quarterly decline in North American fixed income markets since CPPIB’s inception coupled with the Canadian dollar strengthening against most major currencies except for the U.S. dollar,” said Mark Machin, chief executive of the Canada Pension Plan Investment Board.

He said those factors partially offset gains in the public equity portfolio.

In an interview, Machin said the CPP Investment Board is watching the bond market to try to gauge what the ultimate impact will be of the election of Donald Trump as president of the United States.

“It’s always difficult to tell” what the longer-term direction of the bond market will be, he said. “The received wisdom a few months ago was that we were in a lower for longer (period) and negative rates would continue for as far as you can see, but I think the market took a very different view on the elections in the U.S. and the new administration’s policies being very pro-growth.”

The immediate assumption of an inflationary environment took the wind out the bond markets, but Machin said it remains to be seen what policies will ultimately be put in place, how quickly that will happen, and what the knock-on effects will be around the world.

“The big protection for us ultimately is diversification and finding diversification across asset classes, across geographies, across strategies, and that’s what we’re focused on overall so we create a portfolio that will weather the stresses in any individual market anywhere,” he said.

Investing in the United States will remain an important part of the strategy for CPP Investment Board, which invests funds not needed to pay current CPP benefits.

“The U.S. is the biggest destination for our capital… We’re active across just about every one of our strategies” there, he said.

Machin said CPPIB is seeking out “selective opportunities” in markets that could be characterized as stable and even somewhat buoyant.

“There’s no market that’s distressed right now. Volatility is, if anything, at all-time lows in the equity markets,” he said.

For the first nine months of the year, the CPP Fund increased by $19.2 billion and posted an investment return of 6.9 per cent after all costs. Investment income was $19.4 billion, and CPP cash outflows were $0.2 billion.

The CPP Fund routinely receives more contributions than are required to pay benefits during the first part of the calendar year. This is partially offset by payments exceeding contributions in the final months of the year.

Keith Ambachtsheer, a pension expert and co-founder of KPA Advisory Services, said quarterly changes in capital value of an investment fund “are noise…not signal” – regardless of whether they are positive or negative.

“That’s why most of the content of the quarterly CPPIB reports deal with more important longer term issues,” he said.
These are good articles but I normally don't discuss quarterly results from CPPIB or even semi-annual results from the Caisse. Why? Because, unless there is a big bomb I'm unaware of, I honestly couldn't care less about short-term results of any pension, they are totally irrelevant in the longer scheme.

In fact, please repeat after me: "I will stop paying attention to CPPIB's quarterly results." Period, end of story. Critics of the Canada Pension Plan and CPPIB will harp all over these articles, trying to put a negative spin on them, I simply ignore them.

So, if quarterly results are so immaterial, why does CPPIB report them? Short answer is they have to by law, all part of good governance, full transparency and regular communication.

Now, truth is last quarter was full of action following Trump's victory. US long bonds sold off and stocks took off, so a lot of pensions experienced some pretty big losses in their fixed income portfolio last quarter.

Some pensions like HOOPP and Ontario Teachers' were up huge in their fixed income portfolio going into Q4 (CPPIB's fiscal Q3), then experienced losses in the last quarter. The Caisse has been short bonds for a long time and they probably made decent money in Q4, but over the last four years, their short duration bet (including carry and roll down) has cost them big returns in their fixed income portfolio.

Looking forward, you know my thoughts on US long bonds. Back in November, I explained why Trump will not trump the bond market, urging institutional investors to load up on long bonds after the backup in yields.

At the beginning of the year, I warned my readers to beware of the reflation chimera and that it most certainly isn't the beginning of the end for bonds:
I just got off the phone with the president of a major Canadian pension fund who told me that they had another solid year last year. He said they sold US Treasuries in mid-year when the 10-year yield approached 1% "because we didn't see any more upside" and right before Christmas were itching to buy some 30-year Treasuries when yields popped back over 3.3%. He added: "If yields on the 10-year Treasuries rise back to 3%, we'll be buying."

What else did he share with me? Stocks are somewhat over-valued here by a factor of seven on their scale, with ten being significantly over-valued. "This silliness can last a little while longer but people forget the same thing happened back when Ronald Reagan won the elections. Stocks took off then too but after the inauguration, they sank 20% that year."

No kidding! As I've repeatedly stated, most recently in my Outlook 2017: The Reflation Chimera, the best risk-reward in these markets is US Treasuries. I don't care what Bill Gross, Ray Dalio, Paul Singer, Jeffrey Gundlach say in public, in a deflationary environment, I would be jumping on US long bonds (TLT) every time yields back up violently.

Also, take the time to read my comment on the 2017 US dollar crisis where I painstakingly go over the main macro trends and why all that is happening right now is the US is temporarily shouldering the world's deflation problems through a higher dollar. There is nothing structural going on in terms of solid long-term growth.

What else? The global pension crisis is alive and well which is why I don't see yields on the 10-year Treasuries rising anywhere near 3%. Most smart institutional fund managers took my advice and jumped on US long bonds when they yield on the 10-year hit 2.5%.
I started my career at BCA Research back in 1998 after a short stint for the Canada Revenue Agency writing a special report on white collar crime in Canada. At BCA, I helped Mark McClellan write the monthly Fixed Income Analyst (Mark is now the Global Strategist at BCA). Two things I know well: bonds and white collar crooks (Tom Naylor, the combative economist at McGill, taught me everything I need to know on hot money and the politics of debt and bankers, bagmen and bandits).

Speaking of BCA Research, a former colleague of mine from there and later at the Caisse, Brian Romanchuk, wrote a nice comment on his blog explaining why the cyclical situation in the US is still mediocre, stating:
The latest labour market data from the United States remain consistent with my view that the rate of growth is not enough to greatly reduce the mass underemployment that is the reality of the labour market. That said, the market implications are limited, as this is already priced into the curve. The Fed may wish to step up its anemic pace of rate hikes, but they will remain dependent upon the data.
I urge you to read his entire comment here. I think the Fed will raise rates more than once and may even (foolishly) raise three times this year, fueling the US dollar crisis I warned of late last year. That's when things get sticky for emerging markets and financial markets.

Another BCA Research alumnus, François Trahan of Cornerstone Macro, was recently in Montreal at a CFA luncheon to explain why he is bearish and thinks the yield on the 10-year Treasury note will fall back below 1.3% later this year. I happen to agree with him and think a lot of people aren't reading these markets right (if you're an institutional investor, make sure you subscribe to Cornerstone Macro's research, it's truly excellent).

And yet another BCA alumnus and bond guru who later went on to become Steve Cohen's economist at SAC Capital, Gerard MacDonell, wrote a nice short comment in his blog last night, Ug, Trump rally, which you should all read even if his anti-Trump views are all over it (give it a rest old chap, breathe in, breathe out!!).

I will end my comment here, think a lot of people reading too much into CPPIB's latest quarterly results should "breathe in, breathe out". There really isn't anything to worry about here.

When Mark Machin came to Montreal last fall and was nice enough to meet with me, I told him there will be challenging times ahead but to keep hammering the point that CPPIB will typically outperform in a bear market environment and under-perform in roaring bull markets. And to always focus on the long-term, these short-term results are totally irrelevant.

Of course, just like his predecessor, Mark knows all that, he's a very smart and nice guy with tremendous experience and knowledge and he's surrounded by a great group of professionals who are busy investing assets in public and private markets all over the world.

So relax, CPPIB is just fine and so are all of Canada's large pensions!

Below, a PWC clip where CPPIB's CEO, Mark Machin, discusses his views following Trump's victory. Like I said, he's a very smart and nice guy and Canadians are lucky he's at the helm of CPPIB.

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