Wednesday, November 14, 2018

CalSTRS to Divest of Private Prisons?

Chief Investment Officer reports, CalSTRS to Divest of Private Prison Companies:
The investment committee of the California State Teachers’ Retirement System (CalSTRS) has approved divesting its holdings in CoreCivic and GEO Group, the two US publicly held companies running private correctional facilities.

The action by the committee on Nov. 7 makes CalSTRS the third major US public pension fund to divest from the private prison companies. In July, the New York State Common Pension Fund divested from the two correctional companies upon orders from its sole trustee, New York State Controller Thomas DiNapoli.

In 2017, the New York City Pension Funds also divested its holdings in CoreCivic and GEO Group.

While CalSTRS’s global equities and fixed income portfolio holdings in the two companies were worth only around $12 million as of November 6, the divestment by such a large pension plan is expected to shine more light on the companies and their practices. Advocates against private prisons and the federal governments policy of using the private facilities to house immigrant detainees have been pressuring other institutional investors to divest.

CalSTRS is the second-largest pension system in the US with almost $230 billion in assets under management. Combined, CalSTRS and the New York State and New York City plans have almost $600 billion in assets under management, a powerful trio of institutional investors that have said no to private prison companies.

The vote by the CalSTRS Investment Committee comes after CIO Chris Ailman ordered CalSTRS investment staff to conduct a divestment review in July. This came after the Trump administration’s zero tolerance border crossing policy highlighted children being separated from their parents and the housing of detainees, both adults and children, in facilities run by the two private corrections companies.

Several dozen protesters calling on CalSTRS to divest from the two companies had appeared at the July 20 investment committee meeting. It was the same meeting at which Ailman made his decision to conduct the review.

“The board conducted a review of the staff research; we agreed that the engagement efforts were thorough and listened to our expert investment consultants,” said Investment Committee Chair Harry Keiley in a press release issued after the vote on Wednesday. “Based on all the information and advice we were provided, the board decided to divest according to the policy criteria.”

The divestment is scheduled to be completed within six months.

Keiley wasn’t more specific, but the committee wasn’t acting on a recommendation from the investment staff. The CalSTRS investment staff review released Nov. 7 did not take a position either way as to whether the pension system should divest from the private prison companies. The review looked at whether CalSTRS’s investments in the two companies violated its environmental, social, and governance (ESG) policy, which includes respect for human rights and whether the investments in the companies would be jeopardized.

“Staff does not take a position on whether or not private prisons violate the ESG policy to the point of justifying implementation of the CalSTRS Divestment Policy,” the review said. “Staff realizes the operation of prisons (public or private) pose noteworthy risks under the CalSTRS ESG policy. However, in several cases it is the contracting agency, such as the US Government, that creates and carries the risk.”

On the human rights issues, the investment staff report split down the middle pro and con on arguments that the companies were violating detainees’ human rights.

“While staff has been informed by both companies that they were not directly involved in the separation of the family, they did provide capacity for the detention of the parents,” the CalSTRS review noted.

The review said while neither GEO Group nor CoreCivic have facilities to house unaccompanied minors, both have a facility to house detained families. It said the two facilities operate outside San Antonio, Texas, and are designed to keep children with one of their parents.

CalSTRS officials said they toured the facilities and noted detainees were able to roam the grounds, the living units were not locked, and there was no razor wire or weapons carried by staff.

“While staff was not able to obtain evidence that these companies violate the respect for human rights, private prisons do add capacity, and help facilitate a system, that may be viewed as violating the Risk Factor,” the review said.

In an emailed comment to CIO, a GEO Group spokesman defended the company’s practices.

“We believe [CalSTRS’s] decision was based on a deliberate and politically motivated mischaracterization of our role as a long-standing service provider to the government,” the statement said. “Our company has never played a role in policies related to the separation of families, and we have never provided any services for that purpose. We are disappointed that misguided, partisan politics were able to jeopardize the retirement security of California’s educators.”

Officials of CoreCivic could not be immediately reached for comment.

The CalSTRS review disputes GEO Group’s contention that California educators’ retirement security would be affected by divestment. The review said removing the private prison companies from the CalSTRS portfolio does “not pose a significant risk or benefit to the portfolio because they are so small relative to the US equity and fixed income allocations.” CalSTRS’s combined allocations to the asset classes total more than $150 billion compared to its approximate $12 million in holdings of the two prison companies.
The truth is these investments are peanuts for CalSTRS and pose no significant risk to long-term returns but I too wonder whether these divestments were politcally motivated.

Prisons are big business in the US where the prison industrial complex is thriving, especially under a Republican led Senate and a president who wants to be viewed as tough on crime.

The problem with the US prison industrial complex is the criticism that it's a new form of slavery and those enormous profits come from violating basic human rights.

Earlier this month, students at Harvard called the endowment to divest from the prison industry during the first public event held by the newly formed Harvard Prison Divestment Campaign:
The event, hosted at the Law School’s Wasserstein Hall, featured students speakers addressing a near-capacity crowd of roughly 100. Hakeem Angulu '20 and Jackie Wang, a graduate student in African and African American Studies and author of "Carceral Capitalism," began the event by speaking about the history of the American prison system as well as racial disparities in conviction and incarceration rates.

Soon afterwards, organizers projected the campaign’s organizing statement onto a screen.

“The Harvard Prison Divestment Campaign seeks to sever the university’s financial ties to the prison-industrial complex by advocating for Harvard’s total divestment from all corporations whose existence depends on the capture, caging, and control of human beings,” the statement reads.

During the event, organizers also shared an audio tape recorded by Derrick Washington, an inmate at Souza-Baranowski Correctional Center, a maximum security prison in Lancaster, Mass. Washington, who said he had been convicted of murder, described his experiences in the state prison system as well as his later involvement with the Emancipation Initiative, a group that advocates for prisoners.

“Because prison is all of misery and hopelessness — and Harvard readily profits from it — in fact I see as Harvard endorsing every single prison suicide, murder, recidivist and fallen tear drop from the effects of 21st century slavery,” Washington said.

Jarrett M. Drake, a graduate student in Anthropology who co-founded the campaign, said the initiative originated last fall as part of a project for a class on incarceration. He said he developed the campaign with Design School student Samuel A. J. Matthew.

Initially, the two envisioned the project as a way to better inform school affiliates about Harvard’s investments in the “prison industrial complex.” But, after the course ended, he and Matthew decided they “wanted to do something more with the information project.” The duo eventually brought on several organizers to implement a broader initiative.

This October, Drake — along with Anneke F. Dunbar-Gronke, a third-year student at Harvard Law School, and Paul T. Clarke, a graduate student in African and African American Studies — penned a Crimson op-ed criticizing Harvard’s investments in companies associated with the prison industry.

The authors specifically pointed to Harvard’s investments in ETFs that contain stock in private prison operators CoreCivic and GEO Group; Tokio Marine Holdings Inc., an insurer in the bail bond industry; and Axon Enterprise, Inc., the manufacturer of Tasers.

Harvard’s SEC filings for the quarter ending June 30 of this year show holdings in these firms of approximately $67,000. The filings disclose a total $420 million in holdings.

Organizers said they have not directly contacted the Corporation about prison divestment.

Over the years, University administrators have consistently opposed student proposals to change Harvard’s investment strategy — especially when it comes to divesting from fossil fuels, a common undergraduate rallying cry in recent years.

Responding to a question on prison divestment in an itnerview Tuesday, University President Lawrence S. Bacow said that investment decisions should not be used as political tool.

“We’ve stated many times, my predecessors have stated this going back to Derek Bok’s days 40 years ago, that the University should not use the endowment to achieve political ends or particular policy ends," he said. "There are other ways the university tries to influence public policy through our scholarship, through our research, but we don’t think that the endowment is an appropriate way to do that.”

Bacow’s response parallels the position of previous Harvard presidents on divestment movements. In 2013, President Drew G. Faust wrote in a statement on fossil fuel divestment that Harvard’s endowment is “not an instrument to impel social or political change.”

In an interview during the event, Dunbar-Gronke said they believe the University’s investments in prisons are intrinsically political.

“We would like for a depoliticized endowment, and that would mean divesting from a system that is inherently politicized by the fact that it disproportionately affects black, brown, and poor people, and undocumented people, and we as students are in a unique position to hold the University accountable.”

Dunbar-Gronke also said they think Harvard's investments run contrary to the University’s efforts to address its ties to slavery.

“Harvard has expressed remorse for its institution in slavery, but that we are currently still investing in a legacy of slavery, so cannot be fully contrite until we stop investing in it," they said.

After presentations by speakers Thursday, participants broke off into smaller, off-the-record group discussions.
My thoughts? I'm on record stating it's silly to divest from fossil fuels and apart from tobacco where engagement is futile and divestment makes a lot of sense, I'm generally not comfortable with the rush to divest from investments.

Now, in the case of US prisons, there are serious concerns, I do believe there's institutional racism and slavery so corporations can profit, but even there, wouldn't you want a big pension engaging and forcing change from within?

The minute these big pension funds divest, someone else takes their place, a public or private equity fund that doesn't give a rat's ass about ESG, only big fat profits, and basically nothing gets done to change the condition of US prisons.

Again, these investments are peanuts for CalSTRS or Harvard, but I'm not sure divesting is doing the inmates any favors. In fact, I think they're going to be worse off if big pensions divest.

In other California news, Chief Investment Officer reports, CalPERS CIO Leaves Friday, but Replacement Delayed:
California Public Employees’ Retirement System (CalPERS) Chief Investment Officer Ted Eliopoulos is ending his 17-year tenure at the largest US public pension plan on Friday, but his replacement, Yu Ben Meng, remains stuck in China and will be unable to take over the investment reins of the $361.1 billion retirement plan until sometime in January.

Both Eliopoulos’ impending departure and the fact that Meng’s start date won’t be until sometime in January were announced at the pension plan’s investment committee meeting on November 13. CIO had reported before the meeting that Meng could not start sooner because he has a non-compete agreement with the Chinese government following his three-year tenure as deputy CIO at China’s State Administration of Foreign Exchange.

The agreement has prevented Meng, who was named CalPERS CIO in September, from joining the pension plan. Meng is also being prevented by the Chinese government from leaving the country until the non-compete expires, said former CalPERS board member and investment officer J.J. Jelincic. Jelincic has said he has had phone conversations with Meng from China. Several CalPERS sources confirmed Jelincic’s account to CIO.

Eliopoulos, in brief comment at the investment committee meeting, said that Eric Baggesen, a managing investment director who directs the pension plan’s asset allocation efforts, would take over as interim CIO until Meng starts in January. Meng had previously worked at CalPERS and had been one of the investment leaders of asset allocation efforts.

It is unclear exactly when Meng’s non-compete expires and CalPERS officials on Tuesday weren’t specific as to what date in January Meng would start at the pension plan.

Meng had a senior leadership role in investing more than $1 trillion in China’s foreign currency reserves, including US dollars that were invested in Treasuries and US-listed equities. He is a US citizen, but was born in China

That may be part of his problem in terms of leaving the country.

“China treats people born in China as if they were Chinese citizens, even if they have acquired citizenship elsewhere,” Nicholas Yardy, a senior fellow at the Peterson Institute for International Economics and an expert on the Chinese economy, told CIO in an email.

In a surprise announcement in May, Eliopoulos said he would be stepping aside by the end of the year because of health considerations of one of his daughters who is attending college in New York City. Eliopoulos said it is important that he is within “reasonable distance” of his daughter.

Eliopoulos joined CalPERS in January 2007, and served as senior investment officer for the pension plan’s real estate asset class. He oversaw the portfolio during the great financial crisis when it lost more than 48% of its value. He was tasked with rebuilding the portfolio, reducing speculative office and land deals in place of a new emphasis on core real estate assets. In 2014, he assumed the role of CIO following the death of Joseph Dear from prostate cancer.

CalPERS officials and board members had originally hoped that the new CIO could work aside Eliopoulos for several months before he left CalPERS.

It is a particularly critical time for the largest US public pension plan. CalPERS officials are hoping to launch CalPERS Direct, a private equity organization that would invest in later-stage companies in the venture capital cycle as well as buy and hold stakes in established companies, similar to Warren Buffett’s strategy.

Eliopoulos in his remarks on Tuesday thanked CalPERS staff for their support during his tenure but did not address the fact that he would not be working side-by-side with Meng.

It is unclear if the investment committee will vote on the $20 billion direct investment organization at its December meeting or wait until after Meng takes over as CIO.

If CalPERS Direct becomes a reality, Eliopoulos won’t be around to see his biggest idea implemented. Eliopoulos had formally proposed the private equity direct investment organization, the first of its kind for a public pension plan in the US, in July 2017.

CalPERS has one more investment committee meeting this year scheduled for Dec. 17, which is the last meeting for Priva Mathur, the president of the CalPERS board and a proponent of the direct private equity investment organization. Mathur was defeated in a bid for reelection. The investment committee is made up of all 13 CalPERS board members.

Sources say that Mathur has told fellow board members that she would like CalPERS Direct approved before she leaves her post in early January.
I doubt the Board will vote on CalPERS Direct prior to Meng taking over as CIO. It's an important and much-needed initiative but typically you wait for the new CIO to be in place before voting on something like that.

As for Ted Eliopoulos, I wish him all the best in his new endeavor whatever it is and I hope his daughter is healthy and enjoys her college years in New York City.

Below, CalSTRS Chief Investment Officer Christopher Ailman speaks with CNBC’s 'Squawk on the Street' about the pension fund’s push for the gun industry to implement more stringent safety principles. He also discusses the recent volatility and how CalSTRS is reducing risk but remains focused on the long run.

I also embedded an MSNBC documentary which reports on the brutal stark reality of US maximum security prisons (warning: some parts are disturbing).

Lastly, a clip on a new documentary film, American Jail, where Academy Award-winning filmmaker Roger Ross Williams investigates America's mass incarceration crisis. I saw this documentary over the summer, it was excellent and highlighted the many problems at American prisons.



Tuesday, November 13, 2018

Credit Markets Flashing Caution Ahead?

Molly Smith of Bloomberg reports, General Electric Is Flashing Caution Signs in Credit Markets:
General Electric Co. may still have a relatively solid investment-grade rating, but investors aren’t taking their chances. They’re snapping up derivatives that protect against losses on the company’s debt.

The annual cost to insure against a default by GE for five years climbed above 200 basis points for the first time in years, credit-default swap prices from CMA show. That’s almost double what it cost just two weeks ago, and it’s the kind of level that hasn’t been seen for the company since the waning days of the global financial crisis.


That’s still well below the peak crisis levels for GE’s finance unit back then (GE Capital CDS surged to more than 1,000 basis points in March 2009). But the pace of the increase has been rapid, particularly when compared with the broader investment-grade market. Yields on some of GE’s bonds have also reached levels that are in line with junk-rated bonds, Bloomberg Barclays index data show.

Chief Executive Officer Larry Culp tried to reassure investors that the company is prioritizing debt reduction in its effort to combat a multiple-front crisis in a televised interview on Monday, when the bond market was closed. GE is facing weak demand for gas turbines, high debt levels and a federal accounting probe. Its shares have fallen more than 25 percent since Culp’s surprise appointment as CEO was announced Oct. 1, extending a sell-off that has wiped out more than $200 billion in market value since the end of 2016.

Representatives for Boston-based GE didn’t immediately provide comment.

‘Escalating’ Concerns

In his first earnings announcement as CEO, Culp said the company was cutting the quarterly dividend to just a penny a share from 12 cents in an effort to conserve cash and strengthen its balance sheet. Still, credit and equity analysts remain cautious. If GE’s credit ratings were further downgraded, the company could face rising borrowing costs and other expenses that would further pressure its liquidity, Gordon Haskett analyst John Inch wrote in a note.

GE may not be alone in facing these risks, some money managers fear. U.S. investment-grade bonds have been one of the worst-performing U.S. asset classes this year, as rising interest rates have lifted companies’ funding costs and sapped investors’ returns. More pain may be coming for investors, and it could be severe, distressed-debt money manager Marc Lasry warned late last month. Scott Minerd, global chief investment officer of Guggenheim Partners, said on Tuesday that more investment-grade credits will suffer.

“The selloff in GE is not an isolated event,” he wrote in a Twitter post. “More investment grade credits to follow. The slide and collapse in investment grade debt has begun.”

There are around $2.5 trillion of bonds rated in the lowest tier of the investment-grade universe, more than triple the level at the end of 2008. Some of those securities, including issues from GE and Ford Motor Co., trade like they are already rated junk.

Despite being cut to the lowest investment-grade tier, GE is still three notches above junk, with a Baa1 rating from Moody’s Investors Service, and an equivalent BBB+ from S&P Global Ratings and Fitch Ratings. All carry a stable outlook.

Yields on the company’s $1.95 billion of 3.37 percent bonds due in 2025 have climbed above 5.6 percent. That’s higher than the yield on a Bloomberg Barclays index of debt rated in the highest speculative-grade tier.

Meanwhile, GE’s only actively traded perpetual preferred stock now yields more than 15 percent, higher than some distressed credits. If the company chooses not to call the security in early 2021, it will convert into a floating-rate obligation that GE need never refinance.
After getting pummelled on Monday, General Electric (GE) shares were up almost 8% on Tuesday on huge volume after the company announced a plan to reduce its stake in Baker Hughes to shore up its liquidity by $4 billion (click on image):


GE bulls got excited today but it remains to be seen if this is another temporary reprieve where shorts covered and will be back on it as soon as possible (I wouldn't get excited about GE shares until they surge past $12.50 a share).

Anyway, the real risk in the company is reflected in how its bonds, not the shares, are trading. And from the looks of it, GE is far from being out of the woods:



What is more worrisome is if contagion from GE and the slide in oil prices will hit investment grade bonds. In a tweet, Scott Minerd, Guggenheim Partners chairman of investments and global chief investment officer said: "the slide and collapse in investment grade credit has begun."



James Crombie of Bloomberg states the following:
Rising rates have hammered investment-grade debt amid growing concerns about credit quality in the BBB rated tier. The recent equity and oil slumps, Cboe Volatility Index spike and rising concerns about trade wars, Brexit and Italy also pressured junk bonds, which are still positive for the year, despite a big loss in October.
In case you didn't notice, crude oil futures were down nearly 8% on Tuesday in very heavy trading (click on image):


The slide in oil prices is almost unprecedented. According to Bespoke Investments, this is the fastest crude oil has gone from a 52-week high to a 52-week low (30 trading days) since at least 1984:



Not surprisingly, energy shares (XLE) are down again and are close to making a new 52-week low (clcik on image):


I've been short energy but from a trading perspective, when you see moves like this, you have to wonder whether it's way overdone in the short run.

Earlier this afternoon, I emailed an astute commodity trader and asked him what is going on with crude oil prices, down so much so fast. He replied:
Capitulation! The last bulls were counting on OPEC to announce that they would cut production after crude had already fallen by 16$ (76$ to 60$). The fall was due to the waivers granted to 8 countries by the US in their purchases of Iranian crude and just when everyone was expecting anything from the producers... President Trump tweeted that Saudi Arabia and OPEC shouldn't cut at all..they have their hands tied.

And the positioning was still very long among specs in WTI.. and CTAs smelled blood and added to their shorts.

Kind of self-fulfilling downward spiral that we could see in the S&P one day...
On a brighter note, he added this on nat gas futures which have been doing well:
Nat gas is up 7.5% today and 25% since the beginning of the month. Inventories are around 18-20% lower than the 5-year average and colder weather is forecasted for the beginning of December.
A great trade would have been to short oil and go long nat gas over the last month but who would have known the divergence would be so wide (Note: The Macro Tourist put up an interesting post of a large energy hedge fund taken to the chipper on the crude oil - nat gas spread).

Interestingly, Not Jim Cramer tweeted this showing the correlation between S&P earnings and crude oil prices:



It all remains to be seen how the slide in oil impacts earnings but I think it's safe to assume major downward revisions are headed our way.

It also remains to be seen how the slide in oil impacts the high yield market which remains the canary in the coal mine.

If you look at the one year chart, there is some concern, but over the last five years, high-yield bonds (HYG) are still in an uptrend (click on charts):



So take Scott Minerd's dire warning with a pint of salt, there's still no reason to worry about a blowup in the high yield market.

Below, Bruce Richards, chairman and chief executive officer at Marathon Asset Management, discusses policy and market fallout from the midterm elections, the high yield bond market, and the factors that will lead to the next US recession in 2020. He speaks with Bloomberg's Vonnie Quinn on "Bloomberg Markets" (click here if it doesn't load below).

Monday, November 12, 2018

Surviving the Coming Retirement Crisis?

Barbara Kollmeyer of MarketWatch reports, How to survive the next stock selloff ‘without getting your face ripped off’:
Investors must shift quickly from postelection analysis to the latest word from the Fed since October’s market meltdown.

After Wednesday’s postelection rally, some might be entertaining a fairy-tale ending to the week for stocks that involves less fiscal easing and a less vigorous pace of raising interest rates by the Fed. On the contrary, cautions Kit Juckes, global macro strategist at Société Générale.

“I know how this Goldilocks story will end—she will be chased out of the house by an angry (bond) bear,” says Juckes who sees the rally sooner or later bumping into higher 10-year bond yields and a Fed determined to hike (though not Thursday.)

Those bears just won’t stop. And that leads us to our call of the day from former hedge-fund manager Raoul Pal, co-founder of Real Vision, who says equities are topping as a recession knocks on the door.

Pal says in an interview that the current setup for stocks “feels like 2007,” with volatility on the rise, as he rattles through a laundry list of unsettling economic signals, including a rising debt burden, with mortgage rates on the rise.

Consumers are saddled by all manner of debt from health-care costs to student loans, and piling up credit-card delinquencies. He said consumers also are sidestepping the purchase of big-ticket items and are using credit cards to pay for necessities like clothing and food.

“It is the last hurrah being financed by credit cards in things that have no asset value,” Pal asks.

Pal says the fragile stock market is really being held together by Alphabet’s Google (GOOGL) basically an “ad stock” that faces a shrinking global ad market and potential slowdown from weakening global growth. “If Google breaks, everything goes with it,” he say.

He was calling for a recession in 2016. In a bear market, which could be looming, he says there is only one way to survive: “What you have do to trade in that situation is keep your powder dry, reduce into the selloff if you’re short, then you add into the big bounces.

“If you try to add into selloffs, you’ll have your face ripped off,” says Pal. Right now, he’s just waiting for the economic data to back up what he has been seeing under the surface and then everything will start to meltdown at the same time. He’s shooting for the first quarter of next year. Maybe.
General Electic (GE) shareholders know exactly what Raoul Pal means about adding into a selloff, the stock has been decimating shareholders who added on every dip or initiated a position waiting for the big turnaround (click on chart):


All I can say is really smart money has been shorting GE shares since the high to mid-20s and it has been a relentless downturn ever since with no end in sight.

It's another brutal Monday on Wall Street. At the close, the Dow is down 602 points (2.3%), the S&P is down 55 points (2%) and the Nasdaq 206 points (2.8%).

Not surprisingly, following the CBS 60 Minutes report of Europeans taking back their data, the FANG stocks are getting pummelled on Monday hitting the broader tech sector (XLK) which is at a critical level here (click on image):


If tech shares continue to slide lower than their 50-week moving average, we will see broad-based losses in the stock market and the buyback bull won't make a difference.

I wouldn't panic just yet. Lately, markets always start the week weak, pop on Wednesday and finish off so-so. I'm being facetious but it's the truth.

Still, there's a lot of pain out there and even shares of the mighty Goldman Sachs (GS) are getting clobbered on Monday accounting for over 100 points decline on the Dow (click on image):


I know all about the 1 MDB Fund scandal but this feels a bit overdone, at least technically, and may present a nice short-term buying opportunity even if I'm short banks over the next two years.

But buying the dips in a bear market isn't easy because you don't know how low stocks can go and how long this bear market can last.

Are we in a bear market? No, not yet, but a few more weeks like this and we will be and many stocks are already in a bear market, declining below their 200-week moving average, unable to come back.

On Friday, I explicitly recommended you steer clear of cyclical stocks like energy (XLE), financials (XLF), and industrials (XLI) and focus on defensive sectors like healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecoms (IYZ), and hedge that stock exposure with US long bonds (TLT).

The fact that oil prices keep sliding lower and king dollar keeps surging higher also confirms my fear that the global economy is slowing in a meaningful way. 

However, it's important to note even though markets are getting slammed on Monday, nothing goes down in a straight line, we will see volatility leading up to the Fed's December meeting where barring a stock market crash, it's widely expected it will hike again (according to my friend: "no thanks to Trump tweeting about how Powell shouldn't raise rates, effectively cornering him to act in December and raise rates").

Anyway, I started with an article which cited Real Vision's co-founder, Raoul Pal, because he came out recently with a very gloomy 50- minute clip on the coming retirement crisis which I embedded below.

Now, on its website, it states Raoul writes and publishes an elite macroeconomic and investment strategy research service called the Global Macro Investor for the world’s leading hedge funds, pension funds, banks and sovereign wealth funds.

I have to say, I used to invest in top global macro hedge funds, and if any of them came up with some of the stuff Pal comes up with, I'd tear them to bits. A friend of mine sent me the clip below and he loves Pal and Real Vision, I'm less enamored and viewed it through a very critical lens.

First, I want all of you to first take the time to watch this clip, Pal is right, most Americans haven't saved enough and there's a looming retirement crisis as most people will outlive their savings and succumb to pension poverty.

Second, as I've stated many times here, America's private and public pension crisis is deflationary because as people retire with little to no savings, or meager pension payments which might be cut, they will spend a lot less during their retirement and that will impact consumption in a negative way.

But Pal then goes on to make these ridiculous assertions on the US labor force participation rate which has actually been on the rise lately, tying it to everything from gas prices to restaurants to bond yields.

The chart with gas prices and the US labor force participation rate doesn't take into account the over one billion Chinese and Indians who will come out of the agrarian economy to live in the city and drive a car.

Also, the US has better demographics than Europe, so I don't know where he gets his doom and gloom scenario on demographics is destiny and "it's all baked into the pie."

More importantly, as I discussed with a friend, people are putting off retirement for as long as possible and the US can still decide to privatize Social Security which will send stocks much higher.

In other words, depending on how bad it gets, you don't know how all this will play out in the future and how US policymakers will respond at that time.

What else? He shows a chart of an index he concocted to claim the Fed will significantly increase its balance sheet to over $8 trillion but get ready for stocks to crash by over 50%!

Excuse me, on the one hand, you're stating the Fed will do whatever it takes to bolster risk assets but on the other hand, you're stating stocks are toast because of demographics and baby boomers retiring in droves. There's a huge inconsistency there.

Not surprisingly, he ends up by recommending cryptocurrencies even though he admits "some ICOs are a scam" (insert roll eyes here).

Look, I happen to agree with Pal on some things but other arguments are extremely weak and laughable. We will have another bear market, it's going to be long and painful, deflation is headed our way, the Fed will engage in QE infinity, markets will be volatile, but it won't be the end of the world.

The biggest problem, and my friend and I were discussing this earlier, is people are stupid with their money. The Instagram generation loves spending money on things they don't need with money they don't have, is indebted like crazy, knows central banks will backstop their reckless behavior, and continues acting recklessly.

In effect, reckless over-indebted consumers are being rewarded and frugal savers are being punished. As my friend lamented: "There should have been a washout in 2008, we would have had a painful five year period but then began growing on much more solid footing."

I sort of agree but the cost of killing the economy back in 2008 would have brought us over the edge and into the abyss, so it was better to extend and pretend for another ten years and have global central banks backstopping the whole charade.

Anyway, take the time to watch Real Vision's Raoul Pal discussing the coming retirement crisis. Try to watch it all and please don't slice your wrists or go selling all your stocks after you hear his gloomy predictions (all these guys know fear sells subscriptions!).

Friday, November 9, 2018

The Buyback Bull is Back?

Thomas Franck of CNBC reports, The bull market's biggest buyer is back — companies are buying back stock at a record pace this month:
The stock market's biggest buying force is on track to post a historic November as corporations resume a rapid pace of share buybacks after third-quarter earnings announcements.

"November is shaping up to be the strongest buyback month on record," J.P. Morgan quantitative strategist Marko Kolanovic wrote in a note to clients Wednesday, citing activity observed by the bank's trading desk.

Investors blamed a so-called buyback blackout as a reason for the October rout in markets. Companies are barred from buying back their own stock in a window around their earnings releases. Buybacks have been a driving force behind this bull market with companies even issuing debt at low interest rates to repurchase their own stock.

Other data support J.P. Morgan's numbers. In the past four weeks as earnings announcements wound down, buybacks have averaged $3.3 billion daily, with the number of announcements running at the fastest pace in the past three years, according to TrimTabs Investment Research data from Wednesday.

Overall, Goldman Sachs notes that buybacks for companies in the S&P 500 jumped by 51 percent in the first half of the year as companies spent the money from the tax cut, especially the funds that were trapped overseas. Goldman Sachs expects S&P 500 share repurchases to climb another 22 percent to $940 billion next year.

The recent buying has been fairly concentrated, with buybacks for Wells Fargo ($18.1 billion) and Merck ($10 billion) accounting for a combined 43 percent of the volume, the site said in a press release. In all, 13 companies have introduced buybacks of at least $1 billion.

One notable buyer of its own stock was Warren Buffett's Berkshire Hathaway, which said it bought nearly $1 billion worth in August.

While companies are likely to continue to goad the market higher by returning cash to shareholders, it comes against a backdrop of concern that there may be no better place to put the cash. Further, a steady uptick in interest rates has some market strategists worried that lending — which helped pay for the buybacks — may become too expensive.

Both short-term and long-term Treasurys have seen their rates climb over the past 12 months, with the 10-year rate hovering at 3.21 percent, up from 2.3 percent one year ago.

The S&P 500, which fell intro correction territory in October with a drop of 10 percent from its September highs, has rallied 5.6 percent over the past 10 days.
So what to make of the stock buyback hoopla? It's tough to say, buybacks sure haven't helped shares of Wells Fargo (WFC) over the last year but they have helped propel shares of Merk (MRK) higher (click on images):



A quick look at these charts and I'd be long Merk (MRK) and short Wells Fargo (WFC) and it's not just because of golden crosses and death crosses (technical analysis). In these markets, I'm long stability and profitability and short cyclicality.

In fact, I was telling Fred Lecoq, my former colleague at PSP and trading buddy to buy Merk shares at $55 back in April. The thing took off on us but it was a beautiful swing trade and will likely run higher.

Fred now likes shares of Disney (DIS) and I have to agree with him, good stock to own in a slowing economy (click on image):


Anyway, there's no doubt that shares buybacks help markets at the margin but I think some analysts and strategists overestimate the effects of buybacks as if they're the end all and be all of the stock market.

They're not. They're part of the market and people should understand what drives them and what happens during a recession.

The two more important factors weighing on stocks right now are rising rates and a hawkish Fed sending the US dollar to a 16-month high and wreaking havoc on emerging markets stocks (EEM) and many other Risk On assets like biotech shares (XBI) and other momentum plays.

In fact, a lot of momentum stocks that were flying high have come tumbling down recently. For example, check out shares of Roku (ROKU), a favorite stock of momo chasers (click on image):


I can show you many charts like this where you had a big breakout and then "BOOM!", the floor gives out and the shares come tumbling down (in this case, the company disappointed in its growth outlook).

There's a time to buy momentum, this isn't that time, the market is brutal and companies that are disappointing on earnings and growth are getting pummelled. Just check out shares of Zillow Group (Z), Wynn Resorts (WYNN) and Yelp (YELP) this week.

Importantly, despite the massive rally in stocks on Wednesday following the US midterm elections, nothing has changed in my macro analysis and I still don't think we're going to see new highs this year.

But who knows. Chen Zhao, Chief Global Strategist at Alpine Macro posted an article from Asia Times stating that Trump all but announces trade deal with China and Chen shared this on LinkedIn:
GOP’s poor performance in the Midwest in last Tuesday’s elections suggests that China’s trade retaliation, aimed at inflicting pain on soybean growers who were mostly Trump supporter in 2016, might have worked. This may explain why Trump may be changing his trade policy with China. This report suggests that a US-China trade deal may be imminent.
However, Marko Papic, Chief Strategist, Geopolitics at BCA Research shared this on LinkedIn (click on image):

The key passage is this:
What is the investment implication of the Democrats' sweep in the Midwest? President Trump won over many blue collar "Obama-Trump" voters in 2016 by appealing to their belief that free trade was unfair. If Trump plans to outperform with these voters again in 2020, he may have to double-down on trade war in the next 12 months.
If that happens at a time when the Fed is hell bent on raising rates, committing a major policy blunder in the process, we are in for quite a storm for global risk assets.

All this to say they're a lot of moving parts to markets, take the buyback bull with a shaker of salt given the heightened risks there are out there.

You should all reread last week's comment on investors left guessing on stocks. Nothing has changed in my recommendations. Given where we are in the cycle, I'd steer clear of cyclical stocks like energy (XLE), financials (XLF), and industrials (XLI) and focus on defensive sectors like healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecoms (IYZ). And I would hedge that stock exposure with US long bonds (TLT) because the bond bull is far from dead.

And that's no bull! Enjoy your weekend, please remember to subscribe to this blog or donate via PayPal on the right-hand side under my picture. I thank all of you who show your support, it's greatly appreciated.

Below, Federated portfolio manager Steve Chiavarone, the man who called the October selloff, discusses his market outlook into year-end, stating another selloff may be ahead.

Not surprisingly, working in the mutual fund industry, even though he sees volatility ahead, he remains constructive and bullish on the US economy and stock market next year. I have a more pessimistic view because I believe the Fed will overshoot and cause a recession (we will only find out after the fact).

And CNBC's Wilfred Frost and Bertha Coombs report on stocks seeing the worst one-day losses of November.


Thursday, November 8, 2018

Canada's 2018 Power 100 Club?

Chief Investment Officer came out with its 2018 Power 100 list:
For the seventh iteration of the Power 100, confidence is key, and as we approach potentially choppy waters in 2019, maintaining that confidence will be essential to timing the markets. That’s why these asset owners are the best of the best in 2018.

It’s easy to flourish in a bull market, but as we saw this year, anything can happen in an instant. Throughout a swath of selloffs and rallies, these esteemed asset owners kept their cool (and their patience) to deliver stellar returns and innovate new concepts to their strategy as they rolled with 2018’s punches.

Speaking of innovation, our selections took full advantage of their abilities to secure their slots, (innovation accounts for 50% of our methodology). They also made their best effort to reach out to their peers and collaborate some of the highest-profile deals of the year.

Chris Ailman, Britt Harris, and Robin Diamonte have kept their 2017 spots in our top five leader bracket, but they are joined by Lim Chow Kiat and Ash Williams, who have made dramatic ascensions from their #10 and #13 ranks of last year.
You can view this year's Power 100 list here and the profiles here.

There were a few Canadian pension CEOs who made the list, however, only two of them had profiles. First, Mark Machin CEO, Canada Pension Plan Investment Board who is pushing for radical diversity:
Diversity, efficiency, and responsibility are essential to the long-term success of any investment firm, especially the largest retirement organization in Canada.

Mark Machin, President and CEO of the Canada Pension Plan Investment Board, is ensuring that success daily for the body’s beneficiaries and it’s $366.6 billion in assets.

Machin is a believer in diversity, not just across asset classes, but in the boardroom as well. This year, the firm’s sustainable investing team put board effectiveness as a major focus area for its goals, which also include climate change, water, human rights, and executive compensation. That means more women and people of color on company boards, and better corporate governance structures to help keep those companies running —and growing— for years to come.

“While there’s much talk about companies bringing broader perspective to the boardroom, it’s not consistently accompanied by action,” he wrote in an opinion piece in the Globe and Mail titled “How CPPIB is advocating for more women on boards.”

“It’s crucial for companies in which we invest capital to assemble boards that reflect the full range of talent available,” Machin said in a recent statement. “If companies don’t take the required action to achieve the board effectiveness that today’s business environment requires, it falls to investors to provide a nudge, and when necessary, a push.”

The fully funded CPPIB is committed to urging those companies to rigorously evaluate their directors, including their gender makeup,” he wrote, adding that the plan believes companies with diverse boards are “more likely to achieve superior financial performance.”

Last year, Machin and staff helped push for change at 45 Canadian companies that it invested in, which had no female directors. Almost half of those companies have added women to their director seats since. The same was done earlier this year for 22 other companies, where the organization voted against six nominated chairs, and against the entire board slate for seven more.

“By signaling that board effectiveness is a core topic of engagement for us, CPPIB urges other large institutional investors to send similar messages that they, too, believe the pace of change must accelerate,” he said in the newspaper column.

This CEO has a 98% approval rating on job and recruitment site Glassdoor. That’s not an accident. Machin remains staunchly committed to the Canada Pension Plan Investment Board’s goals of long-term sustainable companies.

Some of his investment decisions include considerable private equity ventures and green initiatives to keep the risk as low as possible. This year, the firm became the first pension fund in the world to issue green bonds, and announced plans to expand its renewable energy portfolio by more than $3 billion. The fund takes a direct investment approach to private equity and real assets, and is long on these vehicles.

“Our intention is to hold direct equity investments for several years—and even decades in the case of infrastructure or energy investments,” it said in its report.

The organization’s assets are well-diversified, both by assets and region, as only 15% of that $366.6 billion stayed in Canada. Its asset mix, as of March 31, was 38.8% public equities, 20.3% private equity, 12.9% real estate, 11.1% government bonds, cash, and absolute return strategies, 8% infrastructure, 6.3% credit investments, and 2.6% in other real assets.

As for global diversification, 37.9% of those assets were in the US, 20.4% Asia, 13.2% Europe (excluding UK, which had a 5.6% allocation), 3.5% Latin America, 3.1% Australia. The remaining 1.2% was scattered across other parts.

In fiscal 2018, the Canada Pension Plan Investment Board returned 11.6%, slightly down from 2017’s 11.8%, but still impressive. Over the past 10 years the fund has returned 8%, and 12.1% over the last five.
I'm not surprised Mark Machin made the Power 100 list (#10) nor that he received a 98% approval rating on job and recruitment site Glassdoor. I only met Mark once but he struck me as a very nice, intelligent and thoughtful leader who cares about his employees and having the right culture at CPPIB.

On the issue of diversity, I agree with CPPIB and other institutional investors pushing for more women on boards. It's 2018, women are probably more important contributors to the economy than men, it's totally unacceptable to lack gender diversification on boards.

Also, Mark Machin is the head of the Canada Pension Plan Investment Board, the biggest and most important pension fund in the country. Half the contributors are women so he's right to ask the companies they invest in to have more female representation on boards.

But I'm going to share something here even if some of you think it's unjustified or controversial. Canada's large pensions aren't that different from large banks, large Crown corporations and large government offices and when it comes to gender diversification at all levels of their organization, there is still a lot more work that needs to be done (let's not kid each other, it's still an old white boy's club, especially the higher you go in the organization).

No doubt, it's getting better and will get better over the next decade but there is still way too much gender inequality and lack of equal representation at all levels of the organization.

And for some groups, like people with disabilities, there is no effort whatsoever to attract, accommodate and retain them. None, all they state is "we do not discriminate against applicants based on race, color, sex, religion, national origin, disability or any other status or condition" but a lot of that is just posted for legal reasons, the reality is quite different.

Importantly, and I've written about this before, there should be a comprehensive diversity report in the annual report which provides hard statistics on how each organization is addressing diversity within its workplace at all levels of the organization.

Saying you don't discriminate but never bother to follow up with concrete actions to promote diversity at all levels is akin to window dressing, it looks good on the outside but it's covering up a serious deficiency on the inside and sends the wrong message internally.

Again, you don't have to agree with me, I'm calling it like I see it and in private conversations, many leaders have admitted to me they can do a lot more to promote diversity and inclusion within their organization at all levels.

It might not be easy but nothing worthwhile ever is.

Still, I have to applaud Mark Machin's efforts for promoting diversity outside and within CPPIB. I know it's something he believes in and takes very seriously.

The other profile I wanted to cover is Vincent Morin, president of Air Canada's Pension Plan who discussed how Air Canada retooled its structure for better returns and lower pension plan risk:
CIO: You are in charge of a major enterprise. Air Canada’s pension plan assets are significant in size when compared to its market cap. Tell us about this situation and the challenges it presented at the outset.

Morin: Air Canada Pension Plans, with $20 billion in Canadian dollars in assets, are enormous in size compared to the plan sponsor, mainly due to the relatively generous plan design inherited from the early days when they were a crown corporation. Pension liabilities were and still are a multiple of Air Canada’s market cap.

Pension plans became a significant enterprise risk management issue and pension financial risks had to be reduced. However, long-term expected return needed to be maintained to keep long-term costs reasonable, as the plans were still mainly open in 2008.

Before joining AC in 2009, I was with a large consulting firm, working to develop strategies that would better manage the risks associated with pension plans, while keeping the expected return at a reasonable level. AC had virtually outsourced all investment activities at that time and they asked a couple of key individuals to join them to help build an investment team and the necessary systems to implement the strategy.

CIO: How did you go about doing that?

Morin: The first big innovation was the strategy in itself: Moving from a traditional 60-40 allocation, completely outsourced, to a very sophisticated, mostly internally managed active strategy.

The strategy required a decent use of leverage, so we needed to convince our stakeholders that leverage didn’t necessarily imply increasing risk and could also be a good risk management tool. However, we had to build everything from scratch. From governance, IT, systems, risk management, trading capabilities, operations, reporting, etc., it all needed to be created, as no out-of-the-box system was available to implement our structure and ideas. We were also working on a relatively tight budget.

We had to enter into agreements to trade derivatives—using International Swap and Derivatives Association Master Agreements, or ISDAs, and Global Master Repurchase Agreements, or GMRAs, and ask for credit lines to counterparties. This was just after the financial crisis, which was not an easy task for a company that came close to bankruptcy and needed to negotiate special regulations with the federal government to reduce pension deficit payments. Nevertheless, we gradually convinced them to work with us. We now have ISDAs with 23 counterparties globally and 16 GMRAs, and we trade with 35 executing brokers.

CIO: No doubt you had to win over Air Canada’s management.

Morin: Educating and convincing our board that their primary focus should be on managing the asset versus liability risk, and not only focusing on absolute performance of the assets, was a very long-term process.

Prior to implementing the strategy, we worked on the governance structure to clearly define the roles and responsibilities of the board and the Management Pension Committee, composed of AC executives reporting to the board. They delegated to me and my team the authority for all investment activities. This provided us with much needed flexibility and agility in executing the strategy.

CIO: Then there’s the matter of risk management.

Morin: We are strong believers in alpha and, although beta risk is often the driver, alpha risk is usually too small, over-diversified, and not well-balanced with beta risk. We believed that added value coming from active management could be a strong driver in improving the financial situation of the plans over the long-term, even though our strategy had a very significant allocation to fixed income.

To do so, we had to be very nimble. Therefore, we had to work on our investment structure and governance process to allow for such nimbleness, while keeping risks at a reasonable level. We worked for many years on our risk budget framework and developed investment polices to achieve the desired process.

CIO: How did you do that?

Morin: We needed to ensure we had the best toolbox possible to implement a very dynamic strategy, while also developing internal risk systems and hiring specialized staff to allow us to trade virtually anything. We now use a toolbox similar to many hedge fund managers, and we manage almost 80% of the portfolio internally with a team of close to 50 individuals, versus a 100% outsourced model nine years ago.

We use most of the complex instruments—from traditional interest rate swaps to the most complex variations of variance swaps—to reduce our risk or build hedges to our more traditional positions. We also now run multiple quantitative strategies developed internally and we execute over 2,000 trades every month.

CIO: Do you have an allocation to private markets and, if so, what is your approach?

Morin: We have a significant allocation to private markets(real estate, infrastructure, private equity, private debt, etc.) which we manage with a very dynamic and opportunistic approach. We set an overall target of 20% of plan assets in private markets without a fixed target at the sub-asset class level, allowing us to move around within the latter according to market opportunities.

In addition, we invest significantly in co-investments and niche investments to improve returns, enhance diversification and reduce fees. This is supplemented by risk management models emphasizing embedded leverage—a big challenge in private markets—and some dynamic hedging overlays that are used to manage undesired risks.

CIO: How are you structured for collaboration?

Morin: We have a unique portfolio management approach/team structure, which manages the plans as one team and one book, to avoid the creation of silos and to foster idea generation and discussions. This resulted in a very flexible approach where, for example, a real estate investment can easily be compared to a high-yield bond investment to ensure we invest our capital where the best return expectations by unit of risk reside.

CIO: How has that worked out in terms of performance?

Morin: Ending September 30, our team has added value relative to the benchmark for the last 25 quarters in a row, that’s over six years now. This results in an annualized performance for the plans of 12.1%, versus 8.9% for the benchmark, ranking us first in the universe of large Canadian plans over the nine years ending June 30, both on a total return basis and on a value added relative to the benchmark basis.

The deficit of the plans on a wind-up basis went from a $4.2 billion deficit in 2012 to a $2.6 billion surplus in 2018, while reducing our overall risk compared to liabilities by more than half. Air Canada has been in contribution holiday mode for the last three years.

CIO: Now that you are in surplus and have significantly reduced the risk of the plans, what’s next in your strategy?

Morin: This year, I convinced the board of Air Canada to innovate even further in reducing the risk of its pension plans by gradually purchasing annuities for its pension plans in a whole new way. Air Canada is in the process of creating a new wholly-owned life insurance subsidiary which will be registered with the regulators. That structure will allow us to provide additional capacity in the Canadian market to purchase a significant amount of annuities which will help secure pensions paid to our members and, at the same time, create a new line of business for Air Canada. My team leads this unique project—to our knowledge, a first worldwide—which is still ongoing.
It remains to be seen whether Air Canada’s move to enter the annuity market is the start of a new pension trend but Vincent Morin and his team have done wonders bringing back that pension from the abyss after the 2008 crisis.

As I stated in my last comment on IMCO, Vincent's predecessor, Jean Michel who is now IMCO's CIO, was the one who built the team and the processes that led to this success and Vincent has taken it a step further with this wholly-owned life insurance subsidiary.

In a nutshell, Air Canada's Pension replicated HOOPP's approach (read a nice background here) bringing as many assets as possible internally and using leverage intelligently (bond repos and intelligent use of derivatives) to juice returns while always emphasizing an ALM approach and risk-adjusted returns.

I used to work with their Senior VP Fixed Income and Derivatives, Marc-André Soublière, at PSP and still consider him one of the best global macro managers in Canada. I believe when I last communicated with him in early September, he was telling me "US long bond yields are going higher". He was right but I remain a long bond bull despite the backup in yields this year (He shared this after reading this comment: "No longer short duration, now small long duration through short end of Canada and US").

In late August, their Vice President Asset Allocation, Jean-Francois Paquin, came to my house with his son to pick up two bookcases of finance and economics books which he bought from me. I needed to get rid of all my books and a lot of furniture fast to renovate and hope he and the team at Air Canada Pension enjoy those books which I collected over many years.

Anyway, Air Canada's Pension is in great shape and along with CN Investment Division run by Marlene Puffer, it's one of the best corporate DB plans in the country (from the few remaining).

My only advice to Vincent is the same advice I gave above to everyone else, try to do more to promote diversity within your team at all levels.

Don't take this as harsh criticism, I'm a stickler for diversity and inclusion, real, not bogus diversity at all levels because I believe it not only enriches an organization and makes it better, it's the right moral and ethical thing to do in an open and multicultural society.

Let me end by bringing to your attention something Marlene Puffer, President and CEO at CN Investment Division posted on LinkedIn last month from the Canadian Gender & Good Governance Alliance, a CEO blueprint for gender diversity:
This is a blueprint for CEOs who understand that implementing gender balance throughout their organization is important. It will give you a step-by step framework on the components of building a vision, structuring and mobilizing management teams and focusing on gender diversity initiatives that actually work.

Building a gender diverse organization is more than the morally right thing to do. A conclusive body of evidence indicates that diverse organizations tend to be more innovative and perform better financially than their peers. Your customer base reflects growing social diversity, and you need to respond to stay competitive.

If you are a publicly traded company, your investors might already ask for your gender diversity policies before buying your shares. And in the global race for talent, organizational diversity will be a key recruitment tool.

Designed to help frame a CEO's agenda on gender diversity, the CEO Blueprint outlines three key steps and provides tactics throughout for:

1. Building your vision
2. Making it mission critical
3. Focusing on high impact practices

This guide can show you how to take advantage of leading practices for your organization.
You can can download the guide here. it is also available in French.

Below, UPS's Janet Stovall's TED talk on how to get serious about diversity and inclusion in the workplace. And research proves that diversity and inclusion in the workplace directly correlate to driving innovation, a better understanding of customers, a higher return on equity, and significantly higher earnings. Retail and consumer brand CEOs weighed in at NRF 2018 Retail's Big Show.


Wednesday, November 7, 2018

IMCO Flying Under the Radar?

Geoff Zochodne of the National Post reports, Meet IMCO, the $60 billion Ontario investment manager that's flying under the radar:
One of the biggest institutional investment managers in Canada is sharpening its sales pitch.

The Investment Management Corp. of Ontario only became fully operational in July 2017, but when it came online, it did so as the ninth-largest institutional fund in Canada. The organization has more than $60 billion in assets under management courtesy of its first two clients, the Ontario Pension Board (OPB) and the Workplace Safety and Insurance Board (WSIB).

Now, IMCO is getting ready to try to attract new members from the patchwork of funds that invest on behalf of the province’s public-sector entities. According to the head of the fund, there is “a huge potential client list” for IMCO to go after.

“We believe we’ve got a very compelling value proposition,” said Bert Clark, president and chief executive of IMCO, in an interview. “What we’re building is something that none of them could replicate at the same cost.”

Created by the provincial government (although it is an independent firm), the intent was for IMCO to try to pool funds and offer public-sector pension plans lower costs with economies of scale. It is similar to outfits in other provinces, such as the Alberta Investment Management Corp., although participation in IMCO is voluntary.

“There are many, many public funds in Ontario,” Clark said. “Every university has its own pension fund. Crown agencies have their own pension funds. There are various pools of capital in the province itself, and all of those right now are being administered separately.”

Under its model, IMCO offers advice and makes the day-to-day investing decisions for clients, but members retain responsibility for their liabilities (such as pension payments) and control over the asset allocation strategy.

Since coming into the world under an act of provincial parliament in 2016, Clark said the fund has been busy working on its risk-management system and front-office operation. Come early 2019, IMCO will ratchet up its recruitment efforts.

“We haven’t been out aggressively telling our story yet, because we wanted to have all the foundational capabilities in place,” said Clark, who was formerly the head of Ontario’s infrastructure agency, Infrastructure Ontario.

“In January, we will go out and say, ‘This is who we are. This is what we can do for you. These are our costs. This is the value proposition. And this is the process for joining.’”

IMCO’s name is starting to turn up in some interesting places as well. That includes the announcement last week that the fund was part of a consortium that purchased a 25-per-cent stake in a 413-megawatt portfolio of Canadian hydroelectric assets owned by Brookfield Renewable Partners LP.

“It underscores our capability to provide our clients with access to high-quality investment opportunities and aligns with our strategy of creating strong partnerships with leading, global infrastructure firms,” said Jean Michel, IMCO’s chief investment officer, in a press release announcing the transaction.

IMCO is also teaming up with commercial real estate company Cadillac Fairview to build an $800-million office tower in downtown Toronto, an investment the fund noted was “well-aligned” to the Ontario Pension Board’s return objectives.

“The management fees for some of these asset classes are really high,” Clark said. “But again, if you pool the assets together, and we’re doing that as a $65-billion or bigger organization, we have a different bargaining power. We can establish strategic relationships with funds. And so the costs are a heck of a lot less.”

IMCO, being only a few years old, has no legacy IT systems to update, which Clark called a “huge, huge advantage.” The fund has the benefit of hindsight and history as well.

“What were unique strategies 25 years ago have become much more commonplace,” Clark noted.

IMCO has already reached a “critical mass” with its current mountain of assets, its CEO says, and the fund booked a total return for 2017 of 10.3 per cent.

Existing clients are expecting their membership to pay further dividends. In its 2017 annual report, the Ontario Pension Board, which administers the Government of Ontario-sponsored Public Service Pension Plan, said that its 2018 operating expenses were “expected to decline due to the outsourcing of OPB investment operations to IMCO.”

And with every additional client, Clark added, the costs of doing business are spread over an even wider base.

“I’d like to think that within five years, we’re at $100 billion,” in assets, Clark said. “But in order to hit $100 billion, we’d need to have pretty good growth of the existing assets we’re managing, and new members.”

Clark has no illusions about the challenge ahead in getting those members to sign on.

“These will be big decisions for our clients,” Clark said. “I think there’s a long sales cycle to this, but it begins in January.”
Amanda White of Top1000funds also reports, IMCO plots private, inhouse future:
The C$60 billion ($48 billion) Investment Management Corporation of Ontario, Canada’s newest pension investment manager, is assessing its inherited asset allocations and making plans to revitalise.

The fund, which was created in July 2016 and launched a year later, will look to increase its allocation to private markets and make more direct investments. It will also introduce a global credit portfolio, consolidating the global credit allocations that are now scattered across the asset-class buckets.

“The new structure will have all credit within one diversified portfolio, and we would expect the credit exposure of clients to increase because of that,” IMCO CIO Jean Michel says. “It’s a great way to diversify.”

IMCO’s current asset allocation is public equities (39 per cent), fixed income and money market (23 per cent), real estate (14 per cent), diversified markets (7 per cent), infrastructure (7 per cent), absolute return (6 per cent), private equity (3 per cent) and private debt (1 per cent).

Compare this with Ontario Teachers’ Pension Plan, one of IMCO’s contemporaries, which has an allocation to private equity of about 17 per cent.

Two specific aims of IMCO’s strategy evolution are to increase its amount of private assets and to increase the amount of assets managed inhouse.

When IMCO’s two inaugural clients, the Ontario Pension Board and the Workplace Safety and Insurance Board, came into the fold, the fund inherited their existing strategic asset allocations.

One of IMCO’s core offerings is to provide asset allocation and portfolio construction advice; it is now going through that process with clients. IMCO clients will retain asset allocation decision-making, with input from the IMCO team, which will offer 15 strategies for clients. It offers only eight now.

Key to its approach is the belief that asset allocation is among the most important determinants of investment returns and risk. Another core belief is that understanding and managing risk is at the core of investing.

One of IMCO’s key initiatives, and one of the purposes of the pooled asset management concept, is to provide better access to investments than clients can get on their own; in particular, minimising the use of expensive structures and maximising scale and experience to pick strong strategic partners.

“We inherited asset allocations that were fully invested and were 75 per cent externally managed,” Michel says. “We also inherited a cost structure we think we can improve on, as the existing investments include lots of active management as well as fund of funds and manager of managers.

“We are working with clients to look at the type of portfolio we are offering and working with them on asset allocation 2.0.”

Internal management, manager relationships and fees


Michel was appointed CIO in June, coming from Caisse de dépôt et placement du Québec, where he was executive vice-president, depositors and total portfolio. Prior to that, he was the president of Air Canada Pension Investments. He says the plan is for IMCO to manage the majority of assets inhouse within five years.

“We will be cheaper than our clients [for] the same asset mix,” he says. “The savings we make by managing assets internally we are using to build out our risk and portfolio construction function. Then, overall, we will get a better asset management function.”

As with many pension fund managers, one of IMCO’s core beliefs is that costs matter. That’s something it lives day to day.

“When we look at results, we look at them on a fully net basis, not every asset management firm does that,” Michel says. “We make sure all our portfolio managers understand the full costs of what it takes to invest and know all the external management fees they have, explicitly and implicitly, even those that are not fully transparent, so they can make the best decisions on whether to invest.”

IMCO will internalise investment management where it makes sense and where costs work. About 40 of the firm’s 100 staff are in the investment team. The expectation is that, five years from now, the organisation will employ between 250 and 300 people.

Direct investments are expected to provide a big portion of this growth. But Michel is quick to point out that the evolving investment structure will include a total-portfolio team to look at the fund as a whole.

“The probability of achieving long-term value creation is increased by looking at the total portfolio view. This is critical for us,” he says.

IMCO has many external managers, with an average of 10-15 partners per asset class. This will be reduced and the number per asset class is expected to be closer to five or six.

“Using strategic partners will be very important to us and we will focus on a limited number of great partners,” Michel says.

As the investment decision-making process becomes internalised, with IMCO taking more direct investments, there will also be a shift in the way the firm uses managers.

“We will be making more direct, but also more complex, transactions,” Michel explains. “So we will still use partners but use them differently. The goal is to be closer and create true partnerships. We will also look to co-invest but on more equal footing.”

IMCO chief executive Bert Clark, who was formerly chief executive of Infrastructure Ontario and the recipient of the 2017 Champion Award from the Canadian Council for Public Private Partnerships, says good partners offer something the firm can’t provide itself.

“We think what makes a good partner is origination capability and asset management expertise we don’t think we can replicate,” Clark says. “One clue to what that might look like is the fact IMCO has a global portfolio but just one office, in Toronto. Private assets are becoming more difficult and complicated, as there is more demand and also expertise has risen. We need to be important to external managers, and I think we can, as we can move quickly but still look at complicated transactions.”

IMCO was created following extensive review by the Ontario Government into the best model for managing pension assets, resulting in a report by the pension investment adviser, William Morneau. The report outlines the key attributes of best practice – including appropriate scale and an approach to governance – that could be a guide for all organisations managing pension assets.

Morneau’s report shows the advantages of a pooled pension management organisation, including reduced duplication and costs, greater access to additional asset classes and enhanced risk-management practices. It also outlines potential cost savings between $75 million and $100 million a year, once fully implemented.

Clark says the organisation offers strong risk management and reporting, which also requires scale.

There are two key advantages to such a new investment organisation, Clark says.

“On the IT side, many organisations struggle with legacy systems and it is hard to move off those. Starting at this point means we don’t have those legacy problems and, for example, we can buy software as a service [not a product].

“We also get to step back and see what’s worked for other big public funds globally. Everyone is aware of the success of the Canadian model, but that is not the only successful model and we’ve looked to the Northern European pension funds and the US endowments,” he says. “Starting with C$60 billion means we have the critical mass to build right.”

Specifically, the fund has looked to the specialties of various players and can borrow from each of them. US endowments are good at strategic partnerships with managers and focusing on the origination of investments. Northern European funds are good at total portfolio management. The Canadians are good at internal investment management.

IMCO has now built up its risk and investment functions and is ready for action.

“We are very close to being ready to engage with potential clients and will look to do that in Q1 next year,” Clark says. “We have our CIO, CRO [chief risk officer], a risk system and a way of reporting to clients. We have a set of investment strategies for each asset class and can advise on portfolio construction.”
Earlier today, I had a chance to talk to Bert Clark, IMCO's president and CEO, and go over this article and much more.

First, let me thank Neil Murphy, IMCO's Vice President, Communications, for setting up this conference call and sending me some material to read to prepare, including Bill Morneau's October 2012 report, Facilitating pooled asset management for Ontario’s public-sector institutions.

Take the time to read the full report here and below, I note the passage that struck me (click on image):


This is an important passage, one I will come to later.

Second, let me thank Bert Clark for taking the time to speak with me. It was the first time we spoke and he struck me as an extremely nice, bright, focused and humble guy who really knows what he's talking about.

Bert is a lot younger than his peers but what he lacks in experience he more than makes up for in passion and knowledge. I got the sense he's learned a lot since taking over the helm and enjoys learning and is very focused on delivering the very best value proposition to IMCO's current and potential clients.

He began by giving me a quick backgrounder on IMCO. The image below is taken from the website (click on image):


He explained there are many pools of capital in Ontario that are too small and their investment management is either being outsourced to external consultants (outsourced CIOs) and actuarial firms or is not benefitting from the size and scale of an IMCO. "The bigggest problem is their high cost structure, especially to access private markets."

Bert told me by onboarding and now fully managing the assets of the Ontario Pension Board (OPB) and the Workplace Safety and Insurance Board (WSIB), they were able to achieve "critical mass right out of the gate."

It's important to note that IMCO is a large investment manager like CPPIB, PSP Investments, AIMCo, BCI and the Caisse and only handles the investment side of the equation. Unlike OMERS, OTPP, OPTrust, it does not administer pensions, handle liabilities or set asset allocation (it advises its clients on asset allocation and I would take that advice seriously).

Unlike other large Canadian pensions, however, IMCO does not have captive clients so a considerable amount of time will be going to educating prospective clients on the advantages of joining IMCO. "Much like a private asset manager, a lot of time will be going into client development."

Bert seems fine with that and relishes the fact they need to prove themselves but I told him that Ontario's legislators made a big mistake by not forcing these pools of capital to join IMCO (in fact, this was a recommendation of the Morneau report). Moreover, I said some pools of capital will perceive IMCO as a threat even if they're not run as efficiently and don't benefit from scale and the internal expertise IMCO has.

He told me there's roughly $80 to $100 billion in potential pools of capital and while some may perceive IMCO as a threat and "choose not to join for all the wrong reasons," he hopes to convince most of them that IMCO's value proposition and advantages are too compelling not to join.

In particular, he cited three factors as to why it makes great sense to join IMCO:
  1. Advice around portfolio construction: It's no secret that asset allocation is the biggest determinant of returns and part of IMCO's seven investment beliefs is that by providing strong in-house asset allocation advice and a diverse range of investment products, they can enable their clients to achieve sustained, long-term results that exceed their required rate of return.
  2. Access to private markets: IMCO's scale allows it to form strategic partnerships with top funds all around the world so they can invest and co-invest with them on larger transactions to lower overall fees. Smaller funds lack this scale and end up paying big fees to funds to gain access to private markets. 
  3. Unparalleled risk management: Again, another one of IMCO's seven investment beliefs is that understanding and managing risks is at the core of investing: "We believe that the ultimate risk for our clients is their inability to meet their promised financial obligations. True diversification and capital preservation are key to mitigating this risk and strong risk management systems and practices improve the investment decision making around these factors. Therefore, a robust risk framework and client engagement guide our investment activities."
I firmly believe that potential clients who pass up the opportunity to join IMCO will be doing their members harm over the long run and it can even be argued they are not being good fiduciaries by not seriously considering joining IMCO as soon as possible.

I shifted my attention to investments and asked Bert about deploying capital in public and private markets after a long bull market. He told me: "In retrospect, it has been a very good ten years but if you think back to October 2008 and even 2009, people were very wary of taking risks back then."

Very true. He also agreed with me that a large pension has to invest over the long term and cannot time public or private markets perfectly.

Still, in our discussion on infrastructure, an asset class he's very familiar with because he was the head of Infrastructure Ontario before joining IMCO, he said they're open to doing some greenfield investments as long as the risks are appropriate and that illiquidity premiums of the past are gone and you can't just deploy capital in infrastructure, you really need operational excellence to add value to an asset.

I couldn't agree more and told him that in the old days, they used to hire investment banking people focused on deals and look to buy assets on the cheap. Nowadays, that strategy doesn't work, you really need people in infrastructure who know how to add value, "not plain old originators of deals because illiquidity premiums have come down considerably."

In fact, Bert notes this is the case for all private markets, "they have become mainstream investments and the differentiating factor which will lead to success is scale, building direct investment capabilities (co-investments or purely direct deals you originate) and adding value through operational excellence."

In order to do this properly, IMCO needs to hire a great investment team and that job falls under Jean Michel, IMCO's CIO. Bert told me Jean has been busy meeting with potential candidates to fill the spots of head of public markets, head of private markets and other important investment roles.

Recall, Jean Michel joined IMCO after leaving the Caisse  where he was the Executive Vice-President, Depositors and Total Portfolio. His departure from that organization was another bonehead HR move, one of a few I've seen at Canada's large pensions, but the Caisse's loss is IMCO's big gain.

Prior to joining the Caisse, Jean was the president of Air Canada Pension where he focused on asset liability matching, portfolio construction, risk budgeting and the intelligent use of leverage to bring that plan back to fully-funded status from a huge deficit.

In fact, just today, I read a great interview on Chief Investment Officer where Vincent Morin, the current president of Air Canada Pension, explains how Air Canada retooled its structure for better returns and lower pension plan risk. Vincent is a very smart guy, he learned a lot under Jean's watch.

Anyway, Jean Michel has to build his investment team and he has great candidates to choose from in Toronto, Montreal and other cities. He needs alpha generators in public and private markets and people who will cooperate and work well across all asset classes, not in silos.

I have no doubt he's going to find the right people to join his team and he has the full backing and support of Bert Clark.

Bert told me he's very happy and proud of his entire executive team and has full confidence in them. He even told me they recruited a great Chief Risk Officer, Saskia Goedhart who served 20 years as Group Chief Risk Officer at AMP Limited in Australia prior to joining IMCO.

It sure looks like the ramp-up phase at IMCO is over and come 2019, the rubber will meet the road.

We ended our conversation discussing communication and diversity in the workplace.

I asked Bert if he's going to be out there more often talking to the media. He told me not particularly but whenever there is something material to discuss concerning IMCO, be it a big investment or something else, he believes it's his duty to be open and transparent with members and all stakeholders, including the media.

As far as diversity in the workplace, I told him that over 20 years ago, I was diagnosed with MS and it hasn't always been easy (doing fine now). It's a disease which affects many young Canadians in the prime of their life and in too many cases, it impacts income security.

The experience of living with MS has made me very sensitive to the struggles of people with disabilities who through no fault of their own, do not have equal access to employment opportunities at large private and public organizations.

I told Bert I admire his father, Ed Clark, for his long-term focus on diversity in the workplace and hope he will continue this tradition. He told me it‘s part of his core values that were instilled in him.

I can't think about a better role model than Ed Clark to be a great leader, but make no mistake, Bert Clark is his own person with his own views and he will pave his own road to success using the values both his parents instilled in him.

I wish him and all the employees at IMCO many years of success, have fun during this journey.

Below, an older (2016) clip where Bert Clark, the then head of Infrastructure Ontario discussed P3s. All I can tell you is P3s are fine but they aren't as good as what the Caisse is doing with the REM project which keeps getting trashed in the media for no good reason.

I also embedded some clips with Ed Clark that I enjoyed watching. First, his talk at Rotman School of Management about receiving CEO of the year in 2010. Listen to what he says about having a strong bias against the great leader theory and what it takes to be a great leader.

Second, four years ago, the then outgoing TD CEO Ed Clark talked to Amanda Lang on his time at the bank, the highlights of his career, and the charitable causes he supports.

Lastly, to mark the 10-year anniversary of the financial crisis, Ed Clark, former CEO of TD Bank Group, shares his views with BNN Bloomberg on how he managed to steer the ship during the crisis. His takeaway: "you have to understand your risks."

Very wise advice which I'm sure Bert Clark knows all too well.