Friday, March 24, 2017

All Hail The UK's State Pension Reforms?

Josephine Cumbo of the Financial times reports, Pensions review recommends later retirement age:
Millions of people should have their state pension age pushed back a year to 68 to cut the UK’s £100bn a year pension costs, according to an independent review commissioned by the government.

John Cridland was appointed to review the state pension age and has recommended it should rise from 67 to 68 by 2039, seven years earlier than currently timetabled.

Experts said this would affect about 5.4m people aged under 45. The current pensionable age is 63 for women and 65 for men, rising to 65 for both by late 2018, 66 by 2020, and age 67 by 2028.

Mr Cridland has also recommended that the “triple lock” — which raises the state pension by whichever is the highest of average earnings, prices or 2.5 per cent — be scrapped in the next parliament and replaced with a link to earnings.

“This report is going to be particularly unwelcome for anyone in their early 40s, as they’re now likely to see their state pension age pushed back another year,” said Tom McPhail, head of retirement policy at Hargreaves Lansdown.

Mr Cridland said his timetable would reduce state pension spending to 6.7 per cent of gross domestic product in 2066-67 — 0.3 per cent less than forecast by the government's fiscal watchdog the Office for Budget Responsibility — or 5.9 per cent of GDP if the triple lock is also abolished. This financial year, state pension spending was 5.2 per cent of GDP.

“My review considers the consequences of an ageing society,” said Mr Cridland, a former head of the CBI business lobby group. “The aim is to smooth the transition for tomorrow’s pensioners, and to try and make the future both fair and sustainable.”

Britain’s demographic profile is of an ageing society in which people are also living longer: the number of 100-year-olds is expected to rise from 6,000 today to 56,000 by 2050.

Along with Mr Cridland’s recommendations, ministers will also consider a report from the Government Actuary’s Department, which projected state pension age rises on the basis of everybody being in receipt of the state pension for either 32 or 33.3 per cent of their adult life.

Sir Steve Webb, a former pensions minister, said that if the government went ahead with “a more radical” timetable for pension age increases (based on 32 per cent of adult life in retirement) “they would be guilty of misleading parliament”.

“In the last parliament, MPs voted for the new arrangements on state pension age increases, on the basis that people would spend two years in work for every one year in retirement,” said Sir Steve, now director of policy at insurance company Royal London.

“On this basis, no one at work today would have a pension age of 70. But on the more aggressive schedule that the government is considering, everyone in their twenties would have a pension age of 70.”

Mr Cridland’s report does not recommend any changes before 2028.

He has rejected calls for early access to the state pension for people in poor health. But said additional means-tested support should be made available one year before state pension age — effective from when state pension age reaches 68 — for those who are unable to work longer because of ill health or caring responsibilities.

“As government goes about making its decision on the future state pension age in May of this year, these contributions and recommendations will provide important insight,” said Damian Green, secretary of state for work and pensions.
Sarah O of the Express reports the new proposals to reform UK's state pension isn't going well with retirees furious over planned cuts:
A review of the age at which people can receive their state pensions also recommended the axing of the ‘triple lock’ which guarantees that pensions rise by the same as average earnings, the consumer price index, or 2.5 per cent, whichever is the highest.

But the UK’s biggest pensioner organisation, the National Pensioners Convention described the Cridland Review as “asking all the right questions, but coming up with the wrong answers”.

Jan Shortt, the new general secretary of the NPC, said: “It seems strange that in his first report, John Cridland went a long way to dispel the myth of generational unfairness, showing that the majority of baby boomers, and those from generations X, born in the 60s and 70s, will get the bulk of their income in retirement from the state pension.

"But he bizarrely ends up recommending that everyone should see the value of their state pension fall by axing the triple lock."

"He has clearly asked the right questions, but come up with the wrong answers."

“There can be little doubt that the future of the triple lock will now become a key election issue in 2020 for all generations.”

Caroline Abrahams, charity director at Age UK agreed, saying: “We are firmly of the view that the triple lock needs to stay in place, because it is not yet ‘job done’ when it comes to eradicating pensioner poverty.

“Sixteen per cent of older people are still poor and figures published just last week suggest a rise in pensioner poverty."

"Looking ahead to 2039 and beyond, we think it is crucial that the state pension continues to retain its value so that the people who retire then can look forward to their later lives with confidence, not fear."

“Research has shown that abandoning the triple lock would reduce the chance that someone with low earnings retires with an adequate retirement income. The same older people who also stand to lose the most from any rise in the state pension age.”

However the triple lock should be abandoned in order to reduce the impact on future government finances, argued Mr Cridland, the former CBI director general who was appointed as the Government’s independent reviewer of state pension age last year,According to the review’s estimates, the UK - which currently spends £100bn a year on pensions - would spend the equivalent of 6.7 per cent of its GDP on the state pension in the 2066-67 financial year if it adopts the review’s age increase.

Abandoning the triple lock and just linking pension increases to earnings data would reduce this figure to an estimated 5.9 per cent of GDP.

Many pension experts broadly agreed with his recommendation. Former pension minister Baroness Altmann said there was “no economic or social rationale” for the triple lock, adding the 2.5 per cent increase was “not related to any economic variables and is politically motivated.”

“The longer the triple lock stays in place, the more disadvantaged those who are not covered will become and the greater the pressure to increase state pension age even further,” she said.

The government has promised to keep the triple lock in place until 2020, but has not revealed its intentions beyond that.Mr Cridland also recommended raising the state pension age to 68 between 2037 and 2039 - seven years earlier than currently planned.

His review coincided with an independent Government Actuary’s Department report, which pointed to a possible state pension age of 70 for anyone currently aged 30 or under.
And it's not just retirees that are furious. Zlata Rodinova of the Independent reports, Millenials could have to wait until they are 70 until they get a state pension, says Government review:
Millions of young people could face having to work an extra year before being able to draw a state pension, according to two separate reports.

Under projections drawn up by the Government Actuary’s Department (GAD), people aged under 30, face working until the age of 70 to qualify for a state pension compared to the age of 68 under current legislation.

A separate official review published by John Cridland, former director-general of the Confederation of British Industry (CBI), proposed that state pension age should rise to from 67 to 68 between 2037 and 2039, seven years earlier than originally planned.

The current state pension age – the earliest age that a person can start receiving their state pension - is 63 for women and 65 for men. It is due to rise to 65 for both by late 2018, 66 by 2020, and 67 by 2028.

However, experts said if the new recommendations were adopted , people in their 40s would face their state pension age being pushed back by an extra year. They warned those in their 30s and younger may eventually face the possibility of having to wait until they are 70 before being able to draw their pension.

The Government is under pressure to address the spiralling cost of the £100bn-a-year state pension, which is expected to increased further as a result of rising life expectancy and therefore the increasing ratio of pensioners to workers.

In Thursday’s report, Mr Cridland said the change is necessary to keep the State Pension “fair and sustainable”.

“My review considers the consequences of an ageing society[…]. The aim is to smooth the transition for tomorrow’s pensioners, and to try and make the future both fair and sustainable.”

Vince Smith-Hughes, retirement expert at Prudential, said that as a result of the proposed changes younger people will need to plan ahead.

They are likely to find their state pension age is significantly higher than they currently assume,” he said.

Steven Cameron, pensions director at Aegon said requiring everyone to wait until an “ever increasing age” to draw a state pension is “inflexible and increasingly outdated”.

“This is a missed opportunity to meet the needs of those who through health concerns, job pressures or lack of employment opportunity simply can’t keep working into their late 60s. We call on the Government to keep the door open to future change,” Mr Cameron said.

Prudential research earlier this week found that at least one in seven people retiring last this year made no financial provision for their retirement. The survey found that many rely heavily on the State Pension to provide an income when they stop working.
My advice to those thirty something workers in the UK and everywhere, start planning for your retirement early on so you can deal with unexpected policy shifts like this one where the state pension age is gradually pushed up and benefits are potentially cut.

Last week I discussed how collapsing US pensions might fuel the next crisis, beginning my analysis by noting the following:
"Please repeat after me: The global (not just American) pension crisis is deflationary because it exacerbates income inequality and will condemn hundreds of millions of workers to pension poverty."
The thing to keep in mind is pensions are important, especially in an ageing population, because they allow people to live out their life after retiring on a modest fixed income. This means they can spend accordingly, allowing governments to collect more sales taxes and boosting overall economic activity in the process.

The UK is trying to slay its pension dragon and this fellow you see above, John Cridland, was appointed to review the pension system and recommended to raise the retirement age faster than previously recommended and to scrap the "triple lock" and link pensions to earnings.

If you ask my opinion, this is just more tinkering at the margins. The real fundamental problem with the UK state pension system is it's grossly antiquated and needs a major overhaul to make it function more like the Canada Pension Plan - Canada Pension Plan Investment Board model.

In fact, I recommend every country in the world adopts the governance that has allowed Canada's large pensions to flourish while most of their global counterparts are witnessing their pension deficits skyrocket.

When I met Mark Machin, President and CEO of CPPIB, last fall, he told me flat out: "What Canada has achieved with the CPPIB is quite amazing, no other country in the world has this state pension system."

And Machin is a UK citizen so he knows what he's talking about. The model we have for our state pension in Canada is unique and we have a similar model for some some large provincial pensions (like the Caisse managing the assets of the Quebec Pension Plan).

There are other countries with great state pensions, like Denmark and the Netherlands, but very few can claim they have achieved a model based on what Canada has done with the CPP and CPPIB.

This is why I keep telling critics and skeptical Canadians to never bash the Canada Pension Plan and plans to enhance it. We Canadians don't realize just how good we have it over the long run with this system.

As far as UK pension reform, it's too late, all these measures to address the growing pension crisis in that country are doomed to fail. All of a sudden, the Brits are waking up to realize how unsustainable and poorly managed their state pension system truly is.

Look, fine, we can openly debate whether the state pension system is unsustainable and whether raising the retirement age makes sense since people are living longer, but at one point there needs to be a much more meaningful discussion on whether the system itself needs much deeper reforms to make it truly sustainable and equitable over the long run.

And it's not like the UK pension system is terrible, it's actually pretty decent, but it's been slipping down the global pensions rankings in the last year, mostly owing to the fact that future retirees can expect a “less generous” income from state and workplace pensions.

I will end this comment with a true story from Greece. A few years ago, before the crisis hit, a friend of mine who is a doctor was swimming at the beach and noticed and elderly man who was in "phenomenal shape."

My friend approached him and asked him how old he was, thinking the guy was around 65 years old. The elderly man told him he was 85 years old, which just floored my friend. He asked him how he has maintained his youth and strength.

The guy looked at my friend and told him flat out: "I retired at age 40 and never worked another day of my life."

And then we wonder why the Greek pension system was unsustainable.

Why am I bringing this up? Because no matter where you live, there needs to be an honest, adult discussion on state and other public sector pensions to make sure they are sustainable and to avoid rampant abuses like the one I just mentioned above. And trust me, abuses happen everywhere, not just in Greece.

Below, former pensions minister Baroness Ros Altmann tells BBC Today some people who have contributed to National insurance for fifty years might still have to wait longer to get the state pension. Smart lady, she knows what she's talking about.

And Marcus Hurd, Conduent HR Services talks to BBC Breakfast News about the planned increases to the state pension age. The discussion is pretty standard, ie. UK pensioners are living longer so they need to raise the retirement age (and possibly raise contributions and cut benefits).

Still, he gives a good overview of the problem and why something needs to be done to address the UK's ongoing pension crisis.

Unfortunately, these measures are not addressing a more fundamental problem, namely, the entire UK pension system needs a major overhaul to truly make it sustainable and equitable for future generations, one that looks more like what we have here in Canada.

Update: Bernard Dussault, Canada's former chief Actuary, shared these insights with me:
The UK government would save even more and would greatly improve inter-generational equity if in addition to increase the pensionable age by 1 from 67 to 68, it would afterwards pursue a permanent slow gradual increase based on the calendar of birth.

Indeed, as statistics generally show that longevity in the developed countries has on average steadily increased over the last few decades by about 2 months (i.e. any generation lives longer than the previous one, i.e. the higher the calendar year of birth, the higher the longevity at age 68) and is expected to pursue doing so, there is a case to keep increasing each coming calendar year the pensionable age by setting it as follows on the basis of the calendar year of birth (CYB, click on image):

I thank Bernard for sharing his thoughts with my readers.

Thursday, March 23, 2017

CPPIB, GIC Betting on US College Housing?

Komal Khettry of Reuters reports, CPPIB joint venture buys U.S. student housing portfolios for $1.6 billion:
Canada Pension Plan Investment Board (CPPIB), Singapore wealth fund GIC and property owner Scion Group LLC said on Thursday their joint venture had bought three U.S. student housing portfolios for about $1.6 billion, in its second major deal in the United States.

CPPIB, which manages Canada's national pension fund and is a major global dealmaker, had formed the student housing joint venture with GIC and Scion in January last year.

Canadian pension funds have been buying real estate assets around the world to diversify their investments.

CPPIB and GIC will each own a 45 percent stake in the three portfolios and Scion Group will own the remaining 10 percent.

The companies said on Thursday their joint venture, Scion Student Communities LP, plans to buy more student housing properties in the United States.

The parties struck a similar deal for a student housing portfolio early last year, buying University House Communities Group and its 19 properties for $1.3 billion.
Last week I discussed why the Caisse and CPPIB are investing in Asian warehouses, betting on demand from the rise of e-commerce and a burgeoning middle class in southeast Asia.

Earlier this week, I discussed why CPPIB is looking to increase its investments in China over the long run, again to better position the fund on secular trends in that country where e-commerce is just taking off and where long-term growth remains solid (even if there will be hiccups along the way).

Today I want to cover this latest joint venture with Singapore's GIC and the Scion Group which is a sizable investment in US student housing.

CPPIB provides a lot more detail on this transaction in this press release:
Canada Pension Plan Investment Board (CPPIB), GIC and The Scion Group LLC (Scion) announced today that their student housing joint venture entity, Scion Student Communities LP (together with its subsidiaries, “the Joint Venture”), has acquired three U.S. student housing portfolios for approximately US$1.6 billion. These portfolios comprise:
  • US$385 million acquisition of six Class-A properties located primarily in the southern U.S.;
  • US$640 million acquisition of 11 Class-A properties in premier university markets across the U.S.; and
  • US$550 million in recapitalizations of 12 legacy Scion-owned and operated communities situated in leading campus markets across the U.S.
Since its inception in January 2016, the Joint Venture has completed US$2.9 billion of investments, including the previously announced US$1.3 billion acquisition of University House Communities Group and its 19 properties in June 2016. The Joint Venture has deployed over US$1 billion in equity capital. CPPIB and GIC each own a 45% interest in the three portfolios and Scion owns the remaining 10%.

“The U.S. student housing sector is an attractive investment opportunity, driven by secular strength in enrollment growth and favourable supply dynamics,” said Hilary Spann, Managing Director, Head of U.S. Real Estate Investments, CPPIB. “Achieving scale in this sector is an important global investment objective for CPPIB, and we are pleased to further this goal in the United States with our partners at GIC and Scion.”

The Joint Venture’s well-diversified national portfolio now includes 48 student housing communities in 36 top-tier university markets, comprising 32,192 beds. The average age of the properties is less than five years and over 75% of the assets are located within one mile of their respective campuses.

Adam Gallistel, Regional Head of Americas, GIC Real Estate, said, “These high-quality, revenue-generating assets are good additions to our global student housing portfolio. We remain confident in this sector’s long-term fundamentals and are pleased to continue our strong partnership with Scion and CPPIB.”

The Joint Venture will pursue additional opportunities to acquire high-quality student housing assets primarily in Tier 1 university markets in the U.S.

“We are thrilled to be partnering with two of the world’s premier real estate investors in the ongoing consolidation of the student housing sector,” said Robert Bronstein, Scion’s President. “We especially appreciate the confidence and support of GIC and CPPIB implicit in the volume of investment activity completed by the Joint Venture during its first year of operation as well as the significant commitment of additional growth capital to the partnership. We look forward to the Joint Venture’s continued growth and success.”

About Canada Pension Plan Investment Board

Canada Pension Plan Investment Board (CPPIB) is a professional investment management organization that invests the funds not needed by the Canada Pension Plan (CPP) to pay current benefits on behalf of 19 million contributors and beneficiaries. In order to build a diversified portfolio of CPP assets, CPPIB invests in public equities, private equities, real estate, infrastructure and fixed income instruments. Headquartered in Toronto, with offices in Hong Kong, London, Luxembourg, Mumbai, New York City, São Paulo and Sydney, CPPIB is governed and managed independently of the Canada Pension Plan and at arm's length from governments. At December 31, 2016, the CPP Fund totalled C$298.1 billion. For more information about CPPIB, please visit or follow us on LinkedIn or Twitter.

About GIC

GIC is a leading global investment firm with well over $100 billion in assets under management. Established in 1981 to secure the financial future of Singapore, the firm manages Singapore’s foreign reserves. A disciplined long-term value investor, GIC is uniquely positioned for investments across a wide range of asset classes, including real estate, private equity, equities and fixed income. GIC has investments in over 40 countries and has been investing in emerging markets for more than two decades. Headquartered in Singapore, GIC employs over 1,300 people across 10 offices in key financial cities worldwide. For more information about GIC, please visit

About The Scion Group

Scion is the United States’ largest privately-held owner/operator of student housing communities in major public university markets. Scion’s current portfolio includes 67 properties comprising approximately 46,000 bedrooms, plus management of two university-affiliated communities with an additional 2,200 bedrooms. Scion has focused exclusively on the student housing sector since its inception in 1999, and has provided advisory services and/or invested in over $6 billion of student housing projects. For more information about Scion, please visit
So, what are my thoughts on this deal? It's another real estate deal based on long-term secular trends and it's a great deal for all parties involved, including GIC and the Scion Group.

You might not know a lot about the US or world student housing market but it's a huge market. In fact, I urge all of you to read Savills's latest World Student Housing report to better familiarize with global trends in this market.

The key investment highlights from the latest publicly available report are:
  • 2015 was a record year for investment in student housing with $15bn invested globally in the sector. The first half of 2016 saw lower total volumes but mainland Europe continued to rise off a low base.
  • US and UK student housing REITs outperformed their all REIT indices by 19 and 16 percentage points respectively.
  • Global cross-border investment in the sector accounted for 40% of all deals in the last three years as international investors sought to diversify portfolios
Not surprisingly, US college housing REITs are on the rise:
Like bond prices, real estate investment trust (REIT) values in America continue to soar, as more savers and income investors search for ways to quench their thirst for higher yield without having to take excessive risk with their money. College housing is one category of REIT that has not only been winning the hearts of investors in recent times, but also delivering remarkable returns to its owners. (See also, REITs: How Long Can They Stay This Hot?)

Double-Digit Returns

Since the $1.9-billion acquisition of Campus Crest Communities earlier this year, American Campus Communities (ACC) and Education Realty Trust (EDR) have been the only publicly traded REITs that primarily focus on the college housing market. The two REITs have seen their stock prices increase in the last 12 months by more than 47% and 55% respectively, easily trumping both the 12% increase in the Bloomberg North American Apartment REIT Index and the S&P 500’s total return of 3% realized during the same period. (See also, REITs: Still a Viable Investment?)

Reliable, Recession-Proof Income

With political uncertainty on the rise and weak economic data being released, many investors are beginning to put their efforts into hedging their portfolios in the event that the U.S. and other global economies weaken. One of the contributing factors for such a steep rise in student housing REIT valuations could be that investors are using them as a way to hedge their bets in the market. Unlike others forms of real estate that are susceptible to changes in market conditions, such as commercial property and apartment units, student housing, and college enrollments as a whole, are generally unaffected during recessions, at least in recent history. This may be partly due to the fact that students in the United States have relatively easy access to financing to cover their college-related expenses.
And, as reported by Bloomberg last August, some landlords are making a killing on college students:
College students aren't famous for their tidiness, sober living, or financial prudence, to name three qualities landlords might look for in a tenant. But despite the beer-soaked carpets and general flakiness, renting off-campus apartments to undergrads is turning out to be a great business.

Shares in Education Realty Trust, a Memphis-based landlord whose earnings report met Wall Street expectations this morning, are up 54 percent in the past year. American Campus Communities, the only other publicly traded student housing landlord, is up 44 percent. By comparison, a Bloomberg index of North American apartment landlords is up 12 percent over the same period (click on image).

Why are the student-housing landlords getting top grades?

The long-term theme is that college enrollment has boomed over the past few decades, and investment in new on-campus dorms hasn’t come close to keeping up. In the short term, the shares are likely rising because investors are looking to hedge against the possibility of a U.S. recession.

"In an environment of striking political and economic uncertainty, public investors are ascribing value to [the] certainty of cash flows in student housing," said Ryan Burke, an analyst at Green Street Advisors. "In [the] young life of purpose-built student housing, it's performed really well in good and bad times."

That's because kids keep going to college, and schools have run out of places to put them. Consider these striking data from the U.S. Department of Housing and Urban Development: 17.7 million students were enrolled in post-secondary, degree-granting institutions in 2012, up from 12 million in 1990. Over the same period, the number of students living in on-campus dorms increased by a bit more than 600,000. 

In the late 1990s, an industry grew up to absorb demand from the roughly 85 percent of students who don’t live on campus, building off-campus apartments specifically for students, offering leases by the bed, and luring renters with choice enticements. The amenities at some of the more upscale student housing complexes have drawn scorn from those who wonder: Is there a good argument for racking up student debt to watch moving screenings from your swimming pool or eat meals prepared by a James Beard-award-winning chef?

But plenty of more pedestrian complexes offer things that students want, such as barbecue pits and tanning beds, and in addition to the two publicly traded landlords, a deep roster of private property managers is getting in on the act. In March, the private equity firm Harrison Street Real Estate Capital took a publicly traded landlord private in a $1.9 billion deal.

Part of the reason to own student housing is that, in a period of low interest rates, collecting rent has looked like a good way to earn good returns, whether you're renting out a shopping mall, an office sky-rise, or a self-storage unit.

Student housing has a slightly different appeal, according to one theory. Landlords should suffer when the economy tanks, as renters lose jobs or see wages stagnate. But college enrollment has increased in recent recessions, making student housing landlords an interesting hedge against an economic downturn.

That doesn't mean developers won't eventually overbuild. College enrollment has been declining in the years since the Great Recession, even as investment in off-campus student housing has soared. At some point, there will be so many student apartments that the industry will lose its appeal as a safe haven, Burke said.

In the meantime, landlords won't mind the occasional pool party or all-night kegger, as long as the rent is in the mail.
Yeah, let the rich kids party it up in US college housing, as long as mommy and daddy are paying the rent, the landlords don't care.

As you can see, investing in student housing is a hot sector, especially if investors are worried of an economic downturn.

CPPIB and GIC are investing directly in this market alongside their partner, the Scion Group, to avoid market beta. Very smart move and it shows you how the best real estate investors are always thinking of portfolio construction and diversification, especially now that interest rates and cap rates are at historic lows and real estate valuations are at historic highs.

Are there risks investing in US student housing? Of course, most US students are not rich, they pay their college tuition and expenses via student loans. And many of them are struggling, which is why more than 1.1 million borrowers defaulted on their federal student loans last year.

Quite shockingly, a staggering number of college kids are using their student loans for wild Spring Break trips, which goes to show you we are not dealing with the wisest and most prudent segment of the population (after my recent vacation in Florida, I'm actually shocked that any of these college students can obtain a degree after seeing the way they behave on Spring Break).

But the reality is the demands of an increasingly competitive economy means these students need a college degree at a bare minimum or they risk never getting a job. So rich, poor or middle class, they have to go to college to be able to compete and get a decent job (most of them need to in order to pay off their student loans for the rest of their life).

This entire discussion  on US college housing reminds me of my good old McGill University days when I was part of the United Nations club going to Ivy League universities in the United States to take part in mock UN debates.

Back then, I saw students from all backgrounds living on and off campus. I remember the dorms at Harvard and Princeton, two universities I loved visiting, and the pictures some of the students had on their wall really opened my eyes (like pictures of them with President Clinton).

But most students weren't rich and highly connected, they were poor or middle class and they needed affordable, safe student housing near the campus. The same goes for other universities I visited like Yale, UPENN, and Columbia.

If you broaden it out to include all US colleges, you'll understand why student housing is so popular. Parents want to know their kids are safe and secure, eating and sleeping properly, exercising and living nearby so they don't miss their classes even if they've been drinking too much the night before.

Whatever, you catch my drift. As far as Canada, student housing is a relatively small but growing niche.

Last year I was introduced to Centurion Asset Management, a leader in this space up here, and even got to chat with its President and CEO, Greg Romundt. You can read all about Centurion's success here but I found Greg's background -- he was a fixed income derivatives trader for many years prior to setting up this shop -- particularly interesting. He's sharp and shared my views on inequality and long-term deflation.

For a lot of reasons -- affordability (low tuition and low loonie), great education, proximity to the US -- I expect the student housing market to blossom in Canada over the next decade, but it's still a relatively small market.

Another factor that may help the Canadian student housing and hurt US student housing demand is how foreign students perceive US immigration policy as many are now questioning whether to attend US universities. That all remains to be seen however as it's too soon to tell whether this is the start of a big trend from foreigners to shun US universities.

Below, a YouTube video on the Scion Group, CPPIB and GIC's partner in this large transaction. Also, Daniel Pianko, Co-founder & Managing Director, University Ventures and CNBC's Rick Santelli discuss consumer credit and why so many students are defaulting on their loans.

Last week, the Trump administration issued its first policy on student loans, implementing more fees for student loan borrowers defaulting on their loans.

That might put a damper on all those wild Spring Breakers in Florida but I doubt it, just like I doubt this new policy will impact the demand for student housing in the long run. Keep your eyes peeled on this hot and growing real estate sector.

Wednesday, March 22, 2017

OPTrust Punching Above its Weight?

Kirk Falconer of PE Hub Network reports, OPTrust punches above its weight with private equity strategy:
OPTrust has greatly expanded its private equity program, deploying a strategy that gives the mid-sized pension fund access to opportunities usually available only to larger institutions.

OPTrust, which invests on behalf of OPSEU Pension Plan, the retirement system for about 90,000 Ontario public employees, this week reported a net return of 6 percent for 2016. Net assets grew to more than $19 billion from $18.4 billion in 2015.

Overall numbers were boosted by a strong performance in the PE portfolio. PE investments returned a net 20.6 percent last year, up from 14.4 percent in 2015.

These results cap a major five-year increase in OPTrust’s PE allocation. At the end of 2016, the portfolio held nearly $1.6 billion in assets, more than triple the amount in 2012. Private equity’s share of total assets rose in this period to 9 percent from 4 percent. OPTrust’s notional target is 15 percent.

OPTrust Managing Director Sandra Bosela, who heads the global PE group, told Buyouts that most of the growth owes to a strategic shift favouring direct deals and co-investments.

Prior to 2012, the main focus of OPTrust’s PE portfolio was funds and secondaries, with direct activity accounting for 20 percent of assets, Bosela noted. By 2016, the direct share was 48 percent.

Bosela, formerly a general partner with 15 years of experience, joined OPTrust Private Markets Group in 2012 to develop the PE strategy and ramp up direct investing. She says the result is an ability to “punch above our weight.”

“I’m pleased with the progress,” Bosela said. “Our strategy has been designed to carve out a niche that leverages our size and includes more direct, actively managed investments. It has opened doors for us and created access to deal flow that’s typically available only to our much larger peers.”

Deals plus funds

OPTrust is targeting a 50:50 balance between the portfolio’s direct and fund sides, Bosela said. That’s because many of the best opportunities for co-underwriting deals come from a core group of fund partners.

Opportunities are also sourced with “like-minded partners,” Bosela said. They include a range of market players, such as PE firms, strategic investors, financial players and business owners.

Drawing on these sources, OPTrust has increased both the pace and range of its mid-market buyouts and other PE transactions in North America, Europe and developed Asia.

Disclosed examples include OPTrust’s 2014 investments alongside Altas Partners in St. George’s University, a Grenada medical school, and alongside CDCM in Skybus, an Australian airport transit service.

Over 2014-2015 it also joined Imperial Capital Group in backing U.S. home-alarm monitor Ackerman Security Systems and Canadian dental network Dental Corp.
John Groenewegen, Partner, Osler, Hoskin & Harcourt LLP.

In-house resources

OPTrust’s experience may provide a model to some other small and mid-sized pension funds looking to expand their PE allocations.

John Groenewegen, a partner at law firm Osler, Hoskin & Harcourt, says OPTrust’s private equity program has “put them in a position they would not otherwise be in.”

Groenewegen, who advises pension-fund clients, says a central factor in OPTrust’s approach is in-house resources that include “professional deal-makers.”

“OPTrust has invested in the right funds, and an experienced team has ensured it can act quickly and make decisions quickly,” he said. “That’s key to being a good deal partner, to being invited back.”

Bosela agrees, noting that OPTrust’s ability to be “a value-adding partner, one that can execute shoulder-to-shoulder, even on complex transactions” is essential to its direct investing. “We’re not the big elephant in the room,” she says. “We must offer something other than our money.”

Not standing still

OPTrust aims to place more capital in the months ahead, Bosela said. She is mindful, however, of an “overheated” market environment, fuelled by high values and “heightened levels of dry powder.”

Market frothiness has reinforced a disciplined, selective focus to investments, Bosela said. OPTrust also will give more emphasis to private debt and long-term equities to help balance the portfolio and reduce volatility.

Bosela says OPTrust is not “standing still” with the PE program, but will instead continue to add to its capabilities. For example, it is exploring “proactive origination,” intended to accelerate independent sourcing of direct opportunities.

OPTrust PMG has a team of 18 located in offices in Toronto, London and Sydney, Australia. Overseeing nearly $4 billion in assets, it is co-led by Bosela and Gavin Ingram, a managing director and head of the global infrastructure group.
I recently covered how OPTrust is changing the conversation, emphasizing its funded status first and foremost instead of its annual results.

In that comment, I covered a conversation with OPTrust's President and CEO, Hugh O'Reilly, and its CIO, James Davis, where we spoke at length about the funded status and shift in investment philosophy.

When I went over some of their private market investments, I noted the following:
In private equity, they invest and co-invest with funds but as James told me, "they're not looking to fill buckets" and will use liquid markets to fulfill their allocation to illiquids if they're not fully invested.

In infrastructure, they have done extremely well by investing primarily directly through co-sponsored deals with their strategic partners. Their focus is on the mid-market, with cheque sizes of $100M to $150M and where there is less competition.  
After reading the article above, I noted the following on LinkedIn (click on image):

If you can't read it, here it is again:
Agreed, Sandra Bosela has done a great job expanding co-investments at OPTrust. As far as "proactive origination", that gets tricky because a) it's hard to source great deals and b) you don't want to compete with your GPs because they will end up seeing you as a competitor and cut you out of co-investment opportunities. Still, Mrs. Bosela should be commended for her work at OPTrust and she has the right game plan and strategic thinking.

The truth is OPTrust is punching above its weight in private equity and other activities but just like everyone else, there are limits to what Canada's mighty PE investors can do in terms of "proactive origination" in direct private equity deals.

Most direct investing at Canada's large pensions is done via co-investment opportunities the general partners (GPs) offer their limited partners (LPs, ie. pensions and other institutional investors).

Even though LPs pay big fees for comingled funds, co-investments have little or no fees but they require expertise from the pension staff that needs to quickly evaluate these larger transactions before investing in them.

In fact, John Groenewegen alluded to this: “OPTrust has invested in the right funds, and an experienced team has ensured it can act quickly and make decisions quickly,” he said. “That’s key to being a good deal partner, to being invited back.”

And Bosela is right, OPTrust’s ability to be “a value-adding partner, one that can execute shoulder-to-shoulder, even on complex transactions” is essential to its direct investing. “We’re not the big elephant in the room,” she says. “We must offer something other than our money.”

In order to expand your co-investments to lower the overall fees you pay in private equity, you need to a) invest in the right funds and b) have an experienced team to quickly evaluate co-investment opportunities.

It sounds easy and straightforward but it isn't. If your pension fund doesn't have the right governance to attract and retain qualified staff, you can forget all about expanding direct investments in private equity by gaining access to more co-investment opportunities.

So, first you need to choose the right funds and second you need to have very qualified people on your team to evaluate co-investment opportunities relatively quickly.

And judging by the outstanding long-term returns, Bosela and her team are good at both. She's also right to fret about the current conditions in private equity which I alluded to on Friday when I discussed why there's no luck in Alpha Land:
[...] it's not just hedge funds. The same thing is going on in private equity where there's a mountain of dry powder and the market return differential over public markets is narrowing:
Private equity firms had as much as $1.47 trillion in funds available to invest at the end of 2016, and debt capital was also readily available to bolster their investments. Still, a situation of rising asset prices, together with fierce competition for these assets in an environment overcast with a possibility of an upcoming recession that could drive down prices, made it difficult to close deals, according to an annual global private equity report from Bain & Company. These firms are cautious about whether today’s deals will bring them to their targeted returns. Banks are also wary of financing big deals.

According to Hugh MacArthur, head of global private equity with the Boston management consulting firm, “Capital superabundance and the tide of recent exits drove dry powder to yet another record high in 2016. Shadow capital in the form of co-investment and co-sponsorship could add another 15% to 20% to that number. While caution about interest rates remains, there is a general expectation that debt will remain affordable. As a result, deals won’t be getting any cheaper.”

Investors continued to show interest in private equity in 2016, and these firms raised $589 billion globally, just 2% shy of the 2015 total. One 2016 trend to note is the rise in “megabuyout” funds that raised more than $5 billion each, with 11 such funds raising a total of $90 billion. These funds appear particularly appealing to institutional investors who want to deploy large amounts of money into private equity, the management consulting firm reports.

And an overall decline in the net asset values of buyout firms, as their distributions to investors outpaced their new investments plus the value of their existing holdings, meant that some investors found themselves short of their targeted private equity allocation. For instance, the Washington State Investment Board pension fund found its private equity allocation down to 21% in 2016, from 26% in 2012. This created a positive environment for private equity fundraising in 2016, but the industry is apprehensive that this strong pace cannot last for too long, as a recession and a stalling stock market, for instance, could upset the strong dynamics.

The buyout market started off slow in 2016, as the Chinese stock market bust, declining oil prices and the uncertainty regarding Brexit in Europe all had an impact. In North America, the market did not recover momentum and the total number of deals for the year was down 24%, with deal value off 16%. In Europe, there was a more moderate drop off.

Bain finds that there is a potential for almost 800 public companies to be taken private in buyouts, but expects a much lower level of actual public-to-private buyouts going by historical activity. While returns on private equity buyouts continue to outshine the returns on public markets, the gap is closing, as it is getting harder for private equity to find outsize returns on undervalued assets in today’s more benign economic environment.

Private equity investors have also settled into longer holding periods of about five years for their investments, and this state of affairs is likely to endure for the near term. Historically, these firms have held on to assets for three to five years, but this period was pushed up in the aftermath of the financial crisis as firms had to nurse their assets over a slow recovery period, the management consulting firm reports.

In fact, deals that private equity firms were able to quickly flip over, holding onto them for less than three years, made up a mere 18% of private equity buyouts in 2016, compared to a 44% share in 2008.
No doubt, these are treacherous times for private equity and there is a misalignment of interests there too. Just ask CalPERS, it's experiencing a PE disaster even if it's been completely misconstrued in the popular blog naked capitalism.

I recently had a chance to talk to Réal Desrochers, the head of CalPERS's PE program, and he told me he was concerned about the wall of money coming into private equity from super large sovereign wealth funds, many of which aren't staffed adequately but just write "huge cheques" to private equity funds (and hedge funds).

It's a recipe for disaster and it all reminds me of what Tom Barrack said in October 2005 when he cashed out before the crisis hit:
"There's too much money chasing too few good deals, with too much debt and too few brains." The amateurs are going to get trampled, he explains, taking seasoned horsemen, who should get off the turf, down with them. Says Barrack: "That's why I'm getting out." 
Every large and small  institutional investor playing the cheque writing game should post this quote in their office along with my favorite market quote by Gary Shilling often attributed to Keynes: "The market can stay irrational longer than you can stay solvent."

As far as private debt, it's an increasingly popular asset class among Canada's large pensions, including PSP which is "playing catch-up" to its large peers in this activity.

I will end it there and just say that it's refreshing to see how OPTrust is punching above its weight in private equity and other activities. It's not always size that matters, you can differentiate yourself in other ways as long as the governance is right.

Below, Bain & Company partner Graham Elton talks about the challenges that private equity firms are currently facing. CNBC’s Annette Weisbach reports from Berlin’s SuperReturn conference in late February. Very interesting discussion, well worth listening to his comments on strategics, IPO markets and exits.

Tuesday, March 21, 2017

CPPIB Looking to Raise its Stake in China?

Geoff Cutmore and Nyshka Chandran of CNBC report, Canada Pension Plan looks to raise its bet on China:
China's gradual market liberalization may be good news for Canadian pensioners.

Canada Pension Plan Investment Board (CPPIB), the country's largest pension fund, currently has 4 percent of its portfolio in the mainland — a figure that president and CEO Mark Machin said is too low for a globally diversified portfolio such as his.

But he plans to increase that share as the world's second-largest economy opens itself up.

"We want to significantly increase our investment here over the long term," he said, explaining that his fund is "substantially" underweight relative to GDP, but not necessarily relative to available market cap.

Last month, the People's Bank of China allowed foreign investors to hedge bond positions in the foreign exchange derivatives market — a move that many strategists deemed significant to overall market reform.

"China is now by many measures the third-biggest bond market in the world at around $7 trillion, so allowing that to be more accessible to capital is yet another aspect of making this a more investable place," Machin told CNBC at the China Development Forum in Beijing.

"We're value investors and we're super long term. We like to say a quarter for us is 25 years, not three months," Machin said. "We don't necessarily need our money back for immediate use, so I think we're seen as relatively friendly capital, and therefore our access is reasonably good here."

CPPIB is particularly big on Chinese e-commerce and despite the dominance of giants such as Alibaba and Tencent, Machin said he believes the sector remains exciting.

Below those large behemoths is an ecosystem of start-ups, Machin explained: "The ecosystem around these large companies is part of the secret source of innovation in this country...China's been very thoughtful about creating the ingredients of innovation, which is creating more opportunities for all types of companies, whether it's e-commerce or others, to bloom."

As a long-term investor in a fast-changing market, it's key for CPPIB to speedily identify early-stage trends, he continued.

"It now takes very little money to develop a company given the amount of cloud computing can get a company some market for very little money, very very quickly and have a very disruptive impact."
Last week I discussed why the Caisse and CPPIB are investing in Asian warehouses in Singapore and Indonesia noting the following:
I think it's pretty self-explanatory. The Caisse and CPPIB are betting on the demand from the rise of e-commerce and a burgeoning middle class in southeast Asia. This is a long-term bet and if you've been paying attention to e-commerce trends in North America, you can bet the exact same thing will happen in Asia but with exponential growth.

Canada's large pension funds are competing with large private equity firms for these logistic warehouses. They not only provide great growth potential, they are pretty much all leased up and will provide stable cash flows (rents) over a very long period.
As a burgeoning middle class develops in China and Southeast Asia and their service economy picks up, it will present long-term growth opportunities in many areas, especially e-commerce.

Let me remind you in public markets, CPPIB made a huge windfall off the Alibaba IPO a few years ago but that decision didn't happen overnight. It took years and boots on the ground to nurture that investment.

The article above quotes CPPIB's CEO Mark Machin as stating: "China's been very thoughtful about creating the ingredients of innovation, which is creating more opportunities for all types of companies, whether it's e-commerce or others, to bloom."

I will trust Mark's judgment on this but my own personal money is all invested in US stocks and I think it will only be invested in US stocks for the rest of my life, especially if the new Canadian federal budget announces higher taxes on capital gains and dividends. In my opinion, there is no other country that competes with the US when it comes to real innovation.

And let's not forget, China is a communist country experimenting with "controlled capitalism". This means capital isn't allocated efficiently across various sectors and there is way too much government interference at all levels of the economy.

What the Chinese have managed to do is create a massive overinvestment bubble which  threatens economic growth there. In fact, the OECD recently warned that China should urgently address rising levels of corporate debt to contain financial risks as it tries rebalance the nation’s economy:
Beijing should also step up efforts to retire “zombie” state firms in ailing industries to help channel funds to more efficient sectors and enhance the contribution of innovation in the economy, the organisation said its latest survey of China’s economy.

“Orderly rebalancing requires addressing corporate over-leveraging, overcapacity in real estate and heavy industries and debt-financed overinvestment in asset markets,” the report said.

It forecast China’s economy would grow 6.5 per cent this year and 6.3 per cent in 2018.

The report warned of mounting financial risks as enterprises are heavily indebted, while housing prices have become “bubbly”.

Corporate debt is estimated at 175 per cent of GDP, among the highest in emerging economies, climbing from under 100 per cent of GDP at the end of 2008, the report said.

“Soaring property prices in the largest cities and leveraged investment in asset markets magnify vulnerability and the risk of disorderly defaults,” it said. “Excessive leverage and mounting debt in the corporate sector compound financial stability problems, even though a number of tax cuts are being implemented to reduce the burden on enterprises.

Alvaro Santos Pereira, director of the country studies division at the OECD’s economics department, said at a briefing on the report: “Although the risks are rising, the firepower in the Chinese government is big enough and if there’s a problem, it’s able to sort it out.”

The report called for better and more timely fiscal data releases and to expand funding in health and education. Monetary policy should rely more on market-oriented tools and less on targeted government policy, it said.

China is trying to boost the services sector and encourage greater innovation in the economy, partly through promoting greater entrepreneurship and the commercial use of the internet.

Official data shows more than 100,000 new firms were registered each day last year in China, but the report said there were too many unviable firms and the progress on scrapping zombie state-run companies was modest.

It cited a research report published last year saying that nearly half of steel mills and half of developers were making losses, but could still obtain loans. Zombie companies, mainly state-owned enterprises in industries plagued by excess capacity, have aggravated credit misallocation and dragged down productivity, the report said.

The State-owned Asset Supervision and Administration Commission said last year it aimed to close 345 zombie firms in the coming three years. The report said the number was “rather modest” given that the commission controls about 40,000 companies.

It added that the government should remove implicit guarantees to state firms as a way to stop corporate debt from piling up and that bankruptcy laws should be improved to help phase out zombie state firms.

China is increasing spending on research and development, but innovation does not significantly contribute to growth, the report said. Despite the soaring number of patents, “only a small share are genuine inventions”. The utilisation rate of university patents is only about five per cent compared to 27 per cent in Japan.

“Only a fraction of Chinese patents are registered in the United States, the European Union and Japan and Chinese researchers are weakly linked to global networks,” the report said. Margit Molnar, chief China economist and lead author of the report, added: “The internet should be faster and cheaper.”

The report suggested government support for innovation should extend to more sectors rather than strategically important projects and high-tech industries.

The OECD has 35 member countries, with China a strategic partner.

The organisation has a stringent set of criteria for membership based on data transparency and other factors including oil reserve levels.

The attraction of membership for China has waned as it favours involvement with other international organisations, including the International Money Fund and the G20 group of industrialised nations.

“The OECD is no longer a rich men’s club. It is important the OECD is becoming more and more global because the world has been changing dramatically over the past years,” said Pereira. “China is looking at the OECD, hopefully, with increasing interest.”

He added the organisation had close cooperation with the Chinese authorities. “We welcome that,” he said.
As you can see, even though China is still "officially" growing at a 6.5% clip, most of this growth is increasingly financed by debt to support thousands of zombie companies that should be shut down.

Also, innovation in China is not a meaningful contributor to economic growth because the Chinese don't excel in innovation and have very few patents on any genuine inventions.

Having said this, China has managed its growth admirably thus far and we can debate whether a country like China can thrive on laissez-faire American capitalism (I personally don't think so, not that there has been much laissez-faire capitalism going on in the US either).

In my last comment on the $3 trillion shift in investing, I stated the following:
Given my views on the reflation chimera and the risks of a US dollar crisis developing this year, I would be actively shorting emerging markets (EEM), Chinese (FXI), Industrials (XLI), Metal & Mining (XME), Energy (XLE)  and Financial (XLF) shares on any strength here (book your profits while you still can). The only sector I trade now, and it's very volatile, is biotech (XBI) but technology (XLK) is also doing well, for now.

I still maintain that if you want to sleep well, buy US long bonds (TLT) and thank me later this year. In this deflationary environment, bonds remain the ultimate diversifier.  
Now,  this morning I read that Asian shares are at 21-month highs and the US dollar is soft on Fed views which are less hawkish than previously anticipated.

Great, so am I wrong on my macro call? Nope, I am rarely wrong on my macro calls but the story I'm describing won't hit us till the second half of the year and perhaps even in the last quarter of the year.

Yes, Chinese (FXI) shares have been breaking out on the weekly chart, propelling emerging market (EEM) shares higher too (click on images):

These are bullish weekly breakouts that augur well for these shares in the short run, but given my global deflation view, I wouldn't be investing here and I'm pretty sure once global leading indicators start heading south, these markets are in big trouble (keep shorting them on any strength).

What does this have to do with CPPIB raising its stakes in China over the long term? Nothing except I would be more like PSP and remain very cautious on emerging markets including China over the near term. If there is a massive downturn in China, then reevaluate and go in and raise your stakes.

Having said this, I realize that CPPIB is a super long term investor and doesn't need to perfectly time its entry in public and private markets, but all this bullishness on China at this particular time makes me very nervous.

Still, CPPIB is helping China fix its pension future  (they need all the help they can get) and it has developed solid relationships there, including high level government relationships it can leverage off of to make smart investments over the long run.

Below, Mark Machin, CEO of the Canada Pension Plan, says the fund is looking to increase its allocations in China over the long run. Again, this makes perfect sense over the long run especially since CPPIB is underweight China on a GDP basis, but I would be scaling in very slowly as I expect a massive dislocation to hit China and Asia either this year or early next year.

According to Goldman Sachs where Mark used to work, China’s economy may have slipped down the global worry list, but significant risks remain, including an abrupt end to a massive credit boom or an overly aggressive policy response if inflation should speed up.

I'm less worried of rising inflation and more worried of global deflation and a US dollar crisis developing this year, prompting another Big Bang out of China, hitting risk assets all around the world very hard.

But have no fear, if a big bad bear market develops, and it will, the folks over at CPPIB will be very busy snapping up public and private assets all over the world, including in China. This is why I'm such a firm believer in enhancing the CPP for all Canadians, it pools investment and longevity risks and lowers costs for all Canadians. The Chinese should take note of that and learn from the CPP-CPPIB model.

Monday, March 20, 2017

The $3 Trillion Shift in Investing?

Frank Chaparro of Business Insider reports, There could be a $3 trillion shift in investing, and it poses a huge problem for mutual funds:
A dramatic shift is underway in the investment world.

Passive investment products like exchange-traded funds have hoovered up assets at a fast clip in recent years. US-listed ETFs saw $283 billion in net inflows during 2016, taking aggregate assets under management to $2.5 trillion, according to Citigroup.

Exchange-traded funds could gain a further $2 trillion to $3 trillion in assets in the next three to five years, according to a big report on the future of the finance industry from Morgan Stanley and Oliver Wyman.

Fee pain is coming

ETFs are cheaper and more transparent than mutual funds, while mutual funds have struggled for performance in recent years. As such, money has poured out of mutual funds and into ETFs over the past few years. That has forced mutual funds to compress their fees so that they can compete.

With ETFs set to see their share in the US market increase from 15% to 40-60% over the next ten years, according to Credit Suisse, fee compression in the mutual fund industry will likely continue. Morgan Stanley estimates that fees charged by active managers could shrink by more than a third in 2017.

That's not good news, because lower fees means less profit.

The irony

The price compression that has swept the mutual fund industry has forced money managers to come up with ideas to cut costs in order to save their bottom line. One such solution they've come up with is a bit ironic.

According to Morgan Stanley and Oliver Wyman, mutual funds are now using ETFs, the very funds that have contributed to price compression, to cut their own costs. By investing in ETFs, mutual funds are able to free up time to focus on "more complex alternative investments," the report said.

Here's Morgan Stanley and Oliver Wyman's explanation (emphasis ours):
"Asset allocators such as Outsourced Chief Investment Officers (OCIO) and Wealth Managers will account for a large proportion of this incremental demand as they increasingly use ETFs at near zero cost to source beta exposure, allowing them to focus their resources on high conviction managers or more complex alternative investments. However, looking beyond 2019, the emerging use of passive vehicles as an integral part of an active fund management strategy will be arguably the more significant dynamic. Currently, Mutual Funds have ~$0.5TN invested in ETFs, much of which is used for liquidity management. We estimate using ETFs rather than the traditional approach of holding individual stocks offers a cost advantage of 5-8 bps in large and mid-cap equities. As Asset Managers search for ways to deliver performance at lower costs, this may mean that mutual funds find themselves among the largest investors in ETFs."
The report concludes that mutual funds will potentially be one of the biggest drivers of growth for ETFs.
This dramatic shift in the investment world -- ie. the proliferation of exchange-traded funds (ETFs) -- is nothing new, it's been going on for years which is why I'm increasingly worried that we moved from the big alpha bubble which has popped to one giant beta bubble.

Don't get me wrong, ETFs are fantastic, for most people it's the best low cost way to invest and gain market/ sector/ thematic exposure and I actually believe not only in ETFs but also digital platforms (aka robo-advisors) that manage people's portfolios by diversifying ETFs and rebalancing the portfolios automatically every year or as needed based on some simple rules.

If you're young and starting to invest for your retirement, you should learn all you can about digital investment advice and how it can improve your portfolio. Even seasoned investors and high net worth investors can profit off these platforms but you need to understand the key differences between them in terms of fees and services they provide (for example, some offer tax-loss harvesting, some offer services catering to high net worth clients, others offer no mimimums, etc.).

I'm not going to go over the pros and cons of robo-advisors but they too have contributed to this surge in exchange-traded funds (ETFs) taking place in the investment world.

As far as mutual funds increasingly using ETFs to manage their portfolios, no surprise there as almost all of them are closet indexers charging high fees as they underperform the market. And then we wonder why there is a crisis in active management and why big and small pension funds are increasingly insourcing their public market assets.

Keep in mind what Ontario Teachers' CEO Ron Mock told me back in 2002 when I first met him in Toronto when he was in charge of the multi-billion hedge fund program: "Beta is cheap, we can swap into any bond or stock index to gain exposure to beta for a few basis points. Real alpha is worth paying for."

Unfortunately, real alpha is getting harder to find these days but the point Ron was making is that you don't want to pay fees to any hedge fund for something you can cheaply replicate or gain exposure to using derivatives (swaps) or exchange-traded funds (ETFs) which many retail and institutional investors (including hedge funds) use to gain market exposure.

Why so much focus on fee compression? Because we live in a low growth world where ultra-low rates are here to stay (never mind what you hear in the financial media) and returns going forward will be a lot lower than what we experienced in the last 20 years.

In this low growth/ low rate/ low return environment, fees matter a lot to institutional and retail investors because they detract from net returns (after fees are factored in).

Unfortunately for the financial industry, fee compression isn't a good thing. It's having a marked effect on employment trends as big banks and investment firms myopically focus cost-cutting using computers and artificial intelligence to replace everything from bank tellers to traders and portfolio analysts and managers.

The digitization of finance is breathtaking and very worrisome because a lot of high paying and low paying jobs are vanishing and the new jobs being created to support this new infrastructure will eventually be outsourced to India or elsewhere at a fraction of the cost.

Banks are ruthless. Sure, profits rose in 2016 and bonuses are up but that only tells you part of the story. The truth is the big guys at the top are making all the money, the lower levels analysts are seeing their bonuses rise a little and everyone else in the middle is getting squeezed, fired and replaced by computers and algorithms.

[Note: In foreign exchange trading where big banks still rake their clients, rookie traders are causing problems at crucial moments. So much for letting go of the experienced traders!]

Following the 2008 crisis, new regulations forced banks to increase the base salaries of their employees to keep them happy as they slashed bonuses. What this did is bloat the compensation of some higher level staff (like managing directors) who subsequently weren't incentivized to take risk on their books. It just wasn't worth it for them to take the risk and risk losing their job. A lucky few crossed the street to join their big hedge fund clients but there too, most employees are unsatisfied with their bonuses (but 'quant geniuses' made off like bandits).

This is why I hate looking at the average bonus on Wall Street published in an annual report from the New York State Comptroller's Office. It tells us nothing of what is happening to the bonuses at the very top levels, lower levels and middle and upper levels. They should break it down in a lot more detail than what is currently provided because like I said, it's the people at the very top making the bulk of the money. The lower levels where salaries are relatively low enjoyed a bounce in their bonus but a lot of middle and upper level jobs are vanishing at an alarming rate.

The world of finance is irrevocably changing. Intense competition, fee compression, cost-cutting and artificial intelligence are all trends that will continue in the foreseeable future, exacerbating rising inequality which is deflationary.

In their infinite wisdom to evolve and myopically focus on cost-cutting, big banks are cannibalizing each other and killing aggregate demand in the process, a trend that should worry all of us. Because once those jobs disappear, they are gone forever, never coming back.

But it's not just finance, computers are slowly taking over pretty much every job (click on image; h/t, John Graham of Arrow Capital Management):

Anyway, back to the $3 trillion shift in investing. Beta is cheap, beta is great, but when everyone is jumping on the beta bandwagon, choose your beta carefully or you risk being exposed to severe downside risk.

Given my views on the reflation chimera and the risks of a US dollar crisis developing this year, I would be actively shorting emerging markets (EEM), Chinese (FXI), Industrials (XLI), Metal & Mining (XME), Energy (XLE)  and Financial (XLF) shares on any strength here (book your profits while you still can). The only sector I trade now, and it's very volatile, is biotech (XBI) but technology (XLK) is also doing well, for now.

I still maintain that if you want to sleep well, buy US long bonds (TLT) and thank me later this year. In this deflationary environment, bonds remain the ultimate diversifier

As far as active management, I see tremendous opportunities for stock pickers on the long and short side in these markets which is why I'm a bit surprised when I hear hedge funds say there are no opportunities. There are plenty of opportunities but you need to find them on both the long and short side.

Below, a list of US exchange-traded funds (ETFs) I track closely every day to give me a good overview of the various market sectors (click on images):

This is by no means an exhaustive list but it gives me a very good breakdown of which sectors are moving every day, allowing me to dig deeper into the over 2000 stocks in various sectors and industries I track.

Again, right now my attention is completely on biotech (XBI) where I see tons of great opportunities mostly in smaller names I track closely (click on images):

You can add Nektar Therapeutics (NKTR) to this list, another biotech I track which surged 43% on Monday on promising phase 3 results from its opiod drug.

But let me repeat, investing in biotech isn't for the faint of heart and unless you can stomach gut-wrenching volatility, forget about investing in individual names, stick to the ETFs (IBB, XBI) or ignore this sector altogether.

Some of the names I track above are from my research looking at top funds' activity every quarter but trust me, just because they're top funds, doesn't mean they don't get hammered on their picks too.

Anyway, I know what Jack Bogle would tell me, don't bother trading biotech or any hot sector, invest in a balanced portfolio of ETFs, get instant diversification on the cheap and remember to rebalance your portfolio once a year or as needed. Keep it simple stupid!

Below, CNN's Michael Smerconish's full interview with Vanguard Group founder Jack Bogle, the most important figure in investing most people don't know about. Listen carefully to Bogle's words of wisdom, not just on investing but on politics, inequality and how to live a long and fruitful life.