American Funds Can Learn From Canada?
Canadian pension funds are using their financial heft to benefit an array of stakeholders, and American funds could be doing the same, Lee Egerstrom ventures in this story.Lee Egerstrom's article is worth reading, Capitalizing on pension funds’ potential for good:
He argues that it’s time for Wall Street and managers of state pension funds to engage in a serious discussion about their “fiduciary responsibilities” to main-street America, and not just to bottom-line considerations.
The writer, an economic development fellow at Minnesota 2020, a non-partisan, progressive think tank based in St. Paul, Minnesota, points to two recent reports that highlight conflicts between stakeholders and shareholders: Minnesota 2020′s Money Talks, and What if pension funds grabbed the reins?
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Can pension funds use their enormous financial resources to leverage a better return for stakeholders — workers, communities, main street merchants?
They are in Canada. And it’s time U.S. state governments and pension managers start thinking about ways to flex this muscle.
Between corporations sinking money into public policy campaigns that undermine workers’ rights and business practices that work to destabilize middle class institutions, America must have a serious talk about Wall Street’s “fiduciary responsibilities” to the rest of us.
Is it a “fiduciary responsibility” for managers of teachers’ retirement funds to invest in companies that contribute to public policies to defund public education?
Is it in the interest of retired public employees and future retirees if state investment boards seek only short-term returns on investment in companies and ignore how profits from those securities are being used to undermine public service careers, seniority systems, healthcare and other quality of life issues for stakeholders and shareholders enrolled in the plans?
Two recent reports highlight the complexities among investors, companies, and community stakeholders, known as stakeholder-shareholder conflicts.
Minnesota 2020's June report, “Money Talks,” examined this issue and what Minnesota might do to overcome these problems. In April, a New York-based think-tank, Remapping Debate, examined how pension funds could use their enormous power to shape more sustainable investing practices. Report author Mike Alberti, analyzed California’s teachers and public employees’ funds and Canadian pension funds to answer: “What if pension funds grabbed the reins?”
The goal many of these group investors have is to help corporate managers and boards recognize the value of investing in ESG (environmental, social and governance) issues.
'Misalignment of interests'
Among the big issues Alberti identifies is that public pension funds are often run by inexperienced appointees that hire outside firms with huge fees. These outside managers don’t always make the best long-term decisions and cost funds precious resources. This is due to a “misalignment of interests” among fund managers, beneficiaries and the private firms that manage the money, a classic example of the “agency theory” problems discussed in the Money Talks report.
The answer, if we follow Canada’s example, is for states to directly hire experienced money managers. However, attracting seasoned finance professionals would cost state governments far more than the public might be willing to pay a public servant. Ironically, many private fund managers that states already use cost well more in fees than in-house fund managers.
Also complicating a U.S. experiment using the successful Canadian fund models is that fiduciary responsibilities are interpreted in a variety of ways in the United States. At a basic level, they involve trust, honesty and require the trustee to act (invest) in the beneficiaries’ best interests. Public pension funds are often managed the most conventionally, not always the smartest, according to critics of the current system.
Economies of scale
But economies of scale come into play. Minnesota is a big business state, but it is a middle-of-the-pack to small state in population. That raises questions about how much of a securities research operation the state should employ, and would explain why Minnesota public pension plans use outside management firms.
The Minnesota State Board of Investment manages more than $57.5 billion in pension funds for the Minnesota Teachers Retirement Fund, the Minnesota Public Employees Retirement Fund and the Minnesota State Employees Retirement Fund.
Organized labor, senior citizen funds and other beneficiaries of investment plans also have direct shareholder-stakeholder interests in how their capital ends up being funneled off to policy uses counter to their interests.
The National Institute on Retirement Security (NIRS) in Washington recently completed economic impact statements for the various states on expenditures made by state and local government retirees. In Minnesota, 165,994 residents received $3.4 billion in pension benefits in 2009, the last year for which data are available. This averaged $1,719 per month, or $20,633 per year.
This translates into retiree expenditures supporting 41,337 jobs in Minnesota and total state income for state residents of $1.9 billion. When multipliers are factored in, pension funds from Minnesota and other states paid to state residents supported $5.7 billion in total economic activity.
'Money goes right back into the economy'
In issuing the report, NIRS economist Ilana Boivie said “Minnesota retirees don’t put their pension checks in a drawer and forget about them. They use it for daily living expenses, and to pay taxes. The money goes right back into the economy, which means financial stability for the retiree and economic growth for Minnesota.”
States like Minnesota and its neighbors might not want to take over direct management and placement of pension funds. But beneficiary groups of public and private funds should collaborate to share information, demand corporations reveal where they put campaign funds, and offer guidance to companies on what are legitimate stakeholder and shareholder interests.
The biggest hold back in the national economic recovery has been the loss of public sector jobs from the federal, state and local levels from self-defeating budget cuts. Retirees should not have their pension funds used to do even more harm to their best interests.
Interesting article as it highlights some of the contradictions/ complexities that govern all relationships, including ones with external consultants and money managers.
One of the things that fascinates me is how banksters/ hedge fund and and private equity titans fund politicians looking to impose austerity and weaken public pension funds -- the very hand that feeds them. If these idiots stopped to think about what's in everyone's best interests, including their own, they'd be fighting tooth and nail to bolster defined-benefit pensions.
As far as what is ailing US public and private pensions, I've already discussed the key issues in my last comment on the irresistible pool of money running dry. States, cities, counties and corporations have bled pensions dry by diverting funds or outright stealing from them. Years of neglect have led to massive pension shortfalls.
And the US pension governance model needs to be completely nuked. You can't pay civil servant salaries to people running multi-billion dollar pension funds and rely on outside experts who gorge you on fees. To attract experienced money managers, you need to pay up and they need to be supervised by an independent and highly qualified investment board that operates at arms-length from the government.
California state legislators want a formalized process to have more say in CalPERS' investment decisions and want to know about the $229.8 billion pension fund's investment projects in their districts, according to a draft report by management consultant Booz Allen Hamilton released on Tuesday.
The CalPERS Stakeholder Engagement Report surveyed various groups connected to the California Public Employees' Retirement System, Sacramento, and is being used to develop a strategic plan for CalPERS for the next five years.
No specifics about the legislators' request were provided in the stakeholder report, but top CalPERS officials were quick to downplay any suggestions that legislators could influence the pension fund's investments decisions.
CalPERS Chief Investment Officer Joseph Dear said CalPERS' officials have the fiduciary responsibility for the pension fund's investments and would not let another entity influence their investment decisions.
At a CalPERS retreat meeting in Petaluma, Calif., on Tuesday, Chief Operating Investment Officer Janine Guillot stressed the strategic plan was still being developed and would not include all ideas proposed by stakeholders — retirees, local government entities, state administration officials, CalPERS executive staff and board, CalPERS staff and federal officals.
The actual plan is scheduled to be released by CalPERS at its Aug. 13-15 meetings.
The report gives a snapshot of what the various stakeholders feel is the direction CalPERS should take over the next five years.
While CalPERS staff and board members in public have staunchly defended keeping the CalPERS defined benefit plan in its current form, the report factors in the possibility that some form of California Gov. Jerry Brown's plan to reduce benefits will be enacted.
A key theme expressed in the report by CalPERS board members and executive staff was defending defined benefit plans for CalPERS members while also preparing to administer a hybrid plan.
Mr. Brown's plan, which is expected to be considered by the Legislature later this summer, offers a hybrid plan with elements of DB and defined contribution plans to new state employees.
According to the report, the executive staff and the board also said continued innovation in CalPERS' investment process was necessary to balance risks and returns. The report also expressed concern by CalPERS staff and administration that the risk of a significant system drawdown could impact funding levels permanently.
I happen to agree with CalPERS' CIO, Joe Dear, investment decisions must be taken by CalPERS' officials, not state legislators who don't bear any fiduciary responsibility.
But in a highly charged political climate, and with CalPERS and CalSTRS delivering paltry returns, politicians are using weak returns as an excuse to encroach on investment decisions.
They should instead take a hard look at the governance model underlying these funds and ask some tough questions on the ridiculously high discount rate based on rosy investment assumptions. All US funds should be asking what if 8% is really 0%?
And there is no doubt that American funds can learn a lot from Canadian funds, true Maple Revolutionaries. Last week, Janet McFarland of the Globe and Mail reported, HOOPP: Risky business, healthy payoff:
Jim Keohane’s moment of epiphany came in 2003.
Mr. Keohane, a veteran Bay Street derivatives specialist who had joined the Healthcare of Ontario Pension Plan in 1999 to run its derivatives group, learned the pension fund’s actuaries had determined the odds of a market catastrophe gutting its investment portfolio were 20 per cent, while HOOPP had a 50 per cent chance of remaining fully funded for five years.
The numbers were considered normal – even positive – for a pension fund. But Mr. Keohane, who became HOOPP’s CEO earlier this year, assessed the odds with a trader’s eye and didn’t like what he saw.
It meant a significant market downturn or a prolonged period of weakness could leave HOOPP dangerously underfunded, potentially affecting pensions for hundreds of thousands of Ontario health workers.
“I would never do a derivative trade on that basis, so why would we run the fund that way?” he said. “I starting thinking there’s got to be a better way to do it than this.”
What came next was Mr. Keohane’s journey to embrace a new investment philosophy aimed at making the $40-billion pension fund less vulnerable to market risks – a restructuring that has won HOOPP international plaudits and left the pension plan fully funded in an era when most others are struggling with large deficits.
HOOPP earned a 12.2-per-cent return on its assets in 2011, and reported a 103-per-cent surplus as of Dec. 31. That means HOOPP had assets equal to 103 per cent of its estimated long-term liability for providing pensions to its members.
A typical Canadian pension plan was just 77-per-cent funded as of Dec. 31, after years of hits from volatile stock markets and declining bond yields.
HOOPP’s remodelling was launched under former CEO John Crocker, who retired at the end of last year, and was designed by Mr. Keohane, a 57-year-old Ottawa native who has pensions in his DNA – his father was a federal civil servant and his mother was a school teacher, both of whom retired with comfortable pension plans.
To “de-risk” HOOPP’s portfolio, Mr. Keohane embraced an investment philosophy dubbed LDI – liability-driven investment strategy, which has since become the hottest investing trend in the pension sector.
The core goal of LDI is to more closely match a pension plan’s assets with its liabilities, to try to ensure a plan will remain well funded even in periods of market volatility. To accomplish that, funds invest heavily in bonds with long maturities to ensure their assets more closely match the long-term nature of their pension liabilities.
But bonds can’t earn enough to successfully fund a pension plan in the long term. To earn additional returns in an era of low bond yields – and to further hedge risks – some funds also use an extensive and complex derivatives strategy, using futures, swaps and other instruments to give the fund extra equity exposure without having to own a large traditional stock portfolio that is vulnerable to market volatility.
It is a strategy that is attracting wide attention in the pension community, says pension specialist Malcolm Hamilton of consulting firm Mercer, but one that funds all seem to define differently depending on the extent to which they fully adopt the model.
He says it is unclear yet whether the trend will stick, or will be abandoned if interest rates rise again and pension funds return to better health.
“In the case of the public sector pension plans that are practising this, it’s a relatively recent phenomenon,” Mr. Hamilton says.
Mr. Keohane says HOOPP is in for the long haul, noting he pitched the idea in 2006 when stock markets were soaring and the need to reduce risk was less obvious.
It was not initially an easy sell. When HOOPP sold much of its stock portfolio to buy bonds in December, 2007, he says he secretly hoped the stock market would have a weak year in 2008 so he wouldn’t have to justify missing out on big stock market gains in the very first year of the new strategy.
“You should be careful what you wish for,” Mr. Keohane now says.
As it turned out, stock markets headed into a severe tailspin in 2008, triggering an economic crisis that is still plaguing the globe. HOOPP had launched its risk reduction strategy at the exact moment it could most prove its value.
But despite the early LDI success, the model is not risk-free.
HOOPP’s huge derivative portfolio dwarfs its portfolio of stocks and bonds. The fund has $20-billion alone in equity short positions. As of Dec. 31, it also reported $14-billion of securities sold under repurchase agreements, and $8-billion in other derivatives such as equity options.
Its array of derivative contracts have a total notional value of about $200-billion, including all the currency hedging and swaps that are layered together to protect its investments.
It all adds up to major credit risk if counterparties to those positions should fail to honour their commitments. Mr. Keohane argues the risk, however, is widely spread to ensure no single exposure could cause major damage, and the short position is “perfectly offset” to ensure it is hedged by other instruments.
“It’s what allows us not to own 60 per cent in equities, so by taking these other smaller, incremental risk, it allows us to take the equity risk way down. And the overall portfolio risk goes way down,” he says.
HOOPP’s large bond portfolio is also at risk of falling in value if or when interest rates rise again. But because pension funds also measure the size of their funding commitment – the liability side of their equation – using bond yields, Mr. Keohane says HOOPP will actually end up better funded if interest rates rise. The drop in the size of the funding liability will outpace the drop in the value of its bond assets, and HOOPP’s funded position will strengthen rather than weaken.
Perhaps the greatest risk comes from what HOOPP is not heavily invested in – equities. If bonds languish for years and if stock markets soar, HOOPP will lose out on returns captured by pension funds with bigger stock portfolios.
He says he’s willing to accept doing worse than peers in some years, however, because the risks of LDI pale in comparison to the far larger risk of investing 60 to 70 per cent in equities – a typical proportion for a pension fund – and facing the possibility of being thrust into major shortfall position after just one year of major market losses.
“We want to take enough risk to earn the return we need, but not more than that,” Mr. Keohane says.
Jim Keohane is a smart man and one of the nicest investment professionals I've had the privilege of meeting in this industry. Once again, fully funded HOOPP led its peers in 2011, cementing their position as the best pension plan in North America. They learned a lot from ATP, the world's best pension/ hedge fund.
Another one of the world's best pension plans is Ontario Teachers', which returned 11.2% in 2011. Teachers' president and CEO, Jim Leech, appeared on CNBC Wednesday morning stating stocks are 'fairly priced' and discussing returns in private equity and where he is finding investment opportunities.
Watch the interview below and pay attention to what he says about their asset allocation and the discount rate he thinks is realistic.