Smoking Some Bad Debt Dope?

All week, I've been watching the circus and clowns in Washington make fools out of themselves. The "debt ceiling drama" is annoying me. More smoke & mirrors to scare retail investors away while the big guns load up on risk assets. Let me go over a few key points to convince you to keep buying the dips hard and ignore the debt boogeyman which permeates our mass media every day.

First, take the time to read Peter Coy's article which appears on yahoo Finance (provided by Bloomberg Businessweek), Why the Debt Crisis Is Even Worse Than You Think. I quote the following:

The language we use is part of the problem. Every would-be budget balancer in Washington should read "On the General Relativity of Fiscal Language," a brilliant 2006 paper by economists Laurence J. Kotlikoff of Boston University and Jerry Green of Harvard University (available online from the National Bureau of Economic Research). The authors write that accountants and economists have something to learn from Albert Einstein's theory of relativity, about how measured quantities depend on one's frame of reference. Terms such as "deficit" and "tax," they write, "represent numbers in search of concepts that provide the illusion of meaning where none exists."

The national debt itself is one such Einsteinian (that is, squishy) concept. The Treasury Dept.'s punctilious daily accounting of it -- $14,342,841,083,049.67 as of July 25, of which just under $14.3 trillion is subject to the ceiling and about $10 trillion is held by the public -- gives the impression that it's as real and tangible as the Washington Monument. But what to include in that sum is ultimately a political choice. For instance, the national debt held by the public doesn't include America's obligation to make Social Security payments to future generations of the elderly. Why not?

Suppose that instead of paying Social Security payroll taxes, working people used that amount of money to buy bonds from the Social Security Administration, which they would redeem in their retirement years. In such an arrangement, the current and future cash flows would be identical, but because of a simple labeling change the reported debt held by the public would skyrocket. That example alone should generate a certain queasiness about the reliability of the numbers that are taken for granted by budget combatants on both sides of the aisle.

A more revealing calculation is the CBO's measurement of what's called the fiscal gap. That figure is conceptually cleaner than the national debt -- and consequently more alarming. Boston University's Kotlikoff has extended the agency's analysis from 2085 out to the infinite horizon, which he says is the only method that's invulnerable to the frame-of-reference problem. It's an approach used by actuaries to make sure that a pension system doesn't contain an instability that will manifest itself just past the last year studied. Years far in the future carry very little weight, converging toward zero, because they are discounted by the time value of money. Even so, Kotlikoff concluded that the fiscal gap -- i.e., the net present value of all future expenses minus all future revenue -- amounts to $211 trillion.

Yikes! Douglas J. Holtz-Eakin, a former director of the CBO from 2003 to 2005, says he doesn't favor the infinite-horizon calculation because the result you get depends too heavily on arbitrary assumptions, such as exactly when health-care cost growth slows. But directionally, he says, Kotlikoff is "exactly right."

Which means we've been heading the wrong way for years. Even in the late 1990s, when official Washington was jubilant because the national debt briefly shrank, fiscal-gap calculations showed that the government was quietly getting into deeper trouble. It was paying out generous benefits to the elderly while incurring big obligations to boomers, whose leading edge was then 15 years from retirement. Now the gray deluge is upon us. As Holtz-Eakin, now president of the American Action Forum, a self-described center-right policy institute, says: "We're just in a world of hurt."

The U.S. is in danger of reaching a generational tipping point at which older Americans have the clout to vote themselves benefits that sap the strength of the younger generation -- benefits that can never be repeated. Kotlikoff argues that we may have reached that point already. He worries that the U.S. could become Argentina, which went from one of the world's richest to lower-middle income in a century of chronic mismanagement.

Senior citizens are being told by their own lobbyists, repeatedly, that any attempt to rein in the cost of Social Security and Medicare is an unjust attack on earned benefits. "Stop the liberals from raiding the Social Security Trust Fund once and for all!" says a recent mailing from the National Retirement Security Task Force. Similar messages aimed at Democratic voters make the same charge against Republicans. No wonder Obama and Boehner were rebuffed by their own parties for putting entitlements on the table. In the end neither the House nor the Senate debt-ceiling proposals touched Social Security or Medicare. Not pretty.

So is the US at risk of becoming the next Argentina or worse still, Greece? Of course not!!! This is all nonsense doctored up by the power elite to scare the masses into believing that the US economy is heading down a "path of fiscal destruction" so they can abdicate their duty to pay their fair share of taxes. I watch all these debates on television and think to myself "what a bunch of bullshit!"

On Friday, I spoke to my favorite fixed income senior portfolio manager/analyst at the Caisse -- a guy that PIMCO only wishes would be working for them. As far as brains go, he can take on Bill Gross and any other 'top gun' at PIMCO but he's too nice of a guy to work with sharks there or on Wall Street. He should be working for an elite global macro hedge fund but he's content where he's at and they value him (even though he's probably grossly underpaid relative to his peers at other large Canadian pension funds).

Anyways, this person confirmed a lot of my thinking on the US debt drama, namely, that most people don't have a clue of what they're talking about when it comes to public economics:

• On the 'balanced budget' proposal we both agreed that this is a stupid and dangerous proposal and President Obama would be nuts to accept it. Running government finances is not the same thing as running a family budget (thank God!). By law, states have to balance their budgets. When states need money, they go to the federal government. Why in the world would the US federal government -- the lender of last resort -- accept an economic straightjacket? "That's just stupid and would effectively mean the end of counter-cyclical fiscal policy and the end of the welfare state." I would go a step further and state that a balanced budget at the federal level would effectively kill the US economy for long time by posing serious economic, social and health risks. Only lunatics would accept such a proposal, ignoring the serious risks it actually entails.
• We both agreed that this "US debt crisis" is a political crisis, not an economic crisis. The lack of leadership in Washington is disconcerting. It's actually disturbing to see Tea Party representatives sticking to "their principles" with little or no concern as to the harm that a US default will cause not only in the US, but throughout the world. Already billions have been wiped off the stock market this past week, making a lot of investors poorer, but these politicians have no concern. Like religious zealots who think they will end up in heaven if they carry out their god's work, these lunatics are holding the US economy hostage. The only good thing from this entire messy debt debate is that it will set the Tea Party back years. On that front, Obama and his advisors are brilliant.
• As far as austerity goes, my friend and I are in full agreement. It's a disaster in Greece, it's a disaster in England, and it's pretty much going to be a total disaster everywhere else. My friend told me that the only place austerity worked was in Canada during the 90's but "that's because the economy was growing." Those of you who still cling to this silly notion that austerity works should take the time to listen to Michael Hudson at the end of my comment on the rottenness of the world.
• We both agree that the debt crisis is way overblown. The August 2nd deadline is not set in stone. "The cost of capital extending it by a week is zero but the stock market will likely slide further on uncertainty. In theory, the Fed could mint a trillion dollar 'platinum' coin and the US government will pay all its obligations." More importantly, we both agree that the real long-term issue for the US and other developed economies remains the jobs crisis. And the real unemployment scandal is how it's impacting certain minorities much harsher than others. Importantly, if you don't tackle the jobs crisis, the debt and deficit will only get worse.
  
• As far as Bill Gross and PIMCO, my friend chuckled at his advice to "short Treasuries" when yields were at 3.75%. "Anyone following his advice would have gotten killed, but to be fair to him, he has a fiduciary responsibility to his clients and won't reveal his true positions beforehand." Yields continue to fall as the US economy slows and flight to quality reigns as global investors remain jittery.
• In Europe, my friend sees this as a long, drawn out mess where yields will gyrate widely over the next year. He joked: "the way spreads are moving, BCA Research should start a new publication call the European Fixed Income Weekly."
  
• Finally, my friend thinks universities across the world should "burn standard economics textbooks." Having graduated from McGill University with an M.A. in Economics, I'm somewhat in agreement but also recognize that some of the greatest social thinkers of the 20th century were brilliant economists like Keynes, Hicks, Hayek, Fisher, Friedman, etc. The problem isn't economics, it's what they're teaching students, ignoring a rich history of economic thought (too much mathematics and programming, not enough economics and history!)
  

I leave you with an excellent roundtable discussion from ABC's This Week (entire show is worth watching online; watch both parts of roundtable discussion below). Pay close attention to what Paul Kruman and Mohamed El-Erian are saying. Cutting spending now will only exacerbate the jobs crisis and will make things much worse. In my opinion, Krugman is wrong about targeted cuts to the federal government, but he's absolutely right that the Obama administration has basically pandered to the Republicans and caved into every one of their demands.

As I stated before, the world is sinking into a hellhole. We have incompetent fools running our governments, major corporations, banks and yes, alas, our public pension funds (with a few exceptions). It's a total disaster but remember this: the power elite need to continue making profits. These sociopaths will stop at nothing to extend and pretend, which is why I'm not worried about this entire "debt crisis debacle" and keep buying the dips on risk assets. And lo and behold, as I wind down my comment, Bloomberg reports that a deal framework has been reached on raising the debt ceiling. Relax, it should be a great week in the stock market. :)

Read more »

Oklahoma's AG Launches Pensions Investigation

Michael McNutt reports in NewsOK, Oklahoma AG launches investigation into pension investments:

An investigation was launched Thursday into whether financial institutions are properly handling state pension funds, state Attorney General Scott Pruitt said.

Pruitt said he sent letters to several banks holding pension funds seeking information on investment transactions, including those involving foreign currency exchanges. The pensions include those for state employees, teachers, police officers, firefighters and judges.

The investigation does not involve any Oklahoma bank, a spokeswoman for the attorney general's office said.

Pruitt said he has no evidence of wrongdoing.

“Our investigators in the AG's office will collect that data and we'll make an assessment at that point about the next step, if any,” he said. “If there is any occurrence of fraud, I will take the necessary enforcement steps to recover potential losses of tens of millions of dollars.

“This is something that my colleagues in other states, as well as information we've received heretofore, indicate it's something we need to pay attention to,” Pruitt said.

Investigation urged

The investigation, which could result in criminal charges and civil litigation, is similar to actions taken in California, Virginia and Florida to recover more than $200 million in state pension funds, Pruitt said. Telephone calls to his office prompted the investigation, he said.

“We've been doing quite a bit of homework leading up to today to determine whether it is meritorious for us to initiate an investigation,” Pruitt said.

“This is not something we're doing on a whim. It's not something we're doing blind. We're doing it because we've been informed to the degree that we think it's something we need to pay attention to and look into.”

The investigation will include confirming that banks are following federal guidelines for currency trades for the state's pension funds and are not improperly manipulating foreign currency trade prices to maximize their own profits, Pruitt said.

Claims have been made against some banks, questioning the discrepancy between the time of day the currency transactions are made and the trade price that is charged to the fund.

That could result in a bank's choosing a less favorable exchange rate instead of giving a pension fund the price based on the actual time of the trade, and then keeping the difference, he said.

$21.4 billion invested

Oklahoma's seven pension systems have investment assets of $21.4 billion, said Rep. Randy McDaniel, who is chairman of the House of Representatives Oversight Committee on Pensions. It's expected about 15 percent, or $3 billion, is invested overseas; 20 percent of a portfolio being invested internationally is considered typical.

“I do have reason to believe that there are some recoveries that could be made, and if they are seven figures or larger that could be a great addition to the financial status of the plans,” said McDaniel, R-Oklahoma City. “I am very encouraged by the efforts of the attorney general.”

James Wilbanks, executive director of the Oklahoma Teachers Retirement System, said he was not told in advance of Pruitt's decision to start an investigation. The teachers retirement fund, the state's largest pension fund, represents nearly half the invested pension funds, or about $10.1 billion; the retirement plan has about 153,000 members, including 90,000 active teachers and about 50,000 retirees and beneficiaries.

“I wouldn't say we have concerns,” he said. “We do have a relationship with a custodial bank. To our knowledge, they are behaving in good faith and executing our contract exactly the way they should and not taking advantage of any situation where they could have made some additional money at our expense.”

However, Wilbanks said he welcomes Pruitt's investigation.

“You're never 100 percent sure that somebody who is handling your money for you is not doing something that they shouldn't be,” he said.

Duty to the public

State Treasurer Ken Miller, chairman of the Oklahoma State Pension Commission which oversees each of the pension systems, said public officials have a duty “to scrutinize investments made on behalf of Oklahoma's public pension systems to ensure they are invested ethically and legally.”

“If malfeasance is discovered, damages should be recovered, offenders should be held accountable and pensioners should receive due compensation,” he said.

McDaniel said he will conduct an interim study in October on pension investments. His study will look at whether Oklahoma's pension investments are being handled properly and effectively.

“Investment performance has a significant financial impact on the fiscal health of pension systems,” said McDaniel, a financial adviser.

“The plans are very well-managed, very well-diversified,” he said. “They're doing a good job. Nonetheless, we're still going to look at them and make sure everything is done right.”

I agree with State Treasurer Ken Miller, public officials have a duty to scrutinize investments to ensure they are invested "ethically and legally." A similar investigation with State Street defrauding California's pensions is still ongoing but State Street was re-hired by CalPERS after being likened to 'thugs' (go figure!).

I wouldn't be shocked to discover that the custodian banks raped Oklahoma on F/X transactions. Why do I say this? Because I know senior F/X traders/salespeople who tell me it's too easy to screw clients over, and many corporate and institutional clients are getting raped on F/X transactions because this activity remains unregulated by regulatory authorities. That's why F/X has consistently been one of the most profitable activities at banks. Basically, it's the Wild West, and clients are at the mercy of unscrupulous banks.

Ask Ray Dalio at Bridgewater if he trusts the banks when it comes to F/X transactions. Bridgewater and other elite global macro hedge funds have operational procedures in place to ensure that nobody is screwing them over. Admittedly, they trade huge volume, so banks give them preferred client status, but this should be the case with everyone, not just elite funds.

Let me end my comment by emphasizing that there is a duty to to scrutinize investments to ensure they are invested ethically and legally. That's why I blasted the Auditor General of Canada and that sham Special Examination of PSPIB earlier this week. There was no mention of Diane Urquhart's excellent analysis of PSP's 2008 annual results on my blog which exposed significant risk management gaps that led to huge losses during that fiscal year.

The entire Special Examination is a rubber stamp approval of PSP's entire operations without critically examining serious governance gaps in that organization. Canadian taxpayers deserve better than a political sham job and our Auditor General should publicly apologize for producing such a superficial report that basically proves my point, namely, when it comes to pension governance, our regulatory authorities and government bureaucrats don't have a clue of what they're talking about or worse still, they're covering up malfeasance, gross incompetence and possible fraud for political reasons. They should be ashamed of themselves and can learn a lot from their counterparts down south.

Read more »

Backstopping PSPIB?

Amy Minsky of Postmedia News reports in the Ottawa Citizen, Public-service pension fund's strong profits don't deter critics:

It was one of the most profitable Canadian pension funds in 2010-11, but critics are unwavering that the public service pension fund is unsustainable, going so far as to brand it one of the "biggest drivers of deficit."

The Public Sector Pension Investment Board — which watches over about $58 billion in assets, making it the third-largest pension fund in the country — posted a 14.5 per cent return in 2010-11, resulting in a $7-billion gain after expenses, the board said in an annual report it tabled last week.

But the successful year isn't reassuring for some who still argue the public service pension system is set up in such a way that funding deficiencies will always fall on taxpayers instead of workers.

"Canadians are backstopping the pension shortfalls of public-sector workers," said Niels Veldhuis, vice-president of research with the Fraser Institute.

The investment board manages the pension funds for public-service employees, the RCMP and the Canadian Forces and posted better earnings last year than the other industry beasts.

For instance, the Canadian Pension Plan Investment Board, the largest Canadian pension fund, which oversees $148.2 billion, saw gains of 11.9 per cent during the fiscal year. The Ontario Teachers Pension Plan oversees $104.7 billion and reported 14.3 per cent gains for its fiscal year, which ended Dec. 31, 2010.

Even though the numbers suggest the public service pension fund has been well-managed, some right-leaning critics still aren't buying it.

"We cheer when they have strong returns because government's liability is mitigated," said Gregory Thomas, national director with the Canadian Taxpayers Federation.

It's possible the upward trend will reverse, throwing responsibility for retired public servants and members of the forces and RCMP pensions to the public, he warned.

"When you take (a public servant's) salary and their extended benefits and their incentives, essentially they're looking at guaranteed payment for life. . . . This is one of the biggest drivers of deficit," Thomas said. "Other Canadians don't enjoy anything remotely similar."

Pitting different working groups against each other, focusing on what one group gets compared to another, is a futile practice, said Patty Ducharme, the national executive vice-president at the Public Service Alliance of Canada, one of the country's largest unions.

"Pointing fingers at each other is frustrating and foolish and doesn't deal with any problem," she said. "The problem is not the cost of these pension plans."

Employees are doing their part for the fund, she said, noting that each year since 2005, public-sector workers have increased their contribution rates, and that they will continue to do so through to 2013.

The average annual pension paid to federal public servants as of March 2009 was $24,506, according to the most recent information available.

"It's a promise government has made to our members, it's a promise the government has made to retirees, and we believe people should be able to retire with dignity and live with respect," Ducharme said.

The opinions at the fiscally conservative Fraser Institute on the pension fund run parallel to those at the Taxpayers Federation.

Private-sector businesses have been moving toward defined contribution pensions, wherein employers and employees contribute to the fund, which remains in the hands of the worker, explained Veldhuis.

On the other hand, public servants have defined-benefit plans, an arrangement under which the employer — the government in this case — agrees to pay a certain benefit upon retirement, regardless of whether the funds are available.

"If public-service pension funds in the federal government don't have enough assets to pay benefits for the workers, the shortfall falls to taxpayers," Veldhuis said.

The public-sector pension-investment board posted modest losses in 2007-08, followed by 22.7 per cent losses in 2008-09, when the markets were hit by the economic downturn.

The economic recovery, coupled with some shuffles in its investment portfolio, has helped the fund recover its losses and begin earning more than prior to the downturn.

Still, at the end of the 2009-10 fiscal year, there was a $224-million liability for all public-sector pensions — those which the public-sector pension-investment board holds as well as those for federally appointed judges and MPs — according to the most recent federal accounting books.

Despite any losses, Ducharme said the public-service pension system weathered the economic downturn better than alternative models.

"If we look at how people were hit during the economic downturn, individuals were hit, but larger plans seemed to weather the storm," she said, suggesting that when a plan covers a larger pool, the risk is not as steep as it is for one individual. "Quite frankly, just saying it's your responsibility . . . I don't think is a solution."

Ms. Ducharme is right, the public-service pension system has weathered the economic downturn better than alternative models such as private defined-contribution plans (read my comment on why the fuss over pensions to understand why this is so).

Having said this, Ms. Ducharme and all public servants have to understand the economic realities of our debt-laden economies and appreciate the fact that public pensions are not a vested right. People are living longer, public budgets are strained and private sector workers are working harder, taking home less pay and are not going to top up underfunded public pension plans. All stakeholders have to give something up in order to preserve our public pension plans.

As for the Fraser Institute and all other right-wing attacks on public pensions, I take whatever they have to say with a shaker of salt. I critically examined PSPIB's FY 20011 results as well as the sham Special Examination conducted by the Auditor General of Canada and Deloitte, but I am not calling for radical changes to the public service pension plan. We need sensible pension reforms, better pension governance, more transparency, not more fear mongering by right-wing lunatics who worry that the debt ceiling will cave in on us (it won't so keep buying the dips!).

Read more »

Private Equity Panacea?

Martin Z. Braun of Bloomberg reports, States Miss Pension Targets by 50% Even With Private Equity (HT: Donald):

In the last decade, as a wave of baby boomers began retiring, America’s biggest state pension systems earned less than half what they needed to keep up with promises made to millions of graying civil servants.

The state of Washington’s 3.92 percent return for the 10 years through June 30, 2010, after fees, was the best in a Bloomberg survey of state pensions with more than $20 billion in assets. That was nowhere close to the average yearly gains of as much as 8 percent that fund managers and public officials count on for meeting obligations to retirees.

“To assume that the median plan will reach 8 percent given this environment, that’s optimistic to say the least,” said Karl Mergenthaler, an executive director in JPMorgan Chase & Co. (JPM)’s securities services group in New York. “Public plans have an incentive to maintain their expected rate where it is. The risk is that they’ll overreach for returns.”

The last decade is forcing public pensions to re-evaluate the projected returns that determine how much money taxpayers and retirees need to pour into retirement funds. Some systems such as New York, Rhode Island and the California State Teachers Retirement System have reduced their assumptions. It’s a tough call because lowering projected gains can widen funding gaps, forcing lawmakers to put even more money into the programs.

Complicating the issue of what returns to expect are the extraordinary reverses of the last 10 years, including the Internet stock bubble, the financial crisis of 2008 and the worst recession since the Great Depression. Returns over 30 years still average more than 8 percent, according to the National Association of State Retirement Administrators. And in the 12 months after June 2010, markets and fund assets surged.

Largest Funds’ Gains

For the fiscal year ended June 30, the California Public Employees’ Retirement System -- the nation’s largest -- said it gained 20.7 percent, and the California teachers program, the second-largest pension plan, 23.1 percent. The third-largest, the New York State Common Retirement Fund, returned an estimated 14.6 percent in the fiscal year ended March 31, according to the state comptroller.

Even though state pension funds posted near-record preliminary returns for the last fiscal year, their 10-year gains are still less than 8 percent. Calpers’s 10-year return increased to 5.36 percent last year from 2.6 percent the previous year, and the California teachers’ fund, to 5.7 percent from 2.5 percent.

The median state pension fund will achieve an annual return of 6.5 percent in the next 15 years, according to a February 2011 study by Wilshire Associates, the Santa Monica, California, investment adviser.

Alternatives Beat Stocks

In outperforming other public funds over the last decade, Washington’s system benefited from investments in real estate and private-equity placements. Private-equity pools may invest borrowed funds, which can amplify returns and losses, and their holdings are often opaque. Calpers cited gains on private-equity investments for its 2011 gains.

“It’s an illiquid, high-risk strategy,” said Tim Friedman, head of communications at Preqin Ltd., a London-based private-equity research firm. “You can lose everything.”

Washington’s program, with $52.7 billion of assets as of June 30, 2010, is setting the pace as other systems are boosting private-equity investments, according to consultants. Pensions are also cutting their holdings of U.S. stocks and buying assets in developing countries such as China, India and South Africa.

Political Backlash

Three of the top five performing funds -- Washington, Oregon, and the Pennsylvania teachers fund -- had more than 30 percent of their assets in private equity and real estate, according to data compiled by the state retirement administrators’ group. Four of the five worst performers -- Maryland, Arizona, the California teachers and Georgia -- had more than 50 percent of assets in publicly traded equities.

State pension funds increased average allocations for private equity to 8.8 percent in 2010 from 3 percent in 2000, Wilshire found in its February study. Meanwhile, the average allocation to U.S. stocks by 126 state pensions declined 13.9 percentage points since 2000.

Retirement funding spurred a political backlash against public workers this year. The meager returns after years of deferred taxpayer contributions magnified funding shortages, forcing legislatures and city councils to divert more money to the pensions. This left less for public services.

Adding to the pressures facing pensions, government workers are accelerating retirements as state budget crises have led to salary cuts. Governors in Wisconsin, New Jersey, Ohio and Florida have attacked unions.

Funding Gap

A quarter of the 363 human resources managers for state and local governments reported a rise in such departures in a 2011 survey by the Center for State and Local Government Excellence. Members of the baby boom generation, born from 1946 to 1964, began turning 65 this year, but many programs allow early retirements for civil servants in their 50s.

Statewide U.S. retirement programs were short $694.2 billion, or 24 percent, of having enough assets to pay future pensions at the end of their 2010 fiscal years, based on data compiled by Bloomberg as of July 15. Hawaii and Wisconsin haven’t reported and weren’t included.

Already, 14 states raised retirement age and length-of- service requirements to help close pension funding gaps, including New Jersey, Florida and Maryland, according to the National Conference of State Legislatures. Fifteen states increased employee contribution requirements in 2011, the conference said.

State judges in Colorado and Minnesota have thrown out lawsuits by retired public employees challenging reductions to cost-of-living adjustments, ruling the increases not protected.

Performance Data Opaque

Following the money in public pensions is no easy task for retirees and taxpayers, based on the 10-year performance survey by Bloomberg. Audited results may be published online no sooner than six or nine months after a fiscal year. Returns aren’t reported consistently from fund to fund. Some disclosures may appear in annual reports, or in documents for bond sales that are unrelated to the pension funds themselves.

Bloomberg compiled data from the most recent annual reports of state pension funds with more than $20 billion in assets as of June 30, 2010. Bloomberg made follow-up calls to ensure the returns were after deduction of management fees and to request adjustments when they weren’t. The research also obtained 10- year net returns as of June 30, 2010, for funds that use a different fiscal year-end.

Two of the biggest funds whose fiscal years don’t close on June 30 -- New York’s Common Retirement Fund and Colorado’s Public Employee Retirement System -- said they couldn’t provide returns on that basis.

Median Return

For the 25 programs in the survey, the median 10-year return was 3.15 percent. The pensions did beat the Standard & Poor’s 500 Index, which had an annualized loss of 1.59 percent for the period, according to Wilshire.

Maryland’s fund, which stuck with conventional investments, ranked at the bottom of the survey with annual gains averaging 2.10 percent. The fund had assets totaling $31.9 billion as of June 30, 2010. It posted preliminary returns of 20.04 percent for fiscal 2011, boosting its 10-year return to 5.01 percent.

Top-Performing Washington

Gary Bruebaker was behind Washington’s decision to pour money into alternatives to stocks and bonds. He has been chief investment officer of the State Investment Board since 2001, leading a team of 30 investment professionals. The 56-year-old son of a single mother who worked 29 years for Oregon, Bruebaker says he takes his mission personally. He describes it as getting the best return for 400,000 public employees, retirees and beneficiaries at a “prudent” level of risk.

“Most of these people are people just like my mom,” he says. Before taking over management of the Washington fund, Bruebaker was a civil servant in Oregon for 23 1/2 years, eight of them as deputy treasurer.

At the end of fiscal 2010, the system was fourth-best funded at 92 percent, behind those of New York, North Carolina and South Dakota, according to Bloomberg data.

Alternative investments such as private-equity and hedge funds carry higher risks for retirees and taxpayers than conventional stocks and bonds. Some of the instruments are seldom traded, or not traded at all, so pensions face uncertainty about how much their investments are worth. Investing borrowed funds can amplify losses, which can be hard to limit because money placed with private-equity and hedge funds generally can’t be cashed out on demand.

Private Equity

Public retirement systems don’t disclose most details on their private-equity and hedge-fund portfolios, making it impossible for taxpayers to assess the risks. Pensions themselves may get limited information on holdings from money managers, who argue that disclosing the information could harm their strategy.

Washington was among the first public pension to invest in private equity, Bruebaker says. The state committed $13 million to a 1982 KKR & Co. buyout fund. In 2010, 26 percent of Washington’s assets were in private-equity, Bruebaker said.

They’ve picked some big winners. A placement of $25 million in Menlo Ventures VII, a 1997 Silicon Valley venture capital fund that invested in early Internet companies, was valued at $117.5 million as of Dec. 31, 2010, for a 135.6 percent return, according to fund records.

Investing Advantage

Washington’s 30-year history with private equity gives it an advantage, Bruebaker says. The state has relationships with some of the best-performing funds and takes advisory seats on big investments, allowing it to work closely with the general partner, including sharing investment ideas, he said. Serving on advisory boards enables Washington to closely monitor operations and investments, the investment chief said.

“Whenever they do something special, we want to be one of the first calls,” Bruebaker said.

Washington’s heavier weighting toward private equity gave it a boost from 2004 to 2007, as easy credit enabled buyout funds to borrow cheaply and distribute cash to investors. In 2006, Washington’s private-equity portfolio gained 39.5 percent, compared with 8.6 percent by the S&P 500. Over the decade through June 2010, the fund’s private-equity investments returned 6.6 percent, fund records show.

Index Funds

In asset classes such as U.S. stocks where it believes managers can’t beat the market consistently, Washington has moved to funds that track an index, Bruebaker says. All of Washington’s $10.4 billion of U.S. shares, as of March 31, are in a BlackRock Inc. (BLK) fund matching all American equities, he says. The state has $7 billion of its international developed- market stocks in index funds too, according to the fund’s March 31 quarterly statement.

Washington is also increasing its allocation to emerging markets, Bruebaker says. In April, the state agreed to invest $75 million in a $750 million fund being raised by Prosperitas Real Estate Partners to invest in Brazilian property.

“Growth is clearly not going to come from the U.S.,” Bruebaker said. “That’s not a slap against the United States. It’s the reality of the marketplace.”

Some pensions invested as much as 65 percent in stocks, helping to account for the decade’s low returns, according to Eileen Neill, a Wilshire managing director. The opening 10 years of this century was the first in 70 years in which the U.S. stock market had a negative return, she said.

“If you had a lot of equity-like investments in your portfolio, you certainly didn’t get anywhere near that 8 percent return,” Neill said.

Stocks Betray Maryland

Maryland had 67 percent of its assets in stocks in 2001, a figure that declined to 51 percent by the end of the decade, according to the fund’s reports.

The state’s pension assets at 2010 year-end were 37 percent short of covering pensions promised to 120,247 retirees and 144,343 active vested civil servants, 10th-worst among state systems, according to Bloomberg data.

During the decade, the state’s domestic stock portfolio performed worse than the market, trailing the S&P 500 or the Dow Wilshire 5000 five years out of 10, including four straight from 2005 through 2008, the fund’s financial reports show.

Legislative Critique

The state Department of Legislative Services, a nonpartisan agency that provides research and policy analysis to Maryland’s legislature, has “repeatedly expressed concern” about the performance of the state’s active U.S. equity managers, according to a draft November 2010 presentation to the Joint Committee on Pensions.

For five straight years through 2010, passively managed funds structured to match a stock market index did better than actively managed ones, which collect higher fees, the legislative services analysts found. The percentage of the state’s domestic stockholdings placed with passive funds declined to 45 percent from about 71 percent in fiscal 2008, according to the office.

The performance of active U.S. stock managers has improved this year, beating their benchmark by 0.59 percentage point, said Robert Burd, the deputy chief investment officer for Maryland’s pension system since March.

“We have confidence in our current manager lineup to add value over time,” said Burd, 42, who has been with the system since 2001.

The state’s decision in 2008 to allocate money to a program targeting so-called emerging managers led to the decline in the percentage of passive managers, Burd said. Emerging managers are small firms that may be ignored by large institutional investors and often are women or members of minorities.

Maryland’s New Plan

Manager performance “only slightly explains,” why the fund did worse than its peers, Burd said. “Asset allocation explains 90 percent,” he said.

“A lot of our peers were earlier into private equity,” Burd said. It took the fund’s trustees time to get comfortable with the illiquidity, use of leverage and lack of transparency that are characteristic of private-equity funds, Burd said.

Maryland now aims to put 10 percent of its portfolio in private equity and the same share each into bonds, real estate and “credit opportunities,” which include high-yield instruments and distressed debt, according to Burd. It is also allocating 15 percent to assets that will protect against inflation such as commodities, 7 percent to hedge funds and 2 percent to cash. The program is cutting the proportion for stocks to 36 percent from 51 percent, Burd said.

As Maryland diversifies its investments, it has improved expected returns while reducing portfolio risk, according to an analysis by the investment consulting group Hewitt EnnisKnupp Inc., cited in the Department of Legislative Services report.

Boom, Bust, Reaction

Maryland’s Sharpe Ratio, a measurement of the return that can be expected from each unit of risk, increased to 0.377 as of June 30, 2010, from 0.242 as of June 30, 2007, according to the report.

Although it may not appear achievable based on the last decade, public pensions should be able to return 8 percent a year on average over 30 to 40 years, said Wilshire’s Neill. Stocks have earned about 10 percent annually over the last 70 years, and will continue to produce “high single-digit” returns, she said. The debt weighing on the U.S. government, businesses and consumers will decline over the next 10 years, Neill said.

“There are regular booms and busts, and then there’s reactions,” Neill said. “Ultimately, there’s always recovery, and that’s what you have to keep in mind as you’re looking out over a 10-year period.”

Public pensions should be able to return 8 percent a year on average over 30 to 40 years? I think this is a dangerous pipe dream, one that got us into the current mess to begin with. An aging society, high debt and unemployment do not bode well for stocks or private equity. There will be growth sectors but you have to pick your spots carefully (ex. alternative energy, medical equipment, software to fight cyber crime, infrastructure, etc.).

And what about private equity? Will it be the great panacea for public pensions? Of course not. As every pension fund around the world listens to their brainless consultants and starts pouring billions into private equity, their collective actions will severely dilute future returns. That's why smart pension funds are focusing more on hiring talent and developing their direct investments and co-investments.

Sure, the top PE funds will continue to outperform, but don't get to enamored by them or else you risk being disappointed. When it comes to the pension crisis, there is no magic bullet that will cure all deficits. Only tough political choices will help avert a total disaster.

**Feedback***

Jonathan Jacob of Forethought Risk had these insightful comments to share:

What is worse, in my opinion, is that these private market allocations are being made without regard to the overall liquidity of the fund…what if mature funds (and some of those mentioned may be included in this group) which have a net funding deficit (benefits exceed contributions) put 50-60% in private markets such as real estate, private equity, infrastructure, etc and in a few years another 2008 hits? That means a few years of public market investments providing liquidity to the fund and then a decline in those values could put private allocation above 80% - a very dangerous and illiquid situation for a fund to be in. Just a thought.

Read more »

Special Examination or Special Sham?

This is a follow-up comment to the last one on PSP Investments' FY 2011 results. I wanted to go through the Special Examination conducted by the Auditor General of Canada and Deloitte & Touch. The key findings reported on PSP's website are:

What is a Special Examination?
Special examinations are a form of performance audit of federal Crown corporations. Under the Financial Administration Act, federal Crown corporations are subject to a special examination at least once every 10 years.

In special examinations, examiners provides an opinion on the management of the Crown corporation as a whole. More specifically, they examine whether a Crown corporation's systems and practices provide reasonable assurance that assets are safeguarded, resources are managed economically and efficiently, and operations are carried out effectively.

Conclusion of PSP Investments' 2011 Special Examination
PSP Investments' Special Examination led to the best possible outcome. The joint examiners, the Auditor General of Canada and Deloitte & Touche LLP, concluded: "The Corporation has maintained systems and practices to provide it with reasonable assurance that its assets are safeguarded and controlled, its resources are managed economically and efficiently, and its operations are carried out effectively."

Highlights
PSP Investments is pleased with the outcome of its special examination and with the examiners' comments. Their observations included the following:

• The Corporation has the key elements of a strong governance framework, and its governance practices are consistent with industry practices for stewardship and oversight by boards of directors.
• The Corporation's risk management practices, particularly in the area of investment risk, provide for identification, monitoring, management, and reporting of risks to protect its assets from undue risk of loss.
• The Corporation's compensation framework and practices are comparable with those of the industry. The Board plays an active oversight role in the design and operation of compensation practices, and reviews and monitors them independently of management.
• The Corporation regularly benchmarks its practices against those of comparable organizations in the industry.

The report also provides recommendations for ongoing improvements regarding the public reporting of responsible investment activities, Board appointments, the corporation's strategic planning process and new investment activities. PSP Investments agrees with these recommendations and will be taking steps to implement them.

In the 2011 Annual Report, PSP's Chair, Paul Cantor, wrote this about the Special Examination (page 4):

I am pleased to note the positive outcome of a Special Examination carried out during fiscal year 2011 jointly by the Office of the Auditor General of Canada and Deloitte & Touche LLP (the “Examiners”) in accordance with applicable legislation, which requires such an examination at least once every 10 years.

The Examiners concluded that PSP Investments maintains systems and practices that provide it with reasonable assurance that its assets are safeguarded and controlled, its resources are managed economically and efficiently, and its operations are carried out effectively. This is the best possible conclusion to such an examination.

Given that PSP Investments has existed for little more than a decade, has experienced tremendous growth, and is engaged in a business where the requisite systems and controls tend to be both complex and constantly evolving,this finding is a testament to the strength and rigour of our organization.

The Examiners also identified a few areas in which our practices could be strengthened.

One of these recommendations calls for improvements in the Board selection process, including the staggering of appointments to the Board to avoid significant turnover of membership in any given year.

Appointments to the Board do not fall within the Corporation’s purview although we seek to assist the independent Nominating Committee, Treasury Board and the Privy Council Office in expediting the process. We share the Special Examiners’ view that improvements are required to ensure that vacancies are filled and we will be proposing changes designed to improve the appointment process.

PSP Investments also concurs with the Examiners’ other recommendations and will be taking appropriate steps to implement them. I invite readers to review the full report from the Examiners, as well the Corporation’s response, can be found beginning on page 101.

Let me preface my comments below by giving you some background. I was hired by the Treasury Board of Canada in the summer of 2007 after working as a senior investment analyst at PSP (I was Gordon Fyfe's first investment hire). I was contracted to produce a study on the governance gaps of the Public Service pension plan, which includes PSP Investments, as well as government organizations that handle the administration, liabilities, and oversight of the Plan.

Needless to say, the folks over at PSP Investments were not too pleased that the Treasury Board hired me for this study. Regardless, I needed to work and completed the report. The folks over at the Treasury Board weren't too pleased either because my findings didn't reflect the "scope of the work," which is government bureaucratic double-speak for "you're making us look very bad in this report and we want you to change your findings because we have to share it with the Office of the Auditor General of Canada and show them we're doing our supervision job properly " (they weren't and as far as I can tell, still aren't).

I didn't change a thing in the final report. In fact, I kept adding more recommendations until they were fed up. They delayed my final payments, made my life miserable, but my findings didn't change. All this nonsense for a measly $25,000 contract! Last I spoke with the Office of the Auditor General of Canada, my 85-page report is still collecting dust somewhere in the halls of the Treasury Board, and nobody bothered implementing any of my recommendations (that would entail they actually do their job properly!). Journalists seeking this report should use the access to information to obtain it and I will be happy to go over my findings with them.

In April, 2009, I was invited to speak at the Standing Committee on Finance on matters relating to pensions and in April 2010, I was invited to the Senate Standing Committee on Banking, Commerce and Trade to discuss matters on retirement savings.

Now that I got that out of the way, let me go over the Examiner's recommendations and the "appropriate steps" PSP is taking to implement them. Go to the Appendix on page 114 of the Annual Report to see the Examiner's recommendations and PSP's response:

To assist in providing an orderly transition of appointments of members to the Board of Directors, the Public Sector Pension Investment Board (PSP Investments) should examine whether a more optimal staggering of Board appointments could be implemented and consider whether it should make recommendations to this effect to the Nominating Committee and the President of the Treasury Board (19-31).

And PSP's response:

Agreed. The Board of Directors of PSP Investments is aware of this issue. Recent appointments have been made in groups, which has led to the limited staggering of the terms of our current directors. Through the Chair of the Board of Directors and the Chair of the Governance Committee, PSP Investments will continue to have dialogue with the President of the Treasury Board and the Nominating Committee to attempt to improve the board appointment process.

The Corporation will be proposing two changes in the appointment process to address this issue. The first change will be to restructure the recommendation process of the Nominating Committee. The Corporation will propose to hold an annual meeting with the Nominating Committee to establish the candidate selection criteria, followed by one further meeting with the Nominating Committee in which the preferred candidates and alternates, based on the agreed criteria, are presented to it for recommendation to the President of the Treasury Board. The second change will be to recommend to the Nominating Committee and the President of the Treasury Board that when appointments are to be made in groups, that they be made for different term lengths to achieve a better staggering of the terms.

Since when does the "Corporation" have any say in the candidate selection process of its board of directors? The truth is that PSP's cousin Crown corporation, CPPIB, has a much better nomination process for their board of directors with clear term limits of three years (not four). In my opinion, people like Paul Cantor have to leave PSP's board. They have overextended their stay, been there way too long (since inception), and this is not in the best interest of plan members or other stakeholders.

I would even go a step further. I strongly recommend that plan members have the right to nominate at least two qualified, independent board members who have no industry ties whatsoever. It could be finance or economics professors who are not on the payroll of some financial institutions, or it could be someone like Diane Urquhart who covered PSP's 2008 annual results on my blog and exposed significant risk management gaps that led to huge losses during that fiscal year. Hell, plan members should even consider nominating former PSP employees on the board (I'm not interested but know of a few more qualified people that just might be).

Moving on to the second recommendation, the Examiner recommends:

The Public Sector Pension Investment Board (PSP Investments) should develop and assign measurable outcomes for its strategic goals, to enable measurement of success for each strategic goal. (45–54)

To which PSP responds:

Agreed. In its next Strategic Plan, PSP Investments will endeavour to develop additional measurable outcomes that are designed to measure the overall achievement of the strategic goals.

The third recommendation from the Examiner is:

The Public Sector Pension Investment Board’s (PSP Investments) New Product Committee should systematically review new investment activities using approved investment products to assess whether they introduce new risk exposures. These activities should be subject to the same review and approval process as all new investment products. (62–70)

To which PSP responds:

Agreed. The above concern is implicitly addressed by the Terms of Reference of the Management Investment Committee, which includes the review and approval of the business plans of asset classes, investment activities, new investment products, and other investment-related activities. PSP Investments will amend the New Product Committee’s Terms of Reference and its related procedures to expand its scope to include new investment activities using approved products.

This "New Product Committee" might have been handy prior to 2008, not sure how useful it will be now that the damage has been done. Instead, I would propose a committee made up of independent experts (can't stress that enough) that systematically reviews all investment activities, including the benchmarks governing public and private markets.

On that topic, I noted the following in the Examiner's report (page124) regarding benchmarks:

While the Corporation’s strategic goals and performance indicators encompass many objectives, central to PSP Investments’ mandate is the performance of its investments. To monitor its investment performance, PSP Investments compares its actual investment returns against its Policy Portfolio and specific asset class benchmark returns. For its public market asset classes, PSP Investments uses representative publicly available market indices as its asset class benchmarks. For all of its private asset classes, the Corporation has recently decided to move to cost of capital benchmarks. Implementation of these new measures is currently under way.

I can't stress how important benchmarks governing all investment activities are. The Examiner's report is frighteningly shallow in this regard. Not surprisingly since they teamed up with Deloitte -- an accounting firm with no expertise in investment performance auditing -- to conduct this Special Exam. They should have used a firm like Independent Fiduciary Services to conduct a comprehensive performance audit of all investment activities over the past six years.

Importantly, not all audits are equally comparable; an accounting audit is not the same as a comprehensive review of all investment activities over the last six years to see whether appropriate risks were taken and whether the benchmarks reflected the beta, leverage, liquidity and other risks of the underlying investment activities.

This is the biggest beef I've got with this sham "Special Examination". A lot of hard questions regarding investments, reporting, human resources, etc. were never asked or answered. What sort of questions? Questions that I once outlined in detail in a previous comment. Let me make it even simpler:

• Are the investment managers gaming their benchmarks, especially in alternatives, to maximize their bonuses?;
• Does PSP have comprehensive operational, investment, and fraud policies to ensure assets are protected at all times and decisions are taken in the best interest of all stakeholders, including taxpayers?
• What was the turnover rate at the "Corporation" over the last six years? Were there key departures at senior levels? If so, why? Where did these individuals end up and what is the relationship between their current employer and PSP?
• Specifically, are any of PSP's former senior officers now working for a fund that they invested with while working at PSP? If so, why and what are the terms governing this activity?
  
• Does PSP respect employment equity laws? If so, what percentage of their employees fall under recognized minority groups, including persons with disabilities?
  
• Does PSP have comprehensive whistleblowing policies to protect against fraud and mismanagement? Have certified fraud examiners (CFEs) performed an independent fraud audit on the Corporation? If not, why not?
• How many times did PSP change its benchmarks in public and private markets? How many times did PSP change its performance, risk and accounting systems? How much did this cost?
  
• Does the Head of Risk (operational and investment) report directly to the board or to the CFO or CEO? If not directly to the board, why not?
• Is PSP reporting its activities to all stakeholders, including the public, on a timely basis? If not, why not?

Special Exams on Crown corporations are important. They are performed once every six years. Even though PSP falls under some sections of the Financial Administration Act, it doesn't report a tenth of what other Crown corporations report.

At the end of the day, the biggest risk pension funds face is governance risk. Not inflation, not deflation, not interest rates, but governance! I can't stress that enough and that's why this Special Examination disappointed me (not really surprised, too political). I can't believe Canadian taxpayers are funding such "sham" reports that are just polished smoke and mirrors.

The Auditor General of Canada should be ashamed for producing such a superficial report which looks good but really doesn't address any of the important governance gaps that impact PSP Investments' activities. When it comes to governance, Canadian funds are among the best in the world, but we have a lot more work ahead of us to bolster our public pension funds.

Read more »

PSP Investments Up 14.5% in FY 2011

CNW reports, PSP Investments Reports Fiscal Year 2011 Result:

The Public Sector Pension Investment Board (PSP Investments) announced today that it recorded an investment return of 14.5% for the fiscal year ended March 31, 2011 (fiscal year 2011). The robust overall performance for fiscal year 2011 was driven primarily by strong results in Public Market Equity portfolios as well as in Private Equity and in Real Estate, and follows on the heels of the 21.5% total return recorded in fiscal 2010. The fiscal year 2011 investment return exceeds the Policy Portfolio return of 12.7% by 1.8%.

Consolidated net assets increased by $11.7 billion, or 25%, to a record level of $58.0 billion. During fiscal year 2011, PSP Investments generated net income from operations of $6.9 billion and received $4.8 billion in net contributions.

"The latest results reflect solid performances and contributions from every part of the organization and point to the success of the diversification strategy we began implementing in 2004, with the introduction of private market asset classes such as Real Estate, Private Equity and Infrastructure. Our Public Market equity portfolios also recorded substantial gains, adding to the strong performance of the previous year," said Gordon J. Fyfe, President and Chief Executive Officer of PSP Investments.

For fiscal year 2011, Public Market equity portfolio returns ranged from 6.6% for the EAFE (Europe, Australasia and the Far East) Large Cap Equity portfolio to 19.7% for the Small Cap World Developed Equity portfolio. The Canadian Equity portfolio return for the year was 19.3%.

In private markets, the Private Equity and Real Estate portfolios posted strong investment returns of 20.9% and 13.8%, respectively. The Infrastructure portfolio earned a slightly negative investment return of 1.6% for fiscal year 2011.

The asset mix as at March 31, 2011 was as follows: Public Market Equities 56.5%, Private Equity 9.6%; Nominal Fixed Income and World Inflation-Linked Bonds 20.7%; Real Estate 9.1% and Infrastructure 4.1%.

Special Examination

During the fiscal year 2011, the Office of the Auditor General of Canada and Deloitte & Touche LLP (the Examiners) jointly carried out a Special Examination in accordance with applicable legislation, which requires such an audit at least once every 10 years.

The Examiners concluded that PSP Investments maintains systems and practices that provide it with reasonable assurance that its assets are safeguarded and controlled, its resources are managed economically and efficiently, and its operations are carried out effectively. This is the best possible conclusion to such an examination.

"Given that PSP Investments has existed for little more than a decade, has experienced tremendous growth, and is engaged in a business where the requisite systems and controls tend to be both complex and constantly evolving, this finding is a testament to the strength and rigour of our organization," said Paul Cantor, Chair of the Board of Directors of PSP Investments.

For more information about PSP Investments' fiscal year 2011 performance and the Special Examination, consult PSP Investments' Annual Report available at www.investpsp.ca.

About PSP Investments

The Public Sector Pension Investment Board is a Canadian Crown corporation established to invest the amounts transferred by the Government of Canada equal to the proceeds of the net contributions since April 1, 2000, for the pension plans of the Public Service, the Canadian Forces and the Royal Canadian Mounted Police, and since March 1, 2007, for the Reserve Force Pension Plan (collectively the Plans). The amounts so transferred to the Corporation are to fund the liabilities under the Plans for service after the foregoing dates.

Its statutory objects are to manage the funds transferred to it in the best interests of the contributors and beneficiaries under the Plans and to maximize investment returns without undue risk of loss, having regard to the funding, policies and requirements of the Plans and their ability to meet their financial obligations.

I will cover the Auditor General of Canada and Deloitte & Touche Special Examination of PSP Investments in my follow-up comment because in my opinion, they omitted far too many important governance gaps which I will meticulously expose.

Back to the results and private equity, which is once again the flavor of the day among large pension funds. Tim Kiladze of the Globe and Mail reports, PSP making a name for itself in private equity:

The Public Sector Pension Investment Board, the investment arm of the Public Sector Pension plan, isn’t a name you hear too often. But if it continues to put out numbers like the ones it just posted for the last fiscal year, you’ll probably be hearing it a lot more.

Often overshadowed by behemoths such as Canada Pension Plan Investment Board and Ontario Teachers’ Pension Plan, PSP manages the pension funds for public service employees, Canadian Forces and RCMP. In total, it watches over $58-billion in assets.

In the past year, funds like CPPIB, OTTP and OMERS were very active in the private equity market, making big investments in global companies such as Tomkins PLC. But lately PSP has picked up its activity as well, co-investing with BCIMC in TimberWest Forest Corp., and more recently alongside CPPIB and Europe’s Apax Partners in Kinetic Concepts Inc. in a $6.3-billion (U.S.) buyout.

In fact, PSP has made it a priority to increase the private equity portion of its portfolio (much like the other funds). For the fiscal year that just ended, private equity accounted for 9.6 per cent of its total portfolio. As of April 1, PSP looks to expand that to 14 per cent.

There’s good reason to do just that. Last year, its private equity portfolio posted a return of 21 per cent. That beat out Teachers’ Private Capital’s return of 19 per cent and CPPIB’s private equity return of about 18 per cent.

In other words, PSP is on par with the biggest and best in Canada.

As for total size, PSP is still behind. CPPIB has about $23-billion in private equity investments, most of which are in private equity funds, but it does manage $5.6-billion in direct investments. Teachers has $12-billion in private equity, which includes both fund and direct investments. PSP has $5.6-billion overall.

Of note, these private equity portfolios do not include real estate and infrastructure, which the pension funds separate out on their own.

My sources tell me that PSP sold a significant portion of its private equity fund holdings to CPPIB in FY 2011 for "a song." If true, I can pretty much figure out which vintage years they sold. They did this to focus more on internal private equity activity, which is mostly co-investing alongside funds and direct deals. They're not the only ones. This brings down fees and allows funds to have more control on these investments. But you need to have the proper skill set internally to adopt this approach.

One thing I have to emphasize, however, is that PSP is no better than anyone else in private equity. I know both guys running the PE portfolio there because I helped set up that operation when I worked at PSP. Good, smart, hard working guys (Derek is a hardass but straight shooter and Jim is a great operational guy) but nothing out of the ordinary and if they were that good, they'd be running their own PE fund. Period.

Same goes for anyone else at large Canadian pension funds who thinks they're worth the big compensation they're getting and can compete with the Ray Dalios, David Bondermans or Tom Barracks of this world. If you're that good, have the guts to go out on your own and start collecting 2 & 20, earning some serious money!

One senior pension fund manager shared these comments with me after reading the Globe article:

Hard to take, but the annual contest means no one has a time horizon that makes sense. Hard to expect the media to reflect otherwise. May as well go with the flow, and advocate for better disclosure of short and long term results, directs vs funds, pre and post currency, etc. The data will set you free....

Unfortunately, the data is not available because none of the large Canadian public pension funds disclose short and long-term performance of direct vs fund private equity investments or internal alpha in public markets versus that from external fund managers. They mix it all up and call it "alpha," which of course, suits their compensation.

Moving on, I suggest you take the time to carefully read PSP Investments' 2011 Annual Report. As I've stated before, there is a tremendous amount of work that goes into these annual reports and its worth taking the time to go over them carefully.

You can begin on page 4, the Chair's Report, and read Paul Cantor's comments:

While understandably pleased with this year’s strong performance, we must always be mindful of the cyclicality of markets. We will always be exposed to market volatility even as we maintain a sharp focus on risk management.

Our diversification strategy is derived from our long-term target asset mix. This is what we call the Policy Portfolio.

It is designed with the goal of achieving the long-term returns that are used by the Chief Actuary of Canada to calculate the sustainability of the Plans as it relates to the Post-2000 Liabilities.

During fiscal year 2011, we undertook a comprehensive review of the Policy Portfolio to ensure that it remains effective in delivering the targeted return. Factored into the review were our most recent expectations of long-term market conditions. Other factors taken into account included the inflation-sensitive nature of the Plans’ Post-2000 Liabilities and the net positive inflows expected for at least the next 15 years.

As a result, effective April 1, 2011, we made significant changes that increased the allocation to Real Return Assets such as Real Estate and Infrastructure. Real Return Assets are a good match for the inflation-sensitive nature of the Plans’ Post-2000 Liabilities and will thus contribute to reducing funding risk. This change contributed to an overall shift in our asset mix from publicly traded securities to Private Markets, which will move over time from 28% to 40% of our overall portfolio.

Skip over to page 6, and read the President's report where Gordon Fyfe states:

Contributing to PSP Investments’ strong performance in fiscal year 2011 was the success of two key investment strategies implemented over the past several years.

One such strategy entails expansion into high-growth emerging markets, primarily developing countries that are experiencing robust expansion of their domestic economies. For instance, PSP Investments was among the first foreign institutional investors to take advantage of real estate opportunities in Brazil and Colombia, where rapidly expanding middle-class populations have been driving demand for new housing, retail and, more recently, office space.

Over the past five years, our Real Estate Group has developed solid partnerships in Brazil and Colombia and assembled an attractive portfolio of shopping centers and office buildings, mainly in the metropolitan areas of Sao Paulo and Rio de Janeiro, Brazil. During fiscal year 2011, we were able to realize significant gains from the divesture of some of the Brazilian retail properties. We intend to continue investing in these markets, where sustained economic growth is certain to create new needs — and new opportunities.

Another strategy that has paid off entails capitalizing on PSP Investments’ exceptional liquidity to acquire quality “distressed assets” in developed markets, where sellers are seeking to monetize their investments. Our decision to allocate capital to distressed debt in public markets back in the 2007-2008 period has generated solid added value, and we are continuing to seek and find additional opportunities.

We also expect that several noteworthy private-market transactions completed by our PSP Investments teams during fiscal year 2011 will yield considerable gains down the road. Among them was the acquisition of a significant participation in five container-terminal ports in Australia — which have approximately 50% of that country’s container terminal capacity. We also acquired a 40-story Class-A office tower in Manhattan, in collaboration with local partners that have extensive experience in the New York City real estate market.

Basically, PSP won't have to pay out any benefits over the next 15 years, enjoys roughly $4 billion in contributions every year and is going long public and private emerging markets as well as distressed debt. And they're increasing their allocation to Real Return Assets (Real Estate and Infrastructure) because like everyone else in the world, they're betting on inflation, collecting big bonuses along the way as they trounce their private market benchmarks that don't reflect the risks they're taking. And here is a scary thought: what if a prolonged period of debt deflation sets in? They and other pension funds are pretty much screwed (another reason why extend and pretend must continue).

On private market benchmarks, you can see that PSP is still not publicly disclosing them (page 24, click on image to enlarge):

I am told that as long as the Board and stakeholders are informed of the private benchmarks, the public doesn't have a right to know. But the problem is that if they're not publicly disclosed or if the Special Examination does not undertake a comprehensive review of all private and public benchmarks, then there is the potential for abuse and paying out huge bonuses based on bogus benchmarks. That's just one of the glaring governance gaps that the Special Examination did not address and let me remind everyone taxpayers pay the salaries of public servants, including the good folks over at the Office of the Auditor General of Canada (a little conflict of interest having the OAG and Deloitte do a Special Exam, don't you think? Should have hired me and some former PSP employees instead...that would have been barrel of fun!!!)

Click on the table at the top of this comment to view the breakdown of portfolio returns for each asset class. You see that Canadian Equity underperformed its benchmark (they foolishly got rid of two of the best Canadian portfolio managers in the industry while I was working there), made money in EAFE Large Cap (wisely kept that internal portfolio manager), made a bit in Fixed Income moving assets internally, made money in Private Equity (20.9%) and Real Estate (13.8%) but lost money in Infrastructure (-1.6%).

Importantly, overall the Fund returned 3.6% over the last five years , underperforming its benchmark Policy Portfolio which returned 4.4%, or 80 basis points below the Policy Portfolio in the last five years.

And for all this, what was Management's compensation for FY 2011? It's all there on page 55 (click on image to enlarge):

You can see that Mr. Fyfe and the heads of Private Markets have enjoyed excellent total compensation over the last three years despite underperforming their Policy Portfolio during the last five years. Bruno Guilmette, head of Infrastructure, lost money in FY 2011, underperforming his benchmark by 8.4% and saw his total comp jump to $1.5 M. Even John Valenti, PSP's CFO and COO, enjoyed huge total compensation during the last three years. This man was on the hot seat in front of a parliamentary commission two years ago, squirming to answer basic questions, but is now enjoying the benefits of bloated compensation (ridiculous, he's making triple the money of Michael Sabia, President and CEO of the Caisse!).

To be fair, PSP's compensation is in line with other large Canadian public pension funds (not the highest paid -- CPPIB and Teachers' are), and is far below what the sharks on Wall Street make, but that doesn't tell me much. My humble father and doctor friends who enjoy excellent salaries all roll their eyes when they hear of how much some people in finance make. It's a joke and everyone knows it.

In my follow-up comment, I'm going to go through the Special Examination, exposing several serious governance gaps that were not covered. And it's not only going to be PSP-specific. Most of these governance gaps can be found elsewhere, which is why I urge you to read my follow-up comment as well.

Read more »

Are You Putting Yourself First?

Woke up early this morning. Absolutely beautiful, crisp, sunny day here in Montreal. The excessive heat dissipated and I took advantage to head over to my favorite cafe on Bernard for breakfast, read the paper and just relax and enjoy this awesome weather. I also read my horoscope on my Blackberry:

When you wake up this morning, or as you go about your day, you hold in your grasp the chance to make it whatever you want it to be. Will it be positive and uplifting, with many happy thoughts, pleasant exchanges with the people you meet, and the positive pursuit of your goals? Or, will you anticipate an unhappy ambience, conflicts at home or at work, and a failure or two? It's up to you. But here's a hint: If you wish to have a really great day, the kind of day the stars are encouraging you to have, then you will choose the first option. It really is a choice.

I already chose the first option and so far the day started off on the right note. I enjoy my alone time. Most men and women would never go eat alone. Not me, I love it. Some poor guy next to me had his wife nagging him about fixing stuff around the house. At one point, it was too much, so I gave her an evil stare and felt like saying "can you please shut up and leave the poor man alone to enjoy his breakfast and this beautiful weather!"

The theme of my blog this Sunday is simple: putting yourself first! What do I mean by that? Well, I've been doing some soul searching and with the help of my psychologist who I recently started seeing once a week, realize that I spend an inordinate amount of time in my life worrying about people who don't deserve one minute of my thoughts.

I also realize that the best investments I made this past year are not Chinese solars (lol, now is a good time to scoop up some LDK Solar), but on on myself: Lasik eye surgery to correct my myopia and free myself from contact lenses, CCSVI procedure to help with my MS, joining a gym when I turned 40 and working out religiously, and going to see a psychologist to chat about my inner rage and how its impacting my personal and professional relationships.

I did that because I realize that I'm intense, often confrontational, will push people to the max, back down from nobody, and it has turned people away. I'm like that because I expect a lot from myself and expect the same from others, especially if they're close to me. However, I'm learning to take a step back and realize that others are dealing with their own issues in life. My humble father, a psychiatrist with over 40 years of clinical experience tells me all the time, everyone has issues they're dealing with, from the hard laborer to the CEO of a major corporation. He should know, he treats patients from all walks of life for all sorts of mental illnesses.

I recently went to see a French Canadian physiotherapist. This lady is simply incredible, spending over an hour with me going over everything related to the mechanics of my gait, my bad posture, and giving me specific exercises to do to improve my posture and target the weaker muscles in my right leg. She also showed me how to use a roll to relieve upper back spams and how I should sit properly and get up often from the computer to stretch and open up. I told her most physios I've seen in the past were absolutely useless but she really helped me and I will continue seeing her. You can tell someone is good when they're booked solid months in advance; I got in on a cancellation list.

The other thing I've been investing my time in lately is trading stocks (absolutely love it), meeting people who contact me from my blog, and helping Montreal hedge fund managers raise assets. I'm also swimming, tanning and just enjoying the beautiful summer, which is what everyone should be doing this time of year instead of being cooped up in an office in front of a computer. Remember this: work is a four letter word so enjoy leisure every chance you get.

Enough about me, let's talk about you. How healthy are you physically, mentally, emotionally and financially? If either one of these areas is not going well, don't sit and sulk about it, do something about it. Take action, make a game plan and stick to it. Baby steps at first and then start walking, jogging and running towards your goals.

Take it from a guy who has had MS for the last 14 years, Nietzsche was right: what doesn't kill you, makes you stronger. I've been fired a few times (all on flimsy grounds where I could have sued their pants off), been through a divorce, ups and downs on the health front and with personal and professional relationships, but I now realize there is absolutely nothing you can't do if you put your mind to it. Suck it up, don't let your ego get in the way, and simply focus on short-term, medium-term and long-term goals. Surround yourself with people you trust and can confide in, knowing they'll give you wise advice and get rid of anyone who is a negative drag on your energy. I mean it, "bye-bye, don't need or want you" to negative people or slimy weasels, that should be your motto as you forge ahead.

And there is something else, you can always improve on every facet of your life. I thought I knew it all on diet and MS, but I don't. One person wrote me on allergies and MS and how Caroline Myss's energy medicine helped him. Someone else emailed me urging me to try a gluten free diet, eliminating wheat products. A gluten free diet increases your energy and all patients suffering from autoimmune disorders should try it (casein in dairy can also be problematic if your intestines haven't fully healed from damage caused by gluten. Also, avoid sugar as much as possible and no smoking whatsoever!). A doctor emailed me to get tested for Lyme disease, which can be chronic and mimic MS and other diseases. Another person wrote me about the benefits of Iyengar yoga for MS (link for Toronto and one for Montreal). A lady wrote me about the benefits of medicinal biomagnetism (don't know anything about it and am somewhat skeptical).

And then there was a wonderful lady suffering from COPD, irreversible lung damage, who sent me an Earth Clinic link to holistic treatments for MS. She also sent me James Altucher's article on how to deal with crappy people and shared these thoughts with me after I posted on the real unemployment scandal focusing on the scourge of discrimination against disabled people in the workforce:

Hi Leo, I appreciated your thoughts about discrimination, I am glad someone is willing to be an advocate for those who want to work. I've never told an employer about my COPD because at my US company, everyone I knew who publicly stated they had any kind of issue (bipolar, depression, eye cancer, brain cancer, degenerative eye disease) was laid off. Sure they called it a performance issue to avoid lawsuits. I actually heard a VP say they had to get rid of the guy with progressive eyesight degeneration, based purely on his health. That guy is Canadian, at least he had health care after that: the others were US based who knows whether they had access to care. I'm lucky, in my position heavy labor is not necessary, so I can hide my disability. Many others are not so lucky. Those who show no compassion may be healthy now, but will they be 10-20 years from now? Who will speak up for them when no one will employ them because of their health?

Nobody is speaking up for them, which is why I hammer away at this public policy issue. I think we should introduce laws forcing governments agencies, including Crown corporations, to publicly disclose what percentage of their employees have a disability at all levels of the organization.

The amount of bullshit I've personally been subjected to after disclosing I have MS is incredible (couldn't hide it at times when my limp was noticeable). It opened my eyes to how slimy, sneaky, and unscrupulous people can be. Right before I got fired from a major Crown corporation, I was promoted, warned them about the looming credit crisis, and they still fired me for "being too negative". The chief weasel met up with me after to tell me he gave me "plenty of opportunities," but this was all a lie, he was just covering his legal ass. Remember this, if they want you out, you're out. There are far too many unscrupulous, evil, insecure jerks with thin egos in finance and elsewhere. It's all about ego and they'll run you over as they manage their precious career.

But I have leverage over these insecure, slimy weasels. It's called Pension Pulse, and it's a blog that I'm damn proud of. Also enjoy contributing on Zero Hedge and get into it with some members who love to blast me. But while I can deal with my enemies, I'm most grateful for my family, friends and the many people who have helped me by sharing their thoughts on important pension issues. These people include senior pension fund managers who care about what's going on in the industry but cannot openly blog on certain topics because it's too sensitive or too political.

I leave you with some concluding thoughts on putting yourself first. I want people to take control of their emotional, physical, mental, and financial well being. Take baby steps, but do something every single day. Don't wait to win the lottery or for radical change to hit you. It'll never happen. Reevaluate all your relationships and make sure those closest to you are always by your side through thick and thin. Importantly, make sure you are listening to those who earned your trust and are looking after your best interests.

Finally, I was looking at a 5-year chart of ACME Packet (APKT) and then some of my stock recommendations from my January 2009 comment on post-deleveraging blues. I screwed up on the banks and REITS, but nailed some of them like Priceline (PCLN) and EMC (EMC). Go back to read my comments on spying on elite funds (Part 1 and Part 2) as well as a recent comment on whether phosphate will be Canada's new potash.

I'm mostly swing trading stocks but see tons of opportunities in all sectors. Right now, I am focusing on swing trading networking stocks like JDS Uniphase (JDSU) and Chinese solar stocks like LDK Solar (LDK), but hold core longs in Level Three (LVLT), Satcon Technologies (SATC), Emcore (EMKR), and Arianne Resources (DAN.V). There are many, many other stocks like BMC Software that could continue climbing higher. If you have any other ideas, please share them on Zero Hedge. Enjoy the rest of your weekend, and always remember to put yourself first!

Read more »