Is the Caisse Hiding its Real Losses?

La Presse reported on Friday that Canada's biggest pension fund manager, Caisse de dépôt et placement du Québec, lost a staggering C$38 billion ($31 billion) last year:

The Montreal-based newspaper said the 26 percent loss in value in Caisse holdings was by far the largest suffered by the fund manager in its 45-year history.

The report comes at a bad time for the Caisse, an arm's length Quebec government agency that manages investments for various public and private pension plans.

Early last month the new head of the Caisse resigned for medical reasons, after just four months on the job, amid increasing criticism of how the institution was being run.

La Presse said preliminary figures showed the value of the Caisse's holdings dropped from C$155.4 billion at the start of 2008 to C$120 billion by the end of the year. The largest members of the fund pumped in an extra C$3 billion during 2008, leading to the loss total of C$38 billion, the newspaper said.

The Caisse's auditors have until February 24 to sign off on the figures, which are due to be released on February 26, the paper said. The losses mean that the annual return over the past decade will be a mere 4 percent compared with the 7 percent that the pension fund manager needs to meet its obligations.

La Presse said the value of the Caisse's stock and bond holdings had dropped by C$26 billion, while the fund lost C$5 billion by making bad foreign exchange bets.

It also said the fund had taken a C$4 billion writedown on its C$12.6 billion holdings of asset-backed commercial paper, the market for which froze up in August 2007.

A spokesman for the fund manager declined to comment on the report.

The average pension fund probably lost about 15 percent in 2008, said Paul Forestell, leader of the Canadian retirement professional group at consulting firm Mercer.

"That translates to a fairly significant loss that will ultimately be made up by higher contributions from employers," he said.

Going forward, it remains to be seen how volatile markets will be, said Peter Bethlenfalvy, co-president at DBRS Limited.

"I think most plans do have a fair component of stocks in the plan, real estate and some other illiquid assets so that's going to continue to be under pressure in 2009," he said.

The Globe and Mail newspaper said last November that the Caisse had sold billions in equities in the previous two months after taking losses on currency hedging and derivatives.

I can't say the figures surprised me. I was hearing some scarier figures closer to $50 billion, but this figure may still be understating the true losses.

One professor of economics sent me this comment, questioning the writedown on ABCP:

Look at the ABCP figures, and compare with the previous financial statements since 2007. I think $2B of ABCP got lost somewhere. There was no arms length trade, there could not have been. Two possibilities: the Caisse may be ‘trading” with some non-consolidated subsidiary or the difference may be the junk the Crawford settlement did not accept as part of the deal. In the latter case, there should be a corresponding write-off somewhere. The reserve taken against the remaining $12B implies a remaining value of sixty-odd cents on the dollar.The only bid price I heard of (very unofficially!) is 20 cents on the dollar.That suggests that the real loss is appreciably greater than the number in the article.

Diane Urquhart, an independent analyst and expert witness on the ABCP fiasco, shared similar thoughts with me:

In December 31, 2007 fiscal year end report, The Caisse took a writedown of -$1,900 million or -15% on its 12,600 million invested pre writedown on December 31, 2007. The $12,600 pre writedown exposure is down from the original $13,200 million exposure announced on November 28, 2007 before the Quebec Public Accounts Committee due to the Skeena Trust settlement. The Skeena Trust cash settlement was $0.98 per $1.00 face amount.

Do you think that the Caisse has taken another -$4,000 million writedown on ABCP, in addition to the -$1,900 million it took in the 2007 fiscal year? The Caisse's ABCP writedown % is either -47% or -32% depending upon whether the writedown is -$5,900 million or -$4,000 million.

[My note: Only the Caisse knows the answer to this.]

Your economics professor contact is right about ABCP bid prices at $0.20 for the ABCP and this is for the Class A -1 at the top of the capital structure. The Class A-2 is about half that and there are no bids for the Class B and C.

The securities dealers are not publishing any information on ABCP trades, nor the bids. One securities dealer has written to a retail ABCP noteholder that these are the current distressed bids.

I must admit the $4 billion writedown on its ABCP holdings seems fairly low and if the (unofficial) bid for this paper is 20 cents on the dollar, then they are valuing their ABCP holdings very generously.

But apart from the losses in equities and ABCP, which everyone expected, the $5 billion in bad foreign exchange bets is also stasggering and requires a lot more detail. Were the bulk of these F/X losses due to hedging activities? Were they concentrated in emerging markets or were they due to bad positions on the internal alpha portfolio? Or was it all of the above?

Moreover, we do not know how much they lost in illiquid asset classes like real estate and private equity. These valuations tend to lag and could add to the overall losses.

I also heard rumors that several internal portfolio managers racked up hundreds of millions of dollars of losses in their "alpha" portfolios in 2008. If this is true, the Caisse should make it public and stop hiding this information.

In fact, when public pension funds lose these staggering amounts, they should provide all stakeholders with a clear, detailed and comprehensive performance attribution of all their internal and external investment activities. Stakeholders deserve to know where the losses were concentrated and who was responsible for these losses.

The losses at the Caisse are causing a political uproar in Quebec, but I have already written several entries on the Caisse, including Caisse Sera Sera and my most recent entry, A Caisse of Risk Management Theater?

Last week, the Globe and Mail published an elaborate article on how the Caisse's bets on quants went wrong, but I can tell you exactly what went wrong: greed, stupidity, arrogance, incompetence and a total lack of oversight.

And by the way, it isn't just the Caisse. These same traits can be found in nearly all of the major public pension funds in Canada. I have exposed all of them in my blog and will continue to hammer away at them until I see some real transparency and accountability in our pension system.

But don't worry, there is nothing like staggering losses to humble the most arrogant pension fund managers who for far too long got away with bogus bonuses based on bogus benchmarks.

If these losses don't humble them, the board of directors of these large public pension funds should follow Harvard Management Company and fire their investment staff.

And if they had any backbone, they would fire these senior pension fund managers with no golden parachutes!

***Update 09/02/09***

The Globe & Mail's Andrew Willis posted an excellent comment on his Streetwise blog this morning, Quebec's favourite guessing game is Caisse losses. I quote the following:

The well-documented meltdown in third-party asset-backed commercial paper hit the Caisse harder than any other institution. It was a pioneer in this sector and held $13.2-billion of the paper when the $32-billion market froze, back in August, 2007. The Caisse wrote down the value of the portfolio by 15 per cent at the end of 2007, or $1.9 billion.

The ABCP market was finally restructured in January – just after the Caisse's financial year-end. The best guess on the value of this paper right now, on a harsh, mark-to-market basis, is 20 to 30 cents on the dollar. On that scale, the Caisse is looking at a $9-billion to $10.5-billion hit on ABCP alone.

The latest speculation on the Caise's performance, which comes from Montreal newspaper La Prese, pegs the 2008 ABCP write down at $4-billion. Add that to the $1.9-billion hit taken in 2007, and the number is still far short of where the restructured ABCP will trade.

Now, the Caisse will argue with some justification that it intends to hold the new ABCP notes to maturity, and therefore, the value of the paper doesn't need to reflect what may play out during the first trades of this distressed debt.

However, the larger point is there's no quick comeback from the Caisse's losses on assets such as ABCP. That's why the Caisse's performance is causing such a stir in Quebec - the fund may need to recoup loses from contributors, which means more money from Quebec citizens to fund pension and auto insurance schemes.

The comment also contains links to all the articles covering the Caisse.