Friday, September 5, 2014

Greece at a Breaking Point?

I am off to Greece for the rest of the month so I decided to focus my attention on my ancestral home. Roula Salourou of ekathimerini reports, Pension system nears breaking point:
The ticking time bomb of the social security system will not explode in 2025, but 10 years earlier, or next year, according to a study by the Institute of Labor of the General Confederation of Greek Labor (INE/GSEE) which is to be presented in Thessaloniki on Thursday.

GSEE’s annual report on the Greek economy includes a chapter on the aging population and the sustainability of the social security system from 2013 to 2050. Its conclusions, which Kathimerini has seen, say that the prolonged recession and high unemployment have brought forward the pension system’s crumbling point by a decade and that in order to become viable the system requires additional resources of 950 million euros for 2016 alone.

The system’s extra requirements are expected to grow rapidly in the following years, soaring to 2.67 billion euros for 2020.

The authors of the study note that pension cuts and a hike in the retirement age would have allowed for the sustainability of the system until 2025 had it not been for the deep and protracted recession and high unemployment. As a result 2015 is seen as the year when the social security system could fall apart.

They add that new measures will be necessary due to reduced state funding (from 16.4 billion euros in 2012 to just 8.6 billion per year from 2015 to 2018), an explosive rise in the jobless rate, an increase in the number of new pensioners (from 40,000 in 2009 to 100,000 per year after 2010), salary reductions and the growth in undeclared and flexible labor.

Already the social security funds’ cash reserves have dwindled from 26 billion euros in 2009 to just 4.5 billion last year, while the demographic shift in Greece resulting from longer life expectancy and a reduction in the birthrate has contributed to a 15 percent increase in the pension burden on funds, the study notes.

The INE/GSEE economists also note that after the recent interventions to the pensions system, the average age of retirement has grown to 63 years (not including early retirement options), while pensions have been cut by about 32.5 percent.
Indeed, the Greek pension system has reached its breaking point and if you want to see how mindless austerity is a one way policy to disaster, look no further than Greece. Troika, Germany and the Greek coalition government have turned a deep recession into a prolonged depression and young workers and older Greek men are feeling the pain of job losses:
Most weekdays, Thanassis Tziombras, a 50-year-old worker at the shipbuilding zone here at the main Greek port of Piraeus, is up before dawn and out looking for work by 6 a.m.

Some 40 minutes away, in the posh Athens suburb of Psychico, Constantinos Tsimas, a 54-year-old U.S.-educated marketing consultant, wakes up to another day of working the phones and emails seeking clients.

There is a social gulf between these two men, but they are united in one thing: the financial and psychological struggle that comes with being older and unemployed in a country where the economy has shrunk by almost a quarter in six years.

Greece's economy has taken such a brutal beating that it is in a category apart from other European countries suffering through the recession. Where Greece lost some 25% of its economic output, Spain lost about 6%. Experts say that, even as the Greek economy begins to recover, the shock has been so severe that older workers are unlikely to ever hold full-time jobs again.

Unlike in other parts of Europe, Greek reforms have largely removed provisions that protected older workers. In Spain and Italy labor-market regulations favoring baby-boomers over their children are still largely in place, entrenching the so-called two-tier labor market. But in Greece, everyone seeking work largely faces similarly poor odds, said Raymond Torres, head of research at the International Labor Organization, the United Nations labor agency.

While Greece's youth unemployment is still a record for the EU--almost 60% of people aged 15 to 24 were out of work in 2013--the unemployment rate among older Greek males is about twice the euro-zone average and almost four times that of Germany.

Some 18% of 40-to-59-year-old Greek men were out of work last year, according to Eurostat, the European Union statistics agency. In the U.S. where the recession set in sooner than in the EU, the unemployment rate for men in this age group peaked at 8.2% in 2010 and has been declining since to reach 5.7% in 2013.

One in five jobs lost in Greece between 2008 and 2013 was from the middle-aged male group. The Spanish equivalent was one in eight. In Italy, middle-aged men actually added jobs in the recession years.

Greece's older men are more often families' sole breadwinners. Female employment rates here, at 43.3% in 2013, are the lowest in the EU, where the average is 62.5%, according to Eurostat.

Recent pension reforms, meanwhile, mean older Greek men who have lost their jobs could be looking at several years of no income. Greece has increased the retirement age to 67 for both men and women, changing a decades-old system that allowed some categories of workers as young as 55 to retire on a full pension.

"If they don't have a job and they have to wait so long for a pension, what are they doing in the meantime? They are at serious risk of poverty, " said Anne Sonnet, a senior economist at the Organization for Economic Cooperation and Development, a Paris-based think tank.

In Greece, with its macho, traditional culture, unemployed men are at risk of depression, says Dr. Kyriakos Katsadoros, a psychiatrist and the science chief of Klimaka, a suicide-watch nongovernmental organization in Athens, who also noted risks of alcoholism and domestic violence.

"We were used to providing for our families through honest work. We were proud of our work--now we're just ashamed," says Mr. Tziombras, counting his worry beads between his fingers.

He is sitting in an old classroom on the port now used by the Communist-led laborers' union here. "Don't kill the mosquitoes--it's others who are sucking your blood," is written in chalk on the blackboard.

He says the union, apart from political guidance, provides "solidarity and psychological support" to workers.

The shipbuilding zone at Perama in Pireaus, once buzzing, is now a wasteland of idle cranes and scattered ship parts. Men sit in cafes waiting for word that a vessel has docked for maintenance and is in need of day workers.

At its peak in 2008, 6,500 men worked here. The shipbuilding industry retains workers on a daily rate as opposed to hiring them as staff, but in 2008 there was so much demand that these workers were effectively employed full time. In the good years, they would take home a net daily salary of about EUR70, or about $95. They haven't agreed to cut this rate, despite calls by employers' associations. Today, about 1,000 workers remain, doing sporadic work.

Mr. Tziombras says his wife managed to find a job as a cleaner at a local school, bringing a few euros into the household budget, but their relationship has been strained by the financial woes. Economists say it is a growing trend in Greece for women that didn't previously work outside the home to take jobs as their spouses lose theirs.

Late last year he drove across the country to get a few days' work at a factory. He has been doing odd jobs at construction sites around Piraeus and Athens, and continues to show up each morning at the port ready for work. The last time he got a job was for three days in January.

"We have gone through our savings, we've sold everything we owned, we stopped any nonessential activity," Mr. Tziombras says.

A law against foreclosing on primary homes means that he isn't likely to lose his home because of mortgage arrears, although he frets the provision may soon be revised. His two children, 17 and 22, are in high school and college. They will continue to depend on him for years, he predicts.

Concerns are in some ways similar in Mr. Tsimas's wealthier neighborhood. Shame at being out of work is the first thing mentioned.

"It's socially shameful but, more than anything, I was ashamed because I had to ask my wife for money," Mr. Tsimas says.

His wife brings home a good salary from her investment-banking job, but the loss of income from his work still hit the family budget, which supports one child at a British university and one in a private school.

He, too, has turned to politics and voluntarism to feel useful--although a very different brand to communist Mr. Tziombras and his labor-union activism. Mr. Tsimas is a member of Drassi, a liberal political party that seldom gets more than 1% in elections. He runs an online forum with friends where they debate about the economy and politics.

For all the shared experiences of shame, financial struggle and family strain, the bottom line for the two men is very different.

"I actually think unemployed working-class guys my age may be better off in a way, because their expectations were always lower," says Mr. Tsimas. "Being at this state at 54 is certainly not what I expected for myself."

Still, his material concerns are not about survival.

"Last year I gave my daughter my iPhone for her birthday," he says looking at his own older mobile phone. "I couldn't afford a new one."

Mr. Tziombras says he has given up on all of the smaller joys of life for him and his family, like dance classes for his daughter or the occasional night at the movies with his wife. It's now all about subsistence.

"Cutting everything that's not food turns the workers into animals," he says.
A record number of tourists flocked to Greece this summer and most of them didn't see the economic pain the country is experiencing because they flew off to their island destinations. But Greece is still reeling from the longest and deepest post-war depression it has ever experienced.

Still, as bad as things are, some economists think the worst is over. Niki Kitstantonis of the New York Times reports, Seeing Just One Way for Greece to Go: Up:
The first time Gikas Hardouvelis left his job as a bank economist to try his hand at Greek politics, in 2000, the country was preparing to join the euro currency union, looking forward to a period of prosperity and optimism.

The second time, in late 2011, Greece was teetering on the brink of a disastrous exit from the common currency, its finances and politics in free fall.

Now, as the country’s finance minister, Mr. Hardouvelis aims to steer Greece out of its catastrophic recession, his hopes lifted by the first indications of an upturn.

“A pessimist would say, ‘Everything is difficult around the world — in Europe, how can you grow?’ ” Mr. Hardouvelis, a Harvard-educated economist, said recently in his Athens office. It was his first interview since joining the government in a cabinet reshuffling in June. “An optimist would say, ‘Once you’ve fallen so much, it’s easy to pick up.’ ”

Mr. Hardouvelis is the first finance minister since the onset of the country’s four-year economic crisis to assume his role in the face of predictions that things will get better rather than worse. The Greek economy, now 25 percent smaller than in 2009, is expected to grow 0.6 percent this year.

And because Greece recorded a primary surplus in the spring — a budget in the black before debt repayments — it is eligible to begin exploratory talks with its international creditors about easing its huge debt burden, which stands at 174 percent of gross domestic product.

Success, though, will require him to enforce economic changes pledged to Greece’s troika of international creditors: the European Commission, the European Central Bank and the International Monetary Fund. They have kept the country afloat since 2010, when it narrowly avoided bankruptcy, with rescue loans worth 240 billion euros, or $317 billion.

Three days of talks with representatives of the troika on the progress of those changes are to begin on Tuesday. Analysts and international economists are divided about Mr. Hardouvelis’s chances of success.

In his previous political roles, Mr. Hardouvelis was only an adviser, first to the Socialist prime minister Costas Simitis from 2000 to 2004, and later to the technocrat prime minister Lucas Papademos, who was installed in late 2011 to lead a six-month coalition government after the previous Socialist administration collapsed.

Now, as a senior member of Prime Minister Antonis Samaras’s coalition government, Mr. Hardouvelis faces the challenge of administering harsh medicine that the recession-weary Greek public is finding tough to swallow.

The regimen will include modernizing an antiquated tax system, introducing a new property tax that aims to spread the burden more evenly and continuing a crackdown on tax evasion.

The second overhaul of Greece’s retirement system since 2010 is already in progress. It involves consolidating dozens of pension funds into three. An effort is underway to cut about 6,500 jobs from the Civil Service. Privatization of many state-owned assets, which has long been on the to-do list but has yet to show much progress, is back in focus, as potential buyers — chiefly from China — eye airports and other infrastructure.

Some experts maintain that Mr. Hardouvelis is the right man for the job, saying he has an ideal mix of experience and abilities. A widely cited academic, he has advised private and state banks, including the New York Federal Reserve, and has engaged in politics and diplomacy during critical moments in Greece’s recent history.

“He has a strong reputation in international economic policy circles, which should be extremely helpful in negotiating with international creditors,” said Kenneth S. Rogoff, a professor of economics at Harvard and a former adviser to the International Monetary Fund. “Of course, his task of trying to restore growth in a country with weak institutions that faces strong creditors is not an easy one.”

Others say he lacks the combative nature required for Greek politics and imposing his will on a reluctant populace.

Jens Bastian, an economic consultant and former member of the European Commission’s task force in Athens, compared Mr. Hardouvelis with his predecessor, Yannis Stournaras, who now heads the Greek central bank but had experience running a private bank before he was tapped for the ministry.

“He never held front-line positions which required him to sign decisions like Stournaras,” Mr. Bastian said.

The new minister’s first real test will come when he meets with the troika’s representatives. After the coming talks in Paris, the parties will reconvene later in September in the Greek capital — a symbolic move intended to indicate that Greece is ready to assume greater control of its actions.

“Greece has done most of the reforms; the next phase is to solidify them, to make sure they don’t reverse,” Mr. Hardouvelis said. “I think it will be done in a more efficient way in the future, precisely because the troika is not right on our neck. They’ll be staying in the background.”

Of the €240 billion in rescue loans pledged to Greece by the troika since 2010, only a small portion remains to be disbursed: €1.8 billion from the European side and €15.6 billion from the I.M.F.

The loans have been dispensed in installments in exchange for painful austerity measures, including Civil Service salary cuts and tax increases that have reduced personal incomes by a third, left nearly one in three Greeks unemployed and shrunk the economy by a quarter.

Greek officials contend that it is in the troika’s interest to hold off on additional austerity. “They have an incentive to allow us to let the economy grow because then we can better service our debt,” Mr. Hardouvelis said. He said he was eager to draft a growth plan, investing in promising sectors like agriculture and shipping to create jobs and to diversify exports beyond the economically anemic European Union.

A debt restructuring in 2012 required private sector bondholders to forgive some €100 billion, but the prospect that Greece’s creditors will share the pain this time is essentially off the table. As the eurozone teeters on the brink of recession once again, member states, particularly Germany, are in no mood to ask their taxpayers to incur losses.

Greece’s aim, instead, is to reduce the cost of servicing its debt through lower interest rates or longer maturities. “Our debt is big, but it’s also very long term, so it’s easily serviceable,” Mr. Hardouvelis said.

He added that the government planned to tap international markets with a new bond issue in the coming weeks, the third round of fund-raising in three months after four years during which financial markets were essentially closed to Greece.

Problems in the broader eurozone — stagnation in Italy and France and political jousting over the continued fiscal discipline championed by Germany — may now favor Greece, Mr. Hardouvelis said, smiling apologetically at the irony. The eurozone’s slump, he said, “necessitates an expansionary monetary policy, which keeps interest rates down and keeps borrowing costs down.”

When troika inspectors arrive in Athens, Greece’s budget will once again come under a microscope. Mr. Hardouvelis bristles at the suggestion that inspectors might take a hard line, noting that foreign auditors originally doubted Greece’s predictions of a primary surplus, only to be proved wrong in the spring. “I hope this has taught them a lesson, and they don’t insist so much on the fiscal side,” he said, noting that a Greek recovery would be undercut by any “new, onerous targets.”

Mr. Hardouvelis, the son of farmer from a small fishing village in Greece’s southern Peloponnese peninsula, said he was sensitive to the social effects of the long siege of austerity. And despite his Harvard pedigree — he went there on a scholarship — Mr. Hardouvelis makes it clear he does not consider himself part of the entitled Greek political elite.

“I understand what unemployment is,” said Mr. Hardouvelis, 58, who is married with two children, one still a student, the other doing his obligatory military service. “I didn’t have a dad who would send me $1,000 a month to make it at college.”

Greeks are overtaxed, he said, but he added that tax relief would need to be preceded by growth. There may be action, though, to temper some “extreme cases” — like a tax on heating oil, which has fallen short of revenue targets while having a negative effect on the environment because Greeks have turned to burning wood to heat their homes.

Mr. Hardouvelis contends that the current government is leading a more “mature” society and that the lackluster results of anti-bailout opposition parties in elections to the European Parliament in May signal a public realization that there is no viable alternative to the country’s living within its means — however meager for now.

“Greeks don’t buy promises anymore,” he said. “They know they will be the ones that have to finance them.”
Greeks went from paying hardly any taxes to being overtaxed and not surprisingly, the more dumb taxes they impose, the more general tax revenues decline. When people are out of a job, they don't have money to pay for special taxes ("haratzia"). It's come to the point where Greeks are giving back land and apartments in order not to pay taxes.

In fact, being a landlord in Greece is absolutely terrible. You can't sell real estate because there are no buyers and many people are not paying the rent because they've fallen on hard times. And good luck taking them to court, you'll never get your money. On top of this, you have to pay taxes through hiked up utility bills. The government is desperate for tax revenues, trying to squeeze blood out of stones.

While Greece desperately needed reforms, it has yet to make cuts where they are most needed, in the bloated public sector. Sure, they cut wages and pensions, but the bulk of the pain from unemployment was felt in the private sector, not the public sector which is still largely intact (50% of working Greeks are working in some public sector job).

And the worst might lie ahead, especially if Greece's far-left Syriza builds on its momentum and wins the next elections, which might come as soon as next spring. I think all Greek politicians are hopelessly corrupt and dangerous demagogues and the most dangerous of them all is Alexis Tsipras, leader of Syriza. He continuously preaches that Greece can easily walk away from its debts and stay in the eurozone, which is utter nonsense (but desperate Greeks believe him).

Anyways, I'm off to Greece to spend time with family and friends. In my absence, those of you who want to track pension and investment news can do so by following the links below:

1) Google: pension

2) Google: private equity

3) Google: commercial real estate

4) Google: hedge funds

5) Pension Tsunami

6) Benefits in the News

In addition, you can follow me on Twitter (@Pension Pulse) and there are many links to other sites on the top right hand side of this blog under the Pension News section as well as many excellent blogs I track on my blog roll. 

Please remember to click on the ads and more importantly, to subscribe and donate to my blog. I thank all of you who have subscribed or donated and hope many more will show their support for this blog.

I leave you with a passage, Nikos Kazantzakis on Crete, my home away from home:
I don’t see Crete as picturesque, smiling place. Its form is austere. Furrowed by struggles and pain. Situated as it is between Europe, Asia and Africa, the island was destined by its geographical position to become the bridge between those three continents. That’s why Crete was the first land in Europe to receive the dawn of cvilisation which came from the East. Two thousand years before the Greek miracle, that mysterious, so-called Aegean civilisation was in full bloom on Crete – still dumb, full of life, reeling with colours, finesse and taste which surprise and provoke awe. It is in vain that we defy the traces of the past.

I believe there is an effulgence, a magic effulgence radiating out of ancient lands which have struggled and suffered a great deal. As if something remains after the disappearance of the peoples who have struggled, cried and loved on a patch of land. This radiation from past times is particularly intense on Crete. It penetrates you the moment you set foot on Cretan soil. Then you are overcome by another, more concrete emotion. Anyone who knows the tragic history of the last centuries of the island is transfixed when he reflects on the frenzied struggle on that land between men fighting for their freedom and oppressors raving to crush them. These Cretans have grown so familiar with death that they no longer fear it. For centuries they suffered so much, proved so often that death itself could not overcome them, that they came to the conclusion that death is required in the triumph of their ideal, that salvation begins at the peak of despair. Yes, the truth is hard to swallow. But the Cretans, toughened by their struggle and greedy for life, gulp it down it like a glass of cold water.

“What was life like for you, grandfather?” I asked an old Cretan one day. He was a hundred years old, scarred by old wounds and blind. He was warming himself in the sun, huddled in the doorway of his hut. He was ‘”proud of ear” as we say on Crete. He couldn’t hear well. I repeated my question to him, “What was your long life like, grandfather, your hundred years?” “Like a glass of cold water,” he replied. “And are you still thirsty?”

-- Excerpt from Pierre Sipriot’s interview with Nikos Kazantzakis French Radio (Paris), 6th May 1955
Below, a beautiful production by the "OXI Day Foundation" in the US on the "cultural gene" of Philotimo, a character virtue founded on the same values that elevated the word Philosophy to a universal human expression (h/t, Nadia).

I also embedded a nice clip with some of the best beaches in Greece. Beyond its ageless struggles, Greece is still the most beautiful country in the world and the absolute best place to vacation. I'll be back in October to resume my blogging. If you need to reach me, email me at and I'll try to reply as soon as possible.

Thursday, September 4, 2014

Meet Ontario's New Pension Suckers?

Among the list of arguments advanced for the proposed Ontario Retirement Pension Plan (ORPP), which with the re-election of the Liberal government will now suck up $3.5-billion of Ontarians’ savings every year to invest on their behalf, efficiency was near the top.

Not only are the province’s hapless citizens chronic under-savers, as the recent budget lectured them, but if left to invest unchaperoned they would simply blow it all on things like mutual funds, with their notoriously high management fees. That much is true: people who invest in mutual funds, of the kind that blanket the airwaves with claims of their superior returns at RSP time, are suckers — of which there are, by one estimate, more than 525,000 added to the population every year.

But the premise, that by forcibly merging everyone’s savings into one big, government-sponsored fund, such waste can be avoided, does not necessarily follow. I’ve had a look at several years’ worth of annual reports from the Canada Pension Plan Investment Board (CPPIB), on which the ORPP is to be based (indeed, the government cites the plan as a fallback from its preferred position, of simply expanding the CPP). It was hard slogging: the figures on costs are buried in acres of print near the back. But the picture that emerges is unmistakable, and gives the lie to any claims of savings.

In the last fiscal year (ended March 31), the board incurred costs of about $1.74-billion, or nearly 1% of the $183.3-billion in assets it started the year with. (The fund now stands at $219-billion.) Of this, about $1-billion was in fees paid to external managers, who invest on the board’s behalf. Another $200-million or so was in transaction costs — the cost of executing trades and acquiring assets. The rest, nearly $600-million, was in general operating costs. In the last four years, total costs have more than doubled; since fiscal 2007, they are up roughly seven-fold.

The choice of year is significant: 2007 was the year the board switched from a purely “passive” investing strategy — that is, simply “buying the index,” seeking to replicate the performance of the broad market in each asset class, rather than trying to pick particular stocks or bonds — to “active” management, including a major plunge into private equity and other relatively risky assets, in hopes of earning higher returns than the average. It hasn’t really worked out that way.

In the eight years since it shifted to active management, the CPPIB’s return on investment, net of all costs, has beaten its “reference portfolio” — made up of the indexes for each of the asset classes in which it invests — just four times: 2007, 2008, 2011, and 2012. The other four times it lost. To be sure, in those four good years, it beat the reference portfolio by an average of two percentage points. Add it up, and the board estimates its efforts “added value” to the tune of a cumulative $3-billion, meaning the fund is worth about 1.4% more, eight years later, than it would have been without them. But it spent more than $7.5-billion to do so. And there’s no guarantee even that meagre gain won’t be wiped out next year.

A not inconsiderable part of the bill went in salaries to its senior executives. The seven top managers listed in the annual reports collected an average of $3-million apiece in total compensation last year. (Admittedly that was a good year, but it’s commonly in excess of $2-million.) There’s no need to begrudge them that — they’d probably pull down something comparable in the private sector. But that’s the point: in the private sector, it’s sucker money they’re collecting. Whereas with a compulsory fund like the CPPIB, it’s all of our money.

CPP execs were in the papers boasting of the 16.5% return they earned last year — 16.2% after operating costs. Great: the reference return was 16.4%. That’s the average, meaning it’s the return you could expect to collect, on average, just by picking stocks (and bonds) at random — the proverbial flinging darts at the stock listings, if newspapers still had stock listings. You don’t need to pay people $3-million each to slightly underperform the average. (For example, I would be willing to do it for a third as much.)

That’s not quite fair. Nobody earns the same return as the index: there’s always some costs involved. But the costs the CPP is incurring are vastly higher than they would be had it stuck with the original passive strategy. My own little portfolio of exchange-traded funds (ETFs), all of them strictly index-based, has an average management expense ratio of 0.19% — less than a quarter the CPP’s.

I don’t mean to suggest the CPP is doing anything wrong, or corrupt. As investment funds go, I’d guess it’s better managed than most. Certainly it hasn’t behaved anywhere near as foolishly as Quebec’s Caisse de dépôt, which lost a quarter of its value in 2008 after betting heavily on asset-backed commercial paper, nor does it compare to the continuing mess at the Alberta Heritage Savings Trust Fund. It’s only making the same mistake as all the other actively managed funds — or rather the people who invest in them: thinking they can beat the market.

The evidence on this is overwhelming: in any given year, two-thirds to three-quarters of actively managed funds get taken to the cleaners by their index. Over a 10-year period, it rises to 90%. Their managers aren’t stupid: they just aren’t any smarter than all the other smart managers out there. The only way you can beat the market is if you know something everyone else doesn’t — new information, not previously public — and not just once, but routinely. That’s not just hard to do. It’s damn near impossible. Which is why the smart money buys the index, and leaves the sucker money to do the heavy lifting.

And yet the CPP is spending $1.74-billion a year of your money and mine in the same futile attempt to beat the index. And the Ontario government is about to copy them. Because God forbid they leave it up to you. Suckers.
For a second there, I thought it was Burton Malkiel writing this commentary and he forgot to call it "A Random Walk Down the Canada Pension Plan." In another article, Coyne criticized CPPIB's active management stating it's a "crock."

I like Andrew Coyne. I read and listen to his political commentaries and even agree with some of his positions. Unfortunately, when it comes to pensions, he's completely and utterly clueless and falls into the same trap that many lazy reporters do when they want to rail against "big government" and the "big, bad CPPIB."

First, let me give him a break. He's right, most active managers stink. In fact, 2014 is shaping up to be a particularly brutal year for all active managers, including hot hedge funds. Eighty percent of mutual fund managers are underperforming their index, which reinforces Malkiel's thesis that investors should be diversifying their holdings through low cost exchange-traded funds (ETFs). That much Coyne got right.

He also correctly points out that the cost of running the CPPIB is significant. The CPPIB invests in public and private funds as well as hedge funds. Their private equity and real estate investments are done via funds and co-investments. Their partners are some of the best funds in the world and they dole out big fees to invest with them.

But there is a reason why the CPPIB has invested a significant chunk of its assets in private markets. By their nature, private markets are not as efficient as public markets, so there is greater potential to unlock value over the long-run and make significant gains over public market indexes, ie. their passive benchmark or reference portfolio.

The key in all this is to measure the CPPIB's value-added over a long period, not just one or two years. Why? Because investing in private markets is a money-losing proposition in the short-term (the so-called J-curve effect) and it takes at least four to five years before the money really starts coming in for private equity investments.

None of this is mentioned in Coyne's misleading article. Go back to read my comment on CalSTRS taking CPPIB to school as well as my comment on CPPIB's FY 2014 performance. I explain why CPPIB tends to under-perform when public markets are surging and why it outperforms when a bear market strikes. Over the long run, this has generated big gains for CPPIB.

Importantly, gross value-added over the past eight years considerably outperformed the benchmark totalling $5.5 billion. Over this period cumulative costs to operate CPPIB were $2.5 billion, resulting in net dollar value-added of $3.0 billion.

There is something else that really bothers me about Coyne's slanted piece. If he thinks investing in ETFs is a retirement policy, he's really a lot more clueless on pensions than I think. He completely ignores the benefits of defined-benefit plans which include bolstering overall economic activity, increasing tax revenues and more importantly, lowering costs and pooling investment and longevity risk.

You see while investing in a diversified portfolio of ETFs is fine, if another 2008 or worse strikes, Mr. Coyne and his followers will suffer significant losses and a big hit to their retirement accounts. If they are getting ready to retire when disaster strikes, they're really screwed whereas members of a defined-benefit plan have peace of mind that their pension payments are secure, allowing them to retire in dignity.

I can go on and on about the case for boosting DB pensions and enhancing the CPP, but suffice it to say that the trash the National Post is publishing is completely inaccurate and misleading. The only thing I like about his comment is that it can be used to trash PRPPs which the Harper government is pushing for.

Let me end by congratulating Mitzie Hunter who was named Ontario’s associate finance minister, reporting to Charles Sousa, responsible for the new retirement pension plan. She has a big job at hand and I really hope they get the governance and risk-sharing right (see Newfoundland's new pension plan deal).

Below, Mark Wiseman, CEO of CPPIB, talks about the importance of thinking long term. Also, Leo de Bever discusses taking the long view on pensions. Take the time to listen to their comments, they understand why it's important to think long term when managing pensions.

Wednesday, September 3, 2014

A Tough Year For Stock Pickers?

Jeff Cox of CNBC reports, It's been a tough year for running large-cap mutual funds:
All those headlines about new stock market highs may look sexy, but life for active managers hasn't been quite so much fun.

In fact, running large-cap mutual funds has been a rough business, with about 80 percent underperforming the S&P 500 in 2014, according to S&P Capital IQ Fund Research. That's four out of five managers who've failed to match a simple stock market index fund that usually has lower fees and other advantages.

There are a handful of explanations for why performance has been so weak this year, but at the core seems to be the general and stunningly persistent belief that the market remains ahead of itself, with danger always right around the corner. Fear of a looming correction has kept many investors playing defense.

"We've gone 35 months without a decline of 10 percent or more, and the median since World War II is 12 months," said Sam Stovall, S&P's chief equity strategist. "Everybody seems to be waiting for that all-elusive correction, when everyone will pile in. But if everybody's waiting for it, it won't happen."

Stovall believes the trouble active managers have had actually could feed into the market rally. As the year winds down, managers may begin to chase performance, taking on more risk or actively seeking out poorly performing sectors such as small-cap stocks.

"If they underperform by too much, they don't get their bonus," he said. "With 80 percent underperforming vs. the more normal 73 percent, you have a greater number of fund managers who are going to feel like they've got to really turn in the afterburners to hopefully outpace the market by the end of the year."

There is, however, a bit of a silver lining in the troubles for active managers.

Todd Schoenberger, president of J. Streicher Asset Management, said the underperformance actually is indicative that managers are prudently reducing risk during an aging market rally.

"If you have a portfolio manager who's knocking the ball out of the park and hitting grand slams, doing amazing performance, the investor should always ask what is the amount of risk being taken to achieve that number," he said. "If you have a portfolio manager making 30 percent, there's a solid chance they can lose 30 percent. The portfolio managers, even though they're lagging the averages, they're probably doing the prudent thing in managing risk."

Active management has lagged in the years since the financial crisis—ever since the Federal Reserve employed a historically strong intervention into financial markets and stocks have operated on a risk-on risk-off mode, with correlations high and little place else to go for return but equities.

Investors have flocked from mutual funds since the crisis, though at least in terms of money flows 2013 and 2014 have been better years.

The exchange-traded fund industry, which uses passively managed low-cost index funds, has exploded to $1.81 trillion under management, a 20 percent gain over just the past 12 months, according to the Investment Company Institute. The $15.7 trillion industry has grown 14.8 percent in the 12-month period—respectable, for sure, but behind ETFs.

Doug Roberts at Channel Capital Research believes extreme central bank easing has made it tougher on active managers.

"Once you have everything going up, it's really difficult for an active manager to outperform," he said. "He has to be right on the mark. He has to get into something that not only has good long-term fundamentals but also is at an inflection point. That's no small task."
This shouldn't surprise us, even hot hedge funds are struggling this year. Why are active managers severely underperforming yet again? You know my thoughts already. Just like hedge funds, the bulk of mutual funds stink, getting paid fees for being closet indexers and worse still, for underperforming their index.

The fact is many active managers continue to misread the macro environment and instead of cranking up risk, they're reducing risk by raising cash, preparing for another stock market crash that is unlikely to happen anytime soon as this rally keeps surprising the staunchest bears and bulls.

And as I've warned all of you recently, the real risk in the stock market is another melt-up unlike anything you've ever seen before. In that comment, I warned that the endgame is deflation but before that, we'll get a massive liquidity-driven rally in risk assets, ending my comment with this stark warning:
...remember the wise words of John Maynard Keynes, "markets can stay irrational longer than you can stay solvent." The events I'm describing above won't happen in the next year or even five years. So while the Zero Hedge bears keep posting scary clips, relax and mark my words, the real risk in the stock market is a melt-up, not a meltdown, and institutions betting on another crash will get clobbered.
It seems like the folks at  Morgan Stanley agree with me as they now see this market rallying for another five years. Of course, we all take these prognostications with a shaker of salt as a lot of things can derail this endless rally, especially bad news out of Europe which is at risk of a total collapse.

But have a look at the 10 best and worst S&P 500 stocks of 2014, and you'll be surprised by some names (click on images below):

And the worst S&P performers:

I foresee a lot of of mutual funds and hedge funds will be chasing the winners in the last quarter of the year. What else do I foresee? The high octane momentum stocks that got crushed in Q1 are coming back to life and will severely outperform the S&P 500 in Q4. For example, check out the recent action in Splunk (SPLK) and FirEye (FEYE). And nothing seems to be stopping Tesla's (TSLA) or Netflix's (NFLX) momentum for now. There are other momentum darlings like GoPro (GPRO) ripping higher as momos chase the next big thing.

I still love Twitter (TWTR) and think it can easily double from these levels. Also, biotechs continue to drive the broad market rally, so pay attention to large cap names and some small cap biotechs I recently mentioned here.

Below, Wharton School Professor of Finance Jeremy Siegel has been bullish on the stock market for years now and he's not ready to change his mind yet. But he introduced a caveat Tuesday on CNBC: "We are creeping closer to fair market value [for stocks], which I think is approximately 18 times S&P earnings."

As I've repeatedly warned you, the big risk right now is stocks going parabolic, especially if the ECB engages in quantitative easing on Thursday. That will ignite another fire under global equities and other risk assets. Stay tuned, it should be an entertaining final quarter of the year and I think a lot of underperformers are going to be chasing stocks higher going into year-end.

Tuesday, September 2, 2014

Staying Mum on Corporate Expats?

Andrew Ross Sorkin of the New York Times reports, Public Pension Funds Stay Mum on Corporate Expats:
In the outcry about the recent merger mania to take advantage of the tax avoidance transactions known as inversions, certain key players have been notably silent: public pension funds.

Many of the nation’s largest public pension funds — managing trillions of dollars on behalf of police and fire departments, teachers and others — have major stakes in American companies that are seeking to renounce their corporate citizenship in order to lower their tax bill.

While politicians have criticized these types of deals — President Obama has called them “wrong” and he is examining ways to end the practice — public pension funds don’t appear to be using their influence as major shareholders to encourage corporations to stay put.

In the past six months, some of the nation’s largest companies have announced plans to move abroad. AbbVie, a pharmaceuticals company based in Illinois, has agreed to acquire a smaller British rival, Shire, so the combined company can relocate to Britain for tax purposes. Another drug company, Mylan, which is based outside Pittsburgh, has proposed buying the international generic drug business of Abbott Laboratories so the company can relocate to the Netherlands. Medtronic, a medical device company based in Minneapolis, has agreed to acquire Covidien of Ireland. Applied Materials has agreed to buy Tokyo Electron so it, too, can move to the Netherlands. And last week, Burger King announced it was buying Tim Hortons, the Canadian chain of coffee-and-doughnut shops, in a deal that would make Burger King a corporate citizen of Canada.

The California Public Employees’ Retirement System, the nation’s largest public pension fund and typically one of the most vocal, has remained silent.

“We don’t have a view on this from an investor standpoint — we’re globally invested, as you know, and appreciate that tax reform is a government role,” Anne Simpson, Calpers’s senior portfolio manager and director of global governance, told me. “We do expect companies to act with integrity, whatever the issue at hand — that goes without saying. We also want to see a focus on the long term.”

When I pressed for more, her spokesman wrote to me, “We’re going to have to take a pass on this one.”

Public pension funds may be so meek on the issue of inversions because they are conflicted. On one side, the funds say they care about the long term and the implications for their state. Calpers’s “Investment Beliefs” policy states that the pension system should “consider the impact of its actions on future generations of members and taxpayers,” yet most pension funds are underfunded and, frankly, desperate to show investment returns. Mergers for tax inversion can prop up share prices of the acquirers and clearly help pension funds, at least in the short term, show improved performance.

Some pension managers say that their job is strictly about generating cash for pensioners and that they shouldn’t take other issues into consideration. Ash Williams, the executive director and chief investment officer of the Florida State Board of Administration, which manages more than $150 billion, explained it to me this way: “If you’re in my seat, you’re thinking about it not only as an investor, but you’re thinking about it as a fiduciary, which sort of walls out a lot of the political considerations that might otherwise be there.” He went on: “You just have to think, ‘O.K., so I’m guarding the economic interest of my beneficiary. That is my duty, and that’s the start, the middle and the end of it.’ ”

When I pressed him about whether he felt he needed to consider the impact of these deals on the American tax base, which would affect pensioners, he said, “I guess I’d have to say what’s best for the company, what therefore maximizes the value of the ownership relationship I have to the company.” He added, “I mean, my gut is, as an American you’d like to keep businesses here.”

Mr. Williams’s approach appears to be the norm among most investors. However, Mark Cuban, the investor and owner of the Dallas Mavericks, took to Twitter with the kind of view you’d expect from a public pension fund, not a free-market evangelist.

“If I own stock in your company and you move offshore for tax reasons, I’m selling your stock,” Mr. Cuban wrote on Twitter in July. “When companies move offshore to save on taxes, you and I make up the tax shortfall elsewhere,” he said, encouraging investors to “sell those stocks and they won’t move.”

Last month, Shirley K. Turner, a Democratic New Jersey state senator, introduced a novel piece of legislation in an effort to make inversion deals less attractive. She proposed that the state’s pension board be forbidden to invest in companies that are involved in inversion deals. She said the state of New Jersey “ranks sixth among public pension funds investing in corporate inverter AbbVie, holding more than 1.5 million shares of the company’s common stock, valued at $81.9 million.”

It is unclear how such legislation would work. For example, would the state immediately be forced to sell its holdings in a company involved an inversion?

Not all officials who oversee pension funds are focused only on the immediate bottom line.

“Our fiduciary duty to our members is to vote our economic interest — and that means making an individualized determination of whether a given transaction is in our best interests as long-term share owners,” said Scott M. Stringer, the New York City comptroller. “As a result, we don’t merely look at the offer price on the day of closing but instead take into consideration everything from potential influence on shareholder rights to whether a merger places short-term gain over long-term growth.” Still, as Pfizer, one of the largest companies in New York, has continued to contemplate a merger with AstraZeneca that would make the combined corporation a British entity, neither Mr. Stringer nor any other investor acting on behalf of pensioners has spoken out. Perhaps not surprisingly, the only people who appear to be concerned are a small but growing group of politicians in Washington.

After Burger King announced its deal with Tim Hortons, Senator Carl Levin, Democrat of Michigan, declared, “If this merger goes through, there could well be a strong public reaction against Burger King that could more than offset any tax benefit it receives from a tax avoidance move,” suggesting customers take up the cause.

Indeed, the Walgreen Company, which had been considering a tax inversion transaction with Alliance Boots of Britain, voted against changing its corporate citizenship because the American pharmacy chain’s board and management worried about an outcry from customers, according to people close to the board, and were concerned that pressure from customers could spill over to the government.

Where are the investors? Happily watching their returns rise. When I asked Mr. Williams, the Florida pension manager, what he would do if he had to vote on a deal involving a Florida company pursuing an inversion that would hurt the state’s tax base, he sighed and said: “This issue is new enough — and fortunately, at this point, it’s small enough — that it hadn’t reached those dimensions. And I would just hope that we can get something done at the policy level to resolve it. That’s the best outcome.”
Not one to shy away from controversy, let me give you my take on corporate tax inversions and what U.S. public pension funds should be doing. Absolutely nothing! The reality is U.S. corporate taxes are too high relative to the rest of the world, including Canada, which is why this debate is best left for Congress and the President to tackle.

Having said this, the public needs to be informed of a few giveaways to corporations that is going on right under their noses. For example, in my comment last week on what will derail the endless rally, I wrote:
Of course, nobody really knows where the stock market is heading. A million things can derail this rally and cause jittery investors to pull the plug and sell their stocks. But with pension deficits rising as bond yields fall, pensions will be forced to take on more, not less risk. And where will they be taking that risk? Stocks, corporate bonds and alternative investments like real estate, private equity and hedge funds.
I also provided a clip where Charles Biderman, TrimTabs Investment Research CEO, analyzes current market conditions saying the market is essentially rigged and you have to "ride the tide and hope to get out before it ends."

In that clip, Biderman explains why corporations are buying back their shares. With interest rates at zero, it pays to borrow and buy back shares. While this is true, he ignores another aspect of share buybacks which I've discussed on my blog, namely, it helps corporations boost the bloated pay of their senior executives further exacerbating inequality that Thomas Piketty has brought to the world's attention.

(Also see Profits Without Prosperity, an incredible article at the Harvard Business Review which shows exactly how corporate share buybacks have gotten out of control in the last decade. It then goes on to point out the various ways in which buybacks-gone-wild are killing the capital formation process in America, holding back the investments needed to keep the country competitive and decimating the middle class workforce. For more on this article, read How corporate share buybacks are destroying America).

In fact, while I am in the camp that the Fed did the right thing to move quickly and forcefully to lower interest rates to zero and engage in quantitative easing, I was also conflicted because it was a dead giveaway to banks and the alternative investment industry.

Why? Because a zero interest rate policy (ZIRP) spells disaster for U.S. pension funds teetering on collapse, as their liabilities explode up, forcing them to invest in riskier alternative investments like private equity and hedge funds to meet their actuarial target rate of return.

Importantly, ZIRP is a boon for the alternative investment industry and big banks collecting big fees from hedge funds and private equity funds.

But if the Fed didn't lower interest rates to zero and engage in QE, it would have been a disaster for the global economy, virtually ensuring a protracted period of virulent deflation and high and unacceptable unemployment.

Public pension funds have a role to play on the bloated compensation of U.S. corporate titans and they need to bring the issues I discuss above out in the forefront. Sadly, everyone is staying mum on these issues because discussing inequality is perceived as being "anti-American," which is total bullocks!

Below, my favorite economist, Michael Hudson, unzips America in the latest installment of the Hudson-Keiser interview series where they discuss Russian sanctions and the affect on the US dollar subsidy (fast-forward to minute 14). I don't agree with everything Michael says but listen to his comments on the bubble and the aftermath and how share buybacks and corporate buyouts are enriching corporations, banks and LBO funds.

And don't forget, as I've previously discussed, big banks have aided hedge funds avoid taxes, and many public pension funds stayed mum on that scandal too. It's high time Americans take a closer look at what is driving inequality and start implementing sensible and fairer tax policies (like reducing corporate taxes but closing other loopholes favoring hedge funds and private equity funds).

Friday, August 29, 2014

Avoid the Hottest Hedge Funds?

Lawrence Delevingne of CNBC reports, Why you should avoid the hottest hedge fund hands:
Investors who don't have money with Pershing Square Capital Management are likely salivating at the hedge fund's industry-leading 26 percent return from January through July.

But investing with Bill Ackman and other top-performing managers after a great run is probably a bad idea, according to a new study of long-term hedge fund industry performance.

A white paper by Commonfund, which manages nearly $25 billion for close to 1,500 endowments, pensions and other institutions, shows that putting money with the hottest hedge fund managers can work in the short term, but that sticking with them for three years or more is worse than picking managers at random. Picking up losing hedge fund strategies can even produce slightly positive performance.

"Not only does positive-return persistence tend not to work as a selection strategy, but it is especially ineffective in the medium-to-long-range horizons that institutional investors may prefer, and indistinguishable from a strategy of selecting losers," authors Kristofer Kwait and John Delano wrote.

Kwait and Delano found that picking winning hedge funds produced returns of 13.29 percent after 18 months, versus an average of 10.62 percent for all funds. But the same group held for 36 months gained the same as the average; over 48 and 60 months, they rose just 9.49 percent and 8.48 percent, respectively.

In theory, hedge fund allocators could invest with the best managers and then quickly cash out within 18 months. But the vetting and subscription process to get in can take months or even years, especially for cautious institutional investors. Plus, hedge funds often require that their investors commit money for at least a year, and then restrict redemptions by spreading them out over several quarters.

Commonfund said its findings were consistent with a point made by Cliff Asness of AQR Capital Management.

The hedge and mutual fund manager has written that investors often try to catch short-term results in various asset classes but use a multiyear time frame, which often means they instead get hit with losing reversals—or miss winning ones—when the trade inevitably reverts to the mean. Asness declined to comment on the Commonfund study.

Ackman, for example, underperformed stock indexes in 2013 with a 9.3 percent gain, hurt by losses on J.C. Penney (JCP) and a short position on Herbalife (HLF). But Pershing Square has rocketed back this year with wins on Allergan, Canadian Pacific, a reversal in fortune for Herbalife and others, according to a recent letter to investors.

Another famous example of a hedge fund reversal is Paulson & Co. John Paulson saw his client base increase dramatically after he scored huge returns with bets against the housing market before it crashed. But heavy losses in 2011 and 2012 from too-early bets on the U.S. economic recovery caused investors to pull their money (Paulson's hedge funds snapped back in 2013).

The study also found that teasing out manager skill, or "alpha," from the general market ups and downs, or "beta," is critical to selecting hedge fund managers who will outperform.

"For an allocator, that this relationship between observed alpha and skill is not necessarily certain may leave a door open for inferring a sort of skill even from beta-driven returns, perhaps on the basis of a hard to define but powerful argument that a manager is 'seeing the ball,'" the paper noted.

The Absolute Return Composite Index, which aggregates hedge fund returns across all strategies, gained 3.79 percent this year through July. By comparison, the S&P 500's total return was 5.66 percent and Barclays Aggregate Bond Index gained 2.35 percent.

The challenge is parsing out what alpha really is; hedge fund managers are quick to attribute their gains to skill rather than market forces.

Large investors—and their teams of advisors—appear convinced they can draw the distinction. No less than 97 percent of 284 institutional investors surveyed recently by Credit Suisse said they plan to be "highly active" in making hedge fund allocations during the second half of 2014. That's even more than the 85 percent who already made allocations in the first half of the year.

According to industry research firm HFR, investors allocated $56.9 billion of new capital to hedge funds in the first half, pushing total global assets to more than $2.8 trillion, surpassing the previous record of $2.7 trillion from the prior quarter.
No doubt about it, the big money still loves hedge funds. You should all take the time to read the white paper by Commonfund, which is truly excellent.

And just to add evidence to the findings of this white paper, Michelle Celarier of the New York Post reports, Hedge funds’ all-wet profits nothing to party about:
The mood in the Hamptons isn’t likely to be too celebratory this Labor Day weekend for most hedge fund honchos.

With late August numbers starting to trickle in, some of the biggest stars are barely breaking even. Others are in the red in a year when the broader market is up 8 percent.

Take David Tepper, who turned in an astonishing 42 percent in 2013 to take home $3.5 billion.

That’s not likely in 2014 as his hedge fund was only up 2.3 percent through July, the latest numbers available. The fund fell 1 percent that month.

Richard Perry, another veteran star, is up a mere 1.3 percent through Aug. 22 — after falling 1.4 percent this month. Perry Partners gained 22 percent in 2013.

Leon Cooperman, always a bull market darling, had gained 2.25 percent for the year through July. His Omega Advisors fund rose 30 percent in 2013.

Nelson Peltz of Trian Partners is faring a bit better. His fund gained 6.6 percent through Aug. 22, with 1.9 percent coming in August. But last year, Trian was up 40 percent. That earned him a spot on the Top 20 list — alongside Tepper — published by HSBC.

Jeff Altman’s Owl Creek, which rose to fame last year with a 48.6 percent gain, has done an about face. The former top 20-hedge fund fell 3 percent through Aug. 22, with 2 percent of the loss in August.

Hedge fund legends Paul Tudor Jones and Louis Bacon are also in the red. Bacon’s main fund is down 5.5 percent through Aug. 14, after booking a 1.3 percent loss the first two weeks of the month.

Jones, meanwhile, has fallen 3 percent this year, following a .4 percent loss in the first three weeks of August.

I can't say I'm shocked by the findings. A long time ago, I wrote a comment on the rise and fall of hedge fund titans, where I wrote the following:
...I will tell you Paulson's rise and fall is nothing new. I've seen it many times before. Typically, hedge funds have a great track record, or an incredible year, consultants and brokers start spreading the word to institutional investors and in no time assets under management explode up.

That's when your antennas should go up and you need to start thinking of pulling out. Whenever I see assets explode up, from $5 billion to $40 billion, I pay very close attention because it usually spells trouble ahead.

That's exactly what happened with Paulson. He was riding the coattails of his outsized returns, assets under management mushroomed and returns subsequently faltered. Seen this so many times and yet the institutional herd keeps piling onto yesterday's winners like moths to a flame.
Should you always add more when a hedge fund or external manager gets clobbered? Of course not. Most of the time you should be pulling the plug way before disaster strikes. You need to look at the portfolio, assets under management, people, process, and risk management and make a quick decision.

This isn't easy but if you don't, you'll end up holding on and listening to a bunch a sorry ass excuses as to why you need to be patient. And no matter who he is, I would never accept any hedge fund manager 'chiding' me for redeeming from their fund. That's beyond insulting, but in an era where hedge fund superstars are glorified, this is what routinely happens.

Been there, done that, it's a bunch of BS. The media loves glorifying hedge fund managers but the bottom line is all these 'superstars' are only as good as their last trade. Institutional investors should stop glorifying these managers too and start grilling them hard.

The problem is too many institutions don't have clue of what they're doing when it comes to investing in hedge funds or private equity, so they end up listening to the useless advice of their brainless investment consultants.

I know that might sound harsh but it's the truth which is why I continuously poke fun at how dumb the entire hedge fund love affair has become. Sure, there are some good consultants, but the bulk of them are totally useless.

I used to go to these silly hedge fund conferences where institutional investors were getting all hot and horny over hedge funds and think to myself what a total waste of time. Most of these people don't have a clue of the underlying strategies and more importantly the risks of these strategies.

So what do they end up doing? They all chase performance, getting bamboozled by some hedge fund manager with his head up his ass, telling them to "hurry up and invest because they are setting a soft close at $X billions and a hard close $Y billions."

I used to get phone calls all the time when I was managing a portfolio of directional hedge funds at the Caisse. The pressure tactics were a total joke. I ignored third party marketeers and any arrogant hedge fund manager who was trying to pressure me into investing.

I recall my first meeting with Ron Mock at Teachers back in 2003 when he explained his hedge fund strategy and the way they allocate and redeem. Teachers was and remains very active in hedge funds. I recall specifically asking him about redemptions and how hedge funds react. Ron told me flat out that while "most hedge funds don't like it, if you do it in a professional manner, they'll understand and won't take it personally."

I also asked him what happens if they threaten not to allow him to invest with them ever again or if they act arrogant with him? He told me: "I have no time for arrogance and typically what happens in this industry is when the tide turns, the arrogant managers come back to plead for money. I've seen it happen many times. When they need money, they will come back to you and embrace you with open arms."

And even Ron Mock, who I consider to be one of the best hedge fund allocators in the world, experienced a few harsh hedge fund lessons in his career as a hedge fund manager and as an allocator. Following the 2008 crisis, Ontario Teachers now invests the bulk of their hedge fund assets into a managed account platform (they use Innocap), but they still invest a small portion in less liquid hedge funds (the flip side of transparency is liquidity; no use putting an illiquid hedge fund onto a managed account platform).

Allocating to external managers isn't easy, especially when you're dealing with overpaid and over-glorified hedge fund managers. This is one reason why there is a hedge fund revolt going on out there, led by CalPERS which announced it was chopping its hedge fund allocation back in May and recently confirmed it was rethinking its risky investments.

Most investors, however, aren't backing away from hedge funds. Instead, they're rethinking the way they allocate to hedge funds. For example, co-investments are entering the hedge fund arena. And Katherine Burton of Bloomberg reports, Hutchin Hill, Citadel See Assets Jump as Pensions Call:
Neil Chriss is hitting his stride.

The math doctorate turned hedge-fund manager founded Hutchin Hill Capital LP more than six years ago and built it to cater to large investors. After posting annualized returns of 12 percent, about six times the average of his peers, he finds himself in the sweet spot for fundraising. Hutchin Hill’s multistrategy approach is the most popular hedge fund style this year, helping the New York-based firm double assets by attracting $1.2 billion.

Chriss, 47, is one of the prime beneficiaries as investors are on track to hand over the most cash to hedge funds since 2007, driven by a search for steady returns and protection from market declines. The biggest firms, such as Citadel LLC, Och-Ziff (OZM) Capital Management Group LLC and Millennium Management LLC are bringing in the biggest chunks of money, yet a select group of smaller firms like Hutchin Hill have collected more than $1 billion each.

“There are huge sums of money being put to work,” said Adam Blitz, chief executive officer at Evanston Capital Management LLC, an Evanston, Illinois-based firm that farms out $5 billion to hedge funds. “You are getting some big checks coming into a fairly small universe of brand-name managers who want to grow and are on the approved list of hedge-fund consultants.”

Hedge funds attracted a net $57 billion in the first half of this year, compared with $63.7 billion for all of 2013, according to Hedge Fund Research Inc. Ten firms, including Hutchin Hill, gathered about a third of that amount, investors in the funds said.
Assets Swell

Industry assets have swelled to a record $2.8 trillion even though funds, on average, have posted 7 percent annualized returns since the financial crisis, compared with 12 percent over the previous 18 years, according to the Chicago-based research firm.

Inflows are coming from pension plans, sovereign wealth funds and high-net worth investors. Some of the institutions, such as the Hong Kong Jockey Club, are making direct investments in hedge funds for the first time, rather than going through funds of funds. The club, which controls horse-racing in the city, said in April it gave money to Och-Ziff and Millennium.
Multistrategy Popularity

Multistrategy firms, which use a range of tactics to invest across asset classes are the most popular this year after collecting a net $29.5 billion, according to Hedge Fund Research. The funds returned 4.4 percent through July 31, compared with 2.5 percent for hedge funds overall.

“Pension funds see multistrategy hedge funds as a one-size-fits-all investment,” said Brad Balter, head of Boston-based Balter Capital Management LLC. “It’s very difficult right now to identify attractive opportunities, so they are letting the manager make the tactical decisions rather than wait for their own investment committees to re-allocate capital.”

Hutchin Hill, which employs more than 60 investment professionals, uses five main strategies, including equities, credit and one that makes trading decisions based on quantitative models.

Chriss’s goal is to provide better and more consistent returns than he might using just one approach. His background is in computers and math: He taught himself to program at age 11 and sold a video game to a software company when he was a high-school sophomore.
Lured Away

After obtaining his Ph.D. from the University of Chicago, he was lured away from a teaching job at Harvard University in 1997 to go to Wall Street. He set up his firm in 2007 after working for Steve Cohen’s SAC Capital Advisors LP with early backing from Renaissance Technologies LLC founder Jim Simons.

Hutchin Hill has gained 8 percent this year, according to a person with knowledge of the performance, who asked not to be identified because the results are private.

While firms like Hutchin Hill are beginning to climb the ranks of multibillion-dollar managers, the domination of the biggest funds in raising assets hasn’t slowed, even when they report bad news or post mediocre returns.

Och-Ziff, the biggest U.S. publicly traded hedge-fund firm with $45.7 billion under management, pulled in a net $3 billion into its hedge funds this year, even as it warned shareholders that the Securities and Exchange Commission and the U.S. Department of Justice were investigating the firm for investments in a number of companies in Africa. Its main fund returned 2 percent in the first seven months of the year, less than half the average of multistrategy funds tracked by Bloomberg.
Sovereign Wealth

Chicago-based Citadel, run by billionaire Ken Griffin, helped spark a backlash against multistrategy funds after it lost 55 percent in 2008, one of the worst hedge fund declines stemming from the financial crisis. Six years later, its $22 billion in assets have surpassed its previous peak in 2008.

Its main hedge fund, which is up 9.9 percent this year, has pulled in a net $1.2 billion in 2014, even though it’s limiting inflows primarily to sovereign wealth funds, according to an investor. The firm’s Global Fixed Income fund, run by Derek Kaufman, attracted $2.7 billion.

Millennium, founded by Israel “Izzy” Englander, has collected a net $2.6 billion this year, after only taking in enough money to replace client withdrawals in 2013. The New York-based firm, which manages $23.5 billion, decided to raise money again because it’s adding more teams to the 150 that currently work at the firm. The fund has climbed about 4.2 percent this year and has posted an annualized return of 14.6 percent since January 1990, said investors, who asked not to be named because the fund is private.
Balyasny Assets

The popularity of the multimanager, multistrategy approach that Millennium helped pioneer a quarter-century ago has been a boon to some smaller managers. Dmitry Balyasny’s Chicago-based Balyasny Asset Management LP attracted $1.5 billion this year, bringing total assets to $5.9 billion, while Jacob Gottlieb’s New York-based Visium Asset Management LP pulled in $700 million into its multistrategy fund this year, after raising $1 billion in 2013.

Event-driven funds, which include managers who take activist roles at the companies in which they invest, continue to attract investors this year as the strategy gained 6 percent through July.
Loeb, Solus

P. Schoenfeld Asset Management LP climbed to $4.1 billion in assets as clients invested a net $1 billion and Solus Alternative Asset Management LP attracted $1.25 billion. Dan Loeb’s $15 billion Third Point LLC, which is known for taking activist positions, had been closed to new investments since 2011 and returned capital last year. It recently told investors it would open Oct. 1 for a limited amount of capital that clients expect will be about $2 billion, they said.

A few start ups have also received a billion dollars or more this year, in part because they are coming out of firms with strong track records that are closed to new investments. Herb Wagner, who started FinePoint Capital LP this year and raised $2 billion, was a co-portfolio manager at Baupost Group LLC, the Boston-based firm run by Seth Klarman. Matthew Sidman opened Three Bays Capital LP, another Boston firm, in January and is now managing $1.2 billion. He worked at Jonathon Jacobson’s Highfields Capital Management LP for 14 years.

Spokesmen for all the firms declined to comment on inflows and performance.

Big Money Raisers 2014

Firm PM Net AUM

Citadel Ken Griffin $3.9 bln $22.0 bln
Och-Ziff Dan Och $3.0 bln $45.7 bln
Millennium Israel Englander $2.6 bln $23.5 bln
FinePoint Herb Wagner $2.0 bln $ 2.0 bln
Balyasny Dmitry Balyasny $1.5 bln $ 5.9 bln
Solus Chris Pucillo $1.25 bln $ 4.6 bln
Hutchin Hill Neil Chriss $1.2 bln $ 2.5 bln
Three Bays Matthew Sidman $1.2 Bln $ 1.2 bln
Passport John Burbank $1.0 bln $ 3.9 bln
P. Schoenfeld Peter Schoenfeld $1.0 bln $ 4.1 bln
It looks like I'm going to have to update my quarterly updates on top funds' activity to include new funds and to reclassify others. For example, Visum used to specialize in healthcare stocks and Balyasny was a L/S Equity and global macro fund. Now they've rebranded themselves as multi-strategy shops because they see the potential of garnering more assets.

I suspect you'll see more and more funds rebranding themselves into multi-strategy shops to boost their assets under management and start collecting that all important 2% management fee on multi billions. The name of the game is asset gathering which is understandable but also troubling.

I like managers like Neil Chriss and think he has the potential of being another great multi-strategy hedge fund manager. I'm not worried about Ken Griffin or Izzy Englender as they have proven track records and still deliver great results despite their enormous size.

But I'm warning all of you, even these great multi-strategy shops are not immune to a severe market shock and most of them got clobbered in 2008 and some made matters worse by closing the gates of hedge hell. Of course, Citadel came back strong, as I predicted back then because most fools didn't understand why the fund was hemorrhaging money, but it doesn't mean that it can't suffer another major setback.

When you're investing with hedge funds, you really need to have a smart group of people who can drill down into their portfolio and understand the risks and return drivers going forward. Stop chasing returns, you'll get burned just like those who blindly chase the stocks top hedge funds are buying and selling.

By the same token, don't invest in hedge fund losers thinking they're going to be tomorrow's winners. Volatility in commodities is shaking up many hedge funds in that space and I expect this trend to continue. Some will adapt and survive but most will close up shop.

It doesn't matter which fund you're investing with, you've got to ask tough questions and grill these managers. If they start acting arrogant or cocky, grill them even harder. I mean it, don't be intimidated and don't fall in love with some hedge fund manager because he's a billionaire and fabulously wealthy. Trust me, you're just a number to them and that's exactly what they should be to you.

Finally, while many of you are getting ready to write a big fat ticket to your favorite hedge fund manager, I kindly remind you that I work very hard to provide you with timely and frank insights, so take the time to click on the donation or subscription buttons on the top right-hand side. You simply aren't going to find a better blog on pensions and investments out there so please take the time to show your appreciation and contribute.

Below, a couple of clips providing a rare glimpse Citadel, one of the best multi-strategy hedge funds that is also the world's biggest market maker (h/t, Zero Hedge). For better or for worse, quants have forever changed the landscape of the investment management industry (see my comments on the Wall Street Code and the Great HFT Debate).

And Gregory Taxin, president of Clinton Group Inc., talks about hedge-fund investor Bill Ackman's plan to raise money in a public sale share this year of his Pershing Square Capital Management LP. Taxin speaks with Betty Liu on Bloomberg Television's "In the Loop.”

I've got an emerging manager up here in Canada who I think has the potential to be a really great activist manager if someone is willing to step up to the plate and seed him. I can't share details on my blog but if you're interested in discovering a real gem, email me at and I'll put you in touch with him. Enjoy your long weekend and please remember to contribute to my blog.

Thursday, August 28, 2014

What Will Derail the Endless Rally?

Gene Marcial of Forbes reports, Ride With The Bulls Even As Warnings Of A Big Correction Are On The Rise:
With the market’s major indexes continuing to climb to new all-time highs, investors are getting increasingly jittery about the incorrigible bears’ warnings that the huge correction they have been predicting is on its way. The selloff will signal the market has hit its peak, they assert. What to do?

Ride with the bulls — and face any pullback with enough cash firepower to buy the battered shares of fallen angels with proven track records. The proven antidote to a massive pullback is to embrace it and prepare to buy shares of companies that are fundamentally sound and equipped to thrive after a market pullback. The key is to be prepared – not by selling but to be an opportunistic buyer as prices plummet.

“The bears keep seeing market tops as the bull charges ahead,” notes Ed Yardeni, president and chief investment strategist at Yardeni Research. Even some of the bulls had warned about an imminent correction but instead, after a 3.9% drop from July 24 through Aug. 7, the S&P 5000 made a new record high on Monday, Yardeni points out.

But should perplexed investors really worry about the coming of a Big Correction? Not if you listen to savvy market watchers and analysts who recommend running with the bulls. True, the bull market is over five years old now, but Yardeni looks at it this way: “It seems to be maturing rather than aging. It is certainly less prone to anxiety attacks, and has treated buying dips as buying opportunities.”

Indeed, although the market continues to gain and treks to higher grounds, it appears more persistent in climbing walls of worries in the U.S. and overseas.

“While the bears continue to look for signs that the bull market is about to break up, I don’t see any significantly bearish divergences, or decoupling, between key internal stock indicators and the overall market,” says Yardeni. “It’s a well-adjusted bull,” is how Yardeni describes it.

The market’s technical picture looks particularly healthy, according to some veteran technical analysts. “The trend remains bullish and an extension above 2,000 (in the S&P 500) would favor a strong push higher into 2030, where we would expect some initial profit taking,” says Mark D. Arbeter, chief technical analyst at S&P Capital IQ. He notes that the S&P 500 has been in an uptrend within an ascending trend channel for the last few years.

So where is the index headed from here?

“The long-term outlook is pointed higher, while above support at 1,838 – 76. Only a drop below the lower trend channel boundary and support at 1,738 would substantially damage the structure of the big picture rally,” says the analyst.

And based on the fundamentals, the market’s outlook seem as positive, as well. “Indeed, the market may be feeding off of consensus expectations for a near 11% climb in yearly earnings-per-share growth through the second quarter of 2015, as compiled by Capital IQ,” says Sam Stovall, chief investment strategist at S&P Capital IQ. He sees the S&P 500′s “fair value around 2,100 a year from now, based on earnings per share growth forecasts, the expectation that inflation will remain around 2%, and that we get a meaningful digestion of gains along the way,” says Stovall.

Meanwhile, the bears aren’t getting much confirmation for their bearishness, notes Ed Yardeni – not even from the Dow Theory, which postulates that the Dow industrials and transportation groups should both be moving higher in a sustained bull market. Well, both the Dow Jones Transportation and the S&P 500 Transportation indexes rebounded to record highs in recent days, notes Yardeni.

Now that the S&P 500 is almost at our 2014 yearend forecast of 2014 for the S&P 500, well ahead of schedule, we remain bullish and continue to favor financials, health care, industrials and information technology.

These groups appear to be the stocks of choice for continued strength and stamina in this long-running bull market? As the S&P Investment Policy Committee sees it, the energy, health care, industrials, and information technology are the attractive sectors, which they recommend to clients to overweight in their portfolios. The committee rates the financial sector as “underweight.”
In my last comment on the real risk in the stock market, I discussed why I believe the real risk in the stock market right now is a melt-up, not a meltdown that many bears are warning about.

Admittedly, my thinking centers around the big picture, meaning there is an abundance of liquidity in the global financial system -- even if the Fed continues tapering -- and some risky sectors of the stock market are going to take off.  If the ECB finally engages in quantitative easing to combat the euro deflation crisis, it will unleash another massive dose of liquidity which will further bolster global equities and other risk assets.

Soon after I finished writing my comment yesterday, permabear David Tice,  President of Tice Capital, came onto CNBC calling quantitative easing a "short-term economic fix" and warning that a 50% correction in coming. Abigail Doolittle, Peak Theories founder, also appeared on CNBC proclaiming that the range has started to reverse the QE 3 uptrend, and a major move down is coming.

Another permabear, SocGen's Albert Edwards, wrote a note to clients warning the S&P is running on fumes:
With U.S Federal Reserve policy easing drawing to a close, Societe Generale's uber-bearish strategist Albert Edwards predicts that a bubble in stock markets is on the verge of bursting.

"Is that a hissing I can hear?" Edwards quipped in his latest research note, published on Thursday.

Edwards claimed the "share buyback party"—which some analysts see as the key driver for recent record Wall Street highs—was now over.

"Companies themselves have been the only substantive buyers of equity, but the most recent data suggests that this party is over and as profits also stall out, the equity market is now running on fumes," Edwards said.

Buybacks occur when firms purchase their own shares, reducing the proportion in the hands of investors. Like dividend payments, buybacks offer a way to return cash to shareholders, and usually see a company's stock push higher as shares get scarcer.

According to Societe Generale's research, share buybacks fell by over 20 percent the second quarter versus the first quarter. However, TrimTabs Chief Executive David Santschi said in a research note on Sunday that buyback announcements were "solid" as earnings season wrapped up.

Some firms borrow cash to buy back their shares, taking advantage of ultra-low interest rates in the U.S. and other developed nations. Edwards warned that as companies had issued cheap debt to buy expensive equity, a "gargantuan" funding gap could yet emerge.

"The equity bubble has disguised the mountain of net debt piling up on U.S. corporate balance sheets. This is hitting home now QE has ended. The end of the buyback bonanza may well prove to be decisive for this bubble," Edwards wrote.

Edwards is known for his markedly pessimistic predictions, and regularly touts the idea of an economic "Ice Age" in which equities will collapse because of global deflationary pressures.

Some analysts remain unconvinced. MacNeil Curry, head of global technical strategy at Bank of America Merrill Lynch, sees no imminent hit to equities. He predicts further upside for the S&P 500—currently near all-time highs—over the next few weeks, and sees the benchmark index reaching 2,050-to-2,060 points by late September.
Global deflation is coming and the bond market knows it, but Edwards is wrong if he thinks the S&P is running on fumes and won't continue to grind higher. Some of the riskiest sectors, like biotech, are booming again after a spring selloff. When the ECB starts engaging in massive quantitative easing, risk assets (and gold) will really take off.

Of course, nobody really knows where the stock market is heading. A million things can derail this rally and cause jittery investors to pull the plug and sell their stocks. But with pension deficits rising as bond yields fall, pensions will be forced to take on more, not less risk. And where will they be taking that risk? Stocks, corporate bonds and alternative investments like real estate, private equity and hedge funds.

I leave you with an interesting clip below. Charles Biderman, TrimTabs Investment Research CEO, analyzes current market conditions saying the market is essentially rigged and you have to "ride the tide." You sure do but make sure you're in the right sectors because some tides will be a lot bigger than others.