Wednesday, October 31, 2018

The Danger of Cutting DB Pensions?

Diane Oakley, executive director of the National Institute on Retirement Security, a non-partisan research non-profit in Washington, D.C., wrote a great column for Forbes, The Dangerous Consequence Of Cutting Public Safety Pensions:
Management consulting firm McKinsey reports that organizations that appear on “best places to work” lists often make the cut because their business strategy is premised on a long-term relationship with their employees. McKinsey credits companies for both the large and small signals sent to employees that an organization cares about its people.

Valued by employers as a workforce management tool to recruit and retain talent, offering defined benefit (DB) pension benefits is one way that employers send a loud signal to employees that they are committed to a long-term relationship. The structure of a pension increases the financial value of a DB pension benefit over an employee’s career. This provides a meaningful incentive for employees to stay in their jobs. Research indicates that employees value pensions as a path economic security in retirement, especially as compared to individual defined contribution (DC) accounts.

Offering pensions is particularly important in the public sector where salaries are low and employers can’t offer benefits like stock options. The recruitment and retention effects of pensions are key reasons why the public sector has maintained this type of retirement plan, especially for public safety officers.


I recently attended a Florida Public Pension Trustees Association (FPPTA) conference and met some of the individuals closely involved in one of the most disruptive public pension reform efforts in the country. The story of what happened should be required reading for all public officials dealing with workforce issues. The outcome was predictable for those who closely study public sector pensions.

In 2012, the Palm Beach Town Council ignored the predictions of its police and firefighters and voted to cut pension benefits to roughly one-third of their prior value while adding a 401(k)-like DC plan to its benefit package. That action destroyed the long-term value proposition that played a fundamental role in retaining the police officers and firefighters.

It’s important to provide context. Before the market crash, the Town of Palm Beach attracted and retained its public safety officers largely because these workers understood the long-term value of their pensions. In fact, Palm Beach strove to offer the best public pensions in Florida. This makes sense given that public workers often are willing to sacrifice pay in the short-term in exchange for retirement security.

But things changed in the wake of near collapse of the financial markets in 2008, which left states and municipal governments with deep fiscal problems. Declining property values put cost pressure on government services. Across the country, public employees faced layoffs, hiring and salary freezes, or benefit reductions.

Like all investors, public pensions were hit hard by market losses, and pension benefits became targets for cuts. Using the financial crisis as an opening, advocates for pension reform recommended cuts to the town’s pensions for public safety officers, as well as all other employees.

What followed was months of heated debate in town council meetings that played out in the press. In April 2012, council members failed to heed the warnings that drastic pension cuts benefits would fuel attrition, and they voted to close the existing DB pension systems for police officers and firefighters. The new “combined DB/DC” retirement system offered only a fraction of its prior pension benefit and individual 401(k)-type accounts with a 100 percent employer match of employee contributions.

The impacts were swift and deep. By “freezing” the pensions of 120 police officers and firefighters, 20 percent of the town’s workforce elected to retire right away. What followed was a mass exodus of employees.


Media reports detailed the loss of 42 public safety officers in 2012 and into 2013. Over the  first four years of the combined DB/DC plans, 109 public safety officers left before retirement.

The departure of experienced public safety officers in Palm Beach was unprecedented. Some 53 vested police officers and firefighters left from 2012 to 2015, compared to just two officers in the prior four years from 2008 to 2011. This created high stress levels and physical demands from overtime for those who stayed.

Meanwhile, 56 rookie replacement officers left the Palm Beach police force  before their benefits vested. Each departure left Palm Beach with an estimated $240,000 price tag for training police and firefighters who took their skills elsewhere.


The Palm Beach experience offers an important cautionary tale for other governments considering changes to pension benefits. The switch from a DB pension to a DC retirement savings accounts was an abject failure in Palm Beach. The DC plan actually encouraged officers to leave their town rather than stay.

Faced with shortages of public safety workers and higher costs, the town council in 2016 voted to restore pensions for police officers and firefighters by more than doubling the DB benefit formula and lowering the retirement age. To help offset the cost, the town increased employee contributions and eliminated the matching 401(k)-style plan.

While at the Florida pension trustee conference, one of the Palm Beach attendees told me that high turnover among public safety workers is still a problem. Some 41 police officers have separated from the Town of Palm Beach since 2015. He  shared with me the Palm Beach Daily News editorial from earlier this summer indicating that the high turnover “should be unacceptable, especially to anyone who remembered when Palm Beach led in pay and had career officers who knew and cared about the town.”

So McKinsey had it right. To be the best place to work, employers must signal to employees that they are valued over the long-term. Cutting a pension sends the exact opposite message. Even after reversing a bad decision, Palm Beach is still paying the price for its short-sighted decision. The pension restored, rebuilding trust among its public safety officers indeed will take time.
No doubt about it, McKinsey had it right, to be the best place to work, employers must signal to employees that they are valued over the long-term and cutting pensions sends the exact opposite message.

A recurring theme of this blog is the brutal truth on DC plans. People aren't stupid, they don't want a 401(k)-like defined-contribution (DC) plan, they want a gold-plated defined-benefit (DB) plan so they can retire with dignity and security knowing no matter what happens in the bloody stock market, they won't outlive their savings.

The problem is that not all DB plans are created equally. In Canada, our large (and many smaller) public-sector DB plans are in great shape because they got the governance and risk-sharing right. The governance allows them to attract top talent to their pension to manage more assets internally across public and private markets.

The risk-sharing allows them to spread the risk of their plan across active and retired members and the government and importantly, it keeps intergenerational equity. Typically, Canada's large DB plans like OTPP and HOOPP have adopted conditional inflation protection so when their plan experiences a deficit, not only are contributions raised but benefits are cut by partially or fully removing inflation protection. It also makes a mature plan like OTPP young again.

There is no secret sauce to the success of Canada's large pensions. It's all hard work and tackling both assets and liabilities to ensure the sustainability of the plans over the long run.

In the US, the knee-jerk reaction is to cut public-sector DB plans for "cheaper" DC plans. It's not only shortsighted, it's a dumb retirement and economic policy.

Nowhere else is this exemplified more than in Kentucky which lost its pension mind and was recently featured on PBS FRONTLINE in an espisode called "The Pension Gamble".

It's very simple, all else equal, states that cut DB plans for DC plans are going to be underperforming those that maintain them over the long run. There's no doubt in my mind about this.

Let me end this brief comment with a great clip I saw on CNBC last Friday.

Below, Jana Greer, AIG Retirement CEO, joins 'Squawk Box' to discuss how the selloff is causing retirement anxiety. Listen very carefully to what she says and think carefully about the wisdom of cutting DB plans. It's a disturbing trend, one that should concern all of us, especially policymakers.

Tuesday, October 30, 2018

Wasting $4 Billion on the Caisse's Train?

Michel Girard of Le Journal de Montréal recently wrote an article stating we need to reopen the Caisse's REM deal. The article is in French but I did my best to translate it below using Google Translate and tidying it up:
It does not make sense to see the Quebec government will have to pay 55% of the REM ridership bill for the sole purpose of covering the average annual return of 8% that the Caisse de dépôt et placement has required to operate its electric train. If the Quebec government financed the REM itself, it would save $4 billion over 30 years.

Premier François Legault is expected to reopen the agreement with the Caisse de dépôt et placement and its REM (Réseau express metropolitan) and renegotiate the decline that the former Couillard government had agreed to pay him.

In my column last Saturday, The real bill of the Caisse's train, I mentioned that Quebec would pay over a horizon of 30 years the sum of $ 7.25 billion (average $ 240 million a year in today's dollars) in order to cover the return that the Caisse wishes to obtain with its initial investment of $2.95 billion in the construction of its electric train.

Oh yes! We are talking about a return that will provide the Caisse with an income equivalent to 2.5 times its down payment.

Specifically, in the rate set by the Caisse for a ride on the REM, or 72 cents per kilometer / passenger, you should know that the user will pay 21 cents (29% of the rate), municipalities 11.4 cents (16 %) and Quebec 39.6 cents (55%).

If François Legault finds it necessary to reopen the agreement that provides medical specialists $1 billion in overpaid compensation, he should logically do the same with the REM agreement.

UNREASONABLE RETURN

I do not understand why the government must pay an average of $240 million a year to the Caisse to allow it to cash in its 8% return on the REM.

People tell me: it does not matter since this profit ($240 million a year) that Quebec pays to the Caisse will come back anyway to Quebecers. Following this argument, Quebec could even pay double or triple and we would not lose at the change! Come on!

That the returns of the Caisse enrich Quebeckers is true. But it is not equally distributed. Above all, it is the pension funds of the employees of the province and several cities which benefit from the performance of the Caisse since they are the main depositors.

$4 BILLION TOO MUCH

That being said, what is the idea of ​​paying an 8% return to the Caisse when, as a government, we are able to finance its government projects in the long term at less than 3.5%?

Under the current agreement and the REM traffic forecast, the province of Quebec will, in today's dollars, pay the Caisse $7.25 billion in 30 years, or about $ 4 billion more than it would cost it to finance the project itself.

This is the issue. Can we afford to waste $ 4 billion?
What do I always warn you of? Beware of third-rate reporters in Quebec who get fed garbage by special interest groups and then go to publish garbage in a rag of a newspaper called Le Journal de Montréal (great sports section but that's about it, the rest of it isn't even worth reading in the bathroom).

Several interest groups have axes to grind with the Caisse on the REM project. The unions are pissed (they can't squeeze the government for more money and jobs), environmentalists are pissed (god forbid we cut down trees!), the banks are pissed (they didn't get big fat advisory fees on this project), Bombardier is pissed (it's wasn't able to compete with its competitors and lost a big order), pretty much everyone is pissed and now that a new government has been elected, all of a sudden the papers are publishing more garbage on the REM project so the new government can reopen the agreement.

The best thing Quebec's new premier François Legault did was take my advice and appoint Eric Girard as the province's new finance minister. But as I stated in my comment on the CAQ and the Caisse, Quebec's new government shouldn't interfere with the Caisse in any way, shape or form and it definitely shouldn't reopen the REM agreement.

Someone told me that Legault has a beef with the Caisse because Air Transat, the airline he founded, lost a whack of dough investing in ABCP paper years ago. Well, if true, Mr. Legault shouldn't take out his frustrations on the Caisse's current administration and as I covered on this blog five years ago, the media covered up the ABCP scandal to protect vested interests and gross incompetence by some of Quebec's top financial institutions (that article in Le Journal de Montréal got it right!).

Anyway, back to the article above, it has more holes in it than Swiss cheese and is basically full of inaccuracies.

First, this silly notion that the Quebec government is subsidizing the Caisse's 8% target rate-of-return on the REM project in perpetuity. The Caisse owns a 55% equity stake in the REM, it's assuming the lion's share of the risk if anything goes wrong with this project.

The Quebec government and the federal government have a minority equity stake and they will be reimbursed in full and make a return on their investment. That's not a subsidy, a subsidy is what Bombardier got from the Quebec and federal government (to be brutally honest, the entire aerospace sector around the world survives on subsidies and even down south, Boeing received $64 billion in subsidies from the US government).

Second, it wasn't the Caisse that set the user fee alone, it consulted the provincial and municipal governments and then set it. They basically told the Caisse to repay them over a longer time frame to lower the user fee and make it more affordable.

Third, the Auditor General of Quebec published a lengthy report on the Caisse's REM project which is available here. It is extremely detailed and very well done. I was told by someone inside the Caisse the auditors spent three months at their offices, they were "highly professional, courteous, thorough and apolitical."

The report came out in June and someone sent it to me yesterday and asked my opinion. I said it basically validates everything the Caisse has said thus far on the REM project. Yes, the Quebec government is putting money into this project to get it off the ground and support it but the Caisse assumes the biggest risk if something goes wrong and their projections don't pan out.

This is an important point that is lost among sloppy Quebec journalists, the Caisse stands to lose the most if something goes wrong on the REM project and it, not the government, will need to put up more money if something goes wrong. Its managers have a vested interest to see this project is completed on time and on budget.

This brings me to my final point, Michel Girard's ridiculous statement that the Quebec government could have saved $4 billion over 30 years if it financed the project itself.

I don't know if this guy was smoking legal cannabis when he published his articles but that statement in itself is preposterous. Let me assure all Quebecers reading this blog and everyone else, if the government took on this project by itself, it would have never been completed on time and the final cost would have mushroomed to five, ten or twenty times what it cost the Caisse and the only people who would be happy are unions and construction companies giving kickbacks to government bureaucrats for a piece of the REM pie.

Under the watch of Michael Sabia and Macky Tall, this project was built on governance, ruthless governance to make sure there wasn't even a hint of corruption (trust me, it's not perfect but under Michael's watch, the Caisse has significantly cleaned up its act, it's a lot cleaner now with a lot fewer shenanigans).

That's it from me. If you have anything to add, feel free to reach me at LKolivakis@gmail.com. I will edit this comment if needed but my main points are all here and quite frankly, I'm tired of defending the REM project from sloppy reporters who don't do their homework and rush to post garbage being fed to them.

Below, Michael Sabia discusses the vision behind the REM project, as well as its benefits for Montreal and Quebec, in an address to the Chamber of Commerce of Metropolitan Montreal (February 22, 2017).

And an older interview where Michael spoke with Mutsumi Takahashi of CTV News Montreal on the REM project (December 20, 2016).


Monday, October 29, 2018

Are Global Stocks Cheap?

Akane Otani of the Wall Street Journal reports, Global Stocks Haven’t Looked This Cheap Since 2016:
Global stocks are trading at their lowest valuations in more than two years as pessimism grows over the growth outlook, dangling the prospect of opportunity to some bargain-minded investors.

After a punishing October, major indexes in Europe, Japan, Shanghai, Hong Kong, Argentina and Canada are all languishing in correction territory—a decline of at least 10% from a recent high. The U.S. is teetering on the edge of joining its peers there after a selloff last week wiped out all of the S&P 500 and Dow Jones Industrial Average’s gains for the year.

The breadth of the declines shows a remarkable reversal from 2017, when optimism about the global economy sent shares around the world to multiyear highs.

“The expectation at the start of the year was this story of synchronized global growth,” said Mark Heppenstall, chief investment officer at Penn Mutual Asset Management based in Horsham, Pa. “And it seems like that argument for investing in global equities faded pretty quickly out of the gates.”

These days, investors say they are grappling with myriad anxieties: a slowing Chinese economy, geopolitical hot spots ranging from Italy to Saudi Arabia to Turkey and the still unresolved trade dispute between the U.S. and China. Adding to those concerns, data last week showed the eurozone economy grew at the slowest pace in two years. And technology firms that had helped fuel the U.S. stock rally are stumbling, with companies such as Amazon.com Inc., Alphabet Inc. and Netflix Inc. down more than 10% apiece in October.

The laundry list of issues has chipped away at investors’ optimism, driving the share of fund managers who expect the global economy to decelerate over the next year to the highest level since November 2008, according to Bank of America Merrill Lynch. It has also pushed the forward price/earnings ratio of the MSCI All Country World Index—which tracks performance across 23 developed and 24 emerging markets—to around 18, its lowest since early 2016. That was when fears about a hard economic landing in China and a crash in the price of oil drove markets sharply lower.

So far in 2018, the index is down about 7%, on course for its biggest decline since 2011.


Few investors are ready to call it quits on stocks altogether. And most don’t see the U.S., which until recently had led the global stock rally, tipping into recession in the near term. The Commerce Department said Friday that gross domestic product rose at a 3.5% seasonally and inflation-adjusted annual rate in the third quarter, buoyed by strong consumer spending that helped offset a drop in U.S. exports.

Still, many say the market’s slide—which has wiped out the 2018 gains of technology titans such as China’s Tencent Holdings Ltd. , Facebook Inc. and South Korea’s Samsung Electronics Co. Ltd.—has forced them to take a second look at bets that had formerly been clear winners. Expectations that policy makers at the Federal Reserve will keep pressing ahead with plans to phase out stimulative policies have added to the sense that investors will have to search harder for growth that can fuel further price gains.

“For a while, just a couple of sectors were holding the whole market together,” said Anwiti Bahuguna, senior portfolio manager and head of multiasset strategy at Columbia Threadneedle Investments. “And now we’re finally seeing the beginnings of a rotation.”

Some investors see glimmers of opportunity ahead.

UBS Global Wealth Management’s chief investment officer, Mark Haefele, is recommending that clients put money in global equities, rather than focusing their portfolios in one region or another. He notes that the Fed is moving further away from policy makers at the European Central Bank, who are still holding rates low; the Bank of Japan, which still has a huge stimulus plan in place, and the People’s Bank of China, which is cutting some banks’ reserve requirements in one effort to stimulate growth.

“All of these policies are going in different directions, and they’re probably not all going to be winners,” Mr. Haefele said. “You don’t want to bet on just one of these central banks getting it right—you want to diversify it.”

Others say not to overlook emerging markets, which have been particularly hard hit in the recent global equity selloff.

After their drawdown, emerging markets carry attractive valuations, said BlackRock Inc., which has issued positive ratings for stocks in the U.S., emerging markets and Asia excluding Japan. The group could get a boost if economic data in the U.S. begin to show weakness, pushing the Fed to slow its pace of interest-rate increases, the firm added.

To these firms and other investors, the volatility that has upended markets hasn’t amounted to a big enough threat to pull out of stocks altogether. Instead, the drawdowns have made shares in many regions of the world look less frothy than they did in January, when global stocks roared to records.

The S&P 500 is trading at about 15.55 times the next 12 months of earnings, down from 18.32 at the end of last year and below its five-year average of 16.47, according to FactSet.

After the drops of the past few weeks, 93% of markets in the MSCI All Country World Index are trading below both their 200-day and 50-day moving averages, according to Bank of America Merrill Lynch. The firm’s analysts recommend buying stocks whenever that measure exceeds 88%.
On Friday, I discussed how this is the worst October for stocks since 2008. I highly recommend you read that comment carefully to get a good sense of the factors I'm looking at right now.

The most important factor is the Fed. Barring a stock market crash, it's all but a given the Fed will increase rates in December and some think it will hike rates three times next year.

I highly doubt we will see three more Fed rate hikes next year, especially if global stocks keep selling off like they have this month.

By this time next year, I foresee a recession in the US and generalized global weakness. Instead of synchronized global growth, we're going to see a synchronized global downturn, and the Fed and other central banks will be in easing mode.

Getting back to the WSJ article above, Anastasios Avgeriou, Chief Equity Strategist at BCA Research, posted this on LinkedIN (click on image):

Yes, stocks are cheap but that's because we had a big drop in price. If we see a global economic downturn next year, you will see major downward revisions to those forward earnings (P/Es aren't only about price!) .

All this to say, be careful with valuations, global stocks are cheap for a reason, and the worst is yet to come.

Sure, bargain hunters will come in to buy the dips, but this isn't an easy environment for dip buyers, especially for those venturing into growth stocks.

On Monday, Amazon (AMZN) was down another 6% and like I told you on Friday, in the past, every time it dropped below its 50-week moving average, it was a big buying opportunity but with eight rate hikes and a global recession looming, you really need to be careful buying the dips on these growth superstars which ran up a lot this year.

These are not markets which will reward careless dip buyers and momentum players. They will get crushed in these markets because we are moving away from growth stocks as a defensive theme to stability to weather the global downturn.

This doesn't mean you can't trade big tech stocks, just be cognizant of the risks you're taking to play big bounces in this sector after a selloff. 

Something else, an astute blog reader of mine noticed the Vanguard FTSE All-World Ex-US ETF (VEU) has been outperforming the S&P 500 (SPY) over the last week even though it's declining too and he wondered whether a big rotation is going on to non-US stocks.

I told him I noticed even though emerging markets (EEM) led by Chinese shares (FXI) continue to slide lower, Brazilian shares (EWZ) had a great month of October (click on image):


But this had more to do with the elections with far-right politician Jair Bolsonaro winning a sweeping victory in Brazil's presidential election on Sunday (and traders sold the news on Monday).

I wouldn't read too much into Brazil's outperformance of late nor do I think there is a major rotation going on out of US stocks into cheaper ex-US stocks.

Again, they're cheaper for a reason. Until I see the Fed showing signs of backing off its rate hike path, I would stick with US stocks over international stocks but as I stated plenty of times, you need to be defensive in this environment and overweight 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).

Given my outlook that a global synchronized downturn is headed our way, you want to play safe dividend stocks that got clobbered as rates backed up recently.

You can try buying the dips on big tech stocks (XLK) but be careful not to get your head handed to you. For expert traders, there will be great opportunities on the long and short side on these stocks in the months ahead but it will be very volatile.

Most investors with a low risk tolerance are better off getting defensive and staying defensive over the next year.

And for Pete's sake, the next time someone tells you "global stocks are cheap", tell them "yeah, they're cheap for a reason, earnings are about to get crushed over the next year."

Stop using valuations as a market-timing tool, you will get crushed just like those momentum chasers chasing growth stocks.

Anyway, I think I made my point. Be careful out there, stocks could come roaring back next month (in fact, I'm betting on it) but we're far from out of the woods. The danger is only beginning.

Lastly, I noticed Boeing shares (BA) plunged the most since 2016 after opening the day higher (click on image):


I'm on record stating Boeing shares are my number one short over the next two years among large cap Dow stocks and I stick by this call. It might not happen this year but when this stock really cracks, it's going to tumble hard (click on image):


Below, the Federal Reserve can reverse the damage by stepping away from its current interest rate hike policy, according to veteran investment strategist Ed Yardeni.

"We need the Fed to pause here and just take a breather," the Yardeni Research President said Friday on CNBC's "Trading Nation. "Let's see how the economy plays out, and that will help the stock market a lot."

Yardeni has been too bullish for my liking and the Fed won't pause unless a crisis erupts in or outside the US. Still, I agree with him on one point, inflation isn't a problem, it will subside over the next 12 months and not just for the reasons he states. The global unwind will lead to a global recession. 

Friday, October 26, 2018

The Worst October Since 2008?

Fred Imbert, Ryan Browne and Eustance Huang of CNBC report, Dow plunges 300 points, S&P 500 dips into correction territory:
Stocks plunged Friday as the release of disappointing quarterly results from key tech companies overshadowed strong economic data.

The Dow Jones Industrial Average fell 340 points, with Home Depot lagging, and was about 1.5 percent away from entering correction levels. Meanwhile, the Nasdaq Composite dropped 2.3 percent.

The S&P 500 declined 1.8 percent and was briefly down more than 10 percent from its 52-week high, entering correction territory. The broad index hit a record high on Sept. 21.

Seven of the 11 S&P 500 sectors are also down at least 10 percent from their respective 52-week highs, including energy, materials and financials. Around 80 percent of the index's stocks are also in a correction. The average stock market correction results in a 13.8 percent drop and lasts five months, according to Gluskin Sheff Research.

Larry Benedict, CEO of The Opportunistic Trader, said traders "don't want to be long heading into the weekend." He added, "S&P now down on the year and people are more afraid to be long today than they were when market was 10 percent higher."

Amazon and Google parent company Alphabet fell 7.9 percent and 3.3 percent, respectively, after they released their latest quarterly results on Thursday. Earnings for both companies topped analyst estimates, but revenues fell short.

There were "high expectations" for this earnings season, King Lip, chief strategist at Baker Avenue Asset Management, told CNBC. "The earnings are not coming in as great as people had suspected," Lip said, adding that "for Amazon specifically, forward guidance was surprisingly light."

These declines were enough to offset a better-than-expected report on U.S. economic growth. The Commerce Department reported the U.S. economy grew at a 3.5 percent rate in the third quarter, above a 3.4 percent estimate. The government also said its personal consumption expenditures (PCE) index, a key measure of inflation, increased by 1.6 percent last quarter.

Stock have suffered in recent weeks as fears of rising inflation — and rising interest rates — trim corporate profit expectations. Since the PCE index is the Federal Reserve's preferred inflation gauge, any sign that the measure may be slowing could stall the central bank in its plan to continue to increase the overnight rate.

Consumer spending, which accounts for more than two-thirds of economic activity, surged by 4 percent in the third quarter, the fastest pace since the fourth quarter of 2014.

Friday's decline comes after equities rallied in the previous session. The major average are also set to post big losses for the week. The S&P 500 and Dow are down 2.2 percent and 1.8 percent this week, respectively, entering Friday's session.

These losses also add to a sharp drop seen throughout this month. Through Thursday's close, the Dow and S&P 500 were down 5.6 percent and 7.2 percent for October, respectively. The Nasdaq, meanwhile, had lost 9.1 percent.

"What's happened is we have a number of outside issues overshadowing what has been strong economic data and overall good earnings," said Michael Arone, chief investment strategist at State Street Global Advisors.

Several factors have conspired to knock markets down this month — some earnings disappointment, fear of rising interest rates, a brewing conflict between Italy and the European Union over budget spending, criticism of oil power Saudi Arabia after the killing of a dissident journalist and finally, worries that world growth is losing steam.
It's been another crazy volatile week on Wall Street with tech stocks leading the rout on Wednesday, before snapping back on Thursday, only to fall back hard Friday.

The week started off bad with Caterpillar (CAT) and 3M (MMM) disappointing on earnings and then got progressively worse when Texas Instruments (TXN) and Advanced Micro Devices (AMD) disappointed, and we ended with a surprise when Amazon (AMZN) disappointed on its revenues.

Why are stocks, including tech giants which were only going up, up, up all of a sudden getting slammed so hard?

Since the start of the month, I warned my readers the rise in rates spells trouble ahead and last week I stated the market may be topping out.

One of Warren Buffett's famous quotes is worth repeating here: "Interest rates are to asset prices what gravity is to the apple. When there are low interest rates, there is a very low gravitational pull on asset prices."

There is no question the rise in rates has negatively impacted all risk assets this year, especially emerging market stocks (EEM) which are now at risk of falling below their 200-week moving average (click on image):


Such a precipitous decline below the 200-week signals a bear market for emerging markets and if the Fed continues raising rates and the US dollar (DXY) continues surging higher, it will all but ensure more weakness in these countries (click on image):


The trade war with China just adds gasoline to the fire but make no mistake, the downtrend in emerging markets was ignited by the Fed and the hike in rates which sent the US dollar surging and hit many emerging markets with dollar-denominated debt.

Interestingly, thus far, the weakness outside the US wasn't impacting US stocks but that all changed this month. The decline in US stocks doesn't portend well for the US economy as stocks are a leading indicator of the economy.

But let me show you three sectors I'm watching very closely in the stock market right now. First, have a look at the S&P Homebuilders EFT (XHB) which has fallen into bear market territory (click on image):


Housing is very sensitive to rates so no surprise here to see these stocks falling by the wayside.

Next, have a look at semiconductors (SMH) and biotech stocks (XBI), two tech sectors that got massacred this week (click on image):



Why am I showing you these two sectors? Because they helped lead the entire tech sector (XLK) higher and now the monster rally that took place over the last couple of years looks in trouble (click on image):


Of course, it doesn't help when a tech juggernaut like Amazon (AMZN) stumbles and falls close to 8% in one day but I'm not ready to stick a fork in Amazon yet (click on image):


In the past, when Amazon shares fell below the 50-week moving average, it was a big buying opportunity but it may not be as simple this time around because rates have risen, the global and US economy are slowing, and there is general weakness in tech as portfolio managers move to more stable and defensive names.

Still, Amazon's cloud business grew 46 percent in the third quarter and this tweet by Charlie Bilello is quite incredible and speaks for itself:



Find me one company growing its revenues over the long run like this. That's why I believe top funds will be buying this big dip in Amazon but nobody really knows if this is just a correction or something much worse.

One thing is for sure, we are late in the cycle, many investors got burned being in the wrong trade, chasing momentum stocks. Value investors have been feeling the pain all year as growth outperformed value but are now breathing a little easier (read Joel Greenblatt's comments here).

As I've stated many times, the biggest risk right now remains the Fed and what is going on outside the US. If the Fed hikes too much, it could trigger a major crisis in emerging markets, one that will send another disinflationary/ deflationary wave our way.

This is why I wasn't concerned about talk of a global bond rout, inflation cannot run amok with emerging markets flirting with a crisis and the US dollar surging, lowering import prices.

Barring a stock market crash, the Fed will hike again in December, bringing the total rate hikes to nine.

This is when things get interesting because either we're going to have another growth scare like February 2016, or we might be entering a long bear market and the Fed will have to rethink whether it will hike rates another three times next year.

Is there any positive news for stocks? Yes, the so-called buyback blackout period has challenged markets in October but this freeze on corporate share repurchases lifts for a hefty chunk of companies after this week, giving way to smoother sailing for equity markets, some analysts predict.

We shall see if buybacks boost stocks next week but my best advice for most people remains what I recommended back in July, namely, get and stay defensive in these markets and even though US long bonds (TLT) are not having a good year, they remain the ultimate diversifier and will save your portfolio from being decimated if a crisis occurs.

Please, whatever you do, don't listen to idiots who tell you only a fool would buy bonds now, they are totally clueless and are wrongly extrapolating recent weakness further into the future (click on image):


That's all from me, wish everyone a great weekend and I want to sincerely thank those of you who take the time to support this blog via your donations. You can donate or subscribe to this blog via PayPal on the right-hand side, under my picture. Thank you.

Below, discussing the current state of the markets with Nela Richardson, Edward Jones; Saira Malik, Nuveen; and CNBC’s Rick Santelli.

Also, CNBC's Mike Santoli and Paul Christopher of Wells Fargo Investment Institute discuss Friday's market selloff as stocks are on pace for the worst October since 2008.

Third, we're nearing the end of a brutal October, as volatility soars. CNBC's Dominic Chu discusses how markets are posting the worst October since the financial crisis.

Lastly, for all you Halloween fans, the official trailer to the latest edition of John Carpenter's classic thriller which scared the bejesus out of my generation forty years ago.

Thursday, October 25, 2018

Risks to Canada's Retirement System?

Steve Randall of Wealth Professional reports, Canada’s retirement system is strong but there are risks:
The aging population remains a risk to the stability of Canada’s retirement system but overall things are in good shape.

The annual Melbourne Mercer Global Pension Index has looked at 34 pension systems to assess which nations are best placed to meet the challenges ahead.

Canada is ranked 10th overall with the Netherlands and Denmark best placed with A-Grade world class retirement income systems with good benefits - clearly demonstrating their preparedness for tomorrow’s ageing world.

The right balance between adequacy and sustainability is a good starting place for a strong pension system, says study author and Senior Partner at Mercer Australia, Dr. David Knox.

“For example, a system providing very generous benefits in the short-term is unlikely to be sustainable, whereas a system that is sustainable over many years could be providing very modest benefits. The question is – what’s an appropriate trade-off?” he asks.

Canada scored a B, increased score


Canada maintained its B rating and saw its overall score increase from 66.8 to 68.0 in 2018, due to small improvements in its sustainability, adequacy, and integrity scores.

“Canada’s multi-pillared approach of providing universal government programs, combined with a tax system that promotes voluntary pension and savings programs continues to provide Canadians with a strong retirement system,” said Scott Clausen, Partner, Mercer Canada’s Wealth business.

The key risks are low pension coverage among private sector workers, rising debt and healthcare costs, which will prove challenging as the population ages.

“Canadian governments are already taking steps to help ensure the workforce will be able to adapt to changing needs with the upcoming enhancements to the Canada and Quebec Pension Plans, but more work needs to be done – organizations, government and employees need to come together to drive the future of work,” said J.P. Provost, Senior Partner, Mercer Canada’s Wealth business. “Continuing efforts to find attractive retirement options for Canada – including reducing costs, easing plan management responsibilities, providing Canadians with access to better outcomes and reconsidering increasing the eligibility age for public pension plans to reflect increasing life expectancy – should remain an important focus.”

Alice Uribe of top100funds.com also reports, Dutch end Denmark’s reign in retirement:
The Netherlands ended Denmark’s six-year winning streak by clinching first place in the 10th-annual Melbourne Mercer Global Pension Index (MMGPI), released on Monday. Finland’s system ranked third, followed by Australia’s.

The index measures 34 pension systems, revealing both the Netherlands and Denmark to have A-grade, world class retirement income systems with scores of 80.3 and 80.2 respectively.

Common across all results was the growing tension between adequacy and sustainability, author of the study and a senior partner at Mercer, David Knox said.

Australia has dropped from third to fourth place in the world, weighed down by declines in household savings and the tougher age pension assets test.

In 2018, Australia’s overall index value was 72.6, down from 77.1 last year. Australia’s peak score was 79.9, in 2014.

The index is based on an assessment of both the public and private pension systems using 40 indicators to gauge adequacy, sustainability and integrity.

Knox, said ensuring the right balance between adequacy and sustainability was the “natural starting place” for a world-class pension system.

“It’s a challenge policymakers are grappling with,” Knox said. “For example, a system providing very generous benefits in the short term is unlikely to be sustainable, whereas a system that is sustainable over many years could be providing very modest benefits. The question is, what’s an appropriate trade-off?”

Knox said it was not enough for a system just to be sustainable or adequate.

“An emerging dimension to the debate about what constitutes a world-class system is ‘coverage’ and the proportion of the adult population participating in the system,” he said. “With changes in the way people are working around the world, we need to ensure these schemes include everyone so that the whole workforce is saving for the future. This includes contractors, the self-employed and anyone on any income support, be that parental leave, disability income or unemployed benefits.”

In 2018, Hong Kong SAR, Peru, Saudi Arabia and Spain were included in the index for the first time.
Douglass Appell of Pensions & Investments also reports, Melbourne Mercer Global Pension Index points to challenges of maintaining benefits:
The 10th annual Melbourne Mercer Global Pension Index report on the adequacy and sustainability of national pension systems, released Monday, warns of growing challenges in balancing those twin goals as the Baby Boom generation retires.

The Netherlands took the top spot in the latest rankings — measuring 34 national pension systems for adequacy, sustainability and public trust — with a score of 80.3, edging out last year's leader, Denmark, at 80.2. At the other end of the spectrum, Argentina's pension system ranked 34th with a score of 39.2.

While the average score for all the measured systems edged up to 60.5 from 59.9, the report didn't accentuate the positive.

The tension between "what you offer and how long you can offer it" is growing as more baby boomers enter retirement, and the latest results should serve as a "wake-up call," said David Knox, author of Monday's report and a senior partner at Mercer Australia, in an interview.

While a number of national pension systems provide decent retirement benefits now, many will struggle to maintain those benefit levels over the long term, Mr. Knox predicted.

He cited Italy, Austria and Spain — with relatively high adequacy scores of 67 or 68 but sustainability rates of between 20 and 28 — as examples of countries that could "hit the pressure point" relatively soon.

"Most countries haven't moved up a lot" in the past year, but one that did improve noticeably was Indonesia, which introduced major pension reforms, said Mr. Knox. The new pension system put in place there recently helped lift Indonesia’s adequacy score to 47.3 from 40.1 the year before, boosting its overall score to 53.1 from 49.9.

By contrast, Japan's adequacy score improved — to 54.1 from 48 — because of the introduction of a new measure of household debt in Melbourne Mercer's analysis, said Mr. Knox. The Japanese, on average, have relatively low levels of household debt. High levels of debt can undermine what might appear to be adequate pension benefits, if those benefits have to be used to pay off that debt, he noted.

The Melbourne Mercer Global Pension Index is published by the Australian Centre for Financial Studies in collaboration with Mercer and the State Government of Victoria.
There are many more articles on the Melbourne Mercer Global Pension Index here including one which states the US retains a "C" ranking which is no surprise to me or anyone else reading this blog.

The full report on the 2018 Melbourne Mercer Global Pension Index is available here and below is a snapshot of top rankings (full rankings are available in the report and here):


Canada came in number 10, a slight improvement from the previous year when it ranked 11th overall.

If Canada's large and some small pensions are in great shape, why isn't Canada's retirement system ranked among the top five?

As stated above, the key risks are low pension coverage among private sector workers, rising debt and healthcare costs, which will prove challenging as the population ages.

Go back to read my recent comments on how CAAT is increasing its membership and on the pension dashboard where I discussed how Nest Wealth's Randy Cass is trying to improve retirement savings for employees of private sector small and medium sized businesses.

The same goes for OPTrust's new pension initiative to cover Ontario non-profit sector. At the margin, all these initiatives help improve coverage and once enhanced CPP kicks in, it will significantly improve Canada's retirement system but a lot more needs to be done, a point made in the report.

Importantly, we already have a two-tiered retirement system, one where public sector employees enjoy the full benefits and peace of mind which comes with a well-managed gold plated defined-benefit plan, and one where a huge chunk of the population has a pittance saved up for retirement and is at risk of ultimately succumbing to pension poverty once they run through those meager savings.

"So what? Tough luck, that's capitalism, it's even worse int he US."

Well, when it comes to healthcare or retirement, we shouldn't be looking to the US for guidance, we need to improve on our great DB plans and look at improving coverage for everyone regardless of whether they work in the public or private sector.

More importantly, we should be looking at the Dutch which seem to have solved their pension problem and continue doing well despite the challenges to that system (watch clips below).


Wednesday, October 24, 2018

CAAT's DBPlus Helps Grow Membership?

Martha Porado of Benefits Canada reports, CAAT wins pension performance award for membership growth strategy:
The Colleges of Applied Arts and Technology pension plan’s plan to share its expertise with as many Canadian workers as possible nabbed it the award for pension performance at Benefits Canada’s 2018 Workplace Benefits Awards in Toronto on Oct. 11.

With a backdrop of strong fund performance in its main plan, as evidenced by its 118 per cent going-concern funding as of Jan. 1, 2018, the CAAT is seeking to grow the number of employers and employees it serves. In May 2018, it launched the DBPlus pension, a secondary plan design that employers and other plan sponsors can join as a simple method of offering a defined benefit pension to employees.

“We’re not growing because we have to grow, we’re a very strong sustainable pension plan,” says Derek Dobson, chief executive officer of the CAAT. “But we’ve been listening to the industry and to employers and governments, and there seems to be a gap and we’re in a position to help fill that gap. So growth will help us make our plan stronger but also increase coverage, reduce risk, help employers and help members.”

The DBPlus design provides its members with lifetime retirement income and survivor benefits, with inflation protection. The fixed contribution rates range from five to nine per cent of employee contributions, matched by the employer. It allows plan sponsors with fewer resources to allocate towards retirement readiness the chance to benefit from the CAAT’s long-standing experience in institutional investment, as well as the more complex return-seeking methods it can employ.

The first employer, Torstar Corp., to join the DBPlus plan recently finalized its transition, moving its eight DB pensions to the new model and growing the CAAT’s overall membership by 3,000. Indeed, some employers have also recently joined the original CAAT plan, including the Youth Services Bureau of Ottawa in 2017 and the Royal Ontario Museum in 2016.

Underpinning its strong membership growth is the plan’s investment expertise. Its small team recommends an asset mix to its board of trustees that’s based on asset-liability modelling studies it conducts every few years, according to the award entry. External investment managers then assist in implementing the strategy, which results in the production of a diversified portfolio with three key category strengths: return-enhancing, inflation sensitive and interest-rate sensitive.

Read the full list of 2018 Workplace Benefits Awards winners here. And stay tuned in the coming days to learn more about each of the winners.
You can see CAAT Pension Plan's small team here. Led by Julie Cays, the CIO, they have done a great job on asset allocation and finding good external managers across public and private markets to carry out their strategy.

Back in March, I discussed how CAAT Pension hit 118% funded status and noted the following:
[...] 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. 
In June, CAAT introduced DBPlus, a new defined benefit design for those who work part time or on contract:
Designed to meet the unique needs of other than regular full-time (OTRFT) employees, DBplus is an easy-to-understand defined benefit (DB) pension plan with a fixed contribution rate for members, matched dollar for dollar by employers.

DBplus comes into effect on January 1, 2019, and is designed to pay a higher lifetime pension to members who work other-than-regular-full-time (OTRFT) hours. DBplus improves equity between member groups, and easily accommodates the transition to full-time employment.
You can read all about CAAT's DBPlus here. Below, you will find all the relevant information:
Designed to meet the unique needs of other than regular full-time (OTRFT) employees, DBplus is an easy-to-understand defined benefit (DB) pension plan with a fixed contribution rate for members, matched dollar for dollar by employers. As a member of the CAAT Pension Plan who works part-time or contract, your DBplus lifetime pension is based on your actual earnings each year, rather than an annualized average over a five-year period.

The focus of DBplus is on maximizing your lifetime pension and providing similar value per contribution dollar as the current Plan design. In fact, in DBplus, the average member can expect an 800% return on their contributions in pension payments - that’s $8 in pension payments for every $1 in contributions.

A change for OTRFT members on January 1, 2019

All OTRFT employees who are CAAT Pension Plan members will begin earning a pension under DBplus on January 1, 2019. You don’t have to do anything – the switch will be automatic. The pension you have earned to January 1, 2019 will still be there for you. In fact, it will continue to grow every year until retirement.

If DBplus applies to you, you’ll receive a letter from the CAAT Plan in the fall of 2018. It will provide you with the information you need about the transition to DBplus, and what it means to your pension. At the same time, we’ll launch a new Pension Estimator, so you can calculate your combined pension from the current Plan design, and DBplus, at any retirement date you choose.

You don’t have to do anything – the switch will be automatic.

OTRFT employees who haven’t joined the CAAT Plan still have the option to join DBplus by the CAAT Pension Plan at any time during employment.

DBplus provides a secure lifetime income in retirement, plus so much more

DBplus is designed to maximize the lifetime pension you can earn.

In the current Plan design, OTRFT members typically: earn lower pensions as a result of shorter service; do not reach milestones to receive an early unreduced pension; and are more likely to retire at or after age 65. Also, they rarely take advantage of the bridge benefit, available to members who retire early. Instead of having these features, DBplus has been designed so that more of your contributions dollars are used to build your annual lifetime pension.
DBPlus is a great idea and one that I think other provinces should carefully consider or just contact CAAT directly to say you're interested.

I just learned of this initiative, it sounds a lot like OPTrust Select but targeting a different group of people.

The point is this, however, these pension plans are using their expertise to address a demand for DB pensions out there. A lot more initiatives like this are needed and this on top of enhancing the CPP which I'm a huge proponent of.

I realize markets are moving and all my buddies want me to focus on markets, not on pensions. I won't let you down but you will need to wait till Friday for me to collect my thoughts as there is a lot to cover.

But the brutal selloff on Wednesday just reminds us all how defined-contribution (DC) plans are not the answer to the looming retirement crisis. They are too vulnerable to the vagaries of public markets.

Do you really want to be picking stocks in this environment or would you rather have your retirement professionally managed by pension fund managers who invest across public and private markets directly and through top external managers?

That's what CAAT, OPTrust, CPPIB and all of Canada's large pensions offer their members, peace of mind knowing their retirement is being managed properly.

And after watching The Pension Gamble on Fronline PBS last night, you realize how lucky Canadians with a good DB plan are. I didn't agree with everything on the show but clearly there is a huge problem with some state plans in the US.

Below, learn about how DBplus member’s contributions work to provide a secure lifetime pension and other valuable benefits and the advantages beyond the secure, defined benefit pension that DBplus provides to members.

Lastly, go  inside the moment the volatile fight over teachers' public pensions in Kentucky took a surprising turn in this excerpt from "The Pension Gamble." That was a very chilling scene.



Tuesday, October 23, 2018

OPTrust’s Safe Space for Innovation?

Sarah Rundell of top1000 funds.com reports, OPTrust’s safe space for innovation:
Pension plans are not designed for innovation, they are designed to be efficient. Yet Canada’s C$20 billion ($15.3 billion) OPTrust, the pension fund for Ontario’s blue-collar civil servants, is challenging that idea.

OPTrust president and chief executive Hugh O’Reilly told delegates at the Fiduciary Investors Symposium at Stanford University about the pension fund’s new entity, OPTrust Labs, where an internal research and development team will nurture and integrate innovation across administration and investment processes.

In a panel discussion with Ashby Monk, executive director of the Stanford Global Projects Center, O’Reilly said the inspiration for the idea came from an observation that OPTrust needed to be part of the innovation economy. He observed that many pension funds’ administrative processes were still rooted in the mid-1980s. The fund’s beneficiaries needed an experience like what they had with other service providers, he said, adding that innovation was about “unleashing human activity” and allowing people to take risks. It also demands a culture in which leadership listens to ideas.

For OPTrust Labs to succeed, the pension fund will have to be ambidextrous – adding innovation to ongoing efficiency. O’Reilly said OPTrust would still celebrate its “main jobs”, related to ensuring a well-funded plan and a strong investment record, but also would have a new organisation prepared to make mistakes and fail.

You can’t ask people engaged in efficiency to be innovators as well, he said. Hence OPTrust Labs comprises a separate staff of six, whose main job is innovation. They are tasked with seeking out start-ups and innovative companies developing technological solutions that could help the pension fund’s “pain points”. These technologies could include innovative ways to measure climate risk across the portfolio or help with data gathering.

OPTrust Labs will oversee the testing of new software. Money for investment will be unlocked if a software pilot transitions to a fully deployed contract. O’Reilly expects failures and aims to share OPTrust’s experience publicly via documents and case studies.

The entity will be governed by an investment committee; however, the governance will be more nimble and agile than that surrounding the fund’s wider investment decision-making process. O’Reilly also noted that OPTrust was well positioned to fund innovation because of its ability to write smaller cheques. He added that investment in innovation would help start-ups scale, something that’s a challenge for Canada’s innovative companies. Start-ups would also be able to tap into OPTrust’s network and apply their technologies across the portfolio, he said, citing how a portfolio company in Canadian general partner Yaletown Partners’ Innovation Growth Fund, in which OPTrust is a limited partner, has been able to do just that.

O’Reilly said introducing innovation at the pension fund required a change in culture. He explained that some parts of the organisation could feel threatened by the new entity and an important part of his role has been assuring people of the positive sides to greater automation.
Reading this article, it reminded me of something AIMCo's former president and CEO Leo de Bever said at the Montreal pension conference two years ago: "Like Gretzky says, you miss 100% of the shots you don't take."

Leo de Bever has been imagining a better world for a long time and he believes pensions and other institutional investors are too conservative in their risk-taking and following the herd won't set you apart over the long run.

I'm glad to see Hugh O’Reilly and OPTrust starting this new initiative, OPTrust Labs, which will be a small group focusing on innovation.

I believe in innovation and personally invested in a few biotech stocks (XBI) over the last five years. Some were home runs, many were dogs, all were exciting.

By its very nature, innovation is exciting but fraught with pitfalls. Whether it's in healthcare, energy, AI or whatever sector, innovation requires a different risk appetite and it's far from easy. I'm glad Hugh said they are willing to make mistakes and fail and the governance will be more nimble.

This is especially true now more than ever because there is a bubble going on in venture capital as a bunch of amateur hedge funds are throwing money at every idea coming their way in Silicon Valley.

Go back to read my comment, In Defense of Private Equity, where I wrote about my experience with VC at PSP and the Business Development Bank of Canada (BDC):
[...] I'm highly skeptical on venture capital ("VC") funds and wouldn't invest in most of them, even the so-called cream of the crop.

That goes back to my old days at PSP in 2004 when I was helping set up private equity there and called Doug Leone of Sequoia three times to secure a brief meeting with Gordon Fyfe and Derek Murphy. "Listen kid, I like your persistence and will meet your top guys for 15 minutes but we're fighting over whether Harvard or Yale will receive an allocation. We don't want or need pension money. Our last $500 million fund was oversubscribed by $4.5 billion. I'll save your pension a lot of time and money, don't invest in VC, you will lose your shirt."

I remember Gordon and Derek loved that meeting, they both came to see me when they got back and told me it was "awesome". Derek grumbled something like "I've never felt so poor in my life".

Later, during the financial crisis, when I worked at the Business Development Bank of Canada (BDC) for two years, I saw huge losses in the venture capital portfolio. It was a disaster. The guy who hired me, Jérôme Nycz, eventually took over that department and he was appointed Executive Vice President, BDC Capital in 2013. Last I heard, they are doing well.

But make no mistake, VC is very competitive and it's extremely difficult to make money even for the Sequoias of this world. I'm pretty sure they'd gladly jump on pension money these days instead of thumping their chest, bragging about internal disputes over whether Harvard or Yale gets an allocation.

In terms of the overall private equity industry, VC is peanuts and it will always remain peanuts. I foresee a major, MAJOR, shakeout in the VC world over the next three to five years and it will rock Silicon Valley to its core.
How do I know there's a major shakeout coming in VC land? Because a close friend of my brother's lives out there, has a big position at a very successful tech company and he told me "they're all ill-prepared for the coming downturn, it will be brutal."

He has been warning his employees to upgrade their skills or risk becoming "obsolete very fast" and he's extremely worried about the rise of AI and secular long-term unemployment. The last time we spoke, I got really depressed because he wasn't painting a very rosy picture of the future of the US and global economy.

Anyway, my point here is OPTrust is taking a conscious risk with OPTrust Labs but one that may very well prove very worthwhile if their home runs swamp the effects of their dogs, and there will be many dogs. It's the nature of the game.

Still, OPTrust isn't afraid of innovation and being innovative and fiercely independent in its pension administration. Whether it's with OPTrust Select, climate change, or starting a new pension plan for Ontario's non-profit sector, it isn't afraid to "go where no other pension has gone before."

Alright, I'm being corny, laying it on thick, but I will give credit to the folks at OPTrust for thinking outside the box and expanding the limits of what is possible and more importantly, sharing the knowledge of their findings and experience with others for the betterment of the larger pension community.

What else? I wanted to congratulate OPTrust's CIO, James Davis, for being a finalist in the Institutional Investor Allocator's Choice Awards for technology use.


James, who you see above, is one sharp guy and he's extremely nice too. He recently sat down with Rick Baert of Pensions & Investments to go over how OPTrust is pushing climate change into LDI framework:
OPTrust, Toronto, which has put climate change risk management front and center with its C$20.3 billion ($15.7 billion) in investments, is working to align its pledge to reduce climate risk with its version of liability-driven investing, said James C. Davis, chief investment officer.

"This is evolutionary," said Mr. Davis, adding that metrics that work in the public markets don't necessarily apply to climate risk measurement. "For us, we've said there's been a lot of talking about climate change but not a lot being done about it," he said. "Our ability to apply innovation has put us on the leading edge, but we're not anywhere near done on this."

He said member-driven investing — OPTrust's version of LDI that focuses on maintaining full funding for the Ontario Public Service Employees Union Pension Plan, Toronto, instead of targeting a plan termination date — "is about pension certainty, that our members get the pensions they're promised at the current cost. When I look at that, I look at all the risks that can affect that today — equity risk, interest-rate risk, longevity risk. But I can also look at it in terms of longer-term risk, like climate change. It's not acceptable to pick and choose the risks you want to price. You can't do that with climate-change risk, but that doesn't give you an excuse to ignore it."

Hugh O'Reilly, president and CEO of OPTrust, agreed that measuring climate risk is a long-term endeavor. "When it comes to climate change and LDI, I think it's more like a cricket game than a baseball game," Mr. O'Reilly said. "Baseball games usually end after nine innings, but cricket games can go on for days. We think in the long run, our position on climate action fits with our member-driven investing strategy."

But for now, Mr. O'Reilly said, the inability to currently price climate-change risk is a major issue for a plan that was 111% funded as of Dec. 31.

"With our member-driven investing strategy — our LDI — we must get properly rewarded for the risk we take," said Mr. O'Reilly. "We find the issue we need to grapple with is how do we price climate change. With investors like us, even with the information and the technology we can apply, it's hard to properly price it, so that affects us as investors."

Some reinforcement

Mr. O'Reilly reinforced that point in a Sept. 25 presentation to a New York seminar organized by MSCI Inc. in partnership with the United Nations-supported Principles for Responsible Investing.

"As a pension management organization, OPTrust looks at investments over a long time horizon," Mr. O'Reilly said at the seminar. "Funded status is our key measure of success — it is the measure that matters. In order to preserve our funded status and fulfill our pension promise to our members, we endeavor to fully understand and price our risk exposure. That includes climate risk. Accurately pricing risk, however, in a world without commitments to proper climate-related disclosure from corporations is almost an impossible task. That brings us back to the need for action."

OPTrust in June announced its own action plan to manage climate-change risk, focusing on eight points — of which three directly deal with measurement issues.

Mr. Davis said the points of the action plan dealing with measurement present the biggest challenge. "As investors and accountants, there's a lot of emphasis in getting the numbers and looking at things around those numbers," Mr. Davis said. "Well, I'd like to know the price of carbon, but I don't. Accountants don't, investors don't — but that doesn't mean we don't consider carbon in choosing what we invest in."

Without data to price climate change, Mr. Davis said OPTrust is finding more holistic ways to measure it. "What in the investments we're making is being affected by climate change?" he said. "Maybe not in dollars and cents, but maybe by looking at peer groups, we can compare firms in a given sector and see which are looking at climate change more than others. It's also important to see what the boards of companies we invest in, the management of those companies, are doing in considering climate change in their daily operations. There's not some kind of metric to do that."

'One step further'

Along with comparing companies' management and boards, Mr. Davis said, "We take it one step further. We're looking at how we and our partner companies can look to incorporate climate change in investments."

Mr. Davis said OPTrust just asked the boards and management of companies in which they invest what they're doing to measure or monitor climate-change risk, which could guide how OPTrust measures it.

"We're hoping to get standards that can serve as a baseline, not only to compare companies but also to decide on specific company investments," he said. "That way, we have something we can track. That way, we're not fixated on one measure, like greenhouse gas emissions, but we can look at that as one aspect of climate-change risk and look at the entire risk in a more holistic way."

Artificial intelligence can also help, Mr. Davis said. OPTrust works with ClimateAI, a Palo Alto, Calif.-based enterprise software platform provider that uses AI to make quantitative and qualitative evaluations of climate change-related impacts, particularly geographic.

"Geography also matters," Mr. Davis said, adding that ClimateAI can help assess "the impact of climate change on a geographic area as well as an individual company. It can look at downtown Toronto and determine the risk of flooding; it also can look at how wind pattern changes could affect a wind farm in Australia. That provides us with better information and better ways of determining the effects of climate change on our investments."

The issue with pricing risk isn't only with public markets, Mr. Davis said. "The advantage we have here is that attention has been paid to public markets, but the private market is a great place to try new things, especially since we have a seat at the boardroom table," Mr. Davis said. "We get to see the impacts directly."

While using climate change as a factor in determining investments, Mr. Davis said companies that do take climate-change risk into account doesn't automatically ensure an OpTrust investment with them.

"You can argue that you're making a thematic play," Mr. Davis said, "but if it's not good for us, we won't invest in it. This theme will play out as we move forward. Technology and climate change are likely to be overlapping. We're not just looking at impacts on oil and gas and wind farms, we need to know where we are with all investments from a risk-return view when it comes to climate change. It's everybody's problem, everybody's challenge. The more pension funds, regulators and companies talk about this, the more likely we are to resolve this issue."
This is an excellent interview. Last week, I attended a CAIP conference here in Montreal and wrote about how Canadian pensions have crossed an ESG threshold.

I will remind you what Stéphanie Lachance, Vice President Responsible Investing at PSP, said at that conference. She emphasized that ESG integration isn't just about due diligence, the focus is shifting on actively monitoring these risks once the investment is made across public and private markets.

She also told me that every large Canadian pension has integrated ESG in their investment framework even if they do not all advertise it. She also said that perceptions are changing because ESG used to (wrongly) be considered a money-losing operation but now investors see the added value and how it can enhance risk-adjusted returns.

One thing is for sure, James Davis is right, technology and climate will likely overlap. Better technology will lead to new innovation in the energy sector and better data on climate change across public and private markets. Data which pensions and others will desperately need to assess their climate change risks.

Lastly, OPTrust shared this on LinkedIN:
We believe a winning culture embraces #diversity, #inclusiveness and different perspectives. We are proud to collaborate with the Canadian Gender & Good Governance Alliance as an extension of our goal to help drive gender-balanced boards and organizations in Canada and globally.
Details are available here and as I stated, I'm all for inclusiveness of more women at all levels of an organization and of minorities, especially people with disabilities where there is virtually no effort to hire and promote them (it's scandalous).

Below, Sequoia Capital Managing Partner Doug Leone during his Stanford GSB View From The Top talk on November 4, 2014. Leone discussed luck and taking risks, the venture capital industry, what his team looks for in entrepreneurs, and more. Listen to what he said about private markets being in bubble land three years ago.

And since I began with a quote from the Great One, I will end with a nice clip from the NHL on the Great One. Just remember, you miss 100% of the shots you don't take!