Friday, August 31, 2018

Get Into Stocks Right Now?

Michelle Fox of CNBC reports, 'Outright bullish' on the market, money manager says to get into stocks 'right now':
With the stock market about to leave the summer behind, now is the time to buy, according to Jerry Castellini, president and chief investment officer of CastleArk Management.

In fact, he told CNBC on Thursday the market can move up 10 percent just to get back to "fuller valuation."

"I'm outright bullish," Castellini said on "Power Lunch."

He said market watchers have been focusing on the wrong things, such as emerging market weakness, politics and earnings that some worry may have reached their peak.

However, Castellini said the global economy is poised to turn.

"The consumption around the globe is now following all the liquidity that the central banks have provided these economies. And you're likely to see a continuing higher and higher expectation now for earnings kind of play out," Castellini said.

"That's what drives markets higher. And that's a surge that we still haven't seen the greatest part of, and you really want to be in front of that," he added. "You probably want to get in right now, and you want to get in before the [Labor Day] holiday."

Earlier Thursday, President Donald Trump took a victory lap on the recent market rally, tweeting about financial market news being "better than anticipated." He also promised "more good news is coming" for those who have "made a fortune" in markets.



However, on Thursday, U.S. stocks snapped a four-day winning streak after a report said Trump would support moving ahead with additional tariffs against China.

Robert Pavlik, chief investment strategist at Slatestone Wealth, told CNBC he isn't ready to jump into the market right now "with two hands and two feet."

"We're up about 8 percent since June," he told "Power Lunch."

Instead, he said, he will wait until after people come back from vacation and "see where the market wants to go."

When it comes to the global economy, Pavlik said the rest of the world isn't in the same type of situation as the United States. While the U.S. is in a great position to negotiate tariffs, other nations aren't ready to handle interest rate increases, he explained.

"We have major, major countries that are still at zero percent interest rates. What happens when those countries that are not doing so great start to raise rates? That's what concerns me," Pavlik said.

He said the S&P 500 could trade as high as 3040, but if gets past that mark he thinks there may be a "bit" of a pullback on concerns over the midterm elections.

That could bring the S&P 500 down to 2875, he said.

"As we go into next year, there's going to be a little bit more concern about maybe some changes in Congress, about maybe a slowdown in earnings pace, maybe the Federal Reserve, less repatriated cash to come back from overseas and fuel buybacks," Pavlik said.

He ultimately sees a market gain in the range of 7.5 percent this year and another 5.25 to 5.5 percent next year.
Last week, I discussed riding the bull market to nirvana where I showed you most of the gains in US stocks this year are coming from two growth sectors, consumer discretionary (XLY) and technology (XLK), both of which have been on fire since early 2016.

And most of that growth is coming from one powerhouse tech giant, Amazon (AMZN), up 70% year-to-date and 40% since early April after the last dip (click on image):


Amazon is on fire and you have a parade of analysts on CNBC telling you they're executing on all fronts especially in the all-important Amazon Web Services (AWS) which is recurring business.

What CNBC doesn't tell you is every single hedge fund is long Amazon shares and so are mutual funds, pension funds and other institutional and retail investors. So there is a tremendous amount of herding going on here which is good until something goes wrong and everyone is looking to exit at the same time.

But growth stocks are where institutional investors hide when Risk-Off markets dominate. So, from that perspective, it shouldn't surprise us growth stocks are doing extremely well, that's where earnings growth is most impressive.

In fact, the divergence between growth versus value stocks has reached an extreme, something which has many value investors upset thinking a mean reversal is inevitable:


I would be careful, however, and not base any investment decision on mean reversion.

In an email to clients today, Cornerstone Macro's Michael Kantrowitz discusses why growth will continue dominating value, stating: "We've been making the case for Growth investing for several years now and do not see an end in sight of it's dominance over value."

Michael examines how the composition of growth and value indexes has changed since 2000 (click on image):


And he warns:
I wonder what the relative price chart of an iPhone versus a Palm Pilot looks like today?

Expensive doesn't necessarily mean overvalued and cheap isn't always a "good deal."

There are many "cheap" Value companies today (these are the lower-quality companies) that survived due to post-2008 global fiscal and monetary stimulus. They are now MOST at risk of a central bank tightening cycle and another reason why I think Growth continues to be a better investment than value.
Michael's colleague, Francois Trahan, wrote a great research comment this week showing how profitability factors are working everywhere as investors shift their focus on stability (click on image):


Francois also demonstrates how the rise in rates has caught up to leading economic indicators and financial markets and signals slower growth ahead in the US and around the world (click on image):


Slower growth ahead is bullish for US long bonds (TLT) as it suggests inflation pressures will be transitory:


Admittedly, US long bonds haven't done much this year but if the global economy is slowing, which I believe it is based on global PMIs rolling over, then you need long bonds in your portfolio to cushion the blow.

What else? A slowing global economy will support defensive sectors that offer stable profits. I've been warning my readers since mid-July that it's time to get defensive, focusing on defensive sectors like healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecoms (IYZ). And I would hedge that stock exposure with good old US long bonds (TLT).

All this to say, never mind what Jerry Castellini and all the cheerleaders on CNBC telling you to load up on stocks now, you need to be selective and defensive heading into year-end.

As I explained last week, mutual funds end their fiscal year at the end of September, so we might get a decent pop in markets in the next few weeks as they all shed their losers to buy market leaders, but after that, watch out, things can get very rocky, very quickly.

Below, Jerry Castellini, CastleArk Management president and chief investment officer, and Bob Pavlik, Slatestone Wealth chief investment strategist and senior portfolio manager, join the 'Power Lunch' team to discuss markets amid trade talks and Labor Day.

And one sector has been tearing up the S&P 500 this quarter, rocketing to new highs, and it's not tech. Healthcare (XLV) has been the surprise winner as the third quarter enters the home stretch but one technician sees a ceiling (I would ignore him too).

I'll be back next Tuesday, have a great Labor Day weekend and please remember to kindly donate or subscribe to this blog via payPal on the top right-hand side under my picture. Thank you!


Thursday, August 30, 2018

New Jersey and Ohio Embroiled in Scandal?

Andrew Perez and David Sirota wrote an article that was co-published in MapLight, Capital & Main and Fast Company: Ohio, N.J. pension funds invested $625M in hedge fund that controls “National Enquirer” parent:
Taxpayers in New Jersey and Ohio have a large financial stake in the owner of the media company that allegedly helped the Trump campaign bury negative stories, according to documents reviewed by Capital & Main and MapLight.

Under Republican governors, the two states committed at least $625 million of pension cash into Chatham Asset Management, a high-risk hedge fund that has taken control of the National Enquirer‘s parent company, American Media Inc., which is at the center of the federal investigation into President Donald Trump’s 2016 campaign. California’s pension fund also has a $235 million stake in a Chatham fund.

The hedge fund is run by Anthony Melchiorre, a GOP donor who reportedly met with the president and AMI CEO David Pecker at the White House soon after Trump took office. Melchiorre and his wife have donated more than $100,000 to Republican candidates and party committees since 2010.

Trump’s former attorney, Michael Cohen, recently pleaded guilty to breaking campaign finance laws stemming from payments he made to women to hide affairs with the former reality TV star and real estate magnate. AMI executives helped Cohen purchase stories that could have hurt Trump’s presidential bid, according to the Wall Street Journal.

AMI has denied it helped Trump’s campaign, although Pecker was recently granted immunity as part of the Cohen probe. Former FEC commissioner Trevor Potter, the head of the nonprofit Campaign Legal Center, last week said the situation “presents a serious legal problem for AMI.” If those legal troubles end up depressing the market value of AMI, teachers, firefighters, cops and other public employees also could potentially suffer losses at a time when their pension funds are already facing shortfalls.

A New Jersey Treasury Department spokesperson said in an email that its Division of Investment “is in regular contact with its investment partners regarding underlying portfolio companies and provides feedback when appropriate. While DOI plays no role in the management of a fund’s portfolio companies, it expects the funds to invest in good businesses with strong management teams that follow all applicable laws.”

“I am personally appalled by the Enquirer being an accessory to Cohen’s criminal behavior on behalf of the candidate,” said Tom Bruno, a state union representative who is the chairman of the pension’s board of trustees and serves on New Jersey’s State Investment Council, which oversees the pension system’s investments.

“If asked to vote, I can assure you I will be voting for us to divest,” he said. “I cannot talk on behalf of the entire SIC, but I will be doing everything in my power to convince a majority to vote the same way.”

Chatham did not respond to questions about how exposed taxpayers and pension systems might be to AMI and any financial consequences of its legal entanglements. The Ohio pension system did not respond to questions about whether it will seek to divest assets from Chatham.

“State officials are well-positioned and duty-bound to investigate allegations of potential wrongdoing in hedge fund portfolios,” said former Securities and Exchange Commission attorney Edward Siedle.

In 2013, former New Jersey Gov. Chris Christie’s administration moved $300 million of pension cash into the Chatham Fund, LP, which has owned a stake in AMI, according to SEC records. Last year, barely three months before Christie left office, his administration steered another $200 million to another Chatham vehicle. AMI gave $10,000 to a super PAC supporting Christie’s 2016 presidential bid, and Mother Jones reported that Christie placed Pecker on his campaign leadership team.

In 2013 and 2014, an Ohio pension system partially controlled by Gov. John Kasich’s appointees committed $125 million to Chatham. The hedge fund finalized its deal to buy an ownership stake in AMI in the summer of 2014.

The Christie administration’s shift of $500 million into Chatham makes New Jersey retirees a substantial investor in the hedge fund, which manages $3.2 billion in assets, according to state records. Those records show the original $500 million investments are now worth as much as $692 million.

Best known for its lurid Enquirer headlines (“Aliens Are Living in My Toilet“), AMI has been beset by a difficult environment for print publications. Chatham has warned that its investments are risky and that a client “may lose its entire investment in a troubled company.” In early 2018, private equity giant Blackstone removed Chatham from one of its major investment funds.

Along with the public pension funds, four other private pension funds—including those for Ford and Toyota Motors employees—have had investments with Chatham, according to financial research firm Preqin.

AMI represents a large portion of Chatham’s portfolio. Internal hedge fund records from late 2017 show that AMI investments comprised 23 percent of the Chatham Asset Partners High Yield Fund’s portfolio. The hedge fund also has officials who serve as directors at AMI.

Jay Youngdahl, a Harvard researcher who has served as a steelworkers pension trustee, said state officials may be able to take action to try to protect retiree investments.

“There are often clauses in agreements between pension funds and hedge funds that give states certain rights and recourse if they believe retirees’ money has been invested in companies engaging in criminal activity,” he said.
I read this article and thought a few things. First, who in their right mind buys and reads the National Enquirer? I guess the same idiots who buy and read British tabloids but the Enquirer is so 1980s, such mindless drivel which is free and ubiquitous in the age of the internet.

The second thing that came to mind is the article makes some good points but it also makes a lot of unfounded allegations. For example, reading it, you'd think Chatham directed AMI CEO David Pecker to "catch and grab" all negative or sleazy articles that pertain to Trump.

Unless there is proof that Chatham did this, I can't see how any laws were broken on its part. Sure, it controls AMI but it doesn't necessarily control all the sleazy operations that take place there. It could be that David Pecker did all this without Chatham's consent or knowledge (we don't know).

The article also makes some other accusations. A layperson reading this will think Ohio Gov. John Kasich and former New Jersey Gov. Chris Christie directed hundreds of millions into Chatham to repay them for politcal favors. They didn't directly do this, they did it through appointees.

That could be true. In my previous comment, I went over America's broken retirement system, discussing some of the things hampering US public pensions. I discussed how undue political interference in the US has impacted public pensions in negative ways and this is one of them.

Political donors in the US aren't in the charity business, not when it comes to politics, that's not the way the game works. When Democratic or Republican donors give money to politicians, they always expect favors in return, so it's more than likely that Chatham did receive some preferential treatment because it donated to the campaigns of these two governors.

Still, the hedge fund universe is very competitive, Chatham can't solely rely on its campaign donations to get money from state pensions, it needs to deliver strong results.

As this 2016 document of Blackstone's subadvisors shows, Chatham was part of its hedge fund of funds portfolio that was managed by Tom Hill (click on image):


Why am I bringing this up? Because Blackstone Alternative Asset Management (“BAAM”) typically invests in world-class, elite hedge funds (it's made its share of world-class blunders too), so if Chatham passed the smell test there, including intense operational and investment due diligence, then you know it's a legitimate hedge fund which delivers exceptional results (New Jersey Investment Division's own records show the original $500 million investments are now worth as much as $692 million).

Of course, political conspiracy theorists will link Blackstone co-founded by Stephen Schwarzman with Chatham and AMI. Schwarzman is a close friend of President Trump, and has emerged as one of his most generous donors, as well as a key adviser with rare and regular access to the president.

Could it be that Schwarzman directed Chatham to take a controlling stake in AMI and then "catch and grab" all smut related to the president?

Inquiring (more like Enquirer) minds want to know but it's a large stretch to reach such a conclusion. Blackstone exited its investment from Chatham but we don't know why. It could be for all sorts of reasons like they found a more suitable investment but conspiracy theorists will claim Schwarzman wanted to distance himself from Chatham and AMI (again, I don't buy this rubbish).

Would I have invested in Chatham? I honestly don't know enough about it. I couldn't care less if the founder is a big donor to Republican candidates (so is Ken Griffin, Paul Singer and Steve Cohen and I wouldn't flinch to invest in their hedge funds).

The only serious concern I have is that Chatham took control of the National Enquirer and as such had a say it who runs it and how they run their operations. If they knew or directed David Pecker to run a sleazy operation to catch and grab any negative articles against Trump, then they broke the law. Plain and simple.

But again, these are just allegations, any wrongdoing on Chatham's part has to be proven in a court of law. It could very well be they had no clue of what David Pecker was doing on Trump's behalf.

We also don't know if Chatham is looking to sell its controlling stake in the National Enquirer (at a loss) now that these revelations have been made public or if it's going to shake things up in its leadership. Remember, Chatham is still a fiduciary and must act in the best interests of all its investors.

This is why I prefer that public sector unions and politicians stay the hell away from pension investments, they typically make things worse with their recommendations.

US public pensions need independent boards run by qualified professionals and they need to start compensating their pension fund managers a lot better to manage ever more assets internally.

Anyway, in the highly politicized environment in the US right now, it will be interesting to see how all this plays out.

Below, former vice president Joe Biden delivered an impassioned eulogy at a memorial service for the late Sen. John McCain on Thursday, crediting the former POW for living by a "timeless code."

It's sad but they don't make them like John McCain or Ted Kennedy anymore. These two lions of the Senate fought hard for principles they believed in but they always put the interests of their country ahead of their own party's interests. That's the way it's suppose to be.

Wednesday, August 29, 2018

America’s Broken Retirement System?

Knowledge@Wharton recently put out a research comment, The Time Bomb Inside Public Pension Plans:
Sanitation workers, firefighters, teachers and other state and local government employees have performed their duties in the public sector for decades with the understanding that their often lackluster salaries were propped up by excellent benefits, including an ironclad pension. But Moody’s Investors Service recently estimated that public pensions are underfunded by $4.4 trillion. That amount, which is equivalent to the economy of Germany, accounts for one-fifth of national debt. It’s a significant concern for public employees who were banking on a fully funded retirement to get them through their golden years.

But the issue has wider implications for all taxpayers, who likely will be tapped to make up the shortfall. The Knowledge@Wharton radio show, which airs on Wharton Business Radio on SiriusXM, asked two experts to explain how governments dug themselves into such a deep hole — and whether they can ever get out. Olivia Mitchell is a professor of business economics and public policy at Wharton. She’s also director of both the Pension Research Council and the Boettner Center on Pensions and Retirement Research at the school. Leora Friedberg is a professor of economics and public policy at the University of Virginia’s Frank Batten School of Leadership and Public Policy. The following are key points from their conversation.

Not Enough time, Not Enough Money

There are plenty of reasons why state and municipal pensions are sorely underfunded, and those reasons sound unnervingly familiar. Mitchell and Friedberg ticked off a list of ingredients reminiscent of other financial stews, including the collapse of the housing market. Like that event, the pension problem has been simmering for decades. Government administrators believed their investment returns would be bigger, and they believed retired employees would die sooner. They used overly optimistic actuarial assumptions, and they thought the long-term nature of the investments could handle higher risk.

They were wrong.

“It seems like there’s enough blame to point to everyone,” Mitchell said. “All of those different approaches proved wrong, especially after the financial crisis where state and local pensions lost 35% to 40% of their money. It’s true that things have been doing a little bit better in terms of their investments, but still the fundamental flaw is that over the years employees were offered a future benefit that was not properly collateralized.”

Mitchell said the problem is worsening because state and local governments have neglected to take corrective action.

“Every year that goes by leads to more red ink and more concern because the state and local plans across the country have clearly not done what they should have done to contribute the right amounts, to invest their assets in their pension plans carefully and thoughtfully,” she said. “Older folks are living longer and needing more medical care, needing longer retirement benefits. It’s a series of challenges that, frankly, nobody is paying much attention to.”

Friedberg said the problems with pensions are often inherent in the system, and they only compound.

“There aren’t strong incentives for the governments to actually take care of this … before it becomes a problem…,” she said. “After years of underfunding, some combination of taxpayers and state and local government workers bear the cost of that. We’ve already seen that going on for the last 10 years.”

In addition to the pension overhang, Friedberg noted, many states also face health insurance obligations that they aren’t adequately funding. Elected leaders are forced to increase taxes or cut spending to balance budgets thrown out of whack by pension debt, and the public workers are often vilified in the process.

“Politically, that ends up easier than dealing with the funding,” Friedberg said.

Money Problems Run Deep

Mitchell and Friedberg warned that the pension hole will swallow public- and private-sector employees alike, because all income earners will pay for it. Mitchell ran a simple calculation to illustrate her point: If the shortfall were $5 trillion, divide that amount by the 158 million workers in the American labor force for an obligation of about $32,000 per worker.

“That gives you a concrete sense of the shortfall that we’re facing,” she said. “A lot of people don’t have $32,000 for their own retirement, much less to pay for state and local workers.”

Mitchell also said that governments are probably underestimating pension debt because they are allowed to use whatever actuarial assumptions “that they feel like without any oversight from the federal government.” While states and municipalities are reporting that they are 72% funded, the real rate is closer to 45%, she said.

Broaden that to the federal level, where the impending shortfall in Social Security is well-documented, and the scope of the problem grows. Instead of $32,000 per worker, it’s about $171,000, according to Mitchell.

“I think the problem is one of political non-transparency and also of population aging,” she said. “You keep running unfunded or underfunded plans as long as you have a growing workforce. Our workforce is not growing as quickly as it should be or could be. Our productivity is not what it could be, and what it means is we are going to be supporting more and more retirees on fewer and fewer workers. That gets very expensive quickly.”

Save Your Pennies

The professors have some advice for public-sector workers who are counting on a pension — don’t.

They said workers should take control of their own retirements by saving often and early.

“I think they need to be aware that the benefits they’ve been expecting may not be there,” Friedberg said. “It depends on those states and how tight those legal obligations are. In some states, it’s written into the constitution. In other states, it’s not. And it’s not legally protected by the federal government in any way as private-sector pensions are.”

Governments sometimes manage pension debt by cutting benefits, postponing cost-of-living adjustments or extending the vesting period. Many states are also starting to require employee contributions, similar to a 401k.

“There’s some advantage to that because it makes workers aware of their own savings and it familiarizes them with investment in the stock market,” she said. “But we know from the history of the private sector and moving away from defined benefit plans toward 401ks that voluntary contributions often fall well below what workers need to replace their recumbent retirement.”

Governments have turned to other coping mechanisms, including shedding employees before they are vested or not filling vacant positions.

“I think it is undercutting the competitiveness of the public sector as a place of employment,” Friedberg said. “It was already the case that pay was often lower for comparable jobs, especially for high-skilled workers. The promise of the pension benefit was supposed to make up for that. If that promise is no longer being fulfilled, talented people will certainly go elsewhere.”

Indeed, some cities and states have turned to outsourcing items once thought of as strictly in the public domain. Mitchell pointed to the privatization of prisons and emergency services as examples. Governments that outsource don’t have to deal with a pension payout at the end of a worker’s career.

But those measures still aren’t enough, Mitchell said.

“The bigger issue is the so-called hidden borrowing problem that, when folks that hired teachers and firefighters and so forth 30 years ago, they didn’t pay them the full amount that would make their salaries as well as their pensions robust,” she said. “Instead, they underfunded the plans, leaving today’s taxpayers to pay for services that were rendered 30 years ago.”

Start with Transparency

Mitchell and Friedberg strongly believe that governments need to be more open with employees, citizens and investors about how they handle their pension plans. In turn, those stakeholders need to engage.

“I think the place to start is to begin with transparency,” Mitchell said, citing federal regulations that require corporate plans to report their financial promises and set aside money to meet those obligations. But decentralization means the federal government has no power to compel states to report liabilities and assets or to follow similar protocols.

Mitchell reiterated the point that, ultimately, everyone will pay. She referred to a recent study that contended property owners will be held responsible for unfunded liability through what could be considered a “stealth tax.”

“Twenty percent of your property value is already going to be liable to be covering these state and local pension shortfalls,” Mitchell said. “So, you can sell and move out of Chicago or Detroit, but there’s already that capitalization of the underfunding in the value of your house.”

Friedberg said insolvency comes down to constitutional issues. Citizens need to start asking the right questions, because it’s easy for politicians to “pass the buck.”

Sharing a personal example, Friedberg noted that her home city of Charlottesville, Virginia, operates its own pension fund for police and municipal workers.

“There’s not much information about it, so it’s hard to know [how it’s performing],” she said. “I’d be happier if the city of Charlottesville didn’t have to do this very complicated financial operation of running a pension fund.”

The professors agree that many of the proposed solutions being floated are unlikely to fill the pension hole because the only way to get bigger investment returns is to take on greater risk. The stock market is just too volatile for that.

“There’s no magic investments that states can make here to recoup the money. Just like we saw with the financial crisis, high risk means that at some point there are going to be big declines and they won’t be able to pay their bills,” Friedberg said. “The other problem with bonds is it pushes the problem off to the future, then it makes it harder to understand what the future obligations are.”
Wharton's Olivia Mitchell and Leora Friedberg of the University of Virginia discussed the $4.4 trillion public sector pension shortfall in a podcast which is available here. Take the time to listen to it.

I agree with the points raised by the professors. State and local plans have done a lousy job managing these public pensions and the federal government has no say in how they manage these pensions or how they estimate their liabilities using rosy investment forecasts that will never materialize.

I'm going to add to the discussion, however, because there are solutions to the looming pension crisis that need to be brought forth. These are structural solutions to shore up these plans over the long run:
  1. Eliminate contribution holidays, make them constitutionally illegal no matter how well funded the plans are.
  2. Stop using rosy investment forecasts or 20-year inflation averages to discount future liabilities. US public pensions need to get real, the 10-year Treasury yield now stands at 2.88% which tells you at best, you'll be lucky to earn 5%-6% annualized rate-of-return over the next ten years (and that's assuming there's no major bear market in stocks which lasts a couple of years). 
  3. Implement Canadian governance model: There's a reason why Canada's pensions are in great shape, they are overseen by independent and qualified boards that operate at arm's length from the government and they pay their senior pension executives extremely well to manage public and private market assets internally. While some think this is a gravy train, the long-term results and more importantly, the fully funded status of Canadian public plans speak for themselves.
  4. Adopt conditional inflation protection so the plan's risk is equally shared among active and retired workers. In Canada, when public pensions run into trouble, they share the risk by increasing the contribution rate and cutting benefits (typically by partially or fully removing  inflation protection) until the plan's fully funded status is restored. This is trivial cut to pensioners' payments but it's meaningful in terms of shoring up a plan, especially when there are as many or more retired members than active workers. Conditional inflation protection has the added advantage of making a more mature plan like the Ontario Teachers' Pension Plan young again.
One last piece of advice, avoid shifting public sector workers to a defined-contribution plan at all cost, that's not a real pension, it's a recipe for disaster because the brutal truth on DC plans is they're too vulnerable to the whims and fancies of volatile stock markets and will expose millions of workers to pension poverty down the road.

What else? The problem in the US isn't just public pensions, private pensions aren't doing well either despite the "longest bull market in history" (such nonsense, take away global central banks pumping liquidity like crazy in these markets so corporations can continue buying back shares at a record pace and it would have the shortest bull market in history).

Fidelity likes pointing out that the number of 401(k) plan millionaires hit a new high, making it seem like everything is fine, but the truth is there is a lot of pain out there, especially among America's seniors, many of which are declaring bankruptcy in their golden years.

In fact, Lynn Parramore, Senior Research Analyst at the Institute for New Economic Thinking, recently interviewed professor Teresa Ghilarducci, Chair of the Department of Economics at The New School’s New School for Social Research and a nationally-recognized expert in retirement security on why America’s broken retirement system is a recipe for political chaos:
As stocks go up and unemployment comes down, an increasing number of older Americans find themselves dodging bill collectors and spiraling into debt. Many warn of severe economic repercussions if this continues. But there’s more—large swaths of downwardly mobile seniors who thought of themselves as middle class is also a recipe for political chaos. Economist Teresa Ghilarducci, an expert on retirement security and Director of the Schwartz Center for Economic Policy Analysis at The New School, explains what’s happening and what’s at stake if we don’t fix it.

Lynn Parramore: A new report shows that American seniors are filing for bankruptcy at three times the rate that they did in 1991. But headlines say the economy is humming. Why are older people so broke?

Teresa Ghilarducci: The rise of the elder bankruptcy rate is no surprise, even if unemployment is low and stock values are up. Poor elders have terrible job prospects and very few households hold significant amounts of stock, bonds, and other financial assets. The erosion of retirement income security started decades ago.

LP: Can you explain what happened?

TG: In 1983, Congress and the President [Reagan] decided to restore Social Security solvency by cutting benefits and raising revenues equally. The FICA tax [Federal Insurance Contributions Act tax] was raised slightly and benefits were cut by raising the age people can collect full benefits from 65 to 70.

LP: As a Gen-Xer, that has always stuck in the craw because those years of collecting Social Security were taken away before I was old enough to vote!

TG: That’s correct. Though the political principal of equal revenue boosts and benefits cuts sounded fair, it was a nonsense way to make policy. Cutting the solution in half makes as much sense as King Solomon’s solution to cut the baby in half.

In 1983, the system needed much more revenue and not benefit cuts since there was no sign that voluntary actions by employers and workers would make up for the cuts. “Raising retirement ages” is a benefit cut. People can collect Social Security at age 62 and for every year they wait until 70, benefits increase on an average 6.34% per year. Therefore, those who can wait get a large boost and those who have to collect before 70 have a lifetime cut of over 11%.

Also, all the signs that private plans would fail were right. Instead of employers making pensions more available, generous, and widespread, more and more companies shifted financial risks of retirement savings to workers through a cheaper and less generous kind of pension: the 401(k).

Despite the hope that the do-it-yourself retirement accounts—401(k)-type plans and individual retirement accounts (IRAs)—would mean more workers would have some source of income besides Social Security, the retirement plan coverage rates of prime- aged workers has fallen from about 70% to close to 50%.

LP: So half of all workers don’t have a retirement account of any kind?

TG: That’s right. Another sign our retirement system has failed is that the median account balance of all people—including those who have an account from their current job or a past job; no account at all on the eve of retirement (age 55-64); or people who worked a full career under the defined-contribution employer pension revolution with ever-increasing tax breaks—is only $15,000. The low median account balance is because half of older workers have no retirement account balances at all, no 401(k)-type plan or IRA.

Let me repeat: almost half of all workers nearing retirement age will have nothing but Social Security to rely on.

For the lucky half who have some account balance in a 401(k) type plan or IRA, their median balance is $92,000. Spread that amount over a person’s retirement life and it will pay for a cheap dinner and a movie once a month.

LP: What’s going to happen if large numbers of people run out of money in retirement?

TG: If we do nothing to reform the current retirement system, the number of poor or near-poor people over the age of 62 will increase by 25% between 2018 and 2045, from 17.5 million to 21.8 million. That means real hardship and expensive responses by state and local governments through emergency housing, food assistance, and Medicaid costs.

There is another effect if we do nothing that could have serious political ramifications: middle class workers becoming downwardly mobile. Inadequate retirement accounts will cause 8.5 million middle-class older workers—a whopping 40% of all middle class older workers (aged 55-64) and their spouses—to be downwardly mobile, falling into poverty or near poverty in their old age. This is unprecedented since Social Security was formed.

Boomers and G-xers will do worse than their parents and grandparents in retirement.

LP: What do you say to those who argue that the answer if for people to just work longer?

TG: Working into your mid-sixties and beyond is not going to save many people from poverty and downward mobility. The unfriendly labor market for older workers with low incomes and nonprofessional degrees tells a different story.

My research lab’s report documents the growth in older workers’ unstable and low-wage jobs from 2005 to 2015. By 2015, nearly 25% of older workers were in bad jobs—defined as those that require on-call work and low-wage traditional jobs that pay less than $15,000 per year. The share of workers ages 62 and over in bad jobs grew from 14% in 2005 to 24% in 2015.

LP: The American workplace is changing, with union membership in the private sector in the single digits, earnings of workers lagging behind gains in labor productivity and temporary, contract, and on-call work on the rise. Meanwhile, fewer workers get health or pension benefits through their jobs. How are we supposed to save for retirement in these circumstances? What ideas are out there?

TG: Richard Thaler just won a Nobel Prize for his work in behavioral economics, which has been very influential in shaping thinking on pension policy.

He advises that the government engage in “libertarian paternalism.” Instead of mandating pension coverage, Thaler proposes voluntary design changes to the current U.S. “do-it-yourself” system, which is spotty because it is voluntary on the part of employers and employees and requires individuals to direct their own commercial accounts.

But his “design” suggestions are more of the same. He proposes to have employers automatically enroll workers in a retirement plan the employer may (or may not) sponsor. Remember, less than half of employees have a retirement plan offered at work. Workers could opt out and many of the people who need coverage the most opt out for economic reasons, for instance women, and never get an employer contribution.

The second major design change he wants is voluntary “auto-esclation.” The idea here is that employers would automatically contribute all or a portion of their workers’ salary increases in their account. Unfortunately, auto-enroll and auto escalate only works for employees with stable jobs, no breaks in service, continual raises, and high incomes. According to many studies, one from the Urban Institute and a recent one of mine with graduate student Ismael Cid-Martinez, these voluntary features ensure that the tax breaks for retirement plans disproportionately go to the top 20% of workers.

The current voluntary, individual-directed, commercial system design leaves low and middle-income workers behind. Why? Because employers don’t want the expense and hassle of providing a retirement account to workers and may be afraid to offer one if their competitors don’t—a classic collective action problem. Unfortunately, unions are too weak to help employers coordinate and universally provide pensions.

LP: So despite his Nobel Prize, you think that Thaler has got it wrong. How would you help people save?

TG: I propose a retirement plan for all plan — a federal plan that mandates a prefunded layer on top of Social Security. A universal public option for retirement saving. The plan would be portable, accountable, low-fee, pooled and ensure a steady return. A mandated pooled plan is the best way to provide social insurance because no worker can go it alone or insure against employment, financial, investment and longevity risk by themselves.

The idea is to enhance the best features of the decentralized system while making up for its deficits. Hamilton James and I propose Guaranteed Retirement Accounts (GRAs) in our 2018 book Rescuing Retirement. A version of the same proposal was in my 2008 book (When I’m Sixty Four) and in a paper I published for the Economic Policy Institute in 2007. GRAs are universal individual accounts whose investments are pooled and they are funded throughout a worker’s career by employer and employee contributions and a refundable tax credit.

If the GRA plan were implemented today, we could prevent over 8 million elders from falling into poverty. But GRA wouldn’t be enough; we need a stronger Social Security system.

LP: Important that you also mention the need to expand Social Security. Can you explain how it would be possible? What do you say to people who argue that “we can’t afford that” or that Social Security is “running out of money”?

Social Security is fully funded until 2034. The Social Security Board of Trustees estimates that we will only be able to pay three-fourths of current benefits promised after that date if there are no adjustments. That is not insolvency or going broke. It is a potential shortfall, which depends heavily on wage growth and inequality, productivity, fertility, and immigration.

Social Security is designed to be updated periodically, so as time goes on it is always “running out of money” unless it is updated. The FICA tax has been increased 21 times in its 83-year-old history, typically every 2 years. But we have not increased the FICA tax in over 28 years! It’s time for a raise. Right now, the tax rate is 12.4%, split between employer and the employees. If we raise the FICA tax now to about 15%, the system could pay promised benefits for about 75 years. If we raise the earnings cap (now only $128,700) for Old Age and Disability insurance (Medicare tax is on all earnings) then we have revenue to raise the special minimum benefit for the poorest elders and prevent abject elder poverty.

The Social Security Administration has identified the impact of several major proposals to expand and strengthen Social Security—most involve revenue raises.

The reality is that we need both an enhanced Social Security system and an advanced funded layer. No country has provided a stable pension system just on a pay-as-you-go system. The Spanish, Greek, and Italian systems tried but they have moved away from a pay-as-you-go system as their aging populations cause the tax rates to rise to unsustainable political levels.

LP: What are the biggest obstacles to addressing the looming crisis and what are your thoughts on how to overcome them?

TG: Relying on personal thrift to ensure against the financial insecurity of old age has not worked. But the biggest obstacles to mandating a retirement account for all and improving Social Security are members of the industry that thrive on voluntary do-it-yourself retirement accounts. The 401(k) and IRA industry will be challenged by the existence of low cost and high return stable GRAs that offer low-cost lifetime annuities. The industry has fought the efforts at the state level to provide public retirement plan options.

I hope that America is not locked into an extreme, voluntary, market-based retirement income security system.

The most important obstacle to change is political. Workers and, by extension, older workers, need to act collectively and militantly to spur policymakers into action. Only large scale collective action with voting and organizing can get our representatives to build a system that ensures that the retired can live financial comfortable and stable lives.
What a fantastic interview, one that opened my eyes to the origins of the problem and what needs to be done to fix a broken retirement system. I thank Suzanne Bishopric for sending it to me.

Teresa Ghilarducci is a very smart lady who understands the problem well. I don't agree with the revolutionary retirement plan she has been peddling along with Blackstone's Tony James because while it has some advantages over the current system, it's still way too beholden to public markets.

I agree however that's it's high time for a universal pension but I'd like to see radical reforms in Social Security to enhance it and make it more like the Canadian system where the CPP Investment Board manages the assets of the Canada Pension Plan at arm's length from the government, investing across global public and private markets.

In order to fix America's broken retirement system you need to increase Social Security benefits now and fix the system to make it better and more sustainable over the long run. This should involve some form of shared risk when it runs into trouble.

To increase Social Security benefits, you need to increase taxes on the top 1% of income earners and that's where politics comes into play.

For decades, the super-affluent were able to buy Congress to advance their agenda but the limits of inequality are being tested and if Teresa Ghilarducci is right, older Americans will mobilize to advance their agenda, and top of that agenda will be to increase Social Security benefits.

If we don't increase Social Security benefits, more people will fall into pension poverty, economic growth will be anemic, deflation will rear its ugly head, and then it's game over for capitalists and labor.

Chew on that thought as you ponder America's broken retirement system.

Below, Teresa Ghilarducci explains why it's time to kill 401(k) plans and replace them with guranteed retirement accounts (GRAs). And Tony James, Blackstone president & COO, talks about his proposal to tackle the looming retirement crisis in the US by replacing the traditional 401(k) with guaranteed retirement accounts.

I disagree with James, think enhanced Social Security based on the Canadian model (CPPIB managing CPP assets) is enough to fix America's broken retirement sytem but you need to raise taxes on the Jameses, Schwarzmans, Gates, Bezos of this world -- basically the power elite who govern the country -- and introduce real, independent governance models to ensure the solvency of Social Security for generations to come.


Tuesday, August 28, 2018

The End of Greece's Bailout?

Yanis Varoufakis, co-founder of DiEM25 and the former finance minister of Greece, wrote an op-ed for the Guardian, Greece was never bailed out – it remains locked in an EU debtor's prison:
Over the past week, the world’s media have been proclaiming the successful completion of the Greek financial rescue programme mounted in 2010 by the European Union and the International Monetary Fund. Headlines celebrated the end of Greece’s bailout, even the termination of austerity.

Buoyant reports from ground zero of the eurozone crisis portrayed Europe’s eight-year long Greek intervention as a paradigm of judicious European solidarity with its black sheep; a case of “tough love” that, reportedly, worked.

A more careful reading of the facts points to a different reality. In the very week that a devastated Greece entered another 42 years of harsh austerity and deeper debt bondage (2018-2060), how can the end of austerity and Greece’s regained financial independence be presented as fact? Instead, last week should be cited in our universities’ media schools and economics departments as an example of how consent can be built internationally around a preposterous lie.

But let’s begin by defining our terms. What is a bailout and why is Greece’s version exceptional and never-ending? Following the banking debacle in 2008, almost every government bailed out the banks. In the UK and US, governments famously gave the green light to, respectively, the Bank of England and the Federal Reserve to print mountains of public money to refloat the banks. Additionally, the UK and US governments borrowed large sums to further aid the failing banks while their central banks financed much of those debts.

On the European continent, a far worse drama was unfolding due to the EU’s odd decision, back in 1998, to create monetary union featuring a European Central Bank without a state to support it politically and 19 governments responsible for salvaging their banks in times of financial tumult, but without a central bank to aid them. Why this anomalous arrangement? Because the German condition for swapping the deutschmark for the euro was a total ban on any central bank financing of banks or governments – Italian or Greek, say.

So, when in 2009 the French and German banks proved even more insolvent than those of Wall Street or the City, there was no central bank with the legal authority, or backed by the political will, to save them. Thus, in 2009, even Germany’s Chancellor Merkel panicked when told that her government had to inject, overnight, €406bn of taxpayers’ money into the German banks.

Alas, it was not enough. A few months later, Mrs Merkel’s aides informed her that, just like the German banks, the over-indebted Greek state was finding it impossible to roll over its debt. Had it declared its bankruptcy, Italy, Ireland, Spain and Portugal would follow suit, with the result that Berlin and Paris would have faced a fresh bailout of their banks greater than €1tn. At that point, it was decided that the Greek government could not be allowed to tell the truth, that is, confess to its bankruptcy.

To maintain the lie, insolvent Athens was given, under the smokescreen of “solidarity with the Greeks”, the largest loan in human history, to be passed on immediately to the German and French banks. To pacify angry German parliamentarians, that gargantuan loan was given on condition of brutal austerity for the Greek people, placing them in a permanent great depression.

To get a feel for the devastation that ensued, imagine what would have happened in the UK if RBS, Lloyds and the other City banks had been rescued without the help of the Bank of England and solely via foreign loans to the exchequer. All granted on the condition that UK wages would be reduced by 40%, pensions by 45%, the minimum wage by 30%, NHS spending by 32%. The UK would now be the wasteland of Europe, just as Greece is today.

But did this nightmare not end last week? Not in the slightest. Technically speaking, the Greek bailouts had two components. The first entailed the EU and the IMF granting the Greek government some financial facility by which to pretend to be repaying its debts. Then there was the harsh austerity taking the form of ridiculously high tax rates and savage cuts in pensions, wages, public health and education.

Last week, the third bailout package did end, just as the second had ended in 2015 and the first in 2012. We now have a fourth such package that differs from the past three in two unimportant ways. Instead of new loans, payments of €96.6bn that were due to begin in 2023 will be deferred until after 2032, when the monies must be repaid with interest on top of other large repayments previously scheduled. And, second, instead of calling it a fourth bailout, the EU has named it, triumphantly, the “end of the bailout”.

Ridiculously high VAT and small business tax rates will, of course, continue, as will fresh pension cuts and new punitive income tax rates for the poorest that have been scheduled for 2019. The Greek government has also committed to maintaining a long-term budget surplus target, not counting debt repayments (3.5% of national income until 2021, and 2.2% during 2022-2060) that demands permanent austerity, a target that the IMF itself gives less than 6% probability of ever being attained by any eurozone country.

In summary, after having bailed out French and German banks at the expense of Europe’s poorest citizens, and after having turned Greece into a debtor’s prison, last week Greece’s creditors decided to declare victory. Having put Greece into a coma, they made it permanent and declared it “stability”: they pushed our people off a cliff and celebrated their bounce off the hard rock of a great depression as proof of “recovery”. To quote Tacitus, they made a desert and called it peace.
Varoufakis writes well and even though he's right that the bailout was a sham to save German, French and Greek banks, he also embellishes and worse, he's a master of half-truths.

You see, while Varoufakis calls out Trump for being a right-wing egomaniac, he's a left-wing egomaniac who loves to listen to himself speak as if he's a great Greek oracle enlightening us about the Greek economy and its debt situation.

I happen to think Yannis Stournaras, the current Governor of the Bank of Greece, is a lot smarter and a much better economist than Varoufakis, but he's not an international "rock star" sounding off in the media to advance his personal agenda.

Where do I disagree with Varoufakis? First, go visit Greece today, it's hardly in a "coma" or a "permanent great depression". Sure, the country is a lot poorer and there are serious problems (youth unemployment being the biggest) but Greeks are enjoying their lives and have come to accept that they need to live with lower wages and pensions.

More importantly, Varoufakis rails against "ridiculously high VAT and small business tax rates" but fails to state that SYRIZA led by Greek Prime Minister Alexis Tsipras has increased the size of the public sector.

The austerity Varoufakis talks about has been disproportionately borne by the Greek private sector. Taking his cues from Andreas Papandreou, his mentor, Tsipras wasted no time in significantly expanding the public sector at a time when the country is still heavily indebted. That's why he's taxing the hell out of small businesses.

Being a left-wing charlatan, Varoufakis decided to ignore this truth and belabor the fact that poor Greeks are suffering under the never-ending wrath of austerity (they're not).

It's sickening, truly sickening, and Greeks deserve what's coming to them because they will never learn until they kill that profligate public sector beast once and for all.

The problem is no Greek politician dares to talk about major cutbacks in the public sector because it will mean a sure loss. I happen to think New Democracy leader Kyriakos Mitsotakis is exactly what the country needs right now but I'm afraid he will be fighting constant battles with public sector unions who yield tremendous power.

It's pretty much the same situation everywhere in Europe but Greeks have taken it to another level. I'm neither right-wing nor left-wing in my ideology but I believe in the primacy of the private sector. Unless you have a thriving private sector, you cannot have a growing public sector that keeps growing and threatening the economy in the long run.

That's not just a Greek problem, this is increasingly a problem everywhere, just look at what happened to Ontario over the last eight years.

More importantly, and mark my words on this, the Greek debt boomerang will come back to haunt us over the next three years. And I'm being generous here, some think it will be sooner.

Daniel Lacalle wrote an interesting blog comment recently stating Greece's problems are far from over:
Greece has exited bailout territory and the European Union is making a strong case of the success of the program.

While Greece has obviously ended its bailout process, the real issues of the Greek economy remain largely intact.

The real drama is that none of the measures implemented have solved Greece’s real problems. No, it’s not the euro or the austerity plans. It’s not the cost or maturity of its debt. Greece pays less than 2.3% of GDP in interest expenses and has 16.5 years of average maturity in its bonds. In fact, Greece already enjoys much better debt terms than any sovereign re-structuring seen in recent history.

Greece´s problem is not one of solidarity either. Greece has received the equivalent of 214% of its GDP in aid from the Eurozone, ten times more, relative to the gross domestic product, than Germany after the Second World War.

Greece’s challenge is and has always been one of competitiveness and bureaucratic impediments to creating businesses and jobs.

Greece ranks number 81 in the Global Competitiveness Index, compared to Spain (35), Portugal (36) or Italy (49). In fact, it has the levels of competitiveness of Algeria or Iran, not of an OECD country. On top of that, Greece has one of the worst fiscal systems, with a very high tax wedge that limits job creation with a combination of aggressive taxation on SMEs and high bureaucracy. Greece ranks among the worst countries of the OECD in ease of doing business (Doing Business, World Bank) at number 61, well below Spain, Italy or Portugal.

No, it’s not the euro. Greece’s average annual déficit in the decade before it entered the euro was already 6%, and in the period it still grew significantly below the average of the EU countries and peripheral Europe.

Between 1976 and 2012 the number of civil servants multiplied by three while the private sector workforce grew just 25%. This, added to more than 70 loss-making public companies and a government spend to GDP figure that stands at 48%, and has averaged 49% since 2004, is the real Greek drama, and one that will not be solved easily.

One thing is sure, the Greek crisis will not finish by raising taxes to businesses, nor making small adjustments to a pension system that remains outdated and miles away from those of other European countries.

The inefficacy of subsequent Greek governments and Troika proposals is that they never tackle competitiveness and help job creation, they simply dig the hole deeper raising taxes and allowing wasteful spend to go on.

From a market perspective, the risk is undeniably contained, but not inexistent. Less than 21% of Greek debt is in the hands of private investors. Most of the country´s debt is in the IMF, ECB and EU countries’ hands.

The main risk for the Eurozone, which is already showing signals of slowdown, comes from a prolonged period of no solutions.

Greece still shows the highest non-performing loan figure relative to total loans of the eurozone.


While deficits have been contained-mostly by raising taxes-, public debt has not fallen.


The tax wedge is one of the highest in the eurozone and the OECD, making Greece and uncompetitive country in terms of job creation and attraction of capital.


While unemployment has fallen, it is still the highest in the eurozone, and unlikely to be solved with such high tax wedge.


Greece’s problem is not the euro or austerity. It is a problem of a system that penalizes job creation and private enterprise to subsidize a monstrous bureaucracy and political spending.
Lacalle is absolutely right, the main problem in Greece over the last 40 years has been the disproportionate growth of the public sector relative to the private sector as each successive government promised "goodies" to public sector unions and effectively bought votes by increasing the size of the public sector.

SYRIZA is doing what every other Greek government has done in the past, namely, increase the public sector every chance they get to buy votes.

Sound familiar? This is going on everywhere which is why we are in for a prolonged period of low growth and low rates as there's simply too much debt out there, fiscal austerity will come no matter who's in power.

Those of us who know and love Greece know exactly what the country needs, major reforms to increase competitiveness and attract foreign investors but don't hold your breath, in a country like Greece, pettiness rules the day and everyone has their hand in the cookie jar, fighting for crumbs.

And while I'm critical of Greeks who keep voting in clowns to govern them, I'm also critical of Germans who are playing stupid while they suck the rest of Europe dry, benefitting the most from the Eurozone without doing anything to ensure its long-term survival.

Europe is a disaster waiting to happen, and when the music stops, the dominos will fall and the repercussions will be felt across the globe.

So, I wouldn't say it's the end of Greece's bailout, just a reprieve, the Greek debt boomerang will come back to haunt us sooner than we think.

Lastly, Bridgewater's Ray Dalio was on LinkedIn peddling his new book, A Big Debt Crisis, which comes out on September 10th:


Ray will be giving it away free in a PDF file and make it available as an eBook or hard copy via Amazon. If you want to get a copy you can click the link here.

I couldn't resist my tongue-in-cheek reply on LinkedIn:
"Ray, go visit Greece, enjoy some ouzo and grilled octopus, talk to the locals, you’ll learn all about the big debt crisis. September is actually the best time to visit, the weather is perfect, the mad herd clamoring to visit Santorini and Mykonos is gone. Go visit my ancestral home, Crete, then visit less well-known islands like Milos, Kefalonia and Antiparos where Tom Hanks has a summer home. Enjoy! "
Below, former Greek Finance Minister Yanis Varoufakis said the euro system is "absolutely not" sustainable as he condemned the eurozone for putting economic burdens on "the weakest of shoulders" across the European Union.

Varoufakis recently sat down with STV's Political Editor Bernard Ponsonby to talk socialism, populism and Scottish independence.

Interesting discussion but I can only take Varoufakis in small doses, he's still the same pompous jerk he was back at the height of the crisis and his approval ratings in Greece have plumetted as many blame him for making a bad situation far worse (indeed, Greeks call him Varoufianos, something not to be translated in polite company).


Monday, August 27, 2018

The Canadian Student Housing Market?

Jonathan Turnbull, Managing Partner at Alignvest Student Housing, sent me a guest comment on insitutional grade student housing investment opportunities in Canada:
Student Housing is a specialized segment of the residential real estate sector and is broadly defined to include multi-tenant housing designed to accommodate students enrolled in post-secondary education.

Student Housing is a well-known sector to global investors who have invested over $15 billion a year since 2015 acquiring properties all over the world (current year volume expected to be similar).

The segment has evolved into a $200 billion market because of two major long-term statistical trends and one fundamental shift in consumer behavior.

Major statistical trends:
  1. global student enrollment growth far exceeds global population growth because of (a) the growing importance of a post-secondary education and (b) the growth of the global middle class and mobility of international students; and,
  2. universities/colleges have directed their limited funding towards academic capacity growth and not new on-campus beds.
The increase in demand for beds has not been met by traditional supply and the market has turned to the private sector for new beds.

The shift in student/consumer behavior:

The typical student (and their parent) is seeking a different experience for their post-first-year school accommodations – one that is safe, community-based, offers high-quality living accommodations, student-oriented amenities and a productive learning environment given the importance (and cost) of the education. Around the world, we have watched as students have moved away from traditional off-campus housing (shared homes, basement apartments, cheap/cramped spaces) to new, secure, modern, highly-amenitized accommodations within walking distance of school.

The student housing sector has experienced tremendous growth in demand over the past 20 years which has been matched in certain markets by a similar growth in the supply of private beds. The typical institutional grade off-campus student housing currently being built offers its tenants high-quality accommodations that caters to students’ increasing demands, including: close proximity to campus, high-end design and common areas, secure/safe design (individual key-fob access), fully furnished private bedrooms, private bathrooms, shared living/dining/kitchen area for 2-5 tenants equipped with high-end appliances and furniture, in-suite laundry, high-speed internet access, common areas/cafes, study areas, board rooms for collaborative studies, games rooms, theatres, exercise facilities, etc. The environment created by the facilities and the operator make the students “want to live in these new facilities” relative to the older, more traditional housing options.

In addition to supply growth, the sector has experienced a tremendous improvement in its investment and operating expertise (learning from mistakes) that has de-risked the sector dramatically over the past decade. The original investor concerns about the student housing sector (including the perceived risks of high annual turnover, low tenant quality and high risk of property damage) have been eliminated by strong and consistent operating performance. The original concerns have been replaced by the reality of almost 20 years of operating history:
  • High turnover risk can be managed proactively by good operators
    • Turnover is known early in the lease cycle - vacancy rates have been consistently low
    • 12-month tenant leases have become the norm (vs 8mos)
    • Turned into a positive – easier to drive topline growth (new tenants at market price)
  • Parental guarantees make the tenant quality better than typical residential real estate
  • Student behavioral shift & investment/operating strategy has reduced risk of damage
    • Cost of school and importance has changed mindset of the average student
    • Furnished suites & security cameras (combined with parental guarantees)
The net operating results speak for themselves - 50 consecutive quarters of same property revenue growth, lower revenue and net operating income volatility than multi-family apartments as well as lower market correlation compared to various real estate asset classes.

The sector’s long-term macro opportunity and results-to-date have attracted substantial global investment into the sector. The ownership structure of the sector has changed dramatically with smaller owner/operators being consolidated by larger entities which have, in turn, been purchased recently by global investment leaders that have pushed valuations to all-time highs.

Valuations have tracked the market’s perception of the business opportunity – shifting from being ‘at a discount’ to the multi-family sector to be priced equal to or at a premium to the multi-family sector. Recent large-scale acquisitions have been completed at historically high valuations despite expected near-term interest rate increases because investors believe the sector can disproportionately grow its cash-flows due to the proven operational element of the business (click on image).


The Canadian Market

The Canadian student housing market is one of a few in the world that has yet to attract substantial institutional capital to consolidate and grow the business.

Market fundamentals are strong -- Canadian student housing supply/demand dynamics are as attractive, if not more so, than its OECD peers. Canadian university population growth is faster than established markets such as the US and UK, driven by increased local student participation and Canada’s disproportionate share of the growing international student population. Similar to their global peers, Canadian universities do not have the capital necessary to build new beds to service the increased demand and therefore more off-campus beds are needed every year in university cities/towns.

Supply limited to date -- Historically that increased demand has been met by traditional student housing options such as low-density home rentals as well as basement apartments. The large-scale development of purpose-built student accommodations has not yet occurred in Canada for various reasons. Local developers and investors have built 30,000 total PBSA beds (3% of student population) in attractive ‘pockets’ around the country but the ownership is fragmented and often in the hands of short-term sellers (developers vs owner/operators). Annual new purpose-built construction is estimated to provide under one-third of the total new beds required from increased enrollment at universities in Canada.

Investment opportunities have been limited to date -- As outlined above, the lack of institutional capital focused on the sector has restricted the development of high-grade / high-governance investment vehicles focused on consolidating and growing the fragment industry. Large real-estate investment firms have been cautious to invest given the heavy operational element of the business.

The largest real estate investors in Canada, the pensions, have shown a love for the sector in other countries; however, those investments have been in fully consolidated markets into operating companies worth hundreds of millions/billions of dollars. The roll-up strategy in Canada (aggregating a large portfolio of $10 - $50 million buildings) could prove to be an attractive long-term strategy for a real-estate investment team that understands the operating element of the business and is able to be a first-mover into the sector as current valuations in the sector are still at substantial discounts to local multi-family apartments. The investment sector is a proven winner in markets around the world and should be as well in Canada.
I thank Jonathan Turnbull for writing such an insightful comment on the Canadian student housing market.

Jonathan is right, Canada's large pensions have invested billions in student housing around the world but mostly in the US and the UK. In 2017, I wrote a comment on CPPIB and GIC betting on US college housing, but PSP and other large pensions are also big investors in this space.

I take a bit of a macro/ thematic view when it comes to student housing over the long run. In particular, the world is becoming ever more competitive, rising inequality will continue, wealthy families around the world are sending their kids to universities in the US, UK, Canada, and elsewhere and they want to know their children are safe and enjoy the best amenities so they can focus their attention 100% on learnng and doing well in school.

In other words, student housing has secular winds supporting it, and it's relatively recession-proof because even during an economic downturn, parents will do everything to send their kids to university to learn.

Having said this, like all investments there are risks here too. Jonathan touched on a lot of them. Valuations are rich, interest rates might rise (I doubt it), and student housing has been a notorious nightmare for property managers in the past (but these issues are being addressed properly now).

As far as Canada, the only other fund I can think of in the space is Centurion Asset Management based in Toronto and founded by its President and CEO, Greg Romundt (a former derivatives trader and one hell of a sharp guy).

But Centurion doesn't exclusively focus on student housing, it also focus on multi-family residences and the fund caters mostly to retail investors (it's RRSP eligible) but it also has institutional investors.

Other issues in Canada? In 2016, an article described how Waterloo is facing sizable glut of student housing:
The oversupply of student housing in this city is far worse than previously thought, says an expert who tracks the investment real estate market.

One of the new student apartment buildings in the university town already is in power of sale proceedings, Karl Innanen, managing director of the Waterloo Region office of Colliers International, said Wednesday.

Currently, there is an oversupply of nearly 1,200 beds, but when new developments that are in the works are included, the surplus increases to 8,321 beds, Innanen said during the commercial real estate firm's presentation of its annual report on market trends.

Innanen said the Colliers analysis does not take into account increases in the student population because the University of Waterloo, Wilfrid Laurier University and Conestoga College are forecasting low single-digit growth in enrolment.

That rate of increase won't be nearly enough to absorb the extra beds, he said.

There are 41,440 university and college students in Waterloo, Colliers said. When you take away students who commute to campuses, that number drops to 31,429.

The Waterloo skyline is dotted with construction cranes for student apartment buildings. When those buildings are completed, the supply of beds will overshoot the market by 20 per cent, said Innanen.

"I think the student market was overbuilt because people got overzealous and there was no discipline," he said in an interview. "Unfortunately, it was a rampant supply of brand new, nice buildings."

Innanen believes newer buildings with modern amenities that are close to the campuses will remain full. That will create problems for student apartment buildings that are not as nice and not as close to the campuses.

At least one recently built student building is now in power of sale proceedings — a forced sale by the financiers to recoup their investment after the owners fell behind in payments.

"That is not a good sign at all, and we expect to see more of that, unfortunately," Innanen said. "There are going to be some real challenges going through that."

Buildings in power of sale proceedings typically sell for lower prices, which creates opportunities for other investors. But the oversupply is a complex problem to unravel, he said.

The buildings "are new, they are nice, they are attractive," he said. "Will they be in places where nonstudents want to live? Will they be in places where young professionals want to live? Possibly. We will have to see how that evolves."

Some of the student apartment buildings contain five-bedroom units. "To convert a five-bedroom unit into a two-bedroom or three-bedroom unit for a family to move into is also difficult," Innanen said.

And mixing students with nonstudents could be problematic. "Will a family want to live in an area that is predominantly a student area?"

But City of Waterloo planners are optimistic the Northdale neighbourhood, where many student apartment buildings are located, will evolve into a mixed use area with a variety of residents.

In recent years, about $600 million was invested in new, multi-unit housing in that area, said Ryan Mounsey, a planner in the city's economic development office. Between 33 and 50 per cent of the residents in the new buildings are nonstudents, he said.

The city spent millions on new streets and parks in Northdale, and changes along nearby streets should also have positive impacts for the student-dominated area, said Mounsey.

The arrival of light rail transit next year and the evolution of the Phillip Street corridor into the Idea Quarter, consisting of a mix of technology companies, retailers and residential developments, will also attract nonstudents to that part of the city, he said.

The market for student apartment buildings was the only dark spot in Collier's report on real estate trends in the region.

Last year was the second best year on record for real estate investment, with more than $900 million in investment sales. The surge in investment was driven by demand for apartment properties.

"This year there were more than $300 million in sales of apartment buildings," Innanen said. "That's three times a usual year."

As the local investment market has grown the type of investor has changed.

"We have institutional investors here now," Innanen said. "We have REITs (real estate investment trusts), pension funds, groups that buy big properties."

Toronto-based Allied REIT and San Francisco-based Spear Street Capital both moved into the region's real estate market in significant ways in recent years.

"Those big, blockbuster deals have really changed the market and made everybody look at this market," Innanen said. "It is certainly secondary to the prime markets across Canada, but it is not one that anyone overlooks anymore."
I had sent this article to Jonathan Turnbull back in July and he was kind enough to share these views with me prior to writing the guest comment above:
I think the Waterloo market, as the largest PBSA market in Canada, is “full of stories”… We have seen many versions of this story over the past couple of years and have done our own extensive diligence on the market (including the development of a proprietary database of over 180 different student oriented rental buildings close to the two schools) and have a different view than the author of the article. We actually think negative articles/comments is to our advantage – keeps others away from the largest and possibly best market in the country that is growing by 1,300+ new tenants each year (students at WLU and UW).

There is negative press in the Waterloo market about being over-built…we believe the commentary is being driven in large part by (1) owners of second/third tier beds that use to command $500-600/bed/month as well as (2) certain owners/investors of recently built condos focused on renting their 1-2 bedroom units to students that have experienced a decline in rental price per bed. Group (1) tells everyone the place is over-built because they are no longer getting the rents the once did - they are being squeezed out because of quality/location whereas quality PBSA assets are 95%+ filled with growing rental rates. Group (2) investors are talking about the decline in monthly rents because their ‘2 years of guaranteed monthly rental streams (set artificially high by the project developer to attract investors) are expiring and the $950 a bed they use to get (funded by the developer) is now at market rates ($850)…demand at market rates is firm as students never paid $950/bed.

Analytical View:

Happy to discuss hard-core numbers/analytics surrounding (1) the growth in Waterloo’s student population (higher numbers than in the article), (2) the decline in commuting student percentage given the increase in out-of-province and international student %, and (3) the substantial decline in licensed rental beds (from 12,000 to 5,000) in the entire Waterloo market (driven by the better/safer/closer options provided by the growing PBSA market). We have dedicated substantial resources to such proprietary work. There is also another trend we are experiencing globally  a fundamental shift in the characteristics of what students are looking for in their accommodations which is a powerful trend which benefits new, institutional grade buildings with student oriented amenities. The days of being happy with an old basement apartment 2 km from school has been replaced with the current generation of student’s desire to live in a nicer student oriented apartment close to school.

Practical View:

If things were over-built…the following would NOT hold true. The building we are closing in mid-July is 99% occupied for sept-18 to sept-19 (with 12 month leases at an 8% average increase in NEW Leases). It has been almost 95% occupied for the 2018/19 school year since Feb 8 of 2018…effectively sold out in under two months. We are in negotiations with 3 other class A PBSA buildings in Waterloo: one is 99% pre-occupied for the ‘18/’19 school year and the other two are both over 96%. I am aware of two other properties for sale that I am not a big fan of (don’t like the location) – one is 100% occupied and the other is 90-91%. If the market was over-built, we wouldn’t have been 95-98% occupied THAT quickly at 8% higher rents

The converted low-density homes are being squeezed out and they are no longer renting to students (12,000 licensed beds now closer to 5,000). Those ‘lost’ homes are likely now being occupied by families/young professionals (growing market similar to student). Pricing has remained firm for high-quality PBSA over the past few years during the surge in construction (supply has been absorbed by student growth, elimination of licensed rental units and the shift in student preferences/budgets). Lastly, there is limited additional construction ‘space’ in areas close to the school – helping ensure the pricing leverage will stay with the high-quality PBSA that is currently close to the school. The current rental market environment for high-quality PBSA close to the school should therefore remain firm for many more years.

The below graphic highlights the typical US PBSA occupancy pattern during the year…I have layered on the asset we are acquiring in Waterloo to give you a sense of the quality of the asset and the market demand. It shows that the average US market ‘fills-up later in the year’ than our soon to be acquired asset.

Once again, I thank Jonathan Turnbull of Alignvest Student Housing for providing my readers a lot of great insights on the Canadian student housing market.

I know this is a very popular space but Canada has some catching up to do relative to the US and UK, so I would advise my readers to discuss further with Jonathan if you require more details.

Below, marble countertops, stainless steel appliances, individual bed and bathrooms, a pool and hot tub - that's what you'll find at the two new student housing complexes at University of Louisville. Students are looking at colleges with an eye on where they'll live on campus and UofL is building the high end apartments to compete for top students.

Yeah, things have changed a lot since my time at university and I doubt there are any student housing complexes in Canada that compare to this but I may be wrong.

Still, student housing is a big deal to attract foreign and domestic students to a university, so keep an eye on this market abroad and at home.