Wednesday, April 16, 2014

Bridgewater's Dire Outlook For Pensions?

Lawrence Delevigne of CNBC reports, Outlook for pensions is pretty awful: Bridgewater:
Here's a scary retirement prediction: 85 percent of public pensions could fail in 30 years.

That's according to the largest hedge fund firm in the world, Bridgewater Associates, which runs $150 billion for pensions and other institutions like endowments and foundations.

Public pensions have just $3 trillion in assets to cover liabilities that will balloon to $10 trillion in future decades, Bridgewater said in a client note last week obtained by USA Today.

To make up the difference, the firm said pensions will need to earn about 9 percent per year on their investments. But Bridgewater estimates pension funds are more likely to make 4 percent. If that's true, the vast majority—85 percent—of retirement systems will run out of money because they will continue to pay out more than they take in.

The report comes as pensions wrestle with what rates of return to assume given their implications on future financial health.

The city of Detroit, for example, has reportedly agreed to increase its pensions' projected return to 6.75 percent on its pension funds, up from 6.25 percent and 6.5 percent, according to a separate USA Today report. The change is part of ongoing pension cut negotiations for the city to exit bankruptcy.

To test the broad financial health of public pensions, Bridgewater simulated the effect of various market environments on retirement system funding using 100 years of data on how stocks, bonds and other assets performed in the past, plus current projections of future long-term yields. Public pensions will run out of money in 20 years in 20 percent of those scenarios; they'll fail in 50 years in 80 percent of the situations.

A leading academic center for retirement and pension research criticized the report.

"These are inflammatory numbers which can create an enormous amount of anxiety," said Alicia Munnell, director of the Center for Retirement Research at Boston College. "The pension issue is not a game. Pensions represent the future security of today's public employees and those are real people."

Munnell, also the Peter F. Drucker professor of management sciences at BC's Carroll School of Management, believes Bridgewater's 4 percent return projection is far too low.

"If we live in a world where 4 percent nominal returns is the only returns people can get, it implies a really horrible economy with high unemployment, very slow growth and a big gap between potential and actual output," Munnell said.

"A cynic could say that these projections suggest that plans are going to earn only 4 percent unless they shift some of their investments to alternatives," Munnell added. She called on Bridgewater to release the full report.

The report was one of Bridgewater's daily notes to clients, called "Daily Observations." The communications are not public, but Bridgewater told it plans to release an explanation of the study in the future.

"Just as we stress test banks by running multiple scenarios through their future conditions to assess what might happen, we think it makes sense to stress test pension funds," Bob Prince, Bridgewater's co-chief investment officer, said in an interview.

"That's in contrast to the common approach, which is to determine sufficient funding by asserting a certain return and discounting that back to a present value and comparing that to your assets. We think that you can have a much more robust assessment by running stress tests based on multiple scenarios."

Bridgewater acknowledges that its 4 percent return projection—based on current asset prices like low bond yields and an already-elevated stock market—is just one potential outcome to consider and any long-term projection is inherently difficult.

Munnell said most public pensions assume long-term returns on their investments of about 7.75 percent annually. Her center regularly studies the impact of lower expectations, around 6 or 6.5 percent.

Bridgewater, founded in 1975 by now-billionaire Ray Dalio and based in Westport, Conn., has long attracted pensions and others with two types of products: "Pure Alpha" hedge funds that bet on broad macroeconomic themes, and a more conservative "All Weather" product that is designed to protect assets in any economic environment (also known as a "risk parity" strategy).

The firm's Pure Alpha II fund has gained 13.6 percent net of fees on average since inception in 1991. All Weather has produced average annual returns of 8.9 percent since inception in 1996.

Public retirement systems were 73 percent funded overall at the end of 2012, according to the latest data available from Boston College's retirement center. The numbers are based on the present liabilities value of $3.8 trillion, which uses a baseline projection of 7.75 percent stock market returns from 2013 to 2016.

"States and localities also continued to fall short on their annual required contribution payments," the report said. But it also noted that "the funded ratio is projected to gradually move above 80 percent, assuming a healthy stock market."
So, Bridgewater is now a leading expert on public pension deficits? Well, they regularly read my blog so let me commend them before I rip into them for being part of a much bigger problem.

First, Alicia Munnell doesn't have a clue of what she's talking about. Pension funds are more likely to see long-term returns of 4% than 7.5% or even 6.5%. This isn't scaremongering on Bridgewater's part, it's called being realistic and not hopelessly optimistic.

Go back to read an older comment on what if  8% is really 0% where I wrote:
Mr. Faber then asks a simple question:
Are funds prepared for a lengthy bear market in equities like when stocks declined nearly 90% in the 1930’s? Are funds prepared for both raging inflation of the 1970’s and 1980’s and sustained deflation like Japan from 1990 to the present? It is our opinion that most funds do not consider these outcomes as they are seen as extraordinary and beyond the scope of either feasible response or possibility.
He's absolutely right, the majority of pension funds are hoping -- nay, praying -- that we won't ever see another 2008 for another 100 years. The Fed is doing everything it can to reflate risks assets and introduce inflation into the global economic system. Pension funds are also pumping billions into risks assets, but as Leo de Bever said, this is sowing the seeds of the next financial crisis, and when the music stops, watch out below. Pensions will get decimated. That's why the Fed will keep pumping billions into the financial system. Let's pray it works or else the road to serfdom lies straight ahead. In fact, I think we're already there.
Now, Leo de Bever isn't the best market timer and I totally disagree with him on a bear market for bonds. I think all the bond panic of  last summer was way overblown and the real threat that lies ahead is a prolonged period of debt deflation which will expose a lot of naked swimmers.

I've been worried about deflation for a very long time. I even went head to head with the great Ray Dalio back in 2004 in front of PSP's president and CEO, Gordon Fyfe, and pushed Ray on this until he finally blurted out: "son, what's your track record?!?"

Well Ray, thanks for asking because my track record has been pretty lousy on some stock picks but right on the money when it comes to calling the big picture. I warned Gordon Fyfe and PSP's senior managers of the collapse of the U.S. housing market and the credit crisis back in the summer of 2006 when I was researching CDO, CDO-squared and CDO-cubed issuance and was petrified. I got promoted in September 2006 and then abruptly fired a month later for "being too negative" (a euphemism for you're not towing the line so we will fire your ass). PSP lost billions in 2008 selling CDS and buying ABCP (and they weren't the only ones "investing" in structured crap in their portfolios). 

The analysts at Goldman Sachs I was talking with tried to reassure me that all is well but I never trusted those hypocrites and knew they were taking the opposite side of the trade, betting against their Muppets. Sure enough, Goldman made a killing off the financial crisis. Ray Dalio and Bridgewater also performed well as they understood the dangerous dynamics of deleveraging but they overstayed their welcome on that trade and underestimated the resolve of politicians and central banks to deal with the European and global debt crisis. 

Things haven't being great for macro funds since the financial crisis. Central banks have effectively clipped their wings and many are not bringing home the bacon they once used to. Apart from Abenomics, which spurred a global macro lovefest and cemented George Soros as the ultimate king of hedge fund managers, there hasn't been much going on in terms of returns in the global macro world. Maybe that's why Soros is pleading with Japan's PM to get their giant pension fund to crank up the risk. He sees the future and it ain't pretty (I threw a bone to global macro funds back in December when I recommending shorting Canada and its loonie...still waiting for a donation, lol). 

But rest assured the Ray Dalios of this world are doing just fine, charging 2 & 20 to their large institutional clients, many of whom are more than happy being raped on fees even if the performance of these large hedge funds has been lackluster as assets under management mushroom. 

Now, before I get a bunch of angry emails telling me how great Ray Dalio and Bridgewater are, save it, I was among the first to invest in them in Canada when I was working at the Caisse as a senior portfolio analyst in Mario Therrien's team covering directional hedge funds. I have nothing against Ray Dalio and Bridgewater, but I think they've become large lazy asset gatherers like many others and their alpha has shrunk since their assets under management have mushroomed to $150 billion.

My beef with all hedge fund gurus managing multi billions is why are they charging any management fee? To be more blunt, why are dumb institutions paying billions in management fees to Ray Dalio or anyone else managing multi billions? Management fees are fine for hedge funds ramping up operations or for those that have strict and small capacity limits but make no sense whatsoever when you're dealing with the larger hedge funds all the useless investment consultants blindly recommend. 

And Alicia Munnell is right on one front, why doesn't Bridegewater publicly release this study? In fact, there are other studies from Bridgewater that magically disappeared from public record, like hedge funds charging alpha fees for disguised beta (I used to have a link on my blog to that study, which was excellent). Another good point Munnell raises is that alternatives funds love talking up their game but public pension funds praying for an alternatives miracle that will never happen are only enriching Wall Street

Go back to read Ron Mock's comments on OTPP's 2013 results as well as Jim Keohane's comments on HOOPP's 2013 results. Ron and Jim both attended HOOPP's conference on DB pensions and they know the next ten or twenty years will look nothing like the last twenty years. They understand why it's important to closely match assets with liabilities and how important it is to manage downside and liquidity risk. The Oracle of Ontario uses one of the lowest discount rates in the world, something which they think reflects reality. 

And Bridgewater is right, the outlook for U.S. pensions is awful. They're not the only ones sounding the alarm. The Oracle of Omaha recently warned that U.S. public pensions are in deep trouble. I'm concerned too but as I wrote in the New York Times, my chief concern remains on the lousy governance model that plagues most U.S. public pensions. Pension reforms have thus far been cosmetic. Until they reform governance, nothing will change. 

Finally, it is worth remembering that even though pensions aren't perfect, they're way better than 401 (k) plans, RRSPs or PRPPs. A new study finds that the typical 401(k) fees — adding up to a modest-sounding 1% a year — would erase $70,000 from an average worker's account over a four-decade career compared with lower-cost options. To compensate for the higher fees, someone would have to work an extra three years before retiring. When it comes to retirement, most people need a reality check on pensions.

On that note, I welcome all comments by Bridgewater and anyone else who has something intelligent to contribute to the outlook for pensions. Feel free to email me your thoughts at

Below, once again, a 2009 report which explains America's 401(k) nightmare. As the default retirement plan of the United States, the 401(k) falls short, argues CBS editor-in-chief Eric Schurenberg. He tells Jill Schlesinger why the plans don't work. The same thing is happening in Canada, which is why now is the time to act to bolster defined-benefit plans for many Canadians that are staring at a retirement crisis.

Tuesday, April 15, 2014

The Big Unwind?

Matthew Boesler of Business Insider reports, The Big Unwind: Here's How Hedge Funds Drove The Brutal NASDAQ Selloff:
Volatility has returned to the markets, and growth stocks in information technology and health care have led the way down.

The chart above (click on image), from Deutsche Bank strategist Keith Parker, shows the extent to which fund positioning has helped fuel the recent decline in the stock market.

"Performance over the last month across stocks and sectors has been driven by position covering," says Parker in a report on recent investor positioning and flows.

"Through the first two months of the year, long/short equity hedge funds and mutual funds were neutral the market but long growth stocks, which helped underpin outperformance through the January-February sell-off. The rotation out of growth and into value starting in early March hurt and funds were forced to unwind positions."

Chart 2 provides a visual display (click on image below).

Coming into the first quarter of 2014, growth stocks and the stocks with the highest hedge fund ownership were one and the same.

Funds were loaded up on health care, consumer discretionary, and tech stocks (think biotech and social media), and the "momentum" trade did well in February following the big market sell-off in late January.

As chart 3 shows, the growth stocks were significantly outperforming the broader market until March (click on image below).

Since then, nearly all of the outperformance of this group of hot stocks has been erased as hedge funds have rebalanced, a process Parker says is probably almost over.

However, the unwind is "now spilling over to mutual funds that are still long growth, with outflows from growth funds exacerbating performance."

In the week through Wednesday, April 9, equity funds oriented toward growth stocks were hit with $1.7 billion of investor redemptions, following an outflow twice the size in the previous week. Flows into value funds, on the other hand, are accelerating — they took in $1.9 billion in the week through April 9 and $1.7 billion the week before. As one might expect from chart 1, consumer goods, utilities, and energy funds are receiving inflows while tech, health care, and financials funds are losing investor money.

David Kostin, chief U.S. equity strategist at Goldman Sachs, says the parallels between recent market action and that in March 2000, when the tech bubble burst, "dominated client discussions" last week.

"The current sell-off in high growth and high valuation stocks, with a concentration in technology subsectors, has some similarities to the popping of the tech bubble in 2000," says Kostin.

"Veteran investors will recall S&P 500 and tech-heavy Nasdaq peaked in March 2000. The indices eventually fell by 50% and 75%, respectively. It took the S&P 500 seven years to recover and establish a new high but Nasdaq still remains 25% below its all-time peak reached 14 years ago."

Kostin's take is that this time is different, as broad market valuations are not as stretched as they were then, and the "bubbly" parts of the market account for a much smaller portion of overall market capitalization today than then (tech accounted for 14% of overall S&P 500 earnings in 2000 but 33% of market cap, whereas today it accounts for 19% of both earnings and market cap).

While that is good news for the broader market, it's still bad news for these high-flying growth stocks (see chart 4, click on image below)).

"The stock market, but not momentum stocks, will likely recover during the next few months," says Kostin.

"Analysis of historical trading patterns around momentum drawdowns shows: (a) roughly 70% of the reversal is behind us following a 7% unwind during the last month; (b) an additional 3% downside exists to the momentum reversal during the next three months if the current episode follows the average historical experience; (c) if the pattern followed the path of a 25th percentile event a further 7% momentum downside would occur, or about double the reversal that has taken place so far; and (d) whenever the drawdown ends, momentum typically does NOT resume leadership."

On average, Kostin says, the S&P 500 has risen on average by 5% following momentum sell-offs like this, led by value stocks that underperformed as growth stocks were going up.

Jan Loeys, head of global asset allocation at JPMorgan, takes a similar view.

"Each of the market reversals of the past few weeks has in common that they represented widely held positions — long equities, overweight small caps, overweight tech, underweight emerging markets, and short duration," says Loeys.

"If there were greater worries about the economy or other downside risks, then we should have seen the dollar rise, credit and swap spreads widen, and emerging markets underperform. Correlations across risk assets should have risen. None of this has happened. There is no breadth to this sell-off."

Of course, there are, as always, reasons to be cautious. Many of them may relate to an optimistic scenario — one in which the economic recovery accelerates, causing the Federal Reserve to tighten monetary policy and interest rates to rise.

"S&P 500 price-to-earnings is demanding excluding mega-caps and likely dependent on interest rates staying low versus history," says David Bianco, chief U.S. equity strategist at Deutsche Bank.

Another factor to consider is corporate stock buybacks, which have restricted the supply of shares trading in the market.

"While everyone is focused on valuation and bubbles (to some degree rightfully so), the fact remains that the last few years have been supported by a low level of net equity issuance that has, all else equal, supported prices," says Dan Greenhaus, chief global strategist at BTIG.

This trend may now be poised to reverse as buyback activity slows, given the fact that shares have become more expensive as the market has headed higher.

"Rather than investing in new equipment and structures, businesses have used their cash positions to buy back stock or to grow through acquisitions," says Aneta Markowska, chief U.S. economist at Société Générale.

"This process, however, may be coming to an end. The ratio of the market value of equities to the replacement value of tangible assets (or the so-called Tobin's Q ratio) has increased significantly in the past year and now stands at the highest levels since 2000. With equity values currently estimated at 25% above replacement value, expanding organically seems to make a lot more economic sense than expanding through acquisitions or stock buybacks."

In other words, earnings per share have been boosted by a shrinking denominator — the amount of shares outstanding. If shares outstanding stop declining as buyback activity recedes and net equity issuance turns positive, it will put more onus on the numerator — the actual earnings — to propel earnings per share higher.

However, an acceleration in wage growth is a likely pre-requisite to Fed tightening. Such a development would pose a further headwind to earnings as corporations face rising employment costs.

"It now seems that what would be good for the recovery — higher labour income — will be detrimental for profit margins," says Gerard Minack, principal of Minack Advisors.

"This may be a good year for the economy, but profits may fall short of forecasts."
There is a lot of food for thought in the article above. First, the hedge fund curse is alive and well. When all the big hedge funds rush into hot stocks, looking for the big beta boost, these stocks tend to overshoot on the upside and downside. That is the nature of the momentum beast. If you can't stand volatility, forget high beta momentum stocks.

Nowhere is this more visible than the biotech sector which led the Nasdaq over the last few years and led the recent selloff. After peaking at 275 in late February, the iShares Nasdaq Biotechnology (IBB) which is made up of large biotech companies, now sits at 215, a 22% haircut in last few weeks. Worse still, the SPDR S&P Biotech ETF (XBI), which is made up mostly of smaller biotech names, got crushed, plunging from 172 in late February to 122, a near 30% haircut in the last six weeks.

Conversely, defensive sectors like utilities (XLU) have been on fire since the beginning of the year and they provide investors with a nice dividend yield so the total return is higher than just price appreciation. I can kick myself for not taking my profits in biotech and moving over to Exelon (EXC) at the end of January but hindsight is always 20/20.

Interestingly, as the article above alludes to, not all risk assets are being sold indiscriminately. Emerging market shares have staged somewhat of a decent comeback since the beginning of the year. The iShares MSCI Emerging Markets (EEM) is up 12% since late February and the iShares China Large-Cap (FXI) is up roughly 8% in last few weeks. Even more interesting, the iShares MSCI ACWI ex US Index (ACWX) has rallied nicely, up close to 8% since late February.

So what is going on? Nothing much except some profit taking and sector rotation. But there was also deleveraging and redemptions exacerbating the downswing as investors pulled out money from hedge funds at the fastest rate for more than four years in December, following a year in which many managers' performance disappointed.

Despite the massive selloff in growth and rally in defensive, emerging markets and ex-US shares lately, I maintain my views from my Outlook 2014 and hot stocks of 2013 an 2014. In fact, as I wrote last week when I warned my readers to beware of dark markets, this selloff in growth and biotech is overdone:
...let me just end this comment by stating that while tech stocks are getting whacked hard, the selloff in momentum stocks is overdone. The WSJ correctly notes that more investors are drawn into dividend stocks, but that's because they realize fears of Fed tapering are overblown and that more tapering will lead to deflation.

Why are momentum stocks selling off hard? A lot of it has to do with normal profit taking. Many of the hot stocks of 2013 ran up 300, 400 or 500 percent or more in the last couple of years so it's only normal they will get whacked hard from time to time. Regardless, I stick with my call in my Outlook 2014 and think all the bears getting greedy here will get their heads handed to them when these momentum stocks, including biotech stocks, snap back up violently. Admittedly, I am long biotech and this may be wishful thinking on my part as one of the smartest hedge fund talents in Canada recently told me he's very bearish on this market but I think he's timing is off (read my comment on the hedge fund curse).

Importantly, forget what all these overpaid strategists on Wall Street are recommending on television. When I see a Dennis Gartman on CNBC telling people he's scared and to "get out of stocks," (so his big hedge fund clients can buy them on the cheap), I know it's time load up on risk assets.

I am using the latest selloff to add to my positions in small biotech shares that got crushed recently, like Idera Pharmaceuticals (IDRA), my top small biotech pick. Interestingly, the drubbing in the biotech sector has been painful for Baker Bros. Advisors, the closely watched healthcare hedge fund with approximately $7 billion under management. Since March, the fund's portfolio holdings have been spanked hard (Baker Brother symbols to watch: ACAD, BCRX, IDRA, PCYC, PGNX, XOMA).

There are plenty of other quality growth names in the Nasdaq 100 (QQQ) that are also set to soar higher after the latest selloff. For example, check out shares of Amazon (AMZN), Facebook (FB), Twitter (TWTR), Netflix (NFLX), and Tesla (TSLA), the most shorted Nasdaq stock.

The only thing going on is the Wall Street crooks are busy scaring retail investors using any means possible and creating all sorts of manufactured panic to buy shares on the cheap so they can ramp them up and dump them again at higher prices. This is what they'll do in the weeks and months ahead, get out of value/ dividend stocks and ramp up momentum stocks.

Bottom line is everyone needs to "CHILLAX" (a term I learned in Jamaica recently). There is no inflation, risks of deflation remain elevated, placing a cap on interest rates, and despite the gradual Fed tapering, there is plenty of liquidity to propel risk assets much, much higher.

To be sure, when the liquidity party ends, the titanic will sink. Momentum stocks will get crushed and stay down but value stocks will also be beaten badly. In a real bear market, there is literally nowhere to hide. Luckily, as Keynes famously quipped, "markets can irrational longer than you stay solvent," so all those bears betting on another 2008 right now are in for a nasty surprise as risk assets, especially growth and biotech, will surge much higher from these levels (and that's not wishful thinking).

Below, James Paulsen, Wells Capital Management, and David Blitzer, S&P Dow Jones Indices, share their outlook on the markets and bonds. Interesting discussion, well worth listening to.

Monday, April 14, 2014

Canadians Heading for a Retirement Crisis?

Vanessa Lu of the Toronto Star reports, Canadians heading for a retirement income crisis:
The warning bells have been clear, but they are growing increasingly louder: Canadians are not saving enough for retirement, and they’ve got to do something about it, quickly.

“I think there’s a broad consensus that we are heading for a retirement income crisis,” said Murray Gold, managing partner at Koskie Minsky law firm, and a pension specialist who advises the Ontario Federation of Labour.

“Two-thirds of the workforce doesn’t have any pensions, and the kinds of pensions we have aren’t as good as they were 20 years ago,” he said.

Since the 2008 financial crisis, the provinces have called for reforms to boost payouts under the existing Canada Pension Plan, but the federal government has balked at the idea.

Premier Kathleen Wynne has said Ontario will go it alone and develop its own pension plan, with details to be revealed in this spring’s budget. It is expected to be a key plank of the Liberal platform if an election is called.

Nearly 1.3 million workers in Ontario do not have access to any type of employer-sponsored workplace pension. In Canada’s private sector, only one person in five has a workplace pension.

That has resulted in an erosion of pension coverage, and an erosion of quality, Gold said, raising questions about whether future retirees will be able to maintain their standard of living. If not, there would be a domino effect that would hurt the overall economy.

The oldest Baby Boomers are turning 68, some happily retired with company pensions and good nest eggs, thanks to equity in booming housing markets. But others are struggling, opting to work longer, even after the typical retirement age of 65.

The picture is even bleaker for the Boomers’ children and grandchildren, who are trying to find that first job, or jumping between jobs, which in all likelihood don’t include a company pension, and certainly not a defined benefit plan.

In recent years, companies have been getting out of defined benefit plans, which offer guaranteed payouts at retirement regardless of how investments performed. Instead, employers that do offer a pension are often moving to defined contribution plans, where employees essentially manage their own plans, much like a RRSP, with no promised set payout at retirement.

“People have now learned the ropes enough to know that there’s something at stake here, which is my retirement security or my kids’ retirement security,” said Susan Eng, vice-president of advocacy for CARP, formerly known as the Canadian Association of Retired Persons.

Eng says her members are watching their kids trying to eke out a better life, but can’t find work or can’t save enough. So those approaching retirement age end up helping the next generations financially.

“Our members are the people who will never benefit from this (pension reform) themselves. It’s too late for them,” she said, adding they want to ensure a safety net exists for future generations.

With talk of a proposed Ontario pension plan expected to heat up in the coming months, here’s a look at proposals to fix our pension woes.

Enhanced Canada Pension Plan

Almost all Canadian workers contribute to the Canada Pension Plan, which pays out in retirement or if someone becomes disabled. Under the current funding model, CPP pays out a maximum annual pension of about $12,000, though many people receive far less.

Some have argued that boosting CPP contributions is the easiest way to raise overall retirement incomes, though critics say raising pensions for all, including the affluent, isn’t the best solution.

Business groups have warned that hiking premiums would hurt employers, and potentially impede job creation.

Even though provinces have pushed for enhanced CPP for several years now, the federal government has signalled it has no desire to go this route.

Little action is expected here, because any changes to CPP would require Ottawa’s backing, along with approval from at least seven provinces representing two-thirds of the country’s population.

Pooled Registered Pension Plans (PRPPs)

Instead of an enhanced CPP, Ottawa has passed legislation permitting pooled registered pension plans, as have a few provinces, such as Quebec, Alberta and Saskatchewan. These plans are managed by financial institutions, with participants selecting options that set contribution rates.

Unlike defined benefit plans, these do not pay out a guaranteed retirement income. The payout depends on how the pool’s investments perform.

Small- and medium-sized businesses say they favour this model because it offers flexibility.

“There is a certain elegance to them. They enable a degree of choice, but at the same time nudging people toward virtuous decisions,” said Josh Hjartarson, vice president of policy and government relations for the Ontario Chamber of Commerce.

Hjartarson argued that enhancing CPP is a blanket move that would benefit people who don’t necessarily need it, while PRPPs are the preferred option for pension reform for its members.

He said many employers would choose to participate in a PRPP as part of an employee retention strategy, though others may not be financially able to do so.

“Let’s be honest, particularly in the current climate, not every employer is in a position to do that,” he said, adding that employees could also benefit as they could opt out if they don’t want to join.

There isn’t agreement on whether employers who offer a PRPP should be required to contribute to the pooled registered pension plan. The Ontario chamber surveyed nearly 1,000 employers in February, of which 33 per cent said yes, while 48 per cent no.

Critics say these plans are similar to group RRSPs, which simply can’t get to the size and scale needed to deliver predictable pensions with low management fees.

A middle way

Keith Ambachtsheer, director of the International Centre for Pension Management at the Rotman School of Management, argues that lower-income earners and high-income earners are well-served by current programs.

“If you are neither rich nor poor, nor in the public sector, then (pensions are) something you should be interested in,” said Ambachtsheer, who says something is needed between PRPPs and an enhanced CPP.

He argues that families with an annual income in the $30,000 to $100,000 range are at greatest risk if there isn’t pension reform. Low-income earners can receive CPP, old age security, which is clawed back based on income, as well as the guaranteed income supplement.

Ambachtsheer has put forward a proposal, published by the C.D. Howe Institute, calling for such a middle way.

He proposes to replace 60 per cent of middle-income family earnings after retirement, which would take an additional 6 per cent of pay contribution rate above the current 9.9 per cent CPP contribution rate. These contributions would be split 50-50 between employer and employee (so 3 per cent each), and would be phased in over a number of years.

While employers complain this model would be too costly, Ambachtsheer says they just want to say no. “I don’t have a lot of patience for these naysayers,” he said.

He insists such a model can be created, noting that even in tight times, employers often make annual inflationary pay increases. So, for example, instead of giving a 2 per cent wage increase, an employer could afford a 1 per cent contribution to pensions and then give 1 per cent in salary, and gradually increase pension contributions, he said.

Ontario pension plan

Details of what the province will propose for its made-in-Ontario solution are under wraps, though the plan has already drawn interest from provinces such as Manitoba and Prince Edward Island, whose populations are too small to go it alone.

Ambachtsheer argues that voluntary programs clearly don’t work, noting Canadians aren’t putting money into their RRSPs and tax-free savings accounts even though the tax incentives are there.

He says the keys to any Ontario pension plan are that it would need to ensure mandatory participation, and that it would need to be independently managed to keep fees lows, possibly modelled on the CPP investment board or the Ontario Teachers’ Pension Plan.

“Let’s get people saving, and do it in a way that is low-cost and professionally managed,” Ambachtsheer said. “We know how to do this. There’s nothing to be invented.”

The advantage is, given the working population of Ontarians, a pension plan could easily get to a size that would give it the advantages of scale. It would be much bigger than plans such as Teachers’ or the Healthcare of Ontario Pension Plan (HOOPP), and could invest in ways that would deliver higher returns than small plans or individual investors can get.

Savings and discipline

CARP’s Eng says the hard truth is that people must realize they have to ante up the cash. The general rule is that you need to contribute 18 to 20 per cent of income to earn a pension that pays 70 per cent of pre-retirement income, she says.

“It’s almost 18 per cent, split between employer and employee, that would otherwise be cash in your jeans,” Eng said. “Are people prepared to pay what it takes? I think we are getting close. There will be some sticker shock.”

She says those who envy Ontario teachers or other public sector workers with their good pensions need to remember they are making hefty contributions. Teachers contribute about 12 per cent of their income, matched by their employers.

But telling people they need to save more isn’t working, given Canadians aren’t taking advantages of existing RRSPs and TFSAs. And even if they are, individuals can’t easily invest in the same way as big pension funds, getting good returns with low fees, compounded over years.

Ambachtsheer blames inertia, saying only a small minority of people carefully plan their future, noting most are just dealing with busy lives without time to deal with retirement plans.

But given that 80 per cent of employees in the private sector do not have a pension, the urgency is growing.

“The societal question is, do we create a framework?” he said. “Is there some public initiative that would help these people?

“It’s just a matter of whether we can collectively wrap our heads around actually doing it.”
None of this is news to me. I started this blog back in June 2008 knowing full well Canada and the rest of the world is heading for a severe retirement crisis. Politicians are only now waking up to this new reality.

What do most Canadians do? If they are able to save — which isn't easy after they pay housing, food, energy, cars, clothing, schools and other expenses  — they shove their money in some shitty mutual fund their bank is peddling, effectively raping them on fees (1% or 2% annual fee compounded over many years takes a huge bite out of their retirement savings).

In the U.S., a  new study finds that the typical 401(k) fees — adding up to a modest-sounding 1% a year — would erase $70,000 from an average worker's account over a four-decade career compared with lower-cost options. To compensate for the higher fees, someone would have to work an extra three years before retiring. When it comes to retirement, most people need a reality check on pensions.

Go back to read Jim Keohane's speech at the HOOPP conference on DB pensions. Also, go back to read my comments on whether Canada is on the right path. We have serious economic challenges ahead, which is why I believe it's high time our politicians get cracking on bolstering retirement incomes by bolstering defined-benefit plans, especially for middle income earners struggling to save for retirement.

Is Keith Ambachtsheer right? Yes and no. Low income Canadians are served well with the current system and would be worse off with enhanced CPP but for the rest of the population, including high income earners, there is no question that enhanced CPP is the way to go. Ask any doctor in Ontario if they can have a DB plan managed by HOOPP instead of shoving it in some shitty mutual fund and they will tell you "hell yes!!."

At the very least, the federal government should revise RRIF rules not to penalize older Canadians who are working well past the age of 65 years old. The current rules are dumb, forcing all Canadians past a certain age to convert their RRSPs into RRIFs and then withdraw money out of their RRIF account even if they took a hit during the financial crisis and are still working and need to save more for retirement.

Below, a 2009 report which explains America's 401(k) nightmare. As the default retirement plan of the United States, the 401(k) falls short, argues CBS editor-in-chief Eric Schurenberg. He tells Jill Schlesinger why the plans don't work. The same thing is happening in Canada, which is why now is the time to act to bolster defined-benefit plans for many Canadians that are staring at a retirement crisis.

Friday, April 11, 2014

A Tribute to Jim Flaherty

Laura Payton of CBC News reports, Jim Flaherty, former finance minister, dead at 64:
Jim Flaherty's colleagues, political opponents and friends are remembering him for his commitment to public service, his playful sense of humour and his devotion to his family.

Flaherty, who resigned last month as federal finance minister, died of an apparent heart attack Thursday at age 64.

Flaherty's wife, Ontario MPP Christine Elliott, asked for privacy on behalf of her and the couple's triplet sons, John, Galen and Quinn.

"We appreciate that he was so well supported in his public life by Canadians from coast to coast and by his international colleagues," Elliott said in a statement.

Prime Minister Stephen Harper, speaking to Conservative MPs and senators, called Flaherty — until last month, his only finance minister — his friend and partner.

"This comes as an unexpected and a terrible shock to Jim's family, to our caucus and to Laureen and me," Harper said, as his wife, Laureen, wiped tears from her face.

A source close to the family told the CBC's Evan Solomon that Flaherty died of a massive heart attack. Emergency services were called to Flaherty's home in Ottawa at 12:27 p.m. Thursday.

Conservative MP Kellie Leitch, who lives in the same building, was administering CPR when paramedics arrived, according to sources. Leitch is a pediatric surgeon who co-chaired Flaherty's campaign for the Ontario PC leadership. Flaherty was her friend and mentor.

Flaherty had battled health problems in the months leading up to his resignation, most publicly, a painful skin condition called bullous pemphigoid. But Flaherty had also experienced a medical issue during a Conservative caucus meeting some time in the last eight months. He was attended to by Leitch on that occasion as well.

Conservative MP Bernard Trottier said on CBC News Network's Power & Politics that Flaherty's Conservative colleagues thought at the time the problem was related to "extreme fatigue."

MPs suspended the House of Commons just before the daily question period Thursday, around 2:15 p.m. ET, as news of Flaherty's death made its way through Parliament Hill. NDP Leader Tom Mulcair moved for the adjournment.
MPs hug, shake hands

"After consultations among House leaders, there is general agreement the House will now suspend," Speaker Andrew Scheer told MPs.

The flag on the Peace Tower was lowered to half-mast in Flaherty's memory and Ontario's provincial legislature adjourned early. Flaherty was a member of Queen's Park in Toronto for 10 years.

G20 finance ministers, including Canada's Joe Oliver, are meeting in Washington, D.C.. They will start their evening with statements on Flaherty's death.

Opposition MPs crossed the floor to shake hands with Conservative MPs and offer their condolences. Some hugged each other.

An hour later, Conservative caucus members were gathered in a room on Parliament Hill to hear Harper's statement and reminisce. Harper had been scheduled to meet with the visiting president of Peru in the room.

Many senators and MPs were visibly upset, wiping tears from red-rimmed eyes. Some gathered to comfort Leitch.

Leitch said in a statement that Flaherty had encouraged her to get involved in politics.

"He was my champion. Canada has lost a giant and our government has lost one of its most respected and capable members," she said.

"Jim’s family meant the world to him and he took great pride in telling his colleagues of their successes and accomplishments. My heart breaks for them and words cannot express what they must be going through."

Treasury Board President Tony Clement, who started working with Flaherty when they were members of Ontario's legislature more than two decades ago, tweeted his grief.

"Just crushed at the loss of my colleague and friend @JimFlaherty. We spent 25 years together in public life. An Irish lion is gone," Clement said on Twitter.

Mulcair, often a fiery opponent of the Conservative government, made an emotional statement outside the House.

"Catherine and I want to express to Christine Elliott our profound sadness at the departure of our friend Jim Flaherty," Mulcair said, his voice breaking.

"We share in their loss. We're very, very sorry for their loss. Jim Flaherty was an extraordinarily dedicated public servant," Mulcair said.

In a statement, Foreign Affairs Minister John Baird said Flaherty had been his mentor at Queen's Park, Ontario's legislature.

"I could always rely on Jim to be a devout friend through tough times, and an encouraging figure through good," he said.

Toronto Mayor Rob Ford, a family friend of Flaherty's, tweeted his condolences to Elliott and said he was devastated.

"The Ford family is heartbroken," he tweeted.
'Absolute commitment' to Canada

Liberal Leader Justin Trudeau was on a plane to Vancouver when the news broke but tweeted his reaction after landing.

"Like all Canadians, I join in expressing my sadness at Jim Flaherty’s passing. My sincere condolences to @chriselliottpc and his children," he said.

Green Party Leader Elizabeth May said MPs were all in shock. "I don't think there was anyone better loved across party lines."

New Democrat MP Charlie Angus recalled being in Rome with Flaherty, relaxing with a couple of beers.

"He looked like a little altar boy, he was so proud to be in Rome," Angus said.

"It's just so bloody sad."

Liberal MP Scott Brison, a former finance critic, said Flaherty was a great father.

"You could differ with him, but you never ever doubted his absolute commitment to serving the people of Canada," Brison said.

Bruce Heyman, the new American ambassador to Canada, noted Flaherty's eight years in "one of government's most demanding roles."

"That he did so during challenging economic times makes his achievement all the more impressive," Heyman said in a statement.

At the time he stepped down from cabinet less than a month ago, Flaherty said he planned to eventually return to the private sector.

His final tweet as finance minister, announcing his departure, was his last: "It has been an honour to serve Canada. Thank you for the opportunity," it said.
You can read more reaction to the death of Jim Flaherty here. Mark Carney, the former Governor of the Bank of Canada and current Bank of England Governor, paid tribute to his friend saying he had an "enormous influence" on him:
Mr Carney, who led the Bank of Canada from 2008 to 2013, said Mr Flaherty was an "enormous influence" on him.

“From his sound management of the Canadian economy to his invaluable contributions to international policy making, Jim Flaherty has exhibited the very best of Canadian virtues in service to our country," Mr Carney said in a statement on Thursday night.

"Jim Flaherty played a central role when the G20 came of age in Washington in 2008, and when it forged its greatest contributions in London 2009 and Toronto 2010. He was a true believer in multilateralism, leading, urging, cajoling the members around the table to pursue policies that would promote strong, sustainable and balanced growth for all.

"He was a man of principle who believed in fixing banks when they were broken, sound money and balanced budgets.

"I had the privilege of working with Jim Flaherty for the better part of eight years. He was an enormous influence on global policy and on me personally. I know many colleagues will feel his loss and I will miss him tremendously.

"He gave everything for his country and the world economy. A man of principle who loved to laugh and debate. He won more often than he lost and he gave more than he received."
Jim Flaherty did give everything for his country. Along with Paul Martin, who publicly shared his condolences, Jim Flaherty will go down as one of the greatest Finance Ministers in our country and one of the most beloved politicians.

Let me share with you what impressed me the most from Jim Flaherty. From 2008 to 2010, I worked as a senior economist at the Business Development Bank of Canada (BDC), replacing another senior economist who was on maternity leave.  It was a very busy and chaotic time at the BDC as they were guaranteeing bank loans from Canada's major banks.

At the time, banks weren't lending money to small and medium sized enterprises. Large companies had access to credit markets but even they were having a hard time obtaining credit. I remember one thing from that experience. Jim Flaherty was on the phone with Jean-René Halde, BDC's president and CEO, every Friday morning getting updates on the situation. I'm sure he did the same thing with Steve Poloz, the current Governor of the Bank of Canada who was then president and CEO of Canada's Export Development Company (EDC).

Canadians will remember Flaherty as a nice, jovial Finance Minister who cut the goods and services tax (GST) and introduced tax-free savings accounts (TFSAs). Flaherty did a lot more than that. He introduced the Registered Disability Savings Plan (RDSP), a long-term savings plan to help Canadians with disabilities and their families save for the future (every major Canadian bank except for the National Bank of Canada offers them. Wake up Louis Vachon!!).

In fact, Flaherty did more to help Canadians with disabilities than any other Finance Minister, probably because one of his three triplet sons also suffered from a learning disability. He also did a lot to help the average working class Canadian and in the end, publicly disagreed with Prime Minister Harper on income splitting.

One area where I wish Flaherty also publicly disagreed with Harper was on enhancing the Canada Pension Plan for all Canadians. Unfortunately, he caved to his boss who shamelessly pandered to banks, insurance and mutual fund companies peddling their silly PRPPs. I truly believe that privately, Flaherty knew defined-benefit plans are far superior to anything the financial industry could offer and was willing to move on it but he got clipped.

In the end, Jim Flaherty died of a massive heart attack. He was taking heavy doses of cortisone to deal with the pain of his rare skin disorder. I only took cortisone treatment twice in my life and hated it. The first time was back in June 1997 when I was diagnosed with Multiple Sclerosis and a year after when I lost partial vision in my right eye from optic neuritis.

Did this treatment contribute to his ill health? It sure did but the stress of the job didn't help either, as Flaherty weathered crisis after crisis. The biggest tragedy in all this was that he resigned from the post of Finance Minister to spend time with his family and to go work in the private sector. CTV reporter Craig Oliver, a close friend, told CTV that he was looking forward to "making some money," no doubt to take care of his family.

Below, the CBC reports on the sudden and tragic death of Jim Flaherty. Canada lost an outstanding Finance Minister and a great Canadian yesterday. My deepest sympathies go to his wife Christine Elliott and his three sons, John, Galen and Quinn. Their father was a great man and they should be proud of his honorable record in public service and incredible achievements helping working class and disabled Canadians.

Thursday, April 10, 2014

Ontario Teachers To Acquire Telesat from PSP?

Alex Sherman of Bloomberg reports, Ontario Teachers’ Said in Lead for $7 Billion Telesat Deal:
Ontario Teachers' Pension Plan is the front-runner to acquire Loral (LORL) Space & Communications Inc.’s Telesat Holdings Inc. for about $7 billion including debt, people with knowledge of the matter said.

The Telesat purchase would come in two pieces: buying publicly traded Loral, which owns 63 percent of the company, and acquiring the rest from Canada’s Public Sector Pension Investment Board, which co-owns the satellite operator.

Loral could be bought for more than $80 a share, said the people, who asked not to be identified because the talks are private. The shares closed at $70.08 yesterday in New York, giving it a market value of about $2.2 billion. Loral rose 7 percent to $75 at 8:26 a.m. in New York today.

Canada Pension Plan Investment Board also has been in talks with both of Telesat’s owners, the people said. Public Sector Pension owns about 37 percent of Telesat and controls about 67 percent of the voting rights. As a result, both Loral and PSP must agree to a deal for a full sale of Telesat.

The discussions signal that Loral’s largest shareholder, Mark Rachesky’s MHR Fund Management, and PSP are working together to get a deal completed. The two co-owners of Telesat were previously not talking with each other, making a joint transaction tricky, according to the people. Rachesky is Loral’s chairman.

A sale could be announced later this month or in early May, the people said.

Michael Bolitho, a Telesat spokesman, declined to comment, as did Deborah Allan, a spokeswoman for Ontario Teachers’ Pension Plan. A representative for PSP didn’t respond to requests for comment, while Linda Sims, a spokeswoman for Canada Pension Plan, declined to comment.
Previous Interest

Buyout firms including Apax Partners LLP, KKR & Co. and Carlyle Group LP had looked at buying Telesat, and all have dropped out of the bidding, the people familiar with the situation said. Reuters previously reported that Loral was in talks with Ontario Teachers’ and Canada Pension Plan.

Loral and PSP acquired Telesat from Canadian telecommunications company BCE Inc., a deal announced in December 2006 valued at about $3 billion including debt.

Telesat owns 14 satellites and manages the operations of satellites for third parties, according to its website. The company was founded in 1969 and launched the world’s first commercial, domestic communications satellite in geostationary orbit in 1972.
A few thoughts came to me as I read this article. First, if it goes through, PSP is making off like a bandit on this deal. I must admit, when Derek Murphy, Jim Pittman and PSP first announced the acquisition of Telesat back in December 2006, I thought they paid way too much and that this deal was going to be a major flop (for a while, it sure looked that way).

But I was obviously wrong. In the pension world, if you hold on to an asset long enough, there is always a greater fool willing to bid up the price of that asset, and in this case, it's Ontario Teachers. Now, the people running Teachers' private equity are no fools, but I have to wonder why are they paying $7 billion to acquire Telesat from Loral Space & Communications and PSP when other bigger and smarter buyout funds dropped out of the bidding process?

Part of the reason might be because this asset falls more into the infrastructure spectrum, so you need a longer investment horizon to unlock its true potential. One PE expert told me if Ontario Teachers' "keeps the leverage level low (which may not be possible to be a competitive bidder) as this business is punctuated by large capex requirements, it would be a decent long term hold, and probably re-listed for long term capital access needs like most of the industry."

This expert added the following on the deal:
PSP took a huge risk at the time, so them doing well is ok. Could have invested in some distressed public companies in the sector at the time and also done very well, so not sure what the risk adjusted outcome against liquid options would have looked like, they still probably did well on this measure due to the Loral synergies. BC Partners and Apax in Europe also did very well in this sector, so it has been hot for years. PE in its classical form was really about clever distress investing, and financially de-risking as quickly as possible. One lesson people seem to forget is everything is cyclical. Understanding the drivers of an industries cyclicality is what winning investors do. 
Great insights from someone who understands the nature of the beast. And he's right, the entire sector has been hot for years and on a risk-adjusted basis, PSP might have done better investing in liquid public companies rather than an illiquid private asset.

It's also worth noting that Ontario Teachers' is still a large BCE shareholder, and Claude Lamoureux, OTPP's former president and CEO and the man who hired Ron Mock at Teachers after Phoenix blew up, sits on BCE's Board, so maybe this company has some operational relevance to BCE that gives OTPP a diligence edge.

In any case, it's funny how Ron Mock was recently talking up illiquidity risk and "increased competition" among Canadian pension plans when he's fully entrenched as part of the great Canadian pension club (now I know why he has yet to subscribe to my blog).

Lastly, it's worth noting Warren Buffett’s Berkshire Hathaway recently cashed out its investment in Dish Network Corp. (DISH), selling its small stake in the satellite broadcaster while buying a number of shares in Liberty Global Plc, John Malone’s European cable TV giant. Hence, PSP's timing to unload Telesat at a nice premium is superb. 

Below, Bloomberg’s Alex Sherman reports on a possible merger between Dish and DirecTV. He speaks with Emily Chang on Bloomberg Television’s “Bloomberg West.”

Wednesday, April 9, 2014

Bogus Private Equity Fees?

Alan Katz of Bloomberg reports, Bogus Private-Equity Fees Said Found at 200 Firms by SEC:
A majority of private-equity firms inflate fees and expenses charged to companies in which they hold stakes, according to an internal review by the U.S. Securities and Exchange Commission, raising the prospect of a wave of sanctions by the agency.

More than half of about 400 private-equity firms that SEC staff have examined have charged unjustified fees and expenses without notifying investors, according to a person with knowledge of the SEC’s findings who asked not to be named because the results aren’t public. While some of the problems appear to have resulted from error, some may have been deliberate, the person said.

The SEC’s review of the $3.5 trillion private-equity industry began after the 2010 Dodd-Frank Act authorized greater oversight of money managers, putting many firms under the agency’s scrutiny for the first time. By December 2012, examiners had found that some advisers were miscalculating fees, improperly collecting money from companies in their portfolio and using the fund’s assets to cover their own expenses.

“A lot of the practices, in the eyes of the SEC, raise conflicts,” said Barry Barbash, co-head of the asset-management group at Willkie Farr & Gallagher LLP in Washington. “The SEC wants those conflicts aired out and wants certain practices ultimately changed, and I’m sure we’re going to see it.”

John Nester, an SEC spokesman, declined to comment on the exams.
Opaque Model

Private-equity firms buy companies using a combination of investor capital and debt, with the goal of selling them or taking them public for a profit. They typically charge annual management fees of 1.5 percent to 2 percent of committed funds and keep 15 percent to 20 percent of profit from investments, known as carried interest. Most buyout firms also charge fees to the companies they acquire to help cover costs related to the deals or restructuring, often sharing some of the proceeds with their investors.

“These organizations, though, are opaque, and that’s the problem. We’re basically taking them at their word,” said William Atwood, executive director of the Illinois State Board of Investment, which oversees three state retirement systems. “The role of the regulator in this situation can’t be overstated.”

The private-equity model lends itself to potential abuse because it’s so opaque, according to Daniel Greenwood, a law professor at Hofstra University in New York and author of a 2008 paper entitled “Looting: The Puzzle of Private Equity.” The attraction of the funds is that the managers have broad discretion, which also means that investors have a hard time knowing what the managers are doing, he said.

“The SEC and SEC enforcement can now see problems that probably existed all along and probably were actionable all along, but there was nobody to bring the action,” Greenwood said. “The big change has got to be the disclosure.”
More Enforcement

Last month, the agency filed a civil case against Clean Energy Capital LLC and its founder Scott Brittenham, accusing them of misusing more than $3 million in funds to pay for office rent, tuition costs, bottled water and group photo sessions. The money should have gone to investors, the SEC said.

“We believe that all of the expenses the SEC was complaining of were permitted by the limited partnership agreements and Delaware law,” said Aegis Frumento, a partner at Stern Tannenbaum & Bell LLP in New York, who represents Brittenham and the firm. “We have every confidence at the end of the day that these charges will not be found to have been fraudulent under the Investors Advisers Act.”

The SEC’s action against Clean Energy Capital is probably just the first of several enforcement cases that will draw the boundaries of what’s allowed, according to Barbash, a former director of the SEC’s investment-management division.

“The industry is going to be forced into change because, frankly, when your big investors are public plans and other money that’s run by fiduciaries, you can’t afford as a business matter to be deemed to be engaging in fraud,” Barbash said. “Fraud doesn’t sell very well.”
It's high time regulators shine the spotlight on private equity fees. You can read the SEC's press release here. I also urge you to read Daniel Greenwood's 2008 paper, “Looting: The Puzzle of Private Equity.”

Charging investors bogus fees is basically legalized theft. It's the same thing that goes on with large hedge funds managing billions and raping clients on fees for beta or sub-beta performance. They quickly forget about performance and focus on sales and marketing. That's the problem with the 2 & 20 model, it incentivizes hedge funds to become large and lazy asset gatherers. Why focus on performance when you can clip hundreds of millions or even billions on a 2% management fee?

In private equity, the management fee is initially based on the total investor commitments to the fund as investments are made. After the end of the commitment period, ordinarily 4–6 years, the basis for calculating the fee will change to the cost basis of the fund, less any investments that have been realized or written-off. But unlike hedge funds, private equity and real estate funds have a hurdle rate to clear before they can charge performance fees.

The Bloomberg clip below discusses the other hidden fees private equity funds charge, like their "consulting fees" to the companies they acquire using investors' capital. This is a joke but it goes on all the time.

The SEC's review focuses on whether private equity funds are abusing the terms of their limited partnership agreements with investors. To be clear, it's up to limited partners (ie. institutional investors) to scrutinize all the fees and expenses their private equity funds and hedge funds charge them. If their funds are violating an LP agreement, it's their fiduciary duty to uncover it and tell their managers to reimburse them.

But institutional investors also need to wake up and start scrutinizing all fees they pay out to hedge funds and private equity funds. I discussed this in my comment on the hedge fund curse:
I also met up with one of Canada's sharpest hedge fund talent in Toronto. This is a guy who I would seed in a heartbeat and unlike all of Quebec's hedge funds, which I foolishly keep promoting, he would have no problem obtaining money from Julian Robertson if the Tiger fund was a true seed fund, not an accelerator fund. HR Strategies is currently looking at him for their SARA Fund but I put him in touch with a few U.S. funds of funds and raised concerns with HR Strategies and their SARA Fund (will they survive in the next three years??).

Anyways, we talked about markets and the entire culture of hedge funds. He told me flat out that he's happy to benefit from the 2 & 20 model (it's more like 1.5 and 15 now) but he thinks it's nuts to pay an established hedge fund manager managing billions a 2% management fee. I agreed and even wrote about how some smart managers are now chopping their fees in half. As I told him: "Why should Ray Dalio or any mega hedge fund 'guru' collect billions in management fees for turning on the lights? It's absolutely nuts!!" (if the ILPA had any balls and clout, they would pressure their established managers to only get paid on performance! I talked about this ten years ago at an ILPA meeting in Chicago but people looked at me like I was from Mars)

We also talked about culture at hedge funds. I told him I liked to meet with senior managers and then randomly meet with a junior analyst when doing due diligence. If the senior managers asked me why, I'd tell them flat out "because they carry the weight of your hedge fund" so I want to gauge their level of engagement and happiness and see how well they are treated.  (He told me Dan Loeb has a terrible reputation for not paying his senior analysts and managers the terms of their contract, something which if true, would make me pull out of his fund pronto, no matter how good he is)

In terms of compensation, he told me analysts and managers at hedge funds should be paid "a direct share of the total P&L with their swing factor determined by 1) quality and quantity of their research and 2) making other analysts better at their jobs." Right on!
I stick by these comments and if Ray Dalio or any other elite hedge fund or private equity manager managing multi billions has a problem, I welcome them to email me with their concerns and I will publish them (

Go back to read Ron Mock's strategy on hedge funds and why OTPP's sweet spot lies with funds managing between $500M and $2B. OTPP got slammed hard in 2008 investing in all sorts of illiquid and funky hedge fund strategies. That experience taught them the importance of managing liquidity risk. Ron recently told me that since 2008, they shifted their hedge funds mostly into managed accounts to "manage liquidity risk, have more transparency and control." But he added that they still invest some of their sizable hedge fund portfolio in "unique alpha funds that are not as liquid."

I can guarantee you, however, that Ontario Teachers scrutinizes all fees and expenses their hedge funds and private equity funds charge them down to the penny. The same goes for all other large Canadian public pension funds investing in private equity and/or hedge funds.

The biggest abuses happen in the United States where you still have far too many incompetent public pension fund managers that aren't properly compensated and staffed to understand whether the fees and expenses their alternatives funds charge them are respecting the limited partnership agreement.

Even CalPERS, the largest U.S. public pension fund, is in the process of revamping their PE portfolio and striking fear into PE firms but Real Desrochers and his team have a lot more work to clean up the mess they inherited. They recently got embroiled in a legal feud with Yves Smith of Naked Capitalism because they refuse to provide her private equity data she requested (Yves replied to my comment -- see my postscript -- but I told her she will never see that data because it will show how grossly incompetent CalPERS was in paying PE funds all these hidden fees).

Once again, I welcome all intelligent feedback from institutional investors and private equity fund managers and will gladly post your thoughts anonymously or I can attribute it to you.

Below, a majority of private-equity firms inflate fees and expenses charged to companies in which they hold stakes, according to an internal review by the U.S. Securities and Exchange Commission, raising the prospect of a wave of sanctions by the agency. Cristina Alesci reports on Bloomberg Television's “In The Loop.”

Tuesday, April 8, 2014

Beyond Quebec's Politics of Division?

Allison Hayes of the Montreal Gazette reports, Quebecers chose 'unity and openness,' Couillard says:
The Quebec Liberal Party staged a stunning comeback 18 months after being ousted from power in the climax to the Maple Spring, winning a majority government in the most divisive and nasty election campaign in recent memory.

The Liberals took 70 of Quebec’s 125 electoral seats and garnered 41 per cent of the popular vote – a stinging blow to the Parti Québécois and its controversial charter of values.

Taking to the stage in Saint-Félicien, after snagging his Roberval riding from a PQ incumbent with 55 per cent of the vote, premier-elect Philippe Couillard said the Liberals will focus on the economy and job creation.

But he also attempted to heal the wounds identity politics tore in Quebec’s social fabric.

“(Quebecers) have chosen unity and openness,” Couillard said. “The division is over. Reconciliation has begun. We will now work together for Quebec.”

Outgoing premier Pauline Marois announced she would step down as leader after support for her Parti Québécois sank to its lowest level since 1970 with just 25 per cent of the popular vote.

Marois, Quebec’s first woman premier, lost her riding of Charlevoix-Côte-de-Beaupréas by 777 votes.

Taking the stage at 11:15 p.m., a poised Marois said she was saddened by her party’s defeat but proud of what the PQ accomplished in 18 short months.

However her parting shot focused on the insecurity on which she based her failed campaign.

“I am worried for the future of our language,” she said. “For 400 years we’ve been speaking our beautiful language in North America... Never forget all the battles we have had to wage. We must continue, we must promote our language all the time.”

PQ cabinet ministers and star candidates heaped praise on Marois for her leadership at a party rally in Montreal.

“We have reason to be disappointed, but we never give up. Ever,” said Bernard Drainville, the minister who championed the charter, who won his Marie-Victorin riding.

“It’s not the end of the story and it’s not the end of the contributions of Pauline Marois,” said Jean-François Lisée, the foreign affairs minister, who won in Rosemont.

Media baron Pierre Karl Péladeau, whose recruitment as a star candidate for the PQ was a defining moment of the 2014 campaign, also took centre stage – perhaps a prelude for the leadership campaign to come.

“Tonight we have mixed feelings,” the former president and CEO of Quebecor Inc. said earlier in the evening after clinching Saint-Jérôme riding. “The results across Quebec were not what we had hoped... we must accept the choice of Quebecers with humility.”

He went on to praise Marois’s leadership and express his “pride” in having made the leap into politics with her.

The PQ won 30 ridings, down from the 54 it won when it formed a minority government in September 2012. Both the Coalition avenir Québec and Québec solidaire posted historic showings, winning 22 and three seats respectively.

The CAQ started slowly, but made steady gains through the evening. Veterans like Éric Caire held La Peltrie, Nathalie Roy won Montarville and Marc Picard hung on to Chutes-de-la-Chaudière. CAQ newcomers like Claire Samson in Iberville and Jean-François Roberge in Chambly helped up the seat count from 19 in 2012.

Legault, celebrating the CAQ’s showing, promised to provide an opposition that is “strong, vigilant and constructive.”
I typically avoid discussing politics on my blog, especially Quebec politics, but this was a crucial election for Quebec and Canada. The overriding message from the majority of Quebecers -- French, English and allophones -- was that they're sick and tired of discussing referendums and the charter of values and want their politicians to focus on the economy, healthcare and education, ie. the important files that unite us all.

I was tweeting my thoughts last night as I was flipping the channel from CBC to RDI watching the coverage in English and French. I kind of felt sorry for Pauline Marois because she is a towering figure in Quebec politics and deserved better. But she opened a can of worms moving on Bernard Drainville's charter of racism and got in bed with Pierre Karl Péladeau, which backfired on her in a spectacular fashion. I think the image below says it all (click on image).

Here are some of my other thoughts on yesterday's Quebec elections:
  • Francois Legault's CAQ had a respectable showing gaining a few more seats from the last election (but losing some of the popular vote). Mr. Legault is an excellent communicator who raises important points on Quebec's crushing public debt but he lacks a real solid team and voters were never really sure what to expect from him.
  • On the left side of the spectrum, Québec Solidaire kept its two seats in the National Assembly in Monday's election and gained a third in the Montreal riding of Saint-Marie-Saint-Jacques. Its leader, Francoise David, is also an excellent communicator who cares about the social fabric of Quebec but for all her idealistic talk, the party offers no real economic plan to improve things in a realistic concrete way. Also, Quebecers are sick and tired of being taxed to death, which doesn't bode well for left-leaning politicians here.
  • In the end, I believe Philippe Couillard's intelligence, stable temperament and calm demeanor, his focus on job creation and his solid team were what made the difference and led to the Quebec Liberals' landslide majority government victory. 
  • Having said this, Mr. Couillard and his team have a big job ahead of them. The honeymoon will be short-lived and if he doesn't deliver on his promises, I predict the CAQ will gain significantly on the Liberals in four years (the PQ is decimated, especially if PKP wins their leadership race). 
Apart from job creation, there are other areas Quebec needs to focus on. Ontario's Premier, Kathleen Wynne, congratulated Mr. Couillard on Twitter last night, to which I replied the following (click on image):

Premier Couillard needs to get on board with Kathleen Wynne and harpoon Harper on pensions. He must tackle Quebec's pension deficits and realize that a sound pension policy pays political dividends. Importantly, Quebec and other provinces must realize that it's high time to stop treating pensions like a political hot potato and build on our successful defined-benefit plans.

I was happy to see Carlos Leitao, Laurentian Bank's former chief economist, win his riding in Robert-Baldwin. Mr. Leitao is touted to be Quebec's next Minister of Finance and I think that's a good thing. If this is the case, he needs to table a budget very quickly and get on with the Liberals' agenda of job creation (Hint: Implement tax free zones like the State of New York and bring investments back to Quebec).

But I have another message for Mr. Couillard, Mr. Leitao and the Liberals. I'm not too happy with diversity in the workplace in our province and think a hell of a lot more needs to be done to promote true diversity in Quebec's civil service and Crown corporations like the Caisse and Hydro.

I also think something needs to be done to revamp Montreal's crumbling financial industry. I've already discussed promoting Quebec's hedge funds but I followed up with a critical comment on them when I went over why the Tiger fund is burning bright. Truth be told, most hedge funds stink, and there is only one Canadian hedge fund I can think of that I'd invest in (West Face Capital, a Toronto based activist fund run by Greg Boland. They got in on OTPP's deal with Saks and are highly regarded as an excellent hedge fund).

Having said this, there are many ways to revamp Montreal's financial industry and it's not just by seeding aspiring managers who wanna start a hedge fund and collect 2 & 20 for beta or sub-beta performance. Quebec needs a plan to attract large investment managers back to our province.

Lastly, I received a message from a Honours Bcom student at McGill University complaining to me that both the Caisse, PSP and Montreal banks are not doing enough to hire McGill grads and that they are not hiring enough minorities from all backgrounds. This fellow is part of an ethnic minority and is understandably distressed, telling me he feels it's next to impossible to land a job in Montreal despite his outstanding work experience and qualifications. He ended his email: "All I know is that the best talent from McGill isn't staying in Montreal for investment banking or investment management. It's a damn shame."

It's not only a shame, it's pathetic, bordering on criminal. I'll tell you exactly what's going on. The Caisse's "Talent Management" department run by a fellow called Frédérick Charette is doing a lousy job promoting true diversity at the Caisse. He's basically extending the same racist policies as his predecessor and implementing all sorts of nonsense policies to shut good people out (wrote about it in my comment on reversion to mediocrity). Also, the Caisse foolishly favors University of Sherbrooke students who complete the MSc in Finance and CFA program (being a McGill alumnus, I laugh whenever I see this).

And PSP isn't doing a much better job either. They pay their top people extremely well (some say outrageously well by Montreal standards) but they have the same organizational issues that they had back when I was working there between 2003 and 2006. Basically, PSP's tricky balancing act is all centered on how their senior managers can get away with multi-million dollar compensation in good and bad years. The turnover rate at that organization is still unacceptably high, which tells you that money alone isn't enough to retain talented employees.

I know far too many talented individuals in Montreal, including yours truly, being shunned by both these "powerful organizations" for all the wrong reasons. Basically, nobody there wants to hire people that are way smarter than them because they are insecure fools holding on to their chair with everything they've got (if they lose their job, they're toast!). This is why the culture at these organizations sucks and why they keep reverting to mediocrity.

There is a lot more but I better stop before I make senior managers at PSP and the Caisse very nervous. They will try (in vain) to dismiss me as a 'disgruntled former employee' but in private, they're terrified of me and my blog because they know I'm telling the uncomfortable truth. In fact, I welcome their feedback on any of my comments but they will ignore me.

One last message to the Caisse and PSP, it's high time you promote our brokers here and put the pressure on foreign brokers and investment managers you deal with to open offices in Montreal. I know, it's a lot sexier dealing with London and New York, flying business class all over the world meeting big powerful hedge fund managers raping you on fees, but it's time to bring some business back here in the local economy.

Below, I leave you with outgoing Premier Pauline Marois' parting speech and Premier-Elect Philippe Couillard's acceptance speech in front of his supporters in Saint-Félicien. I like what he said in his victory speech: "We should all focus on what brings us together. What unites us makes us stronger. Let us say together with passion, 'Nous sommes tous ​fier d'être Québécois.'"

Amen! Maybe it's time to go long Canada again (sorry, not that easy, you'll have to keep shorting the loonie on any strength). Going forward, all Canadians will have to unite to weather the storm ahead.