Thursday, March 29, 2018

Quant Style Crash Finally Arrives?

Dani Burger and Elena Popina of Bloomberg report, Quant Style Slump That Strategists Foretold Finally Arrives:
If you’ve been cursing at technology stocks for the past two days, there’s another corner of the market that’s perhaps just as deserving of your anger.

It’s called momentum -- quant jargon for stocks that have performed the best over the past year or so -- and it’s gone through a rare bout of pain this week.

The lagging performance didn’t come out of thin air. Strategists from Morgan Stanley to Lazard Asset Management Ltd. have recently stoked worries about the popular quantitative strategy. Their primary concern? That investors piling into the same winners, including lofty technology stocks, had heightened the risk of a rush to the exits.

Those warnings, it seems, were scarily prescient. A long-short momentum portfolio, which hedges out greater market movements, had logged its biggest two-day plunge since November 2016 at yesterday’s close, according to data compiled by Bloomberg (see chart above).

And the concerns have yet to abate.

“If we have momentum selling off further, if we have cyclicals selling off further, then also tech will suffer further,” Max Kettner, a Commerzbank AG cross-asset strategist, said during an interview with Bloomberg TV. “I’m getting slightly scared with regards to tech right now.”

Though company-specific news from Twitter Inc. to Nvidia Corp. may have been the catalyst for the sell-off, a plunge in the quant trade highlights the tremors being sent through all of the market leaders. In the momentum portfolio, it’s not just technology companies that contributed to the Tuesday losses. The biggest drag after Twitter was drugmaker AbbVie Inc.

Momentum had been seemingly impervious to equity weakness. Even with the two days of selling, the factor is in the green so far this year. However, that strong performance set up momentum stocks to be among the biggest losers as soon as things turned sour, according to Steven DeSanctis, an equity strategist at Jefferies LLC.

“The momentum trade performed well even in the recent downturn, and thus it was destined to get hit,” DeSanctis said. “Style performance and tech ETF flows were all at extremes.”

Still, much like in prior pullbacks, DeSanctis added, the stocks are likely to rebound before long.
It's the final day of trading for the week, month and quarter. Everybody is on edge after a very volatile week where we saw FANG stocks like Facebook (FB) and Amazon (AMZN) sell off hard and a particularly violent sell-off in Tesla (TSLA), down 18% this week (as of Wednesday's close).

Even Twitter (TWTR) sold off hard earlier this week following a spectacular start to the year, crimping my Long Twitter / Short Facebook pairs trade. I still prefer the former over latter but regulatory risk has arrived and threatens all big tech companies, including the Goliath:

A tweet from President Trump is all it took this morning to validate people's nervousness (you have to wonder if he gave his hedge fund buddies an advanced warning so they can short Amazon last week).

So, is this it? Is this the big tech sell-off so many bears have been warning of? Are hedge fund quants taking over the world about to lose their reign as momentum strategies blow up?

I don't know, I'm still defensive but some of these moves are so violent that I wouldn’t be surprised if top hedge funds pounced and bought big tech stocks this week.

Unfortunately, we won't know what top funds bought and sold in Q1 until mid-May, but by that time the data will be mostly irrelevant because the way stocks move, they can significantly rise or decline  over the next six weeks.

One person who isn't buying the quant style "crash" theory is AQR's Clifford Asness:

I agree with Cliff, he's a smart man, really knows his stuff which is why I read his Perspectives regularly, even though I don't always understand what he's writing about.

I keep my momentum trading simple, use daily and weekly charts with simple moving averages and use other data to make decisions, often spur of the moment decisions.

For example, check out the one-year daily charts of Amazon (AMZN), Facebook (FB), Twitter (TWTR) and Tesla (TSLA) using very simple 50, 100 and 200-day moving averages (click on each image to enlarge):

As you can see, Facebook and Tesla are oversold on the daily while Twitter isn't and neither is Amazon. Twitter has been a buy previously when it fell below its 50-day and Amazon hasn't slumped all year, quite the opposite, it's been in beast mode for a long time.

Now, let's step back and check out the five-year weekly charts of Amazon (AMZN), Facebook (FB), Twitter (TWTR) and Tesla (TSLA) using the same 50, 100 and 200-week moving averages (click on each image to enlarge):

The five-year weekly charts give me a better long-term perspective. Just by looking at these charts, it confirms that Amazon is still in beast mode but rolling over, Facebook has important support at $147 (it hit a low of $149 earlier this week), Twitter has nice support at $27 and Tesla has nice support at $253 (hit a low of $248 on Wednesday).

From looking at the weekly charts, Amazon might make you most nervous but short-sellers have piled into Tesla (20% of the float is being shorted) because that's the one they think will fall furthest from these levels. And if it declines and keeps going below its 200-week moving average, it's in big trouble.

Now, there is nothing scientific about the charts and moving averages I used above. Sometimes I use 10-, 20-, 50  day or week moving averages, it all depends and this is just a tool anyone can use by going on, it cannot be used as the sole factor to make an investment or trading decision.

Why? Because markets are continuously in motion, there are macro, geopolitical, regulatory and other risks which can impact stocks at any given moment. I use charts to gauge some important levels but it's certainly not the only thing I use to gauge my investment and trading decisions.

By far, macro risks are the most important risks impacting markets which is why I always tell people, get your macro calls right or else in you're in big trouble.

I focus a lot on macro in this blog because I worry about investors who don't understand the inflation disconnect being suckered into a market phishing for inflation phools, underestimating the risks of a confounding market, not knowing where to invest.

When I read Bill Gross says the Fed can’t raise rates as fast as everyone thinks, I stop to ponder his points and agree, there's too much leverage in the system for the Fed to hike aggressively, but it still doesn't mean the yield curve won't invert in the second half of the year as short rates stay high and long rates decline as global PMIs decelerate.

Importantly, the real risk to tech shares coming due is a slowing global economy, not some blow-up in large hedge fund quants chasing momentum strategies. Big tech stocks do well in the initital stages of a slowing economy but if things get bad, they too succumb to the pressure.

Interestingly, it was old tech like Microsoft (MSFT) which did particularly well this week, and this falls in line with what Francois Trahan recommended in my Outlook 2018: Return to Stability, namely, focus on safer tech like software going into the new year.

One thing I will warn you of, be very careful buying the dips on large cap tech stocks (XLK), do not buy the dips blindly because you will get your head handed to you:

Some of you who think trading is easy, "just buy the dips on large-cap tech stocks", are cruising for a bruising and I don't care who you are and what your track record is, you need to pay attention here.

Last week, I told you to stay defensive and that my highest conviction long on a risk-adjusted basis remains good old boring US long bonds (TLT) which are doing great despite the bond teddy bear market in Q1:

Sure, there are big opportunities trading stocks, especially small cap biotech stocks like Geron (GERN) which hit a low of $3.49 on Wednesday before bouncing back up big on huge volume, but are you willing to take the binary risk that goes along with trading small cap biotechs?(click on image):

Before you answer "Hell Yes! I want to trade small cap biotechs too!", check out what happened to shares of Edge Therapeutics (EDGE) this week, they got annihilated, down more than 90% (click on image):

Technical analysis would have told you to "buy the breakout" and then you would have felt like this poor chap if you had put all your money in "Edge" Therapeutics:

All joking aside, be careful here, as I keep warning you, the second half of the year will be challenging and many momo chasers will get clobbered thinking it's business as usual, just buy the dips or rips.

I could be wrong, markets are up nicely on the last trading day of the quarter, and there are some big movers on my watch list late Thursday afternoon (click on image):

Just be careful, I trade and watch these markets like a hawk, there is a lot more volatiity and that's not typically a good sign at this stage of the cycle.

Those of you who hate trading, just forget about these crazy markets, put 50% of your money in the S&P (SPY) or S&P Low Vol (SPLV) and 50% into US long bonds (TLT). In fact, I would even recommend 60% or 70% US long bonds here.

In terms of where to invest, I think US long bonds (TLT) are the ultimate diversifier and the US dollar (UUP) will appreciate over the coming two years, and I'm positioned more defensively in equities focusing on stable sectors like healthcare (XLV) and consumer staples (XLP) and interest-rate sensitive sectors like utilities (XLU), telecoms (IYZ) and REITs (IYR).

Given this defensive stance, I'm underweight cyclicals like energy (XLE), financials (XLF), metals and mining (XME) and industrials (XLI).

Right now, I'm also short tech (XLK) and semiconductors (SMH) and would steer clear of value traps like oil service stocks (OIH) which remain cheap despite the rise in oil prices, and will remain cheap as the global economy slows.

I'll be back next Tuesday, going to take the long weekend off. Please kindly remember to contribute to this blog via PayPal on the top right-hand side, under my picture and help support my efforts in bringing you great insights on pensions and investments.

Below, Sam Stovall, CFRA chief investment strategist, and David Joy, Ameriprise Financial chief market strategist, discuss the volatility trends in the market right now and what investors are thinking as the first quarter comes to close.

And Jim Paulsen, the Leuthold Group's chief investment strategist, discusses the state of the market with Michelle Caruso-Cabrera (from Wednesday).

I agree, there's not enough panic yet, but with six rate hikes already under our belt, it won't take much to push this market into panic mode, which is why I remain defensive.

Lastly, the “Fast Money” traders discuss whether investors should trust the bounce in the markets. Until you see these markets making new 52-week highs, don't trust any bounce in the short run.

Wednesday, March 28, 2018

CAAT Pension Hits 118% Funded Status

Benefits Canada reports, CAAT pension plan reaches 118% funded status:
The Colleges of Applied Arts and Technology pension plan’s funded status has grown to 118 per cent, up from 113 per cent last year.

According to its actuarial valuation at Jan. 1, 2018, the plan reached a funding reserve of $2.3 billion and is allocating this surplus to strengthen its benefit and contribution stability as a cushion against unpredictable market downturns or liability growth.

The current surplus represents the strongest position for the plan since it became jointly governed 22 years ago, noted Derek Dobson, chief executive officer and plan manager at CAAT, in a news release. “Long-term projections show the plan’s financial health should remain resilient into the future providing benefit security and contribution stability to our members and employers.

The plan is also on track to grow, with plan members from the Youth Service Bureau of Ottawa voting to join as of Jan. 1, 2018.

“The CAAT plan is open and ready for growth in membership where it is beneficial. This includes workplaces with single-employer defined benefit pension plans, defined contribution plans and those without a pension plan, including those in the private and not-for-profit sectors,” said Dobson, noting CAAT is currently in discussion with several other employee groups and organizations.
Chris Butera of Chief Investment Officer also reports, CAAT Pension Plan Hits 118% Funded:
According to its latest actuarial valuation in January, the $9.4 billion Colleges of Applied Arts and Technology Pension Plan (CAAT) is 118% funded, with a $2.3 billion funding reserve.

While this is not just an upgrade of the previous year, when it was 113% funded with a $1.6 billion funding reserve, the valuation will be filed with the regulator sometime in the next few weeks. By choosing to file the actuarial valuation, CAAT will not have to file another valuation until 2021, keeping flat contribution rates for its 46,000 members and 41 employers until 2022.

To guarantee economic and demographic assumptions are still realistic and appropriate for CAAT’s risk tolerance, each funding valuation includes a review of each of the aforementioned assumptions. According to the valuation, the discount rate remained at 5.6%.

“As of January 1, 2018, our funded ratio, the core measure of benefit security, reached 118%—the strongest position since becoming jointly governed 22 years ago,” Derek W. Dobson, CAAT’s CEO and plan manager, said in a statement.

“Research shows that Canadians want the adequate and predictable retirement income that a well-governed and expertly managed defined benefit plan delivers and they are willing to make meaningful contributions to it. Employers benefit through lower operating costs, stable contribution rates, and lower risk by exiting the pension management business,” he said. “Long-term projections show the plan’s financial health should remain resilient into the future providing benefit security and contribution stability to our members and employers.”

The fund—a modern defined benefit plan—has been jointly governed since 1995, meaning that government, community, and private sectors work together to achieve the goals of the overall fund rather than just focus on individual sectors. The plan is also jointly sponsored by three entities: the College Employer Council, the Ontario Public Service Employees System, and the Ontario College Administrative Staff Association.

When it comes to building additional reserves, prefunding conditional inflation protection, and reducing contributions, the CAAT’s plan governors can utilize any combination under the plan’s funding policy. The plan governors currently decided that the best move at this time is continuing to allocate additional reserves to ensure benefit security and contribution stability.

The plan has also continued to grow by adding new employers, including the Youth Service Bureau (YSB) of Ottawa, whose plan members voted in favor of a merger of the YSB’s defined benefit plan with the CAAT’s. If the regulator approves of the asset transfer, it will be second time a single employer defined benefit pension plan will merge with the CAAT, the first being the 2016 merger of the Royal Ontario Museum pension plan.

“The CAAT Plan is open and ready for growth in membership where it is beneficial. This includes workplaces with single-employer defined benefit pension plans, defined contribution plans, and those without a pension plan, including those in the private and not-for-profit sectors,” said Dobson. “We are in discussions with several organizations and employee groups about them joining the CAAT Plan and are excited to be able to offer our successful model for sustainable defined benefit pensions.”

Alongside its annual investment report, the CAAT will release its 2017 investment results in April.
CAAT's annual report isn't available yet but when it is, you can read all about their 2017 results here.

Clearly, the emphasis is on its funded status, which is absolutely the right thing to focus on, and the plan and its members are on solid footing.

In fact, if you look at CAAT's 2016 Annual Report, you will see their long-term performance is solid and the plan is jointly sponsored and they have implemented a shared-risk model which allows them to increase the contribution rate or cut benefits (typically partial removal of inflation protection) when the plan runs into a deficit. This is the main reason why the plan's funded status is excellent.

Despite its solid funded status, CAAT decided to remain prudent, kept its discount rate at 5.6% and is building a reserve, a cushion which will come in handy if another crisis hits its assets and liabilities.

CAAT's small investment team led by Julie Cays has done a great job delivering excess returns over the last five years and longer. They work with a handful of external managers to build solid relationships and leverage off these relationships to build their internal capabilities and co-invest alongside them.

As stated above, "CAAT Plan is open and ready for growth in membership where it is beneficial". And if you ask me, all educational plans in Canada and non-profit organizations should really carefully consider joining CAAT's members. Maybe CAAT can even help P.E.I. offer pooled pension plans for small businesses.

Today I was reading why pensions are at the heart of the Carleton University strike. There are a lot of problems with defined-benefit pensions at some Canadian universities, so the bombshell revelations at Carlton didn't shock me.

The problems with US public plans governing educational systems are even acuter. Earlier this week, Suzanne Bishopric, the former CIO of the UN Pension Fund, sent me an article on how Chicago Public Schools' huge pension debt just got $1 billion deeper.

Suzanne asked me to compare Chicago Teachers' to Ontario Teachers' and I said there is no comparison, for me, it's like comparing a Ferrari to a beat-up Lada.

If you're a small Canadian plan looking to avoid being chronically underfunded, you should definitely think about joining CAAT pension.

I think CAAT should continue doing what it's doing, namely, focusing on its funded status and solid long-term results, and it needs to engage more prospective members to educate them about CAAT's many advantages over the long run.

Anyway, a short comment on CAAT, a small but well-run defined-benefit plan in Canada which doesn't receive the recognition it deserves.

Once again, CAAT's 2017 results will be available here.

Below, Derek Dobson, CAAT Pension Plan CEO and Plan Manager, explains how the CAAT Plan stays strong, sustainable, and relevant to members.

Also, J. Craig Venter, Human Longevity co-founder, talks about the progress being made in the area of genomics and extending human life.

Listen carefully to what Venter says because as genomics expands and allows doctors to treat disease earlier, it will have a significant impact on quality of life and life expectancy, introducing more longevity risk into defined-benefit plans which will need to pay out pensions for a lot longer.

Tuesday, March 27, 2018

La Caisse Shakes Up Its Senior Ranks?

Benefits Canada reports, Caisse makes leadership changes to address competitive markets ahead:
The Caisse de dépôt et placement du Québec is shaking up its leadership team to address a rapidly changing and increasingly competitive market.

Macky Tall, formerly the head of the Caisse’s infrastructure portfolio, will be head of liquid markets and the Réseau express métropolitain project, the 26 station rail system currently under construction in Montreal. In addition, Tall will continue to help the pension fund’s equity and fixed income teams.

While the Caisse has hired Tall’s replacement, it hasn’t released the name because details of the transition are ongoing. However, it did note in a press release that the new head of infrastructure will start his role on June 1, 2018, and further details will be released in the coming weeks.

In further changes, Maxime Aucoin, previously senior vice-president of total portfolio, will be heading up a new investment strategies and innovation team tasked with idea generation and identification of new investment opportunities.

Claude Bergeron, executive vice-president and chief risk officer, will take on the responsibility of the team managing depositor-related activities, including investment policy framework.
La Caisse put out a brief press release on how it's positioning its team for the future:
La Caisse de dépôt et placement du Québec announced today that its team is evolving to position the institution in a rapidly changing and increasingly competitive market.

Recognized for his strong leadership and solid track record as head of la Caisse’s Infrastructure portfolio, Macky Tall is appointed Head, Liquid Markets and Réseau express métropolitain (REM). In his new role, he will continue to lead the REM project and bring to the equity markets and fixed income teams his extensive knowledge of key economic sectors as well as his operational experience.

In this context, a search for Mr. Tall’s replacement as head of the Infrastructure portfolio was undertaken and has resulted in identifying a strong talent who will start in the position on June 1, 2018. As the details of his transition are still being finalized with his current employer, more information, including his name and background, will be provided in the coming weeks.

Maxime Aucoin, previously Senior Vice-President, Total Portfolio, will now head a new Investment Strategies and Innovation team, in addition to being responsible for asset allocation and portfolio construction activities, and he will create a new group responsible for identifying and generating new investment opportunities. Mr. Aucoin’s appointment and the creation of this team, which will become a pillar of cross-functional innovation at la Caisse, follow the departure of Jean Michel.

The team that manages all depositor-related activities, including the advisory role and investment policy frameworks, is now under the responsibility of Claude Bergeron, Executive Vice-President and Chief Risk Officer.
“We’ve thought a lot about the best way to achieve our goals and position ourselves for the future. One thing became clear: we already have the talent, all we have to do is make the most out of it. With these appointments, that’s exactly what we’ve done. Our people will take on new roles and shed new light on our activities and how we do business. That’s what we need to keep innovating, to stay alert to changes in our environment and to seize new opportunities in an extremely competitive market,” stated Michael Sabia, President and Chief Executive Officer of la Caisse.
Macky Tall, Maxime Aucoin and Claude Bergeron will report directly to the President and CEO.


Caisse de dépôt et placement du Québec (CDPQ) is a long-term institutional investor that manages funds primarily for public and parapublic pension and insurance plans. As at December 31, 2017, it held CAD 298.5 billion in net assets. As one of Canada’s leading institutional fund managers, CDPQ invests globally in major financial markets, private equity, infrastructure, real estate and private debt. For more information, visit, follow us on Twitter @LaCDPQ or consult our Facebook or LinkedIn pages.
Any time la Caisse shakes up its senior ranks, the street in Montreal gets nervous. "Who's in power? Do I know them? Can I get more business out of them?"

I'm being facetious, of course, and you'll excuse me since my attention these days isn't on long-term pensions but short-term trading opportunities in these volatile markets (you can track my thoughts on StockTwits here and have fun looking at these crazy markets real time through my eyes).

The big news is that Macky Tall has taken a lot more responsibility at la Caisse, and is now in charge of REM and liquid markets. This is a huge and well-deserved promotion for Macky who is a very low profile type of guy.

Importantly, while some are questioning the appointment of Macky Tall to lead REM and liquid markets, his profile actually fits perfectly with the organization's long-term strategic vision and I believe Michael Sabia is sending a message to the troops by appointing him as head of liquid markets: there will be zero tolerance for any arrogance whatsoever.

Macky is known for his outstanding leadership, hard work ethic and humility. He's an excellent leader who knows how to lead effectively and while he doesn't micromanage, he will be on top of developments and ask a lot of important questions.

Sure, he will have a bit of a learning curve in order to grasp everything going on in liquid markets, but there are plenty of good people who will help him during this ramp-up phase.

I personally think Sabia is sending a clear message that he wants more stability across the organization and the right culture to deliver outstanding results, which is why he entrusted Macky with such enormous responsibility.

Even within CDPQ Infra, Macky has no tolerance for arrogance which is why he was very careful in who he brought in from other organizations where arrogance is part of the culture.

Who will replace Macky at CDPQ Infra? I know of a couple of outstanding candidates but I honestly have no idea who it will be yet so any educated guess will be pure speculation on my part.

As far as Claude Bergeron, I never met the man but heard nothing but good things about him. One person who worked with him years ago shared this with me: "c'est un brilliant qui a travaillé dans tous les grands dossiers de la Caisse" (he's a brilliant person who worked on all the major files at la Caisse over the years). He will do an outstanding job with depositors.

Maxime Aucoin, previously Senior Vice-President, Total Portfolio, will now head a new Investment Strategies and Innovation team, in addition to being responsible for asset allocation and portfolio construction activities, and he will create a new group responsible for identifying and generating new investment opportunities.

Mr. Aucoin has obviously impressed Michael Sabia a lot and was rewarded with a job that carries enormous responsibility but also a lot of very interesting challenges.

I have not met Maxime Aucoin, Claude Bergeron, or Macky Tall but heard excellent feedback from people who work with them. Notice they will all report directly to Michael Sabia which fits with his hierarchical style (he probably wants less direct reports and I don't blame him).

[Update: My bad mistake, I did meet Maxime Aucoin once for a job interview and he was a very nice guy. I'm embarrassed to admit that I can't remember people or faces very well, my apologies to him.]

I was surprised to learn Jean Michel is leaving as he was a very capable leader at Air Canada Pension prior to joining la Caisse three years ago. Someone told me if you look at the Caisse's 2017 results it might explain the shake-up in senior ranks, but I don't come to the same conclusion.

What else? There is a lot of garbage being published in major Quebec newspapers on the Réseau express métropolitain (REM). Even Quebec's Premier Philippe Couillard was swayed by some of this nonsense, joining Montreal Mayor Valérie Plante in demanding more transparency on the service monopolies obtained by the Réseau express métropolitain (REM), the electric train project that will serve the Montreal area between Brossard and Deux-Montagnes.

A lot of this nonsense is being fed by the heavily biased political minions at l’Agence de transport de Montréal, mostly péquiste-appointed separatists at that organization who have opposed the REM project from the get-go, fearing it will cost them jobs and power.

Without getting into details, don't believe everything you read in Quebec's major newspapers, a lot of it is fake news, misinformation or purely sloppy reporting, like the Caisse's $300 million REM cost overrun. It's actually embarrassing how so many smart people believe this nonsense (la Caisse isn't trying to destroy the ATM, it wants to work with it and other stakeholders to ensure the success of this project).

In fact, Macky Tall addressed some concerns raised by the media recently on French television:

Below, Clive Condie, Chief Executive at Churchill Airports Ltd interviewed Macky Tall who was then Vice-President of Investment Infrastructure at the Global Airport Development 2011 conference.

Macky has worked very hard to get to where he is at CDPQ and I wish him a lot of success in this new role heading up liquid markets and with the REM project.

Also, Sébastien Bovet and Gérald Fillion speak with Bruno Savard of Téléjournal Québec on Quebec‘s Budget 2018 which was revealed late today. The interview is in French and basically they state that the Liberal government gave goodies to everyone going into fall elections.

You can read more about the budget here to obtain details on how it will affect you but from what I heard, there is increased spending on infrastructure and they will expand the blue line in the metro which should appease some of the political minions at the STM spreading lies on the REM project.

Monday, March 26, 2018

Japan's GPIF Puts Squeeze on Fees?

Attracta Mooney of the Financial Times reports, World’s biggest pension scheme overhauls fee structure:
Japan’s Government Pension Investment Fund has accused active asset managers of being too focused on gathering new assets rather than generating returns for clients, as the world’s largest retirement pot gears up to overhaul how it pays investment houses.

Under plans due to come into place in April, the $1.4tn pension fund will pay its active asset managers a fee that is based on the excess returns — or alpha — they generate. “Without excess returns, their fee must be equal to that of passive managers with the same amount of asset size,” GPIF said. The new regime will apply to new and existing managers.

The move by the pension fund comes at a time of growing questions over the value stockpickers add. Active fund managers have repeatedly been accused of charging high fees for disappointing performance in recent years.

GPIF said its current fee structure, where investment houses were paid higher flat fees, did “not motivate asset managers to achieve alignment of interest between GPIF and external asset managers”.

The fund added: “Our external asset managers have tended to focus on getting more [assets] from GPIF and to avoid taking appropriate risks required to achieve their target alpha.

“By introducing the new fee structure, we would like to build a win-win relationship between GPIF and external asset managers.”

Active fund managers are under intense pressure to change fee structures that many clients believe are unfair.

Mercer, the influential adviser to pension funds, recently proposed that asset managers should pay investors to run their portfolios and provide performance guarantees instead of earning fees regardless of the returns delivered to their clients.

Some active fund managers, including Fidelity International and Allianz Global Investors, have put forward new structures that would include lower flat fees, with the addition of a performance fee.

“[This move by GPIF is] the latest and most publicised example of how the old heads-I-win, tails-you-lose fee structure is withering on the vine,” said Amin Rajan, chief executive of Create Research, an asset management consultancy.

But he warned that many asset managers would be unhappy with the move, because a shift away from fees related solely to assets under management “can introduce extreme volatility into fund managers’ revenue stream”.

Active asset managers that run money for GPIF include Amundi, Schroders, Invesco, Eastspring, Nomura, Fidelity International, JPMorgan Asset Management and UBS.

According to GPIF’s own data, its actively managed Japanese bonds and equities holdings, as well as its foreign equities funds, generated negative alpha — the returns above benchmark — over 10 years.

Andrew McNally, chief executive of Equitile, an asset manager that charges a fee related to returns, said the fund industry is being forced to reconsider how it charges investors.

“It seems unrealistic for the financial outcome for the fund management industry to be unrelated to the financial outcome for investors, especially pension funds as large as GPIF,” he added. “We think this [move by GPIF] is the start of a long trend which will see fees for active managers increasingly dependent on performance.”

About 20 per cent of its GPIF’s assets were actively managed at the end of financial year 2016, the latest year data are available for.
So, Japan's pension whale is putting the squeeze on fees, at least to what pertains to traditional stock and bond funds which aren't delivering the required excess returns.

Is this the right approach? In a world increasingly dominated by low-cost exchange-traded funds (ETFs), you have to wonder why everyone in the world isn't doing the same thing, namely, putting the squeeze on fees on traditional stock and bond funds.

In Canada, the large public pensions don't need to put the squeeze on fees on traditional stock and bond funds because they do their own indexing and enhanced indexing based on factor investing internally, foregoing fees. They still invest in large active managers but the bulk of the traditional public equities and fixed income are done internally.

Why is GPIF putting the squeeze on traditional active managers? In short, because active managers are taking a beating in Europe and are still lagging their passive rivals in the US.

Still, active managers tend to flourish in tough markets which is the main reason I expect a lot of these active managers on GPIF's roster will accept the terms of the deal. As I stated on Friday in my comment on phishing for inflation phools, I expect much tougher markets over the next year or two, so I don't believe good active managers will oppose GPIF's terms.

In other non-traditional alternative investments, GPIF will continue paying big fees to gain access to top funds. In February, it awarded the global infrastructure investment mandate to UK-headquartered private equity firm Pantheon, a top fund-of-funds manager.

In real estate, the size of Japan’s largest institutions means that even a tiny allocation to real estate could make significant waves. For example, GPIF has a target allocation of five percent to alternatives, including real estate. If, within this allocation, the overseas real estate portion was 0.5 percent, this would equate to more than US$7 billion of new investment.

Unlike large Canadian pensions, GPIF relies exclusively or almost exclusively on external managers so it's critically important to track and mitigate fees across traditional and alternive investments. This isn't an easy job when you're a $1.4 trillion fund that needs excess returns.

This is something Hiromichi Mizuno, GPIF's CIO, knows all to well.

Below, a panel discussion at the Milken Institute featuring Hiromichi Mizuno, Chris Ailman, Jagdeep Singh Bachleer, and Carrie Thome. You can also watch Mr. Mizumo discussing ESG investing here.

Friday, March 23, 2018

Market Phishing For Inflation Phools?

Desmond Lachman of the American Enterprise Institute wrote a comment, Behind the curve at the Federal Reserve:
History will not judge Janet Yellen’s Federal Reserve kindly should U.S. inflation accelerate in the months ahead as is all too likely to occur. At a time when there was every reason last year for the Fed to be accelerating the pace at which it was raising interest rates, Janet Yellen’s Fed effectively sat on its hands. As a result, Jerome Powell has inherited a Fed that is substantially behind the curve in terms of its efforts to prevent a return in U.S. inflation.

One reason that in 2017 Mrs. Yellen’s Fed should have been adjusting upward its path of planned interest rate increases was because of the substantial increase in household wealth during the year. Since the start of 2017, U.S. equity prices increased by 25 percent while U.S. home prices increased by 6 percent. This constitutes approximately a US$8 trillion increase in household wealth or the equivalent of around 40 percent of U.S. GDP. On the assumption that households are likely to spend 4 cents on every dollar of increased wealth as the Fed itself estimates, this alone constitutes a boost to U.S. aggregate demand of more than 1 ½ percent of GDP.

A second reason why in 2017 the Fed should have been more aggressive was because of the U.S. dollar’s sharp fall. Since the start of 2017, the U.S. dollar is estimated to have depreciated by around 10 percent. Past experience with dollar depreciations of that order of magnitude would suggest that over the next year or two the weaker dollar could boost U.S. aggregate demand by more than 1 percent of GDP. In addition, it could increase U.S. core inflation directly by around ¼ percent.

Yet another reason why the Fed should have adjusted upward its path of interest rate increases was to neutralize the effect of a more expansionary U.S. fiscal policy. Over the past year, not only did President Trump succeed in securing Congressional passage of an unfunded tax cut that would increase the U.S. budget deficit by around US$1 ½ trillion over the next decade, he also went along with Congress’ US$300 billion increase in public expenditures over the next two years.

According to IMF estimates, the net effect of the Trump tax cut and public spending increases will be to boost U.S. aggregate demand by around ¾ percent of GDP in both 2018 and 2019. That alone should have been reason for Mrs. Yellen’s Fed to have been more aggressive than it was in its interest rate policy.

Mrs. Yellen’s failure to pursue a more aggressive monetary policy certainly must heighten the risk that the U.S. economy will soon overheat. At a time that U.S. unemployment is already down to 4 percent, the U.S. economy is now being boosted by extraordinarily easy financial conditions as evidenced by still very low interest rates, buoyant equity prices, and a weak dollar. In addition, at this late stage in the economic cycle, it is receiving additional support from the Trump fiscal stimulus.

It should be little wonder then that the U.S. economy is now humming along at an unsustainable 3 percent pace, which is much faster than its potential growth rate. It would also seem that it is only a matter of time before the U.S. labor market tightens further and inflation starts rising. As if to underline this point, one would think that it should be of concern to the Fed that five-year inflation expectations as measured in the bond market are already significantly above the Fed’s 2 percent inflation target.

There will be those who will be advising Jerome Powell to let the economy run faster and to wait until inflation starts to accelerate before making any upward to its interest rate path. Mr. Powell would do well to disregard that counsel. Rather, he should be mindful that monetary policy operates with long and variable lags and that once the inflation genie is out of the bottle it is difficult to get it back in.

He should also be mindful of the likelihood that any further sign that the Fed is being too easy on inflation will invite the wrath of the bond market vigilantes. At a time when there are asset and credit market bubbles around the globe that are waiting on a trigger to burst, the last thing that Mr. Powell needs is a disorderly rout in the U.S. bond market.
I like Desmond Lachman of the American Enterprise Institute, think he's a first-rate economist who writes and covers markets and the economy extremely well.

The only problem is I don't agree with him, hence the title of this comment which is a word play on a book I'm currently reading, Phishing For Phools. Written by two Nobel-prize winning economists, George A, Akerlof and Robert J. Shiller, this is a very readable great little book which is all about the economics of manipulation and deception.

In fact, read the PDF introduction of this book here just to get a flavor for the subject they cover. There is a passage in the intro I particularly Ioved on the alleged optimality of free-market equilibrium:
There is a perhaps surprising result that, indisputably, lies at the very heart of economics. Back in 1776, the father of the field, Adam Smith, in The Wealth of Nations, wrote that, with free markets, as if “by an invisible hand ... [each person] pursuing his own interest” also promotes the general good.

It took a bit more than a century for Smith’s statement to be precisely understood. According to the modern version, commonly taught even in introductory economics, a competitive free-market equilibrium is “Pareto optimal.” That means that once such an economy is in equilibrium, it is impossible to improve the economic welfare of everyone. Any interference will make someone worse off. For graduate students, this conclusion is presented as a mathematical theorem of some elegance—elevating the notion of free-market optimality into a high scientific achievement.

The theory, of course, recognizes some factors that might blemish such an equilibrium of free markets. These factors include economic activities of one person that directly affect another (called “externalities”); they also include bad distributions of income. Thus it is common for economists to believe that, those two blemishes aside, only a fool would interfere with the workings of free markets. And, of course, economists have also long recognized that firms that are large in size may keep markets from being wholly competitive.

But that conclusion ignores the considerations that are central to this book. When there are completely free markets, there is not only freedom to choose; there is also freedom to phish. It will still be true, following Adam Smith, that the equilibrium will be optimal. But it will be an equilibrium that is optimal, not in terms of what we really want; but an equilibrium that is optimal, instead, in terms of our monkey-on-our-shoulder tastes. And that, for ourselves, as for the monkeys, will lead to manifold problems.

Standard economics has ignored this difference because most economists have thought that, for the most part, people do know what they want. That means that there is nothing much to be gained from examining the differences between what we really want and what those monkeys on our shoulders are, instead, telling us. But that ignores the field of psychology, which is, largely, about the effects of those monkeys.

As exceptions, behavioral economists, especially for the past forty years, have been studying the relationship between psychology and economics. That means that they have brought the consequences of the monkeys to center stage. But, curiously, to the best of our knowledge, they have never interpreted their results in the context of Adam Smith’s fundamental idea regarding the invisible hand. Perhaps it was just too obvious. Only a child, or an idiot, would make an observation like that and expect anyone to notice. But we will see that this observation, simple as it may be, has real consequences. Especially so, because, as Adam Smith might say, as if by an invisible hand, others out of their own self-interest will satisfy those monkey-on-the-shoulder tastes.

Thus we may be making only a small tweak to the usual economics (by noticing the difference between optimality in terms of our real tastes and optimality in terms of our monkey-on-the-shoulder tastes). But that small tweak for economics makes a great difference to our lives. It’s a major reason why just letting people be Free to Choose — which Milton and Rose Friedman, for example, consider the sine qua non of good public policy — leads to serious economic problems.
What does this book and passage have to do with what Desmond Lachman covered in his comment above on the Fed being behind the inflation curve? Is Lachman trying to deceive us?

Of course not but I believe the market is phishing for inflation phools. Lachman, the Maestro, and a few hedge fund gurus like Paul Tudor Jones, Ken Griffin, Paul Singer, and others warning of inflation have completely misunderstood the ongoing inflation disconnect because they don't understand the deflationary structural factors weighing down the economy (or aren't willing to discuss them publicly).

Last September, I wrote a comment on why I still fear deflation is headed to America where I brought up seven structural factors that lead me to believe we are headed for a prolonged period of debt deflation:
  1. The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits. Lots of discussion how more and more people are leaving the ranks of long-term unemployed and re-entering the workforce but in reality, these are just young people who couldn't find work after the 2008 crisis hit and are now only catching up. Hysterisis (long-term structural unemployment) remains a big problem for the US and all developed economies.
  2. Demographic time bomb: A rapidly aging population means a lot more older people with little savings, living longer and spending less. Meanwhile, the younger Millenials are more frugal and better savers which they need to be to meet their retirement needs.
  3. The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
  4. Excessive private and public debt: Rising government and consumer debt levels are constraining public finances and consumer spending. In essence, too much private and public debt constrains long-term growth.
  5. Rising inequality: Hedge fund gurus cannot appreciate this because they live in an alternate universe but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time. This means rates will stay lower for a lot longer.
  6. Globalization: Capital is free to move around the world in search of better opportunties but labor isn't. Offshoring manufacturing and service sector jobs to countries with lower wages increases corporate profits but exacerbates inequality.
  7. Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create.
These are the seven structural factors I keep referring to when I warn investors to temper their growth forecasts and to prepare for a long bout of debt deflation.

It's important to differentiate between structural (long-term) factors and cyclical (short-term) factors when discussing inflation trends. As I've repeatedly stated, the decline in the US dollar last year was a cyclical inflationary headwind because it will temporarily raise US import prices this year and raise US core inflation which seems tame but is rising fast (click on image):

Now, here is where I want you to pay close attention because many investors are currently positioned for the wrong type of inflation and they will feel the pain in the second half of the year as the US and global economy slow.

Importantly, while core inflation is set to accelerate which might cause the Fed to overshoot and hike rates more than anticipated, headline inflation will continue declining in the coming months as global leading indicators decelerate from peak levels.

On Thursday, I listened to François Trahan and Michael Kantrowitz of Cornerstone Macro where they painstakingly went over The Big Inflation Trap of 2018.

Now, keep in mind, after leaving BCA Research in 2000 to join the Caisse, I was working in a small team which was literally in charge of reading external research from brokers and independent firms and filtering the very best ideas to the Caisse's senior portfolio managers. I read everything and still read tons of market related sites to learn and try to get a grasp on what's going on.

When I tell you François Trahan and Michael Kantrowitz killed it yesterday, they really killed it, to the point where I emailed François late last night after viewing the replay to tell him this was their best presentation ever, if people don't walk away really thinking hard about The Big Inflation Trap of 2018, then it's not François or Michael's fault.

If you ever wondered why top institutions pay big money to read research insights from Cornerstone Macro then stop and ask to listen to this presentation and pay very close attention. It's truly worth an hour of your time.

François is sick with the flu but he was kind enough to allow me to share a couple of charts with my readers. There were so many of them so it was hard to choose and I still want you to take the time to listen to their entire presentation (if your company desn't subscribe to Cornerstone Macro, make sure you do so, it's well worth it).

Anyway, François and Michael began by explaining why we are now entering a different phase of the market (click on image, do not redistribute or you will be prosecuted):

The focus of their conference call was the slide below, namely, past peak leading indicators, it's not uncommon to see headline inflation wane while core inflation picks up (click on image, do not redistribute or you will be prosecuted):

And it's the pickup in core inflation which will complicate the backdrop because this is the measure the Fed and investors pay attention to (click on image, do not redistribute or you will be prosecuted):

The problem is investors are positioned for the wrong type of inflation, namely, headline not core inflation (click on image, do not redistribute or you will be prosecuted):

I've shared more than enough, make sure you watch the replay of The Big Inflation Trap of 2018 where François Trahan and Michael Kantrowitz do a masterful job in explaining how core and headline inflation move in opposite directions after leading indicators peak and what this means for your portfolio and what risk lie ahead.

You'll recall François Trahan helped me write my Outlook 2018: Return to Stability, where we explained why it's important to shift to a more defensive stance this year. And this despite the real threat of a trade war going forward (still not convinced it will happen but watching Trump surround himself with hawks makes me nervous).

Another thing I can share with you is François still thinks the yield curve is the most important indicator and it will likely invert over the next year as short rates remain high but long rates decline fast as global PMIs decline. If the Fed hikes too aggressively, he sees a real risk of another recession over the next year or year and a half.

In terms of where to invest, François still likes US long bonds (TLT), the US dollar (UUP) and is positioned more defensively in equities focusing on stable sectors like healthcare (XLV) and consumer staples (XLP) and interest-rate sensitive sectors like utilities (XLU), telecoms (IYZ) and REITs (IYR).

Given his defensive stance, François is underweight cyclicals like energy (XLE), financials (XLF), metals and mining (XME) and industrials (XLI). 

I'm going to go a step further in this comment and tell you I'm short tech (XLK) and semiconductors (SMH) and would steer clear of value traps like oil service stocks (OIH) which remain cheap despite the rise in oil prices (click on image):

I know, some energy stocks are really cheap and are due for a nice bounce but given my long-term inflation views, they will remain cheap for a very long time. Be careful of inflation and value traps!

What else? Both large (IBB) and small (XBI) biotech shares continue to do well but these high beta stocks are also toppish and I would proceed with extreme caution (click on images):

Don't get me wrong, I still see opportunities in biotech and love trading small biotech shares but I'm increasingly nimble, not overstaying my welcome, paying close attention every day to what is moving up and down on my watch list which doesn't just consist of biotechs (click on images):

What else? As I recently shared, I remain short Facebook (FB) / long Twitter (TWTR) as a pairs trade, I'm outright short Micron Technology (MU), think it's headed back to $40 a share or even lower, and I'm short US Steel (X) and Freeport-McMoran (FCX) and wouldn't touch any metal and mining or energy share with a ten foot pole, even for a bounce.

I'm also short Dow high-flyer Boeing (BA) which has defied my wildest predictions when I wrote about its huge pension gaffe a few months ago, rising to new highs before getting clobbered recently (click on image):

In fact, this may be the biggest short the market has to offer over the next year or two so pay attention if you're still bullish on Boeing (lighten up and take some profits).

My biggest LONG? That's easy, on a risk-adjusted basis, I continue to love US long bonds (TLT) over the next year or two (click on image):

As far as the overall market (SPY), it's been a terrible end of the week and we shall see what next week brings:

We'll see what happens next week but one analyst who called the correction now sees a bear market starting within a year:
The stock strategist who predicted the S&P 500's drop earlier this year now expects a big market decline within 12 months.

Barry Bannister, Stifel's head of institutional equity strategy, is telling clients to prepare for a bear market and buy defensive stocks that perform better during periods of market turmoil.

"Our models for the S&P 500 point to minimal price upside in 2018 and a bear market (-20%) in the coming year. What matters for investors is that any decline is likely to be unusually rapid and occur as a result of P/E compression, resulting from policy risks not weak GDP," Bannister wrote in a note to clients entitled "The Fed's 'forced error': It's time to start moving to more defensive positions."

Bannister said on Jan. 26, the day of the S&P's record high, that stocks will correct at least 5 percent this quarter as the Federal Reserve and other central banks tighten monetary policy. The S&P 500 subsequently dropped 10 percent through early February.

The strategist is still concerned about monetary policy. The Federal Reserve raised the benchmark funds rate Wednesday by 25 basis points to 1.75 percent. It was the sixth rate hike since December 2015.

In his note Wednesday, Bannister said the Fed's outlook for the economy points to more aggressive rate hikes.

"We're concerned the Fed's 2019-20 view grew more hawkish," he wrote. "We now expect deflationary policy errors to develop in 2018 to early 2019."

As a result, the strategist recommends investors buy stocks in "defensive" areas such as utilities, consumer household products and food companies.

Bannister reaffirmed his 2,800 S&P 500 price target, representing 3 percent upside to Wednesday's close. He cautioned the forecast may change on any sign of a sudden "break down" in the market.
Pretty much what François Trahan and I stated at the beginning of the year. The last correction didn't turn into something worse but the second half of the year will be challenging, that much you can count on.

A potential full-blown trade war with China will only add fuel to the fire which is why top economists are sounding the alarm, concerned about escalating tensions.

What else? I think I've rambled on enough here. I'm tired and remind all of you that it takes a lot of time and effort to write these comments, so if you take the time to read them and like my blog, take the time to donate and/ or subscribe on the right-hand side under my picture. 

I'm not phishing for blog phools, I'm asking people to do the right thing and donate to support this blog because let's be honest, there's nobody out there crazy enough to provide you with free great daily insights on pensions and markets. 

In fact, there are many financial blogs but there is no blog on earth which covers pensions and investments with the breadth and depth that I do. 

Lastly, take the time to listen to the latest MacroVoices podcast with Jeffrey Snider here and you can view the slides he discusses here. Great discussion, listen to Snider, he really understands the significance of the yield curve. You can also watch it here.

Below, Shawn Cruz, TD Ameritrade manager of trader strategy, discusses buying opportunities as the market sells off into the close.

How come they're always discussing "buying opportunities" on television and not a peep about shorting opportunities? I guess they're phishing for phools to unload their crap on. Be careful!

Thursday, March 22, 2018

Ontario Teachers' Bets on a Gaming Giant?

The Canadian Press reports, Ontario Teachers’ Pension Plan buying $400M stake in video game giant Ubisoft:
The Ontario Teachers’ Pension Plan is spending about $400 million to take a 3.4 per cent stake in French video game giant Ubisoft as part of a complex deal that will allow French conglomerate Vivendi to sell all of its Ubisoft shares.

Vivendi, which was said to be considering a takeover when it accumulated its Ubisoft stake over the past few years, has agreed to sell its 30.5 million shares and not buy any more for at least five years.

Ontario Teachers’ has agreed to acquire 3.8 million shares in the company, which produces games including Assassin’s Creed and Tom Clancy’s Rainbow Six, while Chinese internet giant Tencent is to buy 5.6 million shares.

The rest are to be bought by Ubisoft and cancelled, or sold to existing shareholders and, through an offering, to institutional investors.

Ubisoft says it has a strategic partnership with Tencent that will “significantly accelerate” the reach of Ubisoft franchises in China in the coming years.
Maya Nikolaeva, Matthieu Rosemain and Cate Cadell of Reuters also report, Vivendi selling Ubisoft stake for $2.45 billion, ends battle for control:
French media giant Vivendi is selling its stake in Ubisoft for 2 billion euros ($2.45 billion) to investors including Chinese tech titan Tencent, ending a potential takeover battle for the French video games maker.

Billionaire Vincent Bollore's Vivendi, which had been raising its holding in Ubisoft, has agreed to sell its 27.3 percent stake in the company, best known for its Assassin's Creed and South Park games.

Tencent Holdings Ltd, which dominates China's mobile gaming market, is investing almost 370 million euros for a 5 percent stake, while the Ontario Teachers' Pension Plan is spending 250 million euros for a 3.4 percent stake.

Ubisoft and Tencent will also form a strategic partnership to boost Ubisoft's reach into China, the world's largest video game market with estimated sales of $32.5 billion last year, according to data from gaming consultancy Newzoo.

The move represents a strategic setback for Bollore and Vivendi, which has pledged to make video gaming one of its key pillars along with advertising, music and pay-TV. As part of the deal Vivendi has committed to not acquire any further shares in Ubisoft for five years.

Vivendi's stake-building since 2015 had prompted Ubisoft's founding Guillemot family to court Canadian investors to fend off any hostile takeover.

After the sale Vivendi will remain active in video gaming through its acquisition of mobile game maker Gameloft, which was also founded by a Guillemot brother but is much smaller than Ubisoft, the French leader in this market.

Along with the investments from Tencent and Ontario Teachers, the deal also includes a share buy-back by Ubisoft that adds up to an 8.1 percent stake, as well as a share purchase by Guillemot Brothers SE and an accelerated book building with institutional investors.

Ubisoft said Vivendi had approached it several weeks ago about its intention eventually to sell its stake. Ubisoft started tapping up potential investors at that stage.

Tencent, Asia's biggest listed firm with a market value of around $540 billion, is investing heavily to expand its gaming empire at home and abroad. It launched some of its top games overseas last year, and last month invested 3 billion yuan ($474.73 million) in Chinese peer Shanda Games.

The firm, which stretches from social media to online payment, announced a strong fourth quarter profit on Wednesday, but said mobile gaming revenue growth had slowed.
Ontario Teachers' Pension Plan put out a press release, Ubisoft reaches agreement with Vivendi for its full exit from Ubisoft’s share capital:
  • Vivendi to sell its entire stake in Ubisoft representing 27.3% of Ubisoft's share capital
  • The transaction is structured in the following way:
    • Ontario Teachers' Pension Plan ("Ontario Teachers'") and Tencent, enter Ubisoft's share capital as long-term investors; as part of the transaction, Tencent and Ubisoft have also signed a strategic partnership agreement
    • Share buy-back by Ubisoft of shares owned by Vivendi, accretive to all Ubisoft shareholders
    • Acquisition by Guillemot Brothers SE of shares owned by Vivendi
    • Accelerated Bookbuilding with institutional investors for the remainder of Vivendi's stake
  • All transactions are realized at the price of 66 euros per share
  • Continued roll-out of Ubisoft's growth strategy, based on the company's transformation to a more recurring and profitable business model
  • Ubisoft confirms its financial targets for 2017-18 and 2018-19
Paris – Today, Ubisoft announced that it has signed an agreement with Vivendi for its full exit from Ubisoft's share capital, with the sale of all Vivendi's 30,489,300 shares. The transaction includes an investment by two new long-term investors, the Relationship Investing arm of Ontario Teachers' Public Equities division, and Tencent, a share buy-back by Ubisoft, an acquisition of shares by Guillemot Brothers SE and an Accelerated Bookbuilding with institutional investors. Following the implementation of the transaction, Vivendi will no longer hold any shares in Ubisoft, and has committed not to acquire any shares in Ubisoft for 5 years.

As part of the transaction, Ubisoft and Tencent have also announced today a strategic partnership that will significantly accelerate the reach of Ubisoft franchises in China in the coming years.

Yves Guillemot, CEO and Co-Founder, said: "The evolution in our shareholding is great news for Ubisoft. It was made possible thanks to the outstanding execution of our strategy and the decisive support of Ubisoft talents, players and shareholders. I would like to warmly thank them all. The investment from new long-term shareholders in Ubisoft demonstrates their trust in our future value creation potential, and Ubisoft's share buy-back will be accretive to all shareholders. Finally, the new strategic partnership agreement we signed will enable Ubisoft to accelerate its development in China in the coming years and fully leverage a market with great potential."

"Today, Ubisoft is fully reaping the benefits of our long-term strategy and the successful transformation towards a more recurring and profitable business. Ubisoft is perfectly positioned to capture the numerous video game growth drivers in the coming years. We are focused more than ever on delivering on our strategic plan."

Investment from new long-term shareholders in Ubisoft

Ontario Teachers' has committed to acquire 3,787,878 Ubisoft shares (3.4% of capital), equivalent to approximately €250 million and Tencent has committed to acquire 5,591,469 Ubisoft shares (5.0% of capital). These investments are made at a price of €66 per share and do not grant any representation on Ubisoft's board of directors. Tencent has also undertaken not to transfer its shares nor to increase its shareownership and votings rights in Ubisoft.

As part of the transaction, Ubisoft and Tencent have also signed a strategic partnership agreement that will significantly accelerate the reach of Ubisoft franchises in China in the coming years.

The entry of these two high-profile investors in Ubisoft's share capital validates Ubisoft's strategy and confirms the value creation potential for its shareholders in coming years.

Ubisoft share buy-back

Ubisoft agreed to buy back up to 9,090,909 of its own shares (8.1% of capital) from Vivendi through a structured transaction taking the form of a forward sale of Vivendi shares to Crédit Agricole Corporate and Investment Bank (CACIB), and a forward buy-back mechanism of shares from CACIB by Ubisoft, enabling Ubisoft to progressively buy-back shares from 2019 to 2021. This buy-back will be structured through a derivative product whereby Ubisoft will enter into a pre-paid forward agreement on part of the shares, with settlement in shares at maturity in 2021 or by anticipation, and for the remainder of the shares, a total return swap with settlement either at maturity or by anticipation at Ubisoft's discretion, either in cash (Ubisoft either benefiting or supporting the variation in the value of the relevant shares) or with a settlement in shares against the payment of the price for such shares. The share buy-back will be financed mainly through Ubisoft's existing financial resources. In the event of an increase in the size of the accelerated private placement, the number of shares that are bought back by Ubisoft will be reduced accordingly.

These acquisitions will be made at a price of €66 per share.

Shares bought-back are primarily intended to be cancelled with an accretive effect for all Ubisoft shareholders or used as part of share compensation plans or share-indexed compensation plans for employees.

Finexsi, acting as independent financial expert, rendered a fairness opinion on the share buy-back confirming that the financial terms of the transaction were fair for the minority shareholders of Ubisoft and that the transaction was in the corporate interest of Ubisoft.

Guillemot Brothers SE acquisition of shares

As part of the transaction, Guillemot Brothers SE agreed to acquire 3,030,303 shares (2.7% of capital) at a price of €66 per share, bringing Guillemot Brothers SE's ownership to 17,406,414 shares representing 19.4% of voting rights and 15.6% of share capital and the Guillemot concert to 20,636,193 shares, representing 24.6% of voting rights and 18.5% of share capital. The purchase will be implemented through a structured financing in the form of derivative instruments by which Guillemot Brothers SE will enter into a forward contract with CACIB and a collar financing on these Ubisoft shares, maturing in 2021 or by anticipation, and settled in shares or in cash. Shares underlying the collar financing will be pledged to CACIB, who will be authorized to re-use them from Guillemot Brothers SE subject to certain conditions specified in the agreement.

Accelerated Bookbuilding with institutional investors

The remainder of Vivendi's stake, representing 8,988,741 shares (8.0% of capital), will be sold at a price of €66 per share through an Accelerated Bookbuilding with institutional investors. Based on the level of interest in the placement, the size of the Accelerated Bookbuilding could be increased up to 1,500,000 shares, reducing accordingly the number of shares bought back by Ubisoft.

J.P. Morgan Securities Plc is acting as Sole Global Coordinator on the Accelerated Bookbuilding.

As part of this Accelerated Bookbuilding, CACIB, as Guillemot Brothers SE's counterpart in the forward contract and the collar financing will also sell 2,887,879 shares in the hedging of its derivatives operations.

The transaction will be launched today. Final terms as well as the outcome of the placement will be determined at the end of the bookbuilding expected on March 21, 2018. Settlement will take place two trading days after closing of bookbuilding.

Ubisoft financial targets confirmed

Ubisoft confirms its financial targets for 2017-18 and 2018-19, as well as its long-term growth perspectives.

J.P. Morgan Securities Plc and Lazard Frères are acting as financial advisors to Ubisoft while Bredin Prat is acting as legal counsel.
This is a very big deal for all parties involved. First, Vincent Bollore is selling his stake at a time when Ubisoft’s share price hit a 5-year high (click on image):

Second, this is a big deal for Ontario Teachers' Relationship Investing team led by Ken Manget (click on image):

From its website, Ontario Teachers' explains its approach to Relationship Investing:
Our investments are large — $200 million and upwith no pre-determined hold period. This longer term or "patient capital" view matches reflects Ontario Teachers' long-term obligations to pay pensions, and enables management teams to concentrate on improving long-term shareholder value.

For investee companies, we offer:
  • strong, established partnerships, including a global network of industry and financial contacts who know our reputation and track record
  • sophisticated skill sets of the Relationship Investing deal team
  • the ability to leverage the in-depth industry expertise of our public equities and private equities groups, and the broader resources of our capital markets, and infrastructure teams
  • the ability to structure bespoke investments to meet the needs of unique situations
  • significant liquidity and size, providing the financial firepower needed for large equity investments
  • more than a decade of experience working closely with partner companies
  • a longer-term investing horizon
Our work includes:
  • partnering with industry — we invest in assets alongside premier companies
  • solution investments — we support a major change in a company's strategy
  • constructive engagement — we encourage boards and management to improve business and financial performance
In each situation, we see our involvement as a catalyst. By helping companies to establish themselves, grow through acquisitions, reduce debt and undertake major capital programs, we have been instrumental in transforming entire sectors.

Ontario Teachers' Relationship Investing is different because:
  • We run a concentrated portfolio, more akin to private equity than traditional public equities
  • Our holdings are generally more liquid than private equity, but less liquid than publicly traded stocks
  • We have more influence with our partner companies than investors in widely held public companies do, but less control than private equity investors typically require
  • We conduct appropriate due diligence, similar to private equity investors
  • We are agile
It's obvious Ken Manget and his team know what they're doing and they're well plugged into the who's who of industry leaders which allows them to build and nurture these relationships and invest a significant stake over a long period to match Teachers' long-dated liabilities.

The way I view Relationship Investing is somewhere in between public and private equities without the pros and cons found in both. It's less liquid than public markets and they have less control than private equity but over the long-run, these stakes are significant and allow Teachers' to match its assets and liabilities in another way, foregoing big fees to private equity which is now bracing for a downturn.

You still need to hire a good team that knows how to develop instrumental relationships, one that adds value, and this is where Ken Manget who was appointed to this position three years ago and his team come into play.

Manget holds an MBA from Harvard University and a B.Sc. (Mechanical Engineering) from the University of Toronto. He's obviously very bright and I'm sure holding a Harvard MBA has helped him build very strong relationships with industry leaders.

Why did Ontario Teachers' enter this deal when Ubisoft shares are trading at a 5-year high? Because there is tremendous growth potential, especially in China, and it sees shares rising significantly over the next decade.

As stated above, as part of the transaction, Ubisoft and Tencent have also announced a strategic partnership that will significantly accelerate the reach of Ubisoft franchises in China in the coming years.

Think about it, while President Trump is slapping China with tariffs on up to $60 billion in imports, the 'first of many', others are working with China to grow their internal markets (I guess Larry Kudlow wasn't successful in teaching Trump basic economics on free trade and how the US current account deficit with China necessarily means a capital account surplus, which Wall Street loves!).

Oh well, the way things are going, Trump will soon have plenty of time to enjoy Ubisoft's upcoming video game, Little Rocket Man (I'm being sarcastic on the new game, not on Trump's prospects if he continues implementing idiotic protectionist policies which cost American jobs).

Below, I embedded a clip discussing the successes of Ubisoft nobody is mentioning. Listen carefully to what is discussed in this clip, you will understand what's behind Ubisoft's recent success and why if it continues being a pioneer in gaming, it will continue growing by leaps and bounds.

Lastly, I like this deal for Ontario Teachers' because not only is it investing a significant stake in a gaming giant, it's an industry which is relatively recession proof and one which is growing fast, especially in China. If all goes well, this will prove to be a great deal for all parties involved.