The Long, Long View?

Joel Schlesinger of the Winnipeg Free Press reports, The long, long view:
It's safe to say many Manitobans aren't familiar with Leo de Bever, the CEO of AIMCo.

For that matter, most people have no idea what AIMCo is.

It's likely equally true many Albertans whose pension and public assets were under management with AIMCo during de Bever's six-year tenure don't know too much about this wealth-management entity, either.

Yet AIMCo -- or the Alberta Investment Management Corporation -- is one of Canada's largest institutional-management organizations. With about $75 billion under management, it's the fifth-largest investment-management company in Canada, and it's responsible for Alberta's largest public pension funds, endowments and government funds and the renowned Heritage Fund that has contributed $36 billion to health care and education in Alberta since its inception in 1976.

All these assets were brought under one umbrella -- AIMCo -- in 2008 with de Bever at the helm, and since then, the fund has added more than $21 billion to its net worth.

Now, de Bever is leaving the firm.

Certainly his career has been illustrious by Canadian investment-industry standards. An economist born and raised in the Netherlands before coming to North America to pursue graduate studies, de Bever has worked at Manulife Financial, the Ontario Teachers' Pension Plan and the Bank of Canada, to name a few.

Recently, he was a guest speaker at the CFA Institute's summer analyst seminars in Chicago, discussing the difficulties of managing public money for the long term in a short-term world.

While geared for investment professionals, much of what he discussed also applies to the average mom-and-pop investors as much as it does to managers of vast amounts of capital.

De Bever took time out from his busy schedule to speak to the Free Press about some of the issues he touched upon in Chicago.


Bonds have presented a conundrum for institutional investors as much as they have for retirees looking to make their savings last. Pension funds and insurers, for example, had relied on bonds to generate steady returns to meet their liabilities. But in this ultra-low interest rate environment, bond yields are low -- often not enough to meet financial commitments such as paying the benefits of a growing number of pensioners. Consequently, institutional investors have relied more on stock market returns. They have also sought out alternatives, such as investing in infrastructure and real estate. But like most investors, the big guys still need to invest in bonds.

De Bever said bonds have a major role to play in most investors' portfolios -- even though we are facing an interest-rate hike that would send most bond portfolios' values tumbling.

"So if you're going to be in bonds, be in high-quality bonds that have a short duration of three or four years," said de Bever. "If you're going to get hit as interest rates go up, it won't be that bad, and you still get the incremental yield along the way."

Other low-cost alternatives are exchange-traded funds that invest in floating-rate-style, fixed-income investments such as PowerShares Senior Loan Portfolio ETF, which is traded on the New York Stock Exchange.

"It's in loans that are tied to prime, so that means if rates go up, the interest-rate return goes up with it, but the problem with it is there's been a lot of inflow into these assets, and you start to wonder if there is a bit more risk than there was a year ago," said de Bever. "But at least you can make three or four per cent on something that is tied to short-term interest rates."

Yet investors with a long time horizon, those under age 40, can and likely should be taking on more stock-market risk in their portfolios.

"I would say if you're young and you can withstand the fact that every five or six years you're going to have a stock-market correction, it's still a good idea in my mind to undertake equity risk."

Of course, that comes with one important qualification -- you must have the risk appetite for it.

Stocks don't come cheap

One problem with equity markets is the stock prices of companies are outpacing their revenues. That's led many observers to forecast a correction is coming. So investing in stocks today involves a high probability your capital could fall 10 to 20 per cent a short time down the road, de Bever said. Conditions are such that the markets could keep going upward, he added.

"The only reason you could argue that stock markets aren't overvalued is there is so much productivity that even with slow growth in top lines (revenues), the bottom lines (profits) seem to be holding up really well," he said. "The question is, how much of that is sustainable?"

Needless to say, there's just as much short-term uncertainty with stocks as there is with bonds, but investors with a short time horizon for their money will likely find the stock market too much of a stomach-churning ride for their taste.

"If you have a five- or 10-year horizon or more, though, I would still have a lot of my portfolio in stocks compared to bonds," said de Bever.

Technological panacea

Tech stocks have produced tremendous returns recently, but demand for them is now arguably outpacing their value. Today, newly listed tech stocks -- social-media firms in particular -- are commanding high valuations without any profit. The situation seems quite a bit like the late 1990s and early 2000s, when web-based firms with no profits had skyrocketing values, only to crash by 2002.

Yet de Bever said technology is undoubtedly a driving force going forward, and institutional investors have a major role to play in funding promising firms with innovative technologies that can have a dramatic impact on the world. The problem for retail investors is these companies are not yet listed on stock exchanges, so we average folks can't get much or any exposure to promising new firms (nor would they necessarily want to).

"These are companies that have gone past the lab stage and the initial verification stage, but they still need a lot of money to build a pilot plant and work out the kinks in making a commercially viable proposition," said de Bever. "You need to have that long, patient capital, and a mutual fund structure wouldn't be amenable to that." This is largely because retail investors bail out of these funds when they suffer losses. But even the big dogs with billions to invest are new to this part of the tech sector. De Bever said he even had to convince AIMCo's board this alternative investment area holds tremendous promise. AIMCo is trailblazing with this strategy, and forging new opportunities surprisingly isn't all that common in his industry, he said.

"The typical discussion I have with other pension managers is along the lines of 'You're absolutely right. We should be doing that,' but few of them actually are."

Understanding the J-curve

One of the problems with investing in early-stage technologies with long-term upsides is getting over the initial jitters. This often comes down to understanding the 'J-curve' associated with up-and-coming firms. The term refers to what these firms' growth looks like on a chart over long periods of time. It's shaped like the letter J because, initially, their value usually falls and stays down for some time until their innovative product or service reaches the commercialization stage, when it starts to increase in value. De Bever said the J-curve illustrates the benefits of taking the long view to investing.

"That's often easier said than done because human nature is to say 'Yes, I understand that,' but when times get a little tough, they say 'I didn't know I was buying into that kind of potential outcome.' "

Big investors for the public good

Investing in developing technologies also takes truckloads of investment acumen -- deep knowledge of the sector as well as an ability to read between the lines of hundreds, if not thousands, of pages of reports.

Few investors have the ability or time to do that. But institutional investors often do. That's why de Bever believes they can be a driving force in developing new technologies that will improve health care, education and infrastructure. More importantly, pension funds and other large investors can fund innovation to reduce our impact on the environment, including our footprint in the oilsands. He says companies involved in the industry have a difficult time convincing their shareholders to invest in long-term innovation because there is often no immediate short-term payoff.

That's where institutional investors can step in, he said.

"When we started talking to them (energy companies), a lot of them would say 'This is exactly what we're looking for.' "

Public pensions -- something's got to give

It's no secret public defined-benefit pensions are facing future difficulties as retirees live longer with fewer workers contributing to plans to support their benefits.

"It used to be that you had four workers for every retiree," de Bever said. "Now with most pension plans, it's become one worker for each retiree, so the burden of active members to pensioners is just too high."

This is unsustainable. In fact, many defined-benefit pension plans are now underfunded. "And I can't think of any that are fully funded on an honest discount-rate basis," said de Bever.

Many plans that are fully funded are using a rate of return of about six per cent, he said. But when that expected return falls by two per cent, a once fully funded pension plan could find itself underfunded by 30 per cent. De Bever said what's needed now is action to ensure these plans, which are the best retirement-savings vehicles around, remain solvent. The biggest obstacle is the options often involve some financial hardship for all stakeholders. Still, they're likely necessary.

"I firmly believe you have to tell your clients what they need to know, not just what they want to know, because eventually it will catch up with them," said de Bever. "It's very tough to do because in the current environment, the only way out is to either increase the retirement age, cut pension benefits, which is tough to do, or increase premiums, and premiums are already very high."
I liked this interview which is why I'm posting it. You can read my previous comment where Leo discusses the next frontier of investing.

Most recently, AIMCo acquired a $520 million mortgage portfolio from the Ontario Municipal Employees Retirement System, commonly known as OMERS:
AIMCo says the acquisition of 50 high-quality and geographically dispersed Canadian mortgages fits well with its existing holdings secured by institutional quality, income-producing properties.

No other details on the deal were disclosed.

AIMCo, which invests on behalf of 27 pension, endowment and government clients in Alberta, is one of Canada's largest and most globally diversified institutional investment managers with assets under management of more than $80 billion.

With $3-billion in loans, AIMCo is also one of Canada's leading mortgage lenders.

OMERS, with more than $65 billion in net assets, provides pension administration and products and services to almost 440,000 members in Ontario.
I received this comment from an astute investor:
The advice to stay short duration in fixed income was pretty much good advice from about a year post credit crisis, more or less til this year. Short and long rates have since been falling, and the yield curve is flattening. Despite all central bank efforts, I tend to see a mild deflation scenario playing out, something you have commented on. With that in mind, I think fixed income holders are best served to be diversified in credit and interest rate duration, and currency, definitely avoid an all in directional bet on rates.
Go back to read my last comment on the Caisse warning of headwinds ahead. I discuss my views on why I think deflation is the ultimate endgame and why rates aren't going to rise anytime soon.

Below, Leo de Bever discusses taking the long view on pensions. Take the time to listen to his presentation and the follow-up discussion, they're both excellent.

I also embedded Basil Gelpke and Ray McCormack's ground-breaking film on Peak Oil, A Crude Awakening. I'm not a big believer in Peak Oil and catastrophic doomsday scenarios but the film is well worth watching to get the long, long view on oil and energy.