Wednesday, December 27, 2017

Will 2018 Be a Repeat of 2017?

Bob Pisani of CNBC reports, Could 2018 surprise with the same outsized gains as 2017?:
Will 2018 be a more "normal" year? 2017 was a year of surprises, but for 2018, not surprisingly, things are expected to be more, well, normal.

Which is why you should be suspicious.

It's true — by almost all measures, 2017 was one of the most extraordinary years in the history of the stock market. Investors saw:
  1. Extraordinary returns far above the norm. The S&P 500 is up nearly 20 percent this year, far above the roughly 8 percent average yearly gains since 1945.
  2. Extraordinary new highs. We hit 62 daily all-time highs this year, far above the average of 29 that have occurred in years when at least one new high was reached, according to CFRA.
  3. Extraordinarily low volatility. The S&P moved 1 percent or more on only eight trading days this year; the average since 1945 was 50 days.
  4. Extraordinary sector dispersion. The top-performing sector — technology, up 38 percent —outperformed the worst-performing sectors (energy and telecom, down about 5 percent) by more than 43 percentage points.
What does all this mean? The stock market is a numbers game with a long track record. When you get numbers that are way out of the ordinary, it's logical to believe in mean reversion, that it is highly unlikely that returns or volatility will come anywhere near 2017.

That is exactly veteran market watcher Sam Stovall's advice to his clients. Stovall is chief equity strategist at CFRA, and in a note to clients advised that investors "would be better off anticipating an increase in volatility, a reduction in new highs, as well as a below-average price gain for the '500' in the year ahead."

Getting these extraordinary numbers tends to pull forward stock market performance. In years with above-average new highs and below-average volatility (exactly what we had in 2017), the S&P rose the following year only 55 percent of the time, with an average gain of only 3.1 percent, Stovall noted.

In years where the "dispersion" between the best- and worst-performing sectors was high (also what we saw in 2017), the S&P 500 was also up only 57 percent of the time in the following year, with an average gain of only 1.9 percent.

Stovall's conclusion: "As a result, one could say that in 2018 investors should expect more for less — more volatility for less return."

Get it? "Less surprise" is a big theme for 2018. Jim Paulsen, chief investment strategist for Leuthold Group, has noted that a good part of the stock markets' gain has been related to the string of strong economic numbers that we have seen recently: He notes that the U.S. economic surprise index rose to a 6-year high last week.

"Even if the recovery remains healthy in 2018, it can't continue to surprise," Paulsen says.

But why can't it continue to surprise? Peter Tchir, macro strategist for Academy Securities, is not so impressed with the "reversion to the mean" story.

Tchir notes that the global economic expansion continues, that earnings remain at record highs, and the tax cuts are pushing those numbers up: "It doesn't feel like the tax cut is being fully priced in, and there's no reason corporate America can't keep issuing debt and buying back stock. I'm not sure we can't have more of the same."

And absent some outside shock, why can't volatility remain low, he asks. "With ETFs, people have less need to chase daily trading, and I think that's a good part of the reason why we have seen reduced volatility."

Bottom line: Reversion to the mean does eventually happen, but we are in very unusual times.
These are unusual times. In my last comment on the Santa rally, I discussed why even though the market is overbought on a weekly basis, this isn't necessarily a bad thing and if the rally continues early into the new year, it could be a harbinger of another good year.

But I also cautioned my readers that as the market keeps "melting up", so do downside risks. The silence of the VIX and the silence of the bears are deafening, but risk assets cannot decouple from the economy forever, at one point reality will settle in and it will be a long and brutal winter.

Of course, traders know this but they also know there is a lot of liquidity out there no thanks to central banks trying to stoke inflation expectations higher through creeping market euphoria.

This is why even though it seemed like it's as good as it gets for stocks at the end of Q1, they kept soaring higher, making new record highs.

Nowadays, everyone is talking about the best of all worlds for stocks, meaning low inflation, solid global economic growth, good earnings, all helping to boost stock markets around the world higher.

Interestingly, Anastasios Avgeriou, Chief Equity Strategist at BCA Research., posted this chart on LinkedIn showing the 2017 asset performance in US dollars (as of last week):


I would have liked to have seen this in local currency terms too as the US dollar (UUP) didn't have a good year. Also worth noting, in US dollars, Canadian equities are up 12.6% and Mexico 12% year-to-date. These two countries didn't perform as well as the rest because of energy and onging NAFTA negotiations.

The key message in 2017, risk assets were all the rage as investors chased yield. This is why you saw emerging markets, Japanese and European stocks do very well this year.

Should we expect more of the same in 2018? I wouldn't bet on it but from Bob Pisani's article above, one thing I want to stress is when you see technology shares (XLK) up close to 40% in one year, that's typically a bad omen for the following year (some tech ETFs performed a lot better than the average in 2017).

Why? Because when portfolio managers all turn to large cap technology shares, it's typically a defensive play as they're worried about what lies ahead. So, buying more FANG stocks worked well in 2017 but it might not work as well next year.

One area of tech which I'm watching closely is semiconductor shares (SMH) which have been a little weak going into year-end:


The other sectors I'm watching closely are Metals & Mining (XME) and energy (XLE) which have rallied going into year-end (the former a lot more than the latter):



I think this is normal sector rotation but the reflationistas are going to argue global economic growth is a lot stronger than we think and now is the time to load up on commodities and these cyclical sectors.

I remain highly skeptical, trade these sectors but don't expect a major uptrend and if something goes wrong, they will be sold hard.

Below, closely followed strategist Jeff Saut told CNBC on Wednesday that he expects the stock market to grind even higher in the new year.

"I would expect 2018 to be an almost repeat of 2017," said Saut, chief investment strategist at Raymond James. "People are still way underinvested. Earnings are starting to come in better than expected. And with the tax reform, and especially the corporate tax cuts, I think earnings are going to continue to surprise on the upside."

Maybe but if stocks keep melting up, you'd better hedge your downside risk by buying more US long bonds (TLT)  because as I keep warning you, nothing goes up forever, and when the music stops, all risk assets including stocks are going to get clobbered.

So, if I was betting on it, I'd bet 2018 won't be a repeat of 2017. Hedge accordingly and don't buy the nonsense all these strategists are peddling, namely, "JUST BUY MOAR STAWKS!" and bonds are a terrible investment. You won't get rich off bonds but you will protect your portfolio from being obliterated.

I'll be back next week, wish you all a Happy and Healthy New Year and I'd particularly like to thank all of you who took the time to contribute to this blog in 2017, I truly appreciate it.

Friday, December 22, 2017

It's Time For The Santa Rally?

Patti Domm of CNBC reports, Tax bill 'winners' could help drive the stock market's traditional year-end Santa rally:
Oh, by gosh, by golly, it's time for the Santa rally.

According to "Stock Trader's Almanac," the Santa rally officially begins Friday, the start of the final five trading days of 2017, and ends at the close Jan. 3, the end of the second trading day of the new year.

Some strategists are saying humbug to the seasonal rally because the S&P 500 has already gained 20 percent this year, with 5 percent in just the last five weeks. But Jeffrey Hirsch, editor-in-chief of the almanac, says they've got it all wrong. It's an indicator, not a seasonal trade.

He says the phrase used to explain the year-end phenomena has proven to be true: "If Santa Claus should fail to call, bears will come to Broad and Wall." Hirsch notes that since 1950, the S&P 500 has averaged a consistent 1.3 percent gain in that seven-day period.

"It's an indicator of market health, and if we get the Santa rally, that's good, and if not … The last six times that Santa didn't show up, three were followed by flat years: 1994, 2005 and 2015. Two were nasty bear markets in 2000 and 2008, and a mild bear … in January 2016," said Hirsch.

In 2016, the S&P 500 lost 2 percent during the Santa rally period and continued falling, losing 10.5 percent for the year to date before bottoming on Feb. 11. It then turned around and ended 2016 up 9 percent.

"For the Santa rally itself, a lot of it has to do with the end of tax loss selling and the fact that a lot of us are not around to really trade the market during this period," he said. "It's a period of time where a lot of participants are away, and the smart money comes in and picks up values. It's a time of year for positive vibrations and bullish buying, and if it doesn't happen you get the first sign that things are not so rosy."

Hirsch said while he finds it an important indicator, it's more important when combined with other indicators, such as how stocks trade in the first couple of days in January and the January effect — which is using the first month of the year as a barometer for the rest. "So goes January, so goes the year," is the old adage.

Some find talk of the indicator as just another old Wall Street tradition, kind of like when the traders sing "Wait Till the Sun Shines, Nellie" on the New York Stock Exchange floor on Christmas Eve.

One of those traders, Wall Street veteran Art Cashin, tells me he believes in the Santa rally "a little bit." This past year's Santa rally ended with a 0.3 percent gain, and the month of January was up 1.8 percent.

He said stocks were lifted Thursday, in part by traders picking winners from the sweeping GOP tax bill, approved by Congress on Wednesday. That type of buying could fuel the Santa rally, he said.

Sectors that would benefit from tax reform were trading higher, such as financials, energy, telecom, industrials and materials. Technology companies were trading lower. Many already have a low tax rate and could face new taxes on their overseas operations.

"You could see by the volume, it's not a runaway rally," he said. "Let's remember this year has not been a good year for seasonal patterns. The January effect may be complicated by the tax bill. People weren't doing their tax selling because they weren't sure how things were breaking down."

President Donald Trump signed the Republican tax cut bill Friday morning before leaving for his Christmas break in Florida.

The market reacted with a mild, not a huge selloff. It's typical of traders selling the news and booking profits before heading off for their Christmas break to relax.

Not surprisingly, as Congress moved the tax bill forward, investors pulled the highest amount out of equities funds in more than three years, suggesting some investors may see "tax cuts" as already priced in.

I don't expect a lot of trading going on next week as most people are off and typically what happens is you get a continuation of the trend that has happened all year. In all likelihood, the market could end the year about where it is now after 2017's very big gains.

What will be interesting to see is if there's any tax-loss selling which didn't take place this year as investors waited for the new tax bill to be passed and whether it will happen early next year, adding pressure on stocks in January.

Of course, I'm speculating, nobody knows what will happen in January and the rest of the new year but now that the tax cut bill is behind us, investors will focus their attention on other things, like the Fed, risks in China, Europe and elsewhere.

While I worry the rally might be nearing an end, others think stocks are the most overbought in 22 years, and history says that's bullish:
It's proved to be a major market theme this year: Stocks are hitting all-time high after all-time high in what appears to be an unstoppable juggernaut of an equity rally. Many say that's cause for concern, as the broader market has seen so few pullbacks this year amid virtually no volatility.

According to one analysis, however, the market's historically overbought condition is no reason to press the sell button.

The S&P 500 is the most overbought in 22 years, as measured by its 14-week relative strength index, said Ryan Detrick, senior market strategist with LPL Financial. The classic overbought/oversold indicator is historically elevated, above 80.

But Detrick found that when the S&P 500 has become this overbought (in 13 times since 1950), the market has risen the following year all but once, seeing an average annual move higher of 11 percent.


"In other words, really strong returns going forward, even after we are so overbought, which is one of those rare times that maybe this could be a continuation of the bull market. Things still look pretty good, even though we are still historically overbought here," Detrick said Wednesday in an interview with CNBC's "Trading Nation."

This is just another stunning statistic to pile into a record year for records. This year has also produced the longest daily streak ever without a 3 percent pullback, and the most all-time high records for the Dow Jones industrial average.

Though Detrick is bullish at these levels, he said one risk he sees going forward is potential market turbulence as Jerome Powell's tenure as Fed chair begins early next year. "Overvaluations" are also a concern, Detrick said, but corporate earnings continue to be quite strong.
I don't know about Jerome Powell's tenure as Fed chair but one thing is for sure, he's not going to be walking into a picnic. All risk assets across public and private markets are extremely overvalued right now.

Still, buying begets buying, and that fella is right, an overbought market tends to become more overbought.

To understand why, there are billions of dollars in quantitative hedge funds and commodity-trading advisors (CTAs) chasing trends in stocks, bonds, currencies, and commodities using "sophisticated" mathematical algorithms. Since most markets aren't trending much, stocks have garnered all the attention.

A naive way of thinking about it is using some simple rule like as long as the S&P 500 (SPY) is trading above its 200-week moving average, you guessed it, "JUST BUY MOAR STAWKS!" on any dip:


Of course, I'm being facetious, quant funds and CTAs use very "sophisticated" models to form their price signals but trust me, I'm not too far off. The best CTAs follow some trend following rule and they don't trade often (read Michael Covel's book, Trend Following).

Trend following works until it doesn't, and when markets shift abruptly, watch out, the drawdowns can be just as spectacular as the big gains from following some simple trend following rules.

But traders love breakouts, especially on longer-term weekly and monthly charts, because while everyone expects mean reversion, markets tend to keep melting up, catching everyone off-guard.

It's particularly hard trading when markets enter a melt-up phase, where everything explodes up, and this in spite of the Fed raising rates.

In my experience, this is when the biggest gains are made. This is why I've been trading stocks over the last month like crazy, because I knew as long as that tax bill wasn't signed, markets will keep going higher in anticipation of  the new tax plan.

Now that we got this tax bill out of the way, it will be interesting to see if markets keep forging ahead despite the Fed rate hikes.

Personally, I'd love to see a healthy pullback on the S&P 500 (SPY) right back to its 50-week moving everage before it takes off again. It doesn't mean it's going to happen, especially in these markets where traders chase momentum.

But these markets aren't just about momentum and chasing trends. Some argue the fundamentals warrant more upside in stocks.

In fact, Chen Zhao, Chief Strategist at Alpine Macro, sent me this in an email Friday morning:
Alpine Macro’s 2018 Outlook, titled “Unanticipated Boom and Coming Clashes”, is currently being completed and will be released on January 5th . The report’s release will be followed by a live Webcast where I will answer your questions. Here is a preview of the report:

Entering 2018, the investment community has comfortably converged to the view that economic growth in the U.S. will be around 2.5%, growth in the Eurozone will decelerate to about 2% and China’s economic growth will soften to 6.3%, ergo the consensus calls for a replay of 2017 in 2018. As for markets, most investors are cautious on stocks, bearish on bonds and uncertain about commodities and emerging markets.

Maybe the consensus is right, but we disagree. We are looking for a low-inflation economic boom, driven by private capex, re-leveraging and an possible “race to the bottom” in tax cuts around the world. We are looking for much stronger growth in G7 in 2018, while China’s economy could also deliver a positive surprise.


As for financial markets, our research suggests that the bull market in U.S. stocks has not yet matured. Despite the recent price gains, the total return index for the S&P 500 has not even returned to its long-term trend (see chart above). Should a low inflation boom indeed develop, a “melt-up” in global equity prices could be the big surprise in 2018. We are not particularly bearish on US treasury bonds, but the dollar story will become complicated in the New Year.

Finally, various risks will also escalate next year, suggesting that financial market volatility will be sharply higher. Investors should think about hedging strategy, especially now with VIX index at extremely low levels.
Chen is right, don't discount the low-inflation melt-up in global equities in 2018, it might happen and take everyone by surprise.

Importantly, after years of quantitative easing (QE), there is still a tremendous amount of liquidity in the global financial system driving stocks and other risk assets higher. And all this talk of rate hikes and reducing central banks' balance sheets is much ado about nothing.

Where I disagree with Chen and the folks at Alpine Global is on their "particularly bearish" call on US Treasuries (TLT) as we head into 2018. Why do I disagree with this call? Simply put, deflation remains the biggest threat as lofty stock markets head into the new year.

This is why I'm still recommending buying the dips on US long bonds (TLT) and still believe that melt-up or meltdown, Treasurys offer the best risk-adjusted returns going forward:


I realize this is counterintuitive but think about this way, if stocks keep melting up, downside risks will soar too, and if they melt down, well, there won't be many places to hide except for US long bonds, the ultimate diversifier in these insane markets.

That's all from me, I wish you Happy Holidays and a Merry Christmas. I will be back next week with some more market thoughts and round up the year.

Below, the S&P 500 is the most overbought in 22 years, as measured by its 14-week relative strength index, said Ryan Detrick, senior market strategist with LPL Financial. He thinks this is "bullish"and he might be right, the Santa rally could persist into the new year.

But I warn all of you, if stocks melt up and you see a parade of bulls on CNBC telling you to "JUST BUY MOAR STAWKS!", keep in mind nothing goes up forever and downside risks are rising if this happens. Enjoy your holidays and if I have time, will beef up this comment over the weekend.

Thursday, December 21, 2017

A Christmas Full of Pensions For Life?

Murray Brewster of CBC News reports, Ottawa pouring an extra $3.6B into veterans' benefits:
The Liberal government today initiated an intricate overhaul of the system to compensate wounded ex-soldiers, but it remains to be seen whether it will be enough to placate a volatile community of Canadian veterans.

The plan, rolled out by Veterans Affairs Minister Seamus O'Regan, is meant to address smouldering grievances among veterans that has led to protests and at one point spawned a class-action lawsuit.

As CBC News reported last week, the changes involve a two-part rejigging of the current system. Officials outlined how that would work on Wednesday and announced there will be an injection of fresh cash beginning on April 1, 2019. O'Regan said it will take time to introduce the required legislation.

Speaking on background before the announcement, officials estimated the changes would mean an extra $3.6 billion being poured into veterans benefits.

"We are delivering a package of benefits and supports, and financial security for those who need it," O'Regan said.

"I hope they believe we fought hard for them."

At issue is a tax-free lump sum payment, brought in a dozen years ago, to replace a system of pensions for pain and suffering injuries.

Prime Minister Justin Trudeau's Liberals promised in the last election to give veterans an "option" of taking the lump sum or a lifetime pension.

What the federal government is introducing Wednesday is a patchwork allowing veterans to take either the lump sum or a lifetime pension, which would deliver a maximum tax-free payment of $1,150 per month.

In addition, the Liberals will introduce another tax-free pain and suffering award on top of the existing one. It too will come in either lump sum or pension form that would give wounded veterans up to $1,500 per month, depending on their level of disability.

'Not everyone will receive the maximum award'

The second component involves a bundling of six existing income-replacement benefits — already available under the often-maligned New Veterans Charter — into one payment.

The new income replacement benefit will be taxable and it is meant for those "who are experiencing barriers to re-establishment due to a health problem resulting" from their service.

Significantly, it will be available to veterans, survivors for life, and orphans, should they need it.

The part of the plan that will draw the most scrutiny and perhaps political fire is the pain and suffering awards.

O'Regan was clear that "not everyone will receive the maximum award."

Under the current lump sum system, the maximum payout is $360,000, but documents obtained by CBC News under access to information show the average award is $43,000.

Translated to a pension, that means few wounded soldiers would ever see the entire $1,150 per month. Under the old pension act, the most severely wounded soldiers would have received up to $2,700 per month.

The Liberal government has long said its changes "would not seek parity" with the previous system, but officials emphasize that when the two tax-free benefits are combined, that would only mean a difference of $50 per month.

Officials said only about 12 per cent of veterans will be eligible for the maximum amount.

O'Regan said he can't guarantee that the average veteran will receive the same or more compared to the old pension act.

"No, I cannot guarantee that. Each will be individually assessed," he said. But "any veteran receiving funding under the New Veterans' Charter will not be receiving less under this. In almost every circumstance they will be receiving more."

Before Wednesday's announcement, some ex-soldiers were clear on what their litmus test for success is: more money in their pockets.

"The bar the government has to meet is parity with the pension act in terms of the net dollars in a veteran's pocket every month," said retired major Mark Campbell, who lost both legs in a blast in a booby-trapped ditch in Afghanistan.

"It can only be a real pension if the benefits are tax free and if there is no clawback of their military pension as part of the disability payment."

Veterans Affairs officials used a bevy of charts and hypothetical scenarios Wednesday to demonstrate that combining all elements of the plan — both tax-free and taxable benefits — most soldiers would be better off financially.

Sean Bruyea, a veterans advocate, said it is unclear how the changes will affect average veterans given the complexity of the changes.

"This is going to create a nightmare of anxiety among veterans who are going to wonder whether their lives are going to be made any better — or worse," he said.

O'Regan took pains to emphasize that the government will use the coming months, before the changes come into effect, to work with individuals to reassure them.
And Lee Berthiaume of the Canadian Press also reports, Confusion, frustration greet Liberals' pension plan for disabled veterans:
The Trudeau government’s long-awaited plan to provide lifelong disability pensions to veterans has been met with confusion and frustration from many of those that it is expected to help.

Veterans Affairs Minister Seamus O’Regan unveiled the new pension plan on Wednesday, more than two years after the Liberals promised it during the last federal election — and only days before Christmas.

The plan promises more money to injured veterans than the current suite of benefits, especially the most severely disabled who can’t work and continue to suffer from service-related injuries.

Yet it offers only modest increases to those on the other end of the spectrum, and continues to provide many with less than the previous lifelong disability pensions, which were abolished in 2006.

“We were focused in this program on those who are catastrophically injured,” O’Regan explained during a news conference at National Defence Headquarters.

“Those who have received a disability or an illness during their service. Those who have a hard time going back to work. Those who have a hard time, as they say, re-establishing themselves.”

The plan is expected to cost $3.6 billion over six years, and will take effect in April 2019.

Veterans and support groups were scrambling after the announcement to figure out exactly how the changes would affect them and their clients, citing a lack of detail as a major complaint.

“It’s confusing,” said Jim Lowther, president of VETS Canada, which support homeless veterans in different cities across the country. “We’ve been going over this all morning, but it’s very vague.”

Veterans receive financial benefits and compensation based on the extent of their injuries or disabilities and whether those factors have an impact on their post-military career and earnings.

The existing system, created in 2006, provides a lump-sum worth up to $360,000 for the most severely disabled, in addition to rehabilitation, career training and income support.

While veterans who want the money right away will still be able to choose the lump-sum payment, the Liberals are also giving them the choice of a monthly payment instead worth up to $1,150.

Those with severe or permanent disabilities will also be eligible for an additional new benefit worth between $500 and $1,500 per month. Both benefits are tax free.

Officials said the more than 61,000 veterans who have already received a lump-sum award will be assessed to determine how much they would have received per month. They will also be eligible for the new benefit, which officials said will be retroactive and could result in substantial one-time payments.

The government will also lump together six different benefits for veterans who can’t find work or whose post-military careers pay less than when they were serving in uniform.

Yet it wasn’t immediately clear who will be eligible for different elements of the new pension plan, or even which of the income-replacement programs will remain in existence after they are merged.

O’Regan guaranteed no disabled veteran will end up with less money, and the department plans to launch an advertising campaign to educate former service members about the plan.

“All of those covered under the (existing) New Veterans Charter will be automatically assessed against the new pension-for-life program,” O’Regan said.

“And no individual will be subject to a net-decrease in overall benefit.”

But that didn’t stop many on social media from questioning whether they would see any real benefits, or prevent concerns about existing supports being clawed back.

“They’ve created chaos with a vague presentation,” said Aaron Bedard, one of six disabled Afghan veterans who launched a legal challenge against the federal government in an unsuccessful bid to force a return to the previous pension system.

“It’s like watching Game of Thrones: You get a couple of answers, but you end up with a dozen new questions.”

The Liberals’ new plan was also panned for continuing to offer less financial support for the majority of veterans than the lifelong pension system that existed prior to 2006 — the same criticism that bedevilled the previous Conservative government after it introduced the New Veterans Charter.

“So we still have this ludicrous situation where you can have two guys with the same injuries from the same war but at different times and getting different compensation,” said Mark Campbell, who lost both legs in Afghanistan.

“That’s fundamentally wrong, and it has not been addressed.”

The Conservatives and NDP were also critical that the new pensions won’t come into effect until April 2019, which O’Regan said was necessary to pass required legislation and ensure Veterans Affairs staff are ready for the change.
If you're confused after reading these articles, I don't blame you, and I certainly don't blame the veterans who are equally confused and frustrated with the Liberals' new plan.

As I understand it, depending on their disability, veteran will be eligible for a lump sum payment of up to a maximum of $360,000 or $1,150 per month for life (officials said only 12 percent of the veterans are eligible for the maximum amount and the average amount doled out thus far is $43,000).

In addition, if they are having difficulty re-establishing their lives because of a severe and permanent injury, they may receive an additional $500, $1,000, or $1,500 a month, depending on the extent of their impairment (these are tax-free benefits).

Veterans Affairs Minister Seamus O'Regan said no disabled vet will end up with less money but clearly, the new plan doesn't address the discrepancies that bedeviled the previous Conservative government.

Importantly, one of the vets in the last article is right, you can't have two soldiers with the same injuries from the same war but at different times receiving different compensation. That is fundamentally wrong.

One word of caution to disabled vets, I agree with the government, you are much better off over the long run accepting the monthly payment than accepting a lump sum payment upfront. Don't make the mistake of asking for a lump sum payment, you will regret it.

I know PSP Investments manages the pensions of the Public Service, the Canadian Armed Forces, the Royal Canadian Mounted Police and the Reserve Force. And they're doing a great job, so it's better to stick with the monthly payment for life, trust me on that.

Lastly, I read these stories about how we treat disabled veterans, and I must admit, I'm not impressed with how the Conservatives and Liberals have treated this file. It's just plain wrong and the message it sends out is disheartening, to say the least.

Importantly, I don't find Canada treats all people with disabilities, especially disabled vets, with the dignity and support they deserve.

I'll leave it at that because I have some other more nasty comments on how our country treats people with disabilities but it's Christmas and I'd rather stay polite and composed.

Below, Veterans Affairs Minister Seamus O’Regan unveiled the new pensions Wednesday, more than two years after the Liberals promised them during the last federal election — and only days before Christmas.

And Veterans Affairs Canada explains pensions for life. Disabled vets can find out more here. Again, my only word of caution, don't opt for the lump sum payment, go for the monthly payment for life.


Wednesday, December 20, 2017

CalPERS Rejigs its Asset Allocation?

Randy Diamond of Pensions & Investments reports, CalPERS adopts new asset allocation increasing equity exposure to 50%:
CalPERS' investment committee approved a new asset allocation plan on Monday that is fairly similar to the current allocation, with the equity allocation rising to 50% from 46%.

The new allocation, which goes into effect July 1, 2018, supports CalPERS' 7% annualized assumed rate of return. The investment committee was considering four options, including one that lowered the rate of return to 6.5% by slashing equity exposure and another that increased it to 7.25% by increasing the exposure to almost 60% of the portfolio.

A lower rate of return means more contributions from cities, towns and school districts to CalPERS. Those governmental units are already facing large contribution increases — and have complained loudly at CalPERS meetings — because a decision by the $345.1 billion pension fund's board in December 2016 to lower the rate of return over three years to 7% from 7.5% by July, 1, 2019.

Under the plan adopted Monday, the California Public Employees' Retirement System will have a 28% weighting to fixed income, up from 20%. However, the current 9% allocation to inflation assets, which is largely made up fixed-income instruments such as inflation-linked bonds, is being merged with the fixed-income asset class.

Real assets, which includes real estate, will keep its 13% allocation, while private equity remains at 8%. CalPERS' liquid portfolio, made up of cash and other short-term instruments, will fall to 1% from 4%.

There was one dissenting vote on the 13-member committee, J.J. Jelincic, who argued that CalPERS could take its equity level to almost 60% because it was a long-term investor that could weather ups and downs in the portfolio. By being more aggressive in its portfolio, CalPERS could earn a higher rate of return over the longer term, he said.

Under the more aggressive option favored by Mr. Jelincic, CalPERS staff estimates it could earn annualized rate of 7.25% over the next 60 years.

Other board members said increasing exposure expose was too dangerous given the Sacramento-based plan's 68% funding ratio, endangering the plan's viability in the event of an equity downturn.

Chief Investment Officer Theodore Eliopoulos said the plan adopted was a good balance.

While he said CalPERS would be taking away increased returns if equity bull markets continue, at the same it would be protecting assets in case of a downturn, though even at 50%, CalPERS still has heavy equity exposure.

Critics have pointed out that the new allocation is unrealistic because the pension fund's own estimate shows the portfolio that was adopted would have a 6.1% rate of return annualized over the next 10 years. If investment returns fall under 7% that would increase the system's $138 billion unfunded liability in the near term.

CalPERS officials justified the allocation because they say long term over the next 60 years, they estimate the system can make the annualized 7% rate of return.
Robin Respaut of Reuters also reports, CalPERS invests more in fixed-income to reduce portfolio risks:
Pension fund giant CalPERS said on Monday that it would increase its allocation of fixed income to 28 percent from 20 percent in order to reduce risks in its $346 billion portfolio.

Overall, the California Public Employees’ Retirement System Board opted to keep its asset allocation similar to its current investment portfolio. This decision will guide investment decisions over the next four years.

The fund’s expected rate of return will remain at 7 percent with an expected volatility of 11.4 percent, it said. The expected rate of investment return, or discount rate, was lowered in December 2016 to 7 percent over the next three years. That compares to the fund’s net rate of returns of 8.4 percent since 1988.

Most of CalPERS’ asset allocation will be similar to the portfolio’s current makeup: half the fund will remain invested in global equity, 13 percent in real assets, and 8 percent in private equity. Less money will be devoted to inflation-protection assets and kept in cash.

Henry Jones, chair of CalPERS Investment Committee, said in a statement on Monday that “this portfolio represents our best option for success while protecting our investments from unnecessary risk.”

Board member J.J. Jelincic, the one dissenting vote among the board, said he would have preferred a portfolio with a larger allocation of global equities, arguing that CalPERS had missed market gains after it sold off some equities a year ago.

“We need to be long-term investors,” said Jelincic at Monday’s meeting. “I just do not think that it makes sense to take the lower risk and accept a lower return.”
There's been a lot of discussion in the blogosphere about CalPERS' new asset allocation. Zero Hedge laments, CalPERS Goes All-In On Pension Accounting Scam; Boosts Stock Allocation To 50%.

Leave it up to Zero Hedge to make a big stink out of anything CalPERS or any US public pension decides to do. In a nutshell, the allocation to public equities was increased by 4% to 50% and the allocation to fixed income was raised 8% to 28%.

However, the current 9% allocation to inflation assets, which is largely made up fixed income assets such as inflation-linked bonds, is being merged with the fixed income asset class, so overall, the adjustments were minimal.

Board member J.J. Jelincic was the only dissenting vote but in my humble opinion, he is dead wrong to want to increase the allocation to equities to 60% at this time given CalPERS's underfunded status and the fact the rally in stocks might be nearing an end.

I would have liked to have seen CalPERS more than double its allocation to bonds, and have expressed my reasoning:
I have also repeatedly stated on my blog to load up on US long bonds (TLT) on any backup in yields because when the bubble economy bursts and the next deflation tsunami and financial crisis hit us, it will bring about the worst bear market ever.

Of course, central banks know all this which is why the Fed has signaled it's preparing for QE infinity, something which I fundamentally believe is a foregone conclusion, which can explain pockets of speculative activity in the stock market.

Anyway, back to CalPERS. It's right to reduce overall equity risk but increasing fixed income for a large pension when rates are at historic lows necessarily means it will have to decrease the assumed rate of return going forward (the discount rate) and increase the contribution rate, which will cause major panic among California's public-sector employees and cash-strapped cities.

In fact, CalPERS wants broke cities to deliver bad news to out-of-luck pensioners, namely, some workers will lose a share of their pensions because of their employers’ failure to keep up with bills (get ready for the Mother of all US pension bailouts).

Most of Canada's large public pensions have been  reducing their allocation to fixed income and increasing their allocation to private markets, especially infrastructure, over the last few years.

But CalPERS doesn't have a dedicated infrastructure group and deals are pricey these days. I actually emailed CalPERS's CIO, Ted Eliopoulos, to put him in touch with David Rogers and Stephen Dowd at CBRE Caledon Capital so they discuss a game plan in infrastructure, a must-have asset class which CalPERS and many other US pensions are under-allocated to.

Why do Canada's large pensions love infrastructure? Because it's a long-term asset class, even longer than real estate, which offers stable returns in between stocks and bonds.

It's also highly scalable and Canada's large pensions can put a lot of money to work fairly quickly and they do so by going direct in this asset class, which means no fees to funds like they pay in private equity
.

The only large Canadian pension which has no infrastructure exposure yet is HOOPP which ironically has the largest fixed income allocation and is super funded (120+% and it will increase its benefits to its members).

Why doesn't HOOPP invest in infrastructure? It hasn't found the right deal yet because deals are expensive in this asset class and thus far, it hasn't needed to. Interestingly, however, HOOPP is shifting some of its credit risk as it recently committed a big chunk to a new CLO risk retention vehicle.

I'm not sure CalPERS is ready to increase its infrastructure investments or do anything exotic in its credit portfolio so I would argue it's sensible to tactically shift more assets in bonds in anticipation of a major pullback or bear market which will clobber risk assets.

Alternatively, it can increase its allocation to Private Equity but that portfolio needs some work and Mark Wiseman and BlackRock's special attention.

Let me also state the following, while I applauded CalPERS nuking its hedge fund portfolio three years ago, I think now is the time to allocate a sizable amount to a select few large hedge funds across directional and non-directional strategies.

Of course, in order to do this properly, CalPERS needs to hire experts who know what they're doing and pay them properly, no easy feat (there's a reason why CPPIB and Ontario Teachers' are Canada's largest hedge fund investors).

But at a minimum, if I was Ted Eliopoulos, I would definitely sit down with Bridgewater, Balyasny, Citadel, Farallon, Two Sigma, Angelo Gordon, and many more top funds who focus on alpha.

CalPERS should be looking at all possibilities but it's easy for me to say they should do this and that, the reality is they can't because they don't have the governance to do everything Canada's large pensions are doing.

So, with all due respect to JJ Jelincic, I disagree with him that now is the time to increase risk in public or private markets. Maybe the right move is to hunker down, increase fixed income allocation, accept lower returns and lower volatility for the foreseeable future, and limit your downside risk.

Lastly, I highly recommend Ted Eliopoulos and CalPERS‘s board speak to my friend, Nicolas Papageorgiou, Vice President and Head of Research, Systematic Investment Strategies at Fiera Capital here in Montreal. There may be smarter ways to reduce overall risk and volatility while maintaining decent returns.
The sad fact is CalPERS is getting a lot of flack for doing the right thing, namely, lowering the assumed rate-of-return it can earn (the discount rate) to 7% which is still a lot higher than what Canada's large pensions are currently using (4.75% to 6.3%).

I feel like telling these people out in California who want CalPERS to increase its equity allocation and assumed rate-of-return: "Hey, wake up, you have an underfunded pension plan, the more stocks you buy now, the greater exposure you will have to material downside risk. Are ou willing to live with that given CalPERS's underfunded status?"

In pension parlance, these asset allocation decisions are path dependent, meaning if your starting point is 68% funded and stocks tumble 40% like they did back in 2008, CalPERS will risk going to below 50% funded status, which is then chronically underfunded status.

But wait because I can hear J.J. Jelincic grumbling, "come on Leo, stop with the scaremongering, pension liabilities go out 60+ years and we withstood 2008 and came back strong."

Yup, with a lot of help from global central banks and passive investing taking over, but I caution all of you even though stocks keep climbing to new record highs, the liquidity party won't last forever, and when the bottom falls, you need to prepare for the worst bear market ever.

Now, what if I'm wrong? What if we don't have deflation headed to the US, inflation expectations slowly rise, rates rise gradually and the best of all worlds for stocks continues unabated?

Great, under this scenario, CalPERS will see an increase in its assets but more importantly, a significant decrease in its liabilities (because of higher rates). So what if it misses a bit more upside by allocating more to global equities? It's funded status will improve, and that's what counts most.

But what if I'm right about deflation headed to the US, rates plunge to new secular lows, risk assets get clobbered across public and private markets and the funded status deteriorates to the point of no return? What happens then? Is J.J. going to still be around to say "don't worry, our liabilities go out over 60 years, we need to invest over the long run"?

I'm not picking on J.J. here because J.J. could be any other board member and at least he has the guts to dissent but I'm worried that too many people are focused on missing the upside gains with little to no appreciation of the downside risks that come with increasing the allocation to equities.

I will however concede this much to the reflationistas, I'm a market guy and track markets very closely. One thing that struck me this week isn't the selloff in US long bonds (TLT) which I feel is another big buying opportunitiy, but the weekly breakout in the S&P Metals and Mining ETF (XME):


You look at that chart and wonder maybe global growth has a lot more to go, things aren't that bad and cyclical stocks (energy, metals, banks, industrials) have a lot more upside.

Forgive me, I'm extremely skeptical here, still think once this tax plan is signed, traders will lock in gains and sell stocks and other risk assets.

So, if I had a choice to buy the breakout on  S&P Metals and Mining ETF (XME) or load up on more US long bonds (TLT) here on the selloff, I'd opt for the latter and sleep well at night:


But hey, that's just me, I'm very cautious trading these markets and I'm concerned the big, fat liquidity party is coming to an end, and when it does, the hangover will last for years.

Below, Jonathan Golub, Credit Suisse's chief US equity strategist and one of Wall Street's biggest bulls, tells CNBC's Courtney Reagan why he sees the market rally raging on in 2018. "JUST BUY MOAR STAWKS!" but be careful, especially if you're an underfunded pension.

Update: Malcolm Hamilton, a retired actuary sent me these great insights after reading this comment:
CalPERS assumes a 2.75% rate of inflation while most of the Canadian plans are using 2%. This means that the assumed real rate of return on investment for CalPERS will be down to 4.25% once the new basis is fully implemented, as compared to a Canadian range of 2.75% to 4.3%. So CalPERS is moving its funding target to the bottom of the Canadian range (high discount rates mean low funding targets) and this is a big improvement from years past. Unfortunately, the funding target is well above the funding level so it will take many years and/or surprisingly good investment performance for CalPERS to dig out of the hole in which it finds itself.

Still, as you point out, CalPERS is doing the right thing seemingly without support or encouragement.
I asked Malcolm why would CalPERS assume a 2.75% rate of inflation when 10-year inflation breakeven rate for the United States is 1.88%, which basically means the market is pricing in an average inflation rate of 1.88% over the next 10 years (read more on this here).

Malcolm replied:
I don't know why they do it but it is common in the US. Basically, the US plans ignore market interest rates, yield curves and the inflation expectations revealed by inflation-protected bond prices. They attach great importance to long-term averages of past interest and inflation rates. It's silly, but they are very stubborn - and they like what they see when they look back 25 to 50 years.

Pension plans like looking back 25 to 50 years because that's where they find high returns and high interest rates. It's not easy justifying a 4% real return target when, looking forward, long term interest rates tell you not to expect much more than 1% without taking risk and demographically, as populations age and pension plans mature, the plans are less able to bear the risks that they need to take to earn a 4% real return.
Very silly indeed, again read Brian Romanchuk's comment here. The market isn't pricing in over 2% inflation over the next 10 years so why are these US pensions so dead-set on using long-term averages?

Tuesday, December 19, 2017

Canada's Offshore Pension Scandal?

Zach Dubinsky and Valérie Ouellet of CBC News report, Millions of Canadians have pension money offshore — without knowing it:
Palm-fringed islands, balmy weather, luxury yachts moored in azure waters — offshore tax havens conjure up a wonderland for the well-heeled and their wealth.

But a CBC investigation based on the Paradise Papers leak has found that millions of ordinary Canadians also have an interest in money parked in tax havens — almost certainly without knowing it.

Seven of the country's so-called Big 8 pension funds, representing more than 25 million workers, have used tax havens as they invest Canadians' retirement savings, according to records in the huge leak of offshore financial documents made public last month.

This revelation underscores a delicate quandary. On the one hand, pension funds need to make enough money to ensure they can pay benefits to an aging population, and using tax havens for investments abroad can help the bottom line. But it raises questions about whether Canadians' retirement money is underwriting an offshore industry that undermines tax fairness and transparency.

The pensions' high-profile offshore dealings include the 407 Highway north of Toronto, which the Canada Pension Plan Investment Board bought a 40 per cent stake in — partly through an entity in Bermuda. Or the high-speed rail line from London, England, to the Channel Tunnel, which a pair of Canadian pension funds owned until earlier this year via a shell company in Jersey, a tax haven in the Channel Islands.

None of the pension plans would say exactly how much of their revenue is generated by investments through tax havens. In response to questions from CBC, almost all of them pointed out that Canada doesn't tax pension plans on their investment income, so their use of tax havens makes no difference to federal or provincial government coffers.

But other countries have different tax rules, and some Canadian pension funds acknowledged that offshore investment structures help them legally minimize their tax burdens abroad. Some even said it's their duty to do so in order to maximize savings available for retirees.

"We structure our foreign investments to maximize the after-tax investment returns available to CPP contributors and beneficiaries," the Canada Pension Plan Investment Board (CPPIB) said in a statement, noting that 85 per cent of its assets are abroad.

"CPPIB has a responsibility to over 20 million contributors and beneficiaries to seek a maximum rate of return to help sustain the CPP fund for multiple generations."

A former top pension executive said that while Canada's major retirement funds used to invest nearly all of their assets domestically, it would be impossible to do so today and still generate the profits needed to pay decent benefits.

"Thirty years ago, when all investments were in Canada by those pension plans, they didn't need to structure things through the Bahamas," said Jim Leech, CEO of the Ontario Teachers Pension Plan from 2007 to 2013. "We can go back to that, and the pensioners will get half their pension."

'Absolutely unacceptable'


That doesn't resonate with Hassan Yussuff, the president of the Canadian Labour Congress and one of Canada's most prominent voices for workers. Yussuff said Canadians' pensions simply shouldn't be invested in tax havens because of their notoriety as epicentres for tax dodging.

"We want the tax system here to have credibility," he said. "It's absolutely unacceptable in terms of what we expect of pension funds, in terms of their ethical investment."

The federal government has repeatedly declared that it wants to make the tax system more fair — in part, the Finance Department says on its website, by efforts "to stop the use of tax havens."

Yussuff said it's contradictory to keep pledging tax fairness and transparency while, simultaneously, the CPP — the federal pension plan — is enmeshed in some of the very tax havens that are the targets of tax fairness and transparency campaigns.

CBC's investigation found numerous examples of major Canadian pension funds using or investing in tax havens. Here's a sample:
  • If you contribute to CPP, or work for the federal government or the provincial public service in B.C., then you have a stake in Chile's largest electricity company. That's thanks to a $1.55-billion US joint takeover by the CPP Investment Board, the federal Public Sector Pension Investment Board, the B.C. Investment Management Corp. and a private sector company back in 2006. The transaction was routed through a corporation set up in zero-tax Bermuda, because the island territory was "tax neutral" for all the investors.
  • The Ontario Teachers Pension Plan and OMERS, the pension fund for hundreds of thousands of Ontario municipal workers, owned the High Speed 1 rail line in Britain until September, via a holding company also incorporated in Jersey. Neither pension fund would say why they did it that way.
  • The Caisse de dépôt et placement du Québec, which invests the Quebec provincial pension plan as well as the pensions of many provincial and municipal employees, put money into a number of Cayman Islands companies in order to invest in North American financial markets and in an Israeli-managed venture capital fund. The Caisse said in a detailed statement that it obtained "no tax benefit" from the North American investments. The Israeli fund, it said, is one of many "regularly constituted" in certain tax-haven jurisdictions because of their efficient corporate laws, dependable legal systems and "a neutral taxation policy."
$1 trillion in assets

Canada's biggest pension funds have grown significantly in recent years in order to pay benefits to an increasing proportion of retirees. The Big 8 plans alone are now worth more than $1 trillion, and agencies like the CPP Investment Board, Ontario Teachers and Quebec's Caisse are among the biggest institutional investors in the world.

Couple that demographic trend with historically low interest rates on government and corporate bonds in Canada since the 2008 financial crisis, and pension fund managers have had to look outside the country to find investment returns to sustain retirees' benefits, analysts say.

And that has often meant using tax havens.

Fund managers "must fund these pensions in a very difficult economic context," said Chris Roberts, director of economic policy at the Canadian Labour Congress.

He said that as a result, a lot of CLC's members have "conflicted feelings about what their pension funds are doing, on the one hand, but also feeling like, 'Is my pension going to be there for me as well?'"
In its article, the CBC states the following major Canadian pension fund management bodies are mentioned in the Paradise Papers:
  • Canada Pension Plan Investment Board
  • Caisse de dépôt et placement du Québec
  • Ontario Teachers Pension Plan
  • Ontario Municipal Employees Retirement System (OMERS)
  • Public Sector Pension Investment Board (PSP Investments)
  • British Columbia Investment Management Corporation
  • Alberta Investment Management Corporation
I recently covered the Grand Cayman pension scam where I stated these investigative reports linking public pensions to offshore tax havens are grossly misleading and full of disinformation.

As I stated in that comment, using offshore structures to minimize tax bills is not only in the best interest of hedge fund and private equity managers, but also in the best interest of public pensions and their beneficiaries.

I also stated the following:
Earlier this year, the Caisse's CEO, Michael Sabia, had to defend the Caisse's investments in offshore tax havens (they doubled from $15 billion in 2013 to over $30 billion now). Why the need to do this, especially since it's not in the best interest of the province to remove those assets from these tax havens.

No doubt, we need lower fees, more fee transparency and better reporting information linking fees to returns, but spreading misinformation and lies about offshore tax havens isn't helpful and most certainly isn't in the best interests of the plan's sponsors and beneficiaries (or taxpayers).
Keep in mind, we are talking about legal tax minimizing here, not tax evasion. Three years ago, PSP Investments did run into trouble with German tax authorities for using a very elaborate tax scheme to avoid paying taxes but that issue was resolved amicably. Pushing the enveloppe too far isn't in anyone's best interest.

CPPIB's satement is right: "We structure our foreign investments to maximize the after-tax investment returns available to CPP contributors and beneficiaries." That is their job, part of their mandate to maximize returns without taking undue risks.

Again, people need to understand the governance and mandate of Canada's large pensions. They're not an extension of the federal government, they're independent entities that have a clear mission and need to focus 100 percent of their attention on delivering on that mission.

Let me be blunt. If they paid full taxes on their foreign holdings and didn't minimize taxes as much as possible using all necessary legal means, they wouldn't be fulfilling their mandate, they'd actually be violating it.

Canada's public pensions aren't charities. They're running very sophisticated operations investing across public and private markets all over the world. They do so by minimizing internal costs and maximizing after-tax returns so Canadians can retire with dignity and security and not see their contribution rate go up or benefits slashed.

And Jim Leech is right: "Thirty years ago, when all investments were in Canada by those pension plans, they didn't need to structure things through the Bahamas. We can go back to that, and the pensioners will get half their pension" (he was exaggerating to make a point, see update at end).

There are no free lunches in economics or pensions. If you want to divest from something, you need to invest elsewhere to make up the return. If you want to just invest in Canada, you need to hike the contribution rate and cut benefits. Are we willing to accept the consequences of such ridiculous policy decisions?

With all due respect to Hassan Yussuff, the president of the Canadian Labour Congress, he's out to lunch when it comes to this issue. He's wrong to go after our large public pensions for doing their job, and he doesn't understand the consequences of what he's asking for.

"We want the tax system here to have credibility," he said. "It's absolutely unacceptable in terms of what we expect of pension funds, in terms of their ethical investment."

What is unacceptable is that some very big crooks are getting away with murder in Canada dodging big taxes using questionable tax schemes and the Canada Revenue Agency is going after mom and pop shops while ignoring a much more perverse problem in our society.

How do I know this? Because my first job out of McGill was consulting the then (1998) Special Investigations department at Revenue Canada (that's what it was called back then) to estimate the size of white collar fraud in our country.

The department was grossly under-staffed (it still is) and even though it had some of the very best forensic accountants in the country, they were only able to pursue a fraction of the cases they worked on and most offenders got away with a low fine (and I'm talking millions in each fraud case).

When it comes to tax evasion, Canada isn't the United States where they can throw you in jail for a very long time, and unfortunately, the crooks know this and use it to their advantage.

My advice to Mr. Yussuff and the CBC is focus your attention on covering tax stories that really matter, not our large Canadian pensions which are doing their job and fulfilling their mandate.

Below, the CBC reports the Canada Revenue Agency (CRA) is accused of targeting vulnerable people and failing to answer millions of phone calls. Add to this that most CRA convictions cited by government are not for offshore tax evasion, and you can't understand why many Canadians feel frustrated with our tax collectors (to be fair to the CRA, they are grossly under-staffed and overworked).

Still, don't confuse what Canada's large pensions are doing using offshore tax havens to legally maximize after-tax returns with what crooks and even some big business people are doing to evade or push the enveloppe of tax minimization to its limits. I think it's important to make a distinction because what our large pensions are doing benefit us all, including taxpayers and the federal and provincial governments.

Update: Malcolm Hamilton, a retired actuary shared this with me after reading this comment:
I don't understand how pensioners will lose half of their pensions if pension plans are prevented from organizing their foreign investments to minimize tax.

Personally, I have no objection to pension plans structuring their investments to minimize tax. If this can be done legally, and I'm sure than it can, fiduciaries have a duty to do so.

However, the cost of sub-optimal tax planning cannot be so large that the alternative is to cut pensions in half. Think about it. Pension plans are expecting to earn about 5% to 6% after tax (3% to 4% after inflation). If they earn 3% less than this every year (i.e. earn a 0% to 1% real return after taxes and fees), then they would need to double contribution rates or cut pensions in half. However, it is hard to see how the annual saving from using tax havens can be 3% of total assets under management (not 3% of amounts invested in foreign private equity). Even if they are saving this much, it seems to me that they should be able to earn a 2% or 3% real return by investing in public markets and real estate, like they used to do, and this would obviate the need to cut pensions in half.

Are Canada's "Big 8" public sector pension plans really saving $30 billion per annum (3% x $1 trillion) by using tax havens? I doubt it... but maybe I'm out of touch. In any event, those who make these claims should offer some support for them - not just throw big numbers around to frighten people. And if the "Big 8" are saving $30 billion a year and this covers half of the cost of their pensions, why is there no mention of any of this in their annual reports and financial statements? Why isn't the clever avoidance of foreign tax identified as one of the essential elements of the Canadian Pension Model, right beside good governance and high pay?
Jim Leech, OTPP's former CEO, clarified his comments to me:
That is the problem when a reporter says discussion is “for background only” and then quotes you – and then your words are taken literally and parsed by one of the best actuaries in Canada!

I was simply using hyperbole “off the record” to make a point that every dollar lost is a reduction in dollars available to pay pensions in reaction to reporter suggesting that pension plans should be morally obliged not to minimize taxes anywhere – point is the same if it only cost a few percent. Of course Malcolm is correct – it would not be nearly half.
So, this comment was taken "off the record and it doesn't represent the literal figure Jim had in mind.

I think the important point that is lost in all this is Canadian pensions have a fiduciary responsibility to minimize internal costs and maximize after-tax returns. Period. That's their job.

Second, I received and email from Suzanne Bishopric, the former CIO of the UN Pension Plan, who shared these insights:
Some of the so-called tax havens provide better custodial options than other jurisdictions, offering ample liquidity, transparent reporting, and legal predictability not always available elsewhere. Tax is not the only reason money market funds choose to be domiciled in the Cayman Islands or the Virgin Islands. Many tax-exempt funds find the convenience and liquidity ideal, without the need to avoid taxation.
I thank Suzanne for sharing her thoughts with my readers.

Lastly, CUPE Ontario is shocked and appalled that OMERS pension plan is investing in tax havens:
The revelation that the public sector pension plan, OMERS has been using tax havens to avoid their tax obligation has come as a shock to CUPE Ontario that represents the largest group of the pension plans membership. Tax avoidance is no way to fund a pension plan, says Fred Hahn, the union's president.

"No worker wants their retirement pension to be funded at the expense of community services or the wages of other workers," says Hahn. "As we age, our need for public services like health care actually go up. We still need our roads and bridges, we want good schools and child care for our grandkids. It is not acceptable that our pension plan is trying to avoid paying the very taxes that fund the services we need."

CUPE members make up 40 percent of the members in the OMERS pension plan, that is one of seven pension plans mentioned in the Paradise Papers.

"It's simply false to say that a pension plan has to practice unethical investment behaviour in order to make the necessary financial returns to meet pension needs of our retirees," says Hahn. "It is absolutely unacceptable that our pension plan is complicit in the corporate world view that it's ok not to pay taxes."

"The current corporate culture that believes making money is more important than what money is used for has left workers struggling and has eroded the quality of our public services," says Hahn. "We can and must invest in ways that benefit the people and the bottom line. As the largest member in the OMERS pension plan we believe strongly that the deferred wages of CUPE members lead the way in adhering to these standards."

On behalf of his members, Hahn intends to raise his concerns with the OMERS administration and will be demanding answers.

CUPE is Ontario's community union, with more than 260,000 members providing quality public services we all rely on, in every part of the province, every day. CUPE Ontario members are proud to work in social services, health care, municipalities, school boards, universities and airlines.
All I can say it's clear to me that CUPE Ontario doesn't get it, and they need to read over this comment carefully.

Monday, December 18, 2017

MetLife's Missing Pension Payments?

Reuters reports, Massachusetts regulator opens pension probe against MetLife:
The top securities regulator in Massachusetts on Monday said he has opened an investigation of MetLife Inc after the insurer revealed last week it had failed to pay pensions to potentially thousands of people.

“Retirees cannot afford to have glitches with their pension checks,” Massachusetts Secretary of the Commonwealth William Galvin said in a statement. “I want to uncover why this occurred and how MetLife is going to rectify the problem for the retirees.”

MetLife, which pledged to fully cooperate with regulators, said the standard way for finding retirees who are owed benefits is no longer sufficient.

“While it is still difficult to track everyone down, we have not been as aggressive as we could have been,” MetLife said in a statement.

“When we realized this was a significant issue, we launched an effort to do three things: figure out what happened, strengthen our processes so that we do a better job locating retirees, and promptly pay anyone we find - as we always do,” the company said. “We are now using enhanced techniques within MetLife’s retirement and income solutions business to better locate and promptly pay any group annuitant who may be entitled to benefits.”

MetLife said in a filing on Friday that it believed the group missing out on the payments represented less than 5 percent of about 600,000 people who receive benefits from the company via its retirement business. Those affected generally have average benefits of less than $150 a month, it said.

“We are deeply disappointed that we fell short of our own high standards,” MetLife said. “Our customers deserve better. We are committed to making this right for our customers. We found the issue, we self-reported it, and we are committed to doing better.”
Less than 5 percent of about 600,000 people is still almost 30,000 with no pension payment. At least MetLife found the issue and reported it.

Last week, I discussed why fees are rising for underfunded corporate pensions where I mentioned that US corporations with fully funded pensions are offloading their pension plans, paying insurance companies such as Prudential (PRU) or MetLife (MET) to take them on instead:
Offloading risk isn’t on the table for every company. Insurers don’t take on obligations from underfunded plans, McDonald says. That means companies need to better fund their plans, limiting those variable-rate premiums, before they can transfer the obligations. “In the short term, these PBGC premiums are having a really significant impact,” she says. “This is in a way an expense-management exercise.” 
Companies offload pension risk, and it's up to the insurers to manage those pensions, including the administration of pension payments.

[Note: Not everyone likes de-risking their corporate pension to offload it to insurers. There have been several lawsuits against companies trying to offload pension risk but they've all been dismissed.]

A well-run pension plan has people overlooking investments, liabilities, risks and the administration of pension payments.

Now, I don't want to make this a huge issue because at least MetLife found the problem, reported it and is presumably working hard to make sure this never happens again, but as more and more companies offload pension risk to insurers, these type of operational blunders are simply not acceptable. It's not just embarrassing, it could cost MetLife future business.

If you look at the shares of MetLife and Prudential, they've done alright this year but nothing great given the overall market is up a lot this year:



Insurers, like all financials, typically do better in a rising rate environment, as long as the yield curve is upward-sloping (they lock in gains, it's called net interest income).

Offloading pension risk is increasingly more important to these big insurers but it's still peanuts relative to their bread and butter, which is life insurance.

Insurers (and reinsurers) face many risks but like pensions, their biggest risk is a mismatch between assets and liabilities in a world where rates are at record lows.

The insurance industry has faced many headwinds this year, including soaring costs from hurricanes and earthquakes.

Still, it's an attractive sector for pensions looking for stable returns. In March. I wrote a comment on how the Caisse is betting big on insurance and water, highlighting the $4.3 billion deal with KKR for Onex's USI Insurance.

More recently, the Caisse invested more than $507 million in British insurer Hyperion Insurance Group Ltd and boosted its position in shares of Allstate Corp (ALL) by 2.0% during the third quarter, according to its most recent Form 13F filing with the Securities and Exchange Commission (SEC).

The Caisse has been shorting bonds for a few years now as it believes rates are rising over the next few years.

Given my personal view that global deflation is headed for the US, I'm not particularly bullish on financials (XLF), including insurers, going forward. I would be booking profits and going neutral or even underweight this sector as we head into the new year.

But with Dow 25000 in plain sight and Nasdaq 7000 already here, everybody is excited, so just "BUY MOAR STAWKS!" and hope the rally isn't nearing an end.

Below, Aviva CFO Tom Stoddard recently discussed why a slow gradual increase in yields good for insurance industry. Aviva would prefer to see "a better term structure" of interest rates, Stoddard said.

A slow gradual increase would be good for insurers and reinsurers but a marked decline in rates would be catastrophic for the industry. Stay tuned, more on that in 2018.