OPTrust, one of Canada’s largest defined benefit pension plans, today announced the appointment of Peter Lindley as the President and CEO of the organization, effective September 16, 2019. Mr. Lindley is a financial services industry veteran, with over 30 years of experience in strategy, investments and leading high performance teams.

“Peter Lindley brings deep experience in investing to this role and the Board is pleased to have someone of his expertise and calibre join OPTrust,” said Michael Grimaldi, Chair, OPTrust Board of Trustees. “As a pension management organization, we exist to serve our members, and we are confident our members will continue to be in excellent hands under Peter’s leadership.”

Most recently Mr. Lindley was President and Head of Investments for State Street Global Advisors Ltd. (SSGA Canada), where he was responsible for assets under management of $50bn and SSGA’s overall Canadian business strategy. He was with SSGA for the last 14 years. Prior to leading SSGA, Mr. Lindley held senior roles at Deutsche Bank and CIBC World Markets in Toronto. He is a strong advocate for defined benefit pensions and for responsible investing, which fits with OPTrust’s core mission and values.

“I’m delighted to join an organization that creates retirement security for so many people and I look forward to building on OPTrust’s legacy of delivering excellent results for the Plan’s members,” said incoming OPTrust President and CEO Peter Lindley.

“Defined benefit pensions like OPTrust offer tremendous value for Ontarians in every corner of the province,” said Sharon Pel, Vice-Chair, OPTrust Board of Trustees. “I want to thank Interim President and CEO Doug Michael and our whole team for their diligent service. OPTrust is fully funded and in a strong position as our new CEO begins the work of continuing to deliver on our promise to our members.”

Further details on OPTrust’s recent initiatives and commitment to member experience can be found in the 2018 Funded Status Report, Building for the Future.

ABOUT OPTRUST

With net assets of almost $20 billion, OPTrust invests and manages one of Canada's largest pension funds and administers the OPSEU Pension Plan, a defined benefit plan with almost 95,000 members and retirees. OPTrust was established to give plan members and the Government of Ontario an equal voice in the administration of the Plan and the investment of its assets through joint trusteeship. OPTrust is governed by a 10-member Board of Trustees, five of whom are appointed by OPSEU and five by the Government of Ontario.

“The former CEO of the Ontario government’s employee pension fund has filed a wrongful dismissal lawsuit, alleging he was terminated after trying to rein in “lavish spending” at the fund’s autonomous and high-flying private equity investment group.”

“Mr. Griggs’ lawsuit alleges he was fired after members of the fund’s private markets division lobbied for his dismissal because they were angered by his attempts to review their operations and curtail the division’s “lavish spending”. He alleges he was trying to bring the private markets team under more centralized control because it was operating with little oversight.”

“The lawsuit says the fund’s private management group or PMG had little oversight and could make any size investment without board approval. It has separate computer and data systems, and “in effect operated as an autonomous entity”.

Ontario Teachers’ Pension Plan Chief Operating Officer Rosemarie McClean announced this week that she will be leaving the pension after a 33-year tenure to serve as the chief executive officer of the United Nations Joint Staff Pension Fund. McLean will succeed Janice Dunn Lee, the acting CEO for the UN pension.

In her position at OTPP, McClean leads all operational activities, including management of financial operations for the pension’s investments and portfolio management activities, information technology, process improvement, and project management.

She joined the pension in 1986, and has since simultaneously served as a board member for Alberta Pensions Services Corp., the Toronto Financial Services Alliance, and Heartland Dental, an Illinois-based dental service organization supporting over 800 dentists.

“I have been very fortunate to spend the majority of my career at such a great organization as Ontario Teachers’. The people here are truly exceptional. It has been an honour working with such dedicated teams, who come to work each day with the clear mission of providing excellent service and retirement security to teachers in the province of Ontario,” said McClean.

Her departure comes as the pension’s CEO, Ron Mock, is set to retire at the end of the year. In July, the plan named Jo Taylor as its new CEO and president effective Jan. 1, 2020.

Ron Mock, President and CEO of the Ontario Teachers' Pension Plan (Ontario Teachers') today announced that Rosemarie McClean, Chief Operating Officer, Enterprise Operations, is leaving at the end of 2019 to become CEO of the United Nations Joint Staff Pension Fund, effective January 1, 2020.

"Rosemarie has been with Ontario Teachers' for 33 years, and every part of the Plan has been positively influenced by her expertise and hard work," said Mr. Mock. "In addition to being enormously smart and capable, Rosemarie is a genuinely caring person who has always put our members first. We are thrilled for her as she embarks on this very exciting and impactful next phase of her career."

Rosemarie joined Ontario Teachers' in 1986 and since then she has taken on bigger and broader mandates, leading to her current position as COO, Enterprise Operations. During her tenure she has been instrumental in shaping the Member Services strategy and introducing award-winning programs and efficiencies. She has also helped enable the business through a stronger technology foundation and enhanced innovation and collaboration.

"I have been very fortunate to spend the majority of my career at such a great organization as Ontario Teachers'. The people here are truly exceptional. It has been an honour working with such dedicated teams, who come to work each day with the clear mission of providing excellent service and retirement security to teachers in the province of Ontario," said Ms. McClean.

Ms. McClean's final day at Ontario Teachers' will be December 31, 2019. Ontario Teachers' is evaluating next steps regarding the many areas for which Ms. McClean is currently accountable.

For the past 20 years, many private-sector companies across Canada followed the same risky strategies for their defined-benefit (DB) pension plans as they did in previous decades. Unfortunately, over this time these strategies cost stakeholders almost $158-billion and jeopardized the retirement security of millions of Canadians.

As a result, many companies have abandoned these perilous approaches, but a surprising number have not. To better understand why new strategies are needed, think of the DB pension plan as a division of the company – the DB Pension Division.

A company’s employees lend the DB Pension Division money in the form of deferred wages. In return, the company promises to provide a pension to those employees when they retire. Until then, the DB Pension Division invests this money with the goal of being able to pay these promised pensions.

However, many DB Pension Divisions are investing this money in a way that’s mismatched from the bond-like promises they made to employees. They make bets on equity markets and interest rates in the hopes of generating excess returns that will make it cheaper to pay these promised pensions.

Imagine – what do you think would happen if you went to your CFO and told her that you had a great idea for a new business. You want to borrow money and invest it in the equity markets to generate excess returns for shareholders. I suspect you’d find that it would be a pretty short and career-limiting conversation!

So why would this idea work for a DB pension plan? What’s clear is that for the past 20 years, it has not.

After a lot of ups and downs, the average DB Pension Division is essentially in the same place that it was 20 years ago from a funded-status perspective.

In fact, the typical company contributed significant dollars to its DB Pension Division during this period. According to Statistics Canada, companies in Canada contributed almost $158-billion between 1999 and 2018 to shore up deficits in their pension plans. This means that a typical DB Pension Division earned a negative return – destroying value for shareholders who invested in the company.

If the business model had been successful, the typical DB Pension Division would be well over 100-per-cent funded by now and these $158-billion of contributions wouldn’t have been required.

It’s not surprising that some DB Pension Divisions stuck with their historical business models over the past 20 years. After all, interest rates were at historic lows and were widely expected to rise and equity markets had a long history of providing excess returns.

So why didn’t things turn out as expected? The business model involves making multiple bets on equity markets, interest rates, credit conditions, foreign exchange rates and life expectancy. Companies need to win all these bets consistently as the gains from good bets can be wiped out by the losses from bad bets.

Making multiple successful bets with the DB Pension Division is very hard to do – especially given the increased unpredictability of the markets over the past 20 years. In addition, most companies rely on the same investment managers as their competitors, which doesn’t create a competitive advantage for their shareholders.

Given these challenges, many forward-thinking companies are concluding that the DB Pension Division’s business model no longer works – an appropriate conclusion for a division that’s been losing money for 20 years.

The first step these companies take is realizing it’s better to take risk in their core business rather than in the DB Pension Division. General Motors was one of the first companies to articulate this strategy. In 2012 Jim Davlin, vice-president of finance and treasurer at General Motors, said: “We’re in the business of making great cars – that’s our core competency. It’s not managing pension investments to provide a lifetime income to folks.”

The second step these companies take is changing the business model of their DB pension plan to embrace better risk management. These companies are investing plan assets to match liabilities and/or transferring portions of their plans to insurers through the purchase of annuities.

The bottom line? Everybody pays the price for a failed DB Pension Division. Let’s not lose track of why we created pension plans in the first place – to help Canadians be ready for retirement. Isn’t it time to adopt better risk management and switch to a business model that works?

Established in 1968, the CN Investment Division (the Division), based in Montreal, manages one of the largest single-employer defined benefit pension funds in Canada and holds a long track record of solid performance.

Approximately C$16.4 billion is actively managed in-house by about 80 employees for the CN Pension Plan’s approximately 50,300 pensioners and pension plan members. The Division also manages the assets of the CN Pension Plan for Senior Management and the BC Rail Pension Plan.

The Division’s culture is nimble, innovative, collaborative and risk-aware. Pensioners are always at the heart of what we do. 

Marlene said she oversees a very mature $18 billion pension plan at CN where there are 3 retired workers for every active member and she needs to make sure they have the $1 billion a year they need to make payouts every year.

She said she was balancing out liability hedging component with return seeking component. They hedge a lot of interest rate risk and they have their board's approval to prudently leverage their balance sheet (her experience sitting on HOOPP's ALM committee for years came in handy there).

She stated they are trying to generate the same return using less risk using all the tools available and are investing across public and private markets and anything that falls in between but are managing their liquidity very tightly.

The national statistical agency reported that the market value of Canadian pension assets rose by 5.0% in the first quarter to $1.97 trillion.

The increase was powered by short-term investments, such as corporate bonds, banker’s acceptances, treasury bills and commercial paper, which increased by 10.2% in the first quarter, StatsCan said.

Additionally, mortgage investments rose by 6.3% and bond investments grew by 6.0% in the quarter.

StatsCan said that real estate investments were the only asset class to decline in the first quarter, and they only slipped by 0.2%.

Pension funds also recorded a 52.6% jump in net income in the first quarter, StatsCan reported.

Securities sales drove the increase in pension income, the agency noted, as profits on securities sales jumped 58.2% in the quarter to $20.0 billion.

Twenty-six trillion dollars—that’s what the Asian Development Bank (ADB) has estimated that Asian countries will need to have cumulatively invested in infrastructure between 2017 and 2030 to maintain their respective rates of economic growth. That works out to about $1.7 trillion per year, approximately equal to the entire annual GDP of my home country of Canada.

Simultaneously, rising populations (by 2030, 66 percent of the global middle class will live in Asia), rapid economic growth, and technological progress are transforming Asia into the key world market for goods and services over the next half-century.

As the region grows, institutional investors are further compelled to consider their footprints and their investment interests in the region. As I have said before, the old days of “flying in and flying out” are coming to a close. Many institutional investors are getting ahead of the game—from staffing more employees who are fluent in languages in the region and steadily networking with asset allocators, investment managers, and government representatives, to building a stronger internal understanding of business practices, regulatory regimes, and other key nuances across the jurisdictions that make up this vast market.

As Asia becomes more important to institutional investors, these large, globally oriented pools of capital will also assume a new stature in Asia. Asian countries competing for investment capital to fund their rapid expansion in infrastructure and other areas will need to contemplate adapting laws and regulations as they build closer relationships with these institutions.

As partners in supporting economic progress, institutional investors have an opportunity to help facilitate the conversation between East and West. The design and implementation of structural reforms to attract foreign capital is one such area where we can constructively engage.

As this process unfolds, institutional investors and Asian governments have much to teach each other. Every country has its own approach to infrastructure policy and broader structural reform, while international investors have their own sets of global standards and expectations developed over decades and across jurisdictions.

Institutional investors’ experience of managing challenging and complex projects can constructively inform the process, helping bridge the gap between the international supply and demand for capital.

And let’s not underestimate just how significant the demand for capital will be. With over 400 million people across the region still lacking electricity, 300 million without access to safe drinking water, and about 1.5 billion lacking access to basic sanitation, according to the ADB, the region’s infrastructure needs are enormous.

Closing that infrastructure gap is a challenge that institutional investors can help address by putting their capital to work, directly benefiting the lives of citizens, while participating in and facilitating economic growth.

This edition of the Power of Ideas has got it right—Asia is going to redefine the world, as corporates and institutional investors from all corners of the globe seek to become part of the region’s tremendous growth story.

But this encounter will also reshape Asia, too, as laws and regulations shift in response to inflows of outside capital.

With patience, cooperation, and goodwill on all sides, this multi-decade evolution will benefit all who take part.

The stock market may appear tranquil again after a rollercoaster summer, but many analysts and investors are unnerved by violent moves beneath the surface, reviving memories of the 2007 “quant quake” that shook the computer-driven investment industry.

The FTSE All-World equity index has rallied almost 3 per cent already this month, clawing back some of August’s losses. However, many highly popular stocks suffered a sudden and brutal sell-off this week, a reversal that analysts have already dubbed the “momentum crash”.

The blow was particularly strong in the US, where strong-momentum stocks — those with the best recent record — tumbled 4 per cent on Monday, in the worst one-day performance since 2009, according to Wolfe Research. Only once before, in 1999, has such a rout afflicted momentum-fuelled smaller company stocks, according to investment bank JPMorgan.

“This is massive,” said Yin Luo, head of quantitative strategy at Wolfe Research. “This is something that we haven’t seen for a long time. The question is why it’s happening, and what it means.”

The flipside has been a dramatic renaissance for so-called “value” stocks — out-of-favour, often unglamorous companies in more economically sensitive industries. The S&P value index has climbed about 4 per cent this week and, compared with momentum stocks, enjoyed one of its biggest daily gains in a decade on Monday.

In essence, almost all of 2019’s hottest stocks have taken a hit, while the year’s most unloved dogs have enjoyed a roaring rally. Pravit Chintawongvanich, a strategist at US bank Wells Fargo, points out that the worst 12-month performers in the Russell 1000 equity index were up by the most on Monday, while the best 12-month performers were down the most.

This hurt many investors. The median long-short equity hedge fund — a strategy that strives to beat the market by picking winners — had lost 1.8 per cent in the month by the end of Wednesday, while computer-powered quantitative hedge funds have declined 2.3 per cent, and trend-following funds have shed 3.1 per cent, according to investment bank Credit Suisse.

Such a seismic rotation in investment “factors”, essentially the different groupings of stock market characteristics identified by financial academics, is rare, and reminiscent of a violent bout of turmoil that struck in the summer of 2007.

On August 6 2007, the quantitative investing industry, whose computer scientists used trading algorithms to systematically mine markets for money, suddenly and mysteriously saw their models go haywire, racking up huge losses for many “quant” powerhouses from Goldman Sachs Asset Management to Renaissance Technologies.

The turbulence lasted only a week and was later overshadowed by the financial crisis. But the event quickly became known as the quant quake, and remains etched in the memory of many hedge fund managers.

Now, as then, the cause for the sudden moves is a puzzle. Some have speculated that a big hedge fund or investment group may have been forced to pare back its positions, triggering a snowball that turned into an avalanche this week. But Mr Luo argues that the moves are big and broad enough to make it improbable.

More likely, analysts say, is that the momentum crash was triggered by the recent rise in bond yields. Momentum is often associated with trendy, high-growth companies, but over the past year more defensive “bond proxies” such as utilities and safer, resilient companies with strong balance sheets have actually enjoyed the strongest tailwinds, as investors have sought their safety and income amid concerns over the health of the global economy.

“By just looking at the price of the S&P 500 — not far from all-time highs — one cannot see the true state of equity markets,” Marko Kolanovic, head of quantitative strategy at JPMorgan, said in a note. “Most of the S&P 500 gains came from defensive sectors, stocks that investors tend to buy as a proxy for long duration bonds, and so-called ‘secular growth’ technology stocks. These stocks, incorrectly in our view, are deemed to be impermeable to economic woes.”

That illusion of invincibility appears to have led to investor “crowding” and extreme valuations for many stocks that are acutely sensitive to moves in bond yields, analysts say. On Monday, the 10-year US Treasury note dropped, sending yields 0.08 percentage points higher, and likely precipitating the violent reversal, argues Sarah McCarthy, a strategist at Bernstein.

The question is whether this is a passing market tempest — like the “tech tantrum” of 2017 — or the start of a longer-lasting shift away from the equity market’s biggest winners and into value stocks, which have largely underperformed since the financial crisis.

Mr Kolanovic reckons that the rotation will probably continue, but that the broader market will remain buoyant. Indeed, JPMorgan’s strategists now recommend investors bet on companies that are being heavily shorted by hedge funds, on the basis that many will be forced to ratchet back their positions.

However, the similarities to August 2007 unnerve Mr Luo, who points out that the quant quake was an under-appreciated early symptom of the far greater crisis that was starting to unfold at the time.

“This is a rare event, and might morph into something bigger,” said Mr Luo. “The 2007 quant crisis hinted at much bigger, more fundamental issues . . . [this sell-off] might also hint at much bigger problems.”

Value stocks, which typically have low multiples and stable fundamentals, significantly outperformed their growth counterparts recently, and a J.P. Morgan expert says the trend could continue into October, especially if the planned U.S.-Chinese trade discussions go well.

The iShares Edge MSCI USA Value Factor ETF (VLUE) climbed 1.8% on Monday while the iShares Edge MSCI USA Momentum Factor ETF (MTUM) slumped 1.7%. Data compiled by Bespoke Investment Group displayed this was momentum’s worst daily performance relative to value since its inception in early 2013.

Marko Kolanovic, global head of the macro quantitative and derivatives strategy team at J.P. Morgan, said his opinion is based on how he observes investor positioning, the current lack of performance of value names, and the loosening of technical flows last month in equities and bonds, which catalyzed a drop in yields, which hit extreme lows.

“Given that the S&P 500 is heavy in bond proxies and secular growth, we would expect higher upside potential in small caps, cyclicals, value, and Emerging Market stocks than the broad S&P 500,” Kolanovic noted.

In July Kolanovic wrote, “We think that the unprecedented divergence between various market segments offers a once in a decade opportunity to position for convergence.”

Kolanovic says there is now another hawkish divergence occurring, beginning last Friday with the record performance gap between large-cap companies and small-cap names. The strategist notes that his small-cap momentum indicator, based on a weighted one-, three-, six- and 12-month price momentum, reached its maximum negative reading, while simultaneously, the momentum signal for the S&P 500 was at its maximum positive reading. The only other time this occurred was in February, 1999, he added.

“Many similar indicators suggest the gap is not sustainable between value, cyclicals, SMid and high beta stocks on one side, and momentum, low volatility, and growth on the other side,” he wrote.

The JP Morgan quant experts believes that there could be a boost in manufacturing levels as long as trade talks go well.

“While manufacturing lags both, we see that in the coming months one could expect manufacturing activity to pick up given the increased monetary stimulus, providing support for the market and value stocks. We think October negotiations will be the key for future performance of equity markets and more broadly the global economy,” the strategist wrote.

For investors looking for pure value plays, well-known value ETFs like the iShares Russell 1000 Value ETF (IWD), iShares MSCI USA Value Factor ETF (VLUE), Vanguard Value Index Fund ETF Shares (VTV) and the Vanguard Small-Cap Value ETF (VBR) could be good choices to consider.

For investors who feel value is a long-term play, look to the Direxion Russell 1000 Value Over Growth ETF (RWVG). RWVG seeks investment results that track the Russell 1000® Value/Growth 150/50 Net Spread Index (the “index”). The fund, under normal circumstances, invests at least 80% of its net assets (plus borrowing for investment purposes) in securities that comprise the Long Component of the index or shares of exchange-traded funds (“ETFs”) on the Long Component of the index.

RWVG’s index measures the performance of a portfolio that has 150% long exposure to the Russell 1000® Value Index (the “Long Component”) and 50% short exposure to the Russell 1000® Growth Index (the “Short Component”). For more market trends, visit ETF Trends.

• Quant Quake 2.0' Fallout: Nomura Warns Of "Horrific" Returns For Momo Stocks Ahead
• Something Big Is Taking Place Below The Market's Surface
• Quant Quake Goes Global Amid Momo Meltdown, Bond Bloodbath
• Goldman Warns 'Quant Quake' Marks The End Of Momentum Rally, Not A Buying Opportunity
• Stocks Soar Near Record Highs Despite Bond Bloodbath, Momo Meltdown

The shape and size of the European Central Bank’s new bond-buying program caught market participants off guard, with some now predicting it’ll be years until the euro zone is back to anything approaching normality.

Starting in November, the ECB will make 20 billion euros ($21.9 billion) of net asset purchases per month for as long as it takes for the euro zone’s inflation and growth outlooks to return to satisfactory levels. The purchasing will only end “shortly before” the next rate hike.

ECB President Mario Draghi pointed out Thursday that a major reason for the re-launch of net asset purchases was that inflation expectations remained consistently below the ECB’s target of just below 2%, but implored governments to deploy fiscal policy to supplement his actions.

This will be the second round of quantitative easing (QE) from the ECB, the first coming four years ago in response to the calamitous euro zone debt crisis.

Shweta Singh, managing director of global macro at TS Lombard, said the second round of asset purchases would likely have a “milder impact than QE-I, when borrowing costs were higher, fragmentation across the euro area was severe and domestic risks were far greater.”

“Crucially, there may be much less scope this time for the euro to edge lower and thus boost inflation expectations, while the pool of eligible assets that the ECB can buy has shrunk since QE-I was launched.”

QE infinity?

The smaller increments but open-ended timescale of this second package (QE-II) surprised many, and was well below the 60 billion euro per month implemented at the beginning of QE-I in 2015. The open-ended commitment to continue until the inflation outlook improves carries several implications.

“The sequencing reference also signals that there would only be a short gap between the end of QE and the onset of rate hikes,” Ken Wattret, chief European economist at IHS Markit, said in a note Thursday.

“As we believe rate hikes are well down the line — we have the first DFR (deposit facility rate) hike only in late 2022, with an even later start increasingly likely — this implies a very long period of net asset purchases.”

The ECB forecasts inflation at 1.5% in 2021 which is still below what the ECB regards as “sufficiently close to, but below, 2%,” Berenberg senior European economist Florian Hense pointed out in a note.

“Thus, the ECB seems highly unlikely to raise rates before 2022 — unless inflation were to surprise a lot on the upside,” Hense projected.

“The asset purchase program could therefore last for at least 24 months with a total volume of 480 billion euros. More likely it will last longer.”

Barclays head of economic research Christian Keller anticipates that the asset purchase program will continue at least until the end of 2020.

“We expect the ECB will remain accommodative for a very prolonged period of time. We continue to think that risks to the EA (euro area) growth outlook are skewed to the downside and we do not expect core inflation will re-accelerate in the near term,” Keller said in a research note Thursday.

“As the euro area has arguably entered the mature stage of its economic cycle, we expect interest rates to stay low for a prolonged period and firms’ pricing strategies to remain conservative, and we believe fiscal policy is unlikely to reflate the euro area economy.”

Against this backdrop, Barclays economists do not expect businesses to feel immediate pressure to increase final output prices, and therefore project that core consumer prices are unlikely to catch up to levels consistent with the ECB’s medium-term price stability target. Keller thus expects underlying prices to remain on a “slow recovery trend.”
‘Strong signal for governments’

ECB policymakers unanimously agreed that fiscal policy rather than monetary policy should be the main tool to combat the economic downturn. The duration of the QE program may hinge on the willingness of national governments to take action.

Draghi on Thursday urged “governments with fiscal space” to act in “an effective and timely manner.”

Ana Andrade, Europe analyst at The Economist Intelligence Unit, said in a statement that the open-ended nature of the asset purchase program will be a “strong signal for governments, as it will increase their fiscal space.”

“It could potentially lead them to engage on more fiscal stimulus,” she added.

Hense agreed that by lowering funding costs further, governments may find it easier to finance a “modest fiscal expansion” and the policy might nudge countries with some extra fiscal space, such as Germany, to use it.

“On their own, purchases of 240 billion (euros) in one year will raise the balance sheet of the eurosystem by circa 2 percentage points of GDP (gross domestic product) in a year from its current level of close to 40%.”

One of Canada's largest pension funds has been hauled into court in Denmark in a dispute about whether it improperly claimed hundreds of millions of dollars in tax rebates on Danish stock dividends, in a country already roiling from an alleged $2.5-billion stock dividend fraud.

Denmark says the case against the Healthcare of Ontario Pension Plan, or HOOPP, involves no allegations of fraud, but instead turns on whether the pension fund truly owned billions of dollars of shares in Danish companies or just temporarily borrowed the stock and collected dividends on it.

At stake is $180 million that was paid out to the pension fund in the form of tax rebates between 2011 and 2014, plus another $252 million in rebates HOOPP claimed since then that the Danish Tax Agency refused to reimburse.

HOOPP — the eighth biggest pension fund in Canada and one of the Top 30 in the world, according to one ranking— says it has done nothing wrong and always "followed the laws" and the terms of the Denmark-Canada tax treaty. It would not comment further, citing the ongoing court case.

The pension fund has total assets of more than $79 billion, according to its latest annual statement, and has 350,000 members working for public- and private-sector health employers in Ontario, including nurses and staff at dozens of hospitals and community clinics.

Possible 'exploitation of the tax system'

The case pitting Denmark against HOOPP hangs on one of the "miscellaneous rules" tucked into the closing paragraphs of the Canada-Denmark tax treaty.

Under Danish law, ordinary foreign investors have to pay a withholding tax on any dividends they receive on Danish stocks amounting to 27 per cent. But under the Canada-Denmark tax treaty, pension funds are exempt provided they are "the beneficial owner of the shares on which the dividends are paid" and they own the shares "as an investment."

The Danish Tax Agency alleges HOOPP didn't meet those criteria.

And while it may seem like a stale quibble over the arcana of tax law, the matter has generated media attention in Denmark.

On Sunday, the Danish public broadcaster DR and the financial daily Borsen both published investigations into the case. They reported that HOOPP held some of the shares in question for mere days — just enough time to collect the dividends — and entered into "swap" contracts to return the stocks to their original owners without risk of losses or gains from changes in the stock price. The reports said it was part of an arrangement with a number of big global banks that set up the stock loans and shared in the profits of the transactions.

CBC was unable to independently verify those findings.

HOOPP has always denied any wrongdoing. In its statement in response to questions about its transactions, it said it "followed the laws and processes of the Denmark-Canada tax treaty, and should be entitled to recover the dividend tax refund. Because the dispute is before the tax tribunal and court, it would not be appropriate for us to make any further comment."

Jan Pedersen, a professor of tax law at Aarhus University in Denmark, told DR in a Danish-language interview commenting on its findings: "Since this is one big circular transaction, it is clear that the participants have tried to make it appear as if one had the formal ownership, and thus the claim to have the dividend tax refunded, even if another, from a strict legal point of view, is the real and beneficial owner.

"It must be regarded as an exploitation of the tax system," he said.

A number of HOOPP members expressed surprise to CBC News that their pension fund is embroiled in the Danish litigation. HOOPP is widely respected in the pension world for generating strong returns while adhering to socially responsible principles such as not investing in tobacco or firearms companies.

Pension fund says it's entitled to refunds

While HOOPP wouldn't answer questions about its dealings in Danish stocks, its financial statements hint at significant transactions in the Scandinavian country. They show the pension fund had a sizeable negative position — the equivalent of $287 million Cdn— in the Danish currency, the kroner, in 2017 that was almost entirely wound up by the following year. It was more exposure than in any other foreign currency except the U.S. dollar, the Japanese yen and the euro.

Last year, when HOOPP's name first emerged in Denmark in relation to the dividend tax matter, the pension fund said in a statement: "HOOPP has been an investor in the Danish capital markets for a number of years, purchasing Danish listed company shares through Danish licensed brokerages.

"As the purchaser of the Danish company shares it has bought, and having received the dividend net of the Danish tax, HOOPP, as a tax-exempt entity under the Canada-Denmark tax treaty, should be entitled to a refund of withholding tax on the dividends received on those shares...

"HOOPP has been working co-operatively with the [Danish tax authority] and, while HOOPP maintains it has not done anything illegal, we understand why the Danish Tax Authority had denied HOOPP's application for dividend tax refunds and had raised concerns about the refunds previously paid. We intend to resolve this issue in the best interests of our organization and our members."

Michael Hurley, president of the Ontario Council of Hospital Unions, which represents thousands of workers who are HOOPP members, told CBC News that his union is aware of the Danish tax case but is confident that their pension fund would only have made the investments if it thought they were "credible and valid."

"This is not a pension plan that's making investments without thought to legality or its social obligations. If it has made a mistake, it will own up to that and repay whatever is owing," Hurley said.

Part of bigger scandal in Denmark

Hurley pointed out that the court case pitting HOOPP against the Danish Tax Agency comes in the context of a move years ago by the Danish government to strip its tax regulators of many of their oversight powers and outsource some of their functions to the private sector.

Indeed, the HOOPP-Denmark litigation is a smaller and more innocuous part of a wider scandal involving the Danish Tax Agency. Following funding cuts, the agency farmed out some of the responsibility for processing dividend tax rebate applications in 2001 to three private banks as part of a broader effort to try to streamline and automate tax collection. The arrangement was scotched in 2015 after an internal audit found evidence of possible abuse, and a public inquiry continues to delve into the fallout from the bungled overhaul.

The HOOPP case is a far cry from the most arresting allegations to emerge. In hundreds of other instances, the Danish Tax Agency is alleging civil but also some criminal fraudinvolving $2.5 billion in dividend tax rebates obtained by small-scale, mostly American pension funds. Those cases are part of a wider European scandal around a practice called "dividend stripping" that has cost national treasuries billions of euros.

Court documents from one of those cases state that three of the small pension funds are from Canada.

• Even if this is proved legal, I don't think HOOPP or any other institutional investor should be engaging in this activity. Period. Denmark is right to widen its probe into multi-billion-euro tax fraud from "dividend-stripping". 
• Now, if HOOPP loses its case, it's important to note that $432 represents roughly 50 basis points of its total assets -- hardly the end of the world if they are found guilty and have to pay that sum back to the Danish tax authorities.
• It's also worth noting that HOOPP isn't the only pension fund engaging in this activity. In fact, let me let you in on a dirty little secret, one of the most profitable activities at Canada's big banks is dividend tax arbitrage, a fancy name used to help high net worth clients and institutional clients "cheat' the Canadian tax system out of billions in revenues. Of course, it's legal but if you ask me, it's just legalized tax avoidance so the rich can get a lot richer while the rest of the Canadian hosers get hosed on taxes.
• I find it interesting that HOOPP engaged in this activity in Denmark, probably because its close ties to ATP, Denmark's powerhouse pension fund which recently reported a record 27% gain for the first half of 2019. But Christian Hyldahl, ATP’s former CEO, was linked to the so-called ‘Cum-Ex’ scandal, related to dividend tax speculation by financial institutions and investors in several countries and it ended up costing him his job even though he maintained that the practices were not illegal, and that he thought it was a legitimate business opportunity at the time. 

Good post Leo. Problem with what HOOPP is doing is that it makes a mockery of Double Taxation Avoidance treaties. The end result will be that the tax advantage clause will be removed from the treaties punishing investors. So, if you have a legitimate transaction, the treaty will not have a clause to deal with it.

One of Canada’s largest pension funds “inadvertently omitted” all of its Canadian holdings from a recent disclosure it made to the U.S. Securities and Exchange Commission, failing to include about US$2.46 billion in investments.

British Columbia Investment Management Corporation made the omission in February, when it submitted its disclosures for the three months ending on Dec. 31, 2018. The pension fund, which has $145.6 billion in assets under management, failed to disclose holdings in 98 companies, primarily across Canada’s energy, banking and mining sectors. The Canadian holdings accounted for more than 20 per cent of its total disclosed investments.

BCI, which manages the pensions of B.C.’s public sector workers, said it only discovered that it had omitted these investments following inquiries from the Financial Post about its disclosed holdings in Canadian energy companies, which appeared to decline to zero in the final quarter of 2018.

“As a result of your query, we have discovered that the holdings you listed were inadvertently omitted from the filing,” BCI Director of Corporate Communication Gwen-Ann Chittenden told the Post in an email.

A second look at the disclosure revealed that names BCI has consistently disclosed owning for years such as Toronto Dominion Bank, Canadian National Railway and Rogers Communications Inc. were also missing.

More than two weeks later, BCI corrected the errors in its Dec. 31 filing with an amendment. The errors, BCI told the Post, were a result of a “data filter” that “omitted Canadian-domiciled inter-listed securities.”

BCI also corrected errors in its filings for the quarters ended March 31, 2019 and June 30, 2019 after the Post inquired about the accuracy of the values listed for its Canadian holdings in both reports. The pension fund attributed these errors to “inconsistent conversion” of currency leading to both understated and overstated values. In some cases, values were inflated by more than 35 per cent. While BCI said the number of shares it listed for each stock in the initial reports was accurate, the Post found that it disclosed owning fewer shares of Enbridge Inc. in its amendment for the June 30 quarter than in the original file.

A Post analysis of BCI’s 13F filings over the past six years revealed the fund had previously restated its holdings to address similar inconsistencies. On Oct. 14, 2015, BCI filed 16 amendments to 13Fs dating back to 2010. In 10 straight quarters between March 31, 2013 June 30 2015, BCI appears to have failed to disclose its shares of dual-listed Canadian stocks bought on U.S. exchanges. In each of those quarters, shares of BCI staples TD, Suncor and Enbridge were all missing. Those errors, Chittenden said, were also the result of “inadvertent omissions.”

The SEC declined to comment about the omissions and whether the pension fund would be penalized for them, something a number of experts who spoke to the Post thought was unlikely.

BCI is required disclose its holdings as of the end of each quarter to the SEC because it routinely holds more than US$100 million in what the U.S. watchdog refers to as 13F securities — any equity, closed-end security or ETF that trades on a U.S. exchange. Certain convertible debt and equity options also fall under the SEC’s umbrella. Quarterly disclosures are not required in Canada, and BCI has in the past only revealed its total holdings once per year.

The SEC’s definition means that funds have to report the shares they hold of dual-listed Canadian companies such as TD and Suncor Energy Inc. — but only those that were purchased on U.S. exchanges.

Between March 31, 2018 and Sept. 30, 2018, BCI’s disclosures indicated that its holdings of U.S.-exchange purchased shares of Alberta-based energy companies declined by 43 to 46 per cent across the board. In that six-month span, BCI’s position in Suncor fell from 265,985 shares to 143,530 and Enbridge from 265,728 shares down to 149,734. None of these companies — or any other dual-listed company — appeared on its disclosure for the quarter ending Dec. 31.

Complicating matters, BCI said that it had changed its reporting methodology for the December 2018 quarter, and that it had intended to include its total holdings of dual-listed securities, not just those that were acquired on U.S. exchanges. That shift, which Chittenden said was done as part of a “move to increase transparency and reporting based on a higher standard,” wasn’t immediately noticeable due to the omissions.

The amended filing for the quarter ending on Dec. 31 2018 revealed its much larger overall holdings in the dual-listed companies. Those included 4,062,939 shares of Suncor valued at more than US$113 million, and 4,861,224 shares of Enbridge, valued at more than US$150 million.

By the end of the quarter ending June 30, 2019, those positions had both declined, to 3,292,517 and 3,877,882 shares respectively.

For comparison purposes, the Post asked BCI to provide its overall positions in a series of energy companies for the quarters ending in March, June and September 2018, but the pension fund did not address the request.

BCI’s decision to alter its filing style is uncommon, multiple securities lawyers with knowledge of SEC regulations and 13F filings told the Post.

“This is … kind of strange what they’re doing here,” said David Baum, a Washington-based lawyer at Alston & Bird LLP. “They’re effectively over-reporting.”

Altering their filing format may give investors a wider scope of BCI’s portfolio, but it could also lead to other issues, Baum said, and that’s why he would generally advise a client to remain consistent with their files.

As for the omissions themselves, Ze’-ev Eiger, a lawyer at the firm McDermott Will and Emery, believes they were not the result of any nefarious behaviour.

“It doesn’t jump out at me that they were trying to avoid reporting certain things,” Eiger said in an interview from New York City. “It seems to me it was a mistake.”

Mistakes in 13F filings are not unusual, Eiger said. But it certainly helps the case of a fund in question, Baum added, when the funds themselves admit their mistakes to the SEC instead of waiting for them to be discovered.

The SEC is unlikely to fine BCI or closely track their holdings, according to Edward Siedle, who used to work for the SEC’s Division of Investment Management before becoming a lawyer who forensically investigates pension funds. The last time the SEC appears to have fined a fund in relation to its 13Fs was in 2007, after Quattro Global Capital LLC failed to file its disclosures for more than three years.

But Siedle said repeated compliance oversights when it comes to 13Fs can be a warning sign.

“Is it the end of the world? No,” Siedle said. “But it’s a compliance oversight with respect to the most easy portion of the portfolio. How many other inadvertent omissions are there?”

The Caisse de dépôt dismissed a director of its subsidiary Otéra Capital, Yvon Tessier, in the wake of its investigation into ethical issues in May.

The director had to leave the board of directors of Otéra, where he had sat for eight years.

At a press conference, the Caisse confirmed the departure of three executives. Our Investigation Office had already identified them in February and March in a series of reports on mafia ties and ethical sprains of executives of Otéra, specialized in real estate financing.

The Caisse also mentioned that a fourth person "related to Otéra" no longer "holds functions", following the independent investigation of Osler, Hoskin & Harcourt, triggered at the beginning of our revelations.

According to the law firm, this person "breached his obligation of confidentiality concerning a file, without consequence for the file in question".

The Caisse did not want to confirm that this fourth "related person" at Otéra that was ousted is Yvon Tessier. However, it confirmed his departure, which was linked, according to the financial institution, to the renewal of the Board, announced to raise its standards of governance and ethics.

"I have nothing more to add," says Otéra's Vice President of Legal Affairs, Mélanie Charbonneau.

Yvon Tessier refused the interview requests from our Investigation Office.

He also left the Fonds FTQ

"Please be advised that I deny and refute any allegations of breach of confidentiality," he said in an email last spring.

Until early June, Yvon Tessier also sat on the board of directors and the audit committee of the Fonds de solidarité FTQ, but resigned from office after questions from our Inquiry Office.

The Fund says it ignores why the Caisse separated from Yvon Tessier.

"On our side, we have nothing to reproach him," says spokesman Patrick McQuilken.

Yvon Tessier joined Otéra's board of directors on March 1, 2011. He was replacing his own spouse, Ghislaine Laberge, who was still in her seat the day before.

Director at a client

For two years she was a director at both Otéra and one of the lender's largest clients: Cominar Real Estate Investment Trust.

Otéra granted it nine loans totaling $ 623 million from 2011 to 2018.

According to the Caisse's subsidiary, these loans did not require authorization from the board, "since they did not meet the criteria of value for doing so".

Ghislaine Laberge left the Board of Trustees of Cominar last year.

In an email, Yvon Tessier denies disclosing Otéra's sensitive information.

"I have never had any communications or discussions on Otéra issues with anyone, including Cominar or the Fonds de solidarité FTQ. "

The former boss of Otéra is still at the service of the Church

The former CEO of Otéra Capital Alfonso Graceffa is still a member of the Board of the Compagnie mutuelle d'assurance en Église (CMAÉ), the company that insures the property of parishes and dioceses in southern Quebec.

Since 2017, the businessman sits on the board of the CMAÉ. After the announcement of his dismissal by the Caisse de depot et placement du Québec, the company asked its ethics committee to look into the future of Alfonso Graceffa.

We take it seriously

"Our VP, who is a lawyer by profession, is talking to the other party's lawyer," says Gabriel Groulx, Mutual's Board Chair. We take this case very seriously. "

He thinks he can announce "developments" in "a few weeks".

Our Investigation Office revealed that Alfonso Graceffa's companies had secured loans totaling $ 9.2 million from a subsidiary of Otéra, of which he was CEO.

After his permanent removal in late May, the former leader filed a $ 7.35 million lawsuit against the Caisse for "wrongful dismissal". He believes he was "sacrificed" to calm the "media frenzy".

Lawsuit in 2018

Before our revelations, the businessman had already gotten into trouble with the CMAÉ.

The Company even filed a lawsuit in February 2018 for the removal of Alfonso Graceffa and another director, Ferdinand Alfieri, alleging that they had a conflict of interest.

While sitting on the board of the CMAÉ, Graceffa and Alfieri advised its biggest client, the Archdiocese of Montreal, according to court documents.

The Archdiocese had also put all its weight for the CMAÉ to keep Alfonso Graceffa in office and had won his case.

Canada Pension Plan Investment Board (CPPIB) has made its debut infrastructure investment in Indonesia with the acquisition of a 45% stake in the Cikopo-Palimanan (Cipali) toll road.

CPPIB is partnering PT Baskhara Utama Sedaya (BUS) to jointly acquire the 55% stake, in the concession holder and operator PT Lintas Marga Sedaya (LMS), currently held by PLUS Expressways International.

BUS is an existing owner of 45% of LMS and will increase its stake to 55%. CPPIB will acquire the remaining 45% stake in LMS for an undisclosed sum.

The 117km Cipali toll road is one of the longest operational toll roads in Indonesia and a critical link in the transportation network of the island of Java, as part of the Trans Java Toll Road network.

Scott Lawrence, managing director, head of infrastructure, CPPIB, said: “Cipali toll road provides CPPIB access to a vital infrastructure development supported by rising motorization rates in one of the most densely populated and economically productive regions in Indonesia.”

Suyi Kim, senior managing director and head of Asia Pacific, CPPIB, said: “As CPPIB’s first infrastructure investment in Indonesia, this deepens the fund’s commitment to the Asia-Pacific region as well as our focus on investments in new markets with attractive return and risk characteristics.”

As at the first half of the year, CPPIB – which manages the C$400.6bn (€272.8bn) funds of the Canada Pension Plan – had C$33.1bn invested in infrastructure assets globally.

The Canada Pension Plan Investment Board is making its first infrastructure investment in Indonesia, with the acquisition of a 45 per cent interest in PT Lintas Marga Sedaya, the concession holder and operator of the Cipali toll road, a critical link in the transportation network of the island of Java.

PT Baskhara Utama Sedaya, a wholly-owned subsidiary of PT Astra Tol Nusantara, currently owns a 45 per cent stake and will increase that to 55 per cent, while the CPPIB will acquire the remaining 45 per cent stake.

“We are pleased to invest in the Cipali toll road alongside Astra Infra, a knowledgeable and sophisticated local partner, and look forward to a successful long-term relationship between our two organizations,” said Scott Lawrence, managing director and head of infrastructure at the CPPIB, in a press release. “Cipali toll road provides CPPIB access to a vital infrastructure development supported by rising motorization rates in one of the most densely populated and economically productive regions in Indonesia.”

In other investment news, the Caisse de dépôt et placement du Québec is making a $53 million investment in Neuvoo.ca, a Canadian employment website.

The cash injection is intended to enable the company to further expand and optimize its artificial intelligence-based platform.

“Through this transaction, CDPQ supports a new economy company which is growing at a rapid pace and has distinguished itself and become an international leader thanks to the successful integration of artificial intelligence,” said Charles Émond, executive vice-president and head of Quebec investments and global strategic planning at the Caisse, in a press release. “At Neuvoo, they have designed a unique technology that is positioning their company as a strong competitor in the online job recruiting market.”

Still further, the Ontario Municipal Employees Retirement System’s growth equity group led a $158 million round of financing for TouchBistro, a restaurant technology solution provider. The OMERS is investing $85 million, alongside Barclays, RBC Ventures and BMO Capital Partners. The pension fund’s venture capital arm had previously invested in the company.

“This is a fabulous opportunity to partner with TouchBistro as it continues supporting its restaurant partners with innovative and market-leading software products,” said Mark Shulgan, managing director and head of growth equity at the OMERS, in a press release. “The restaurant industry is a large market and can realize significant improvements in efficiency and profitability by adopting technology like TouchBistro’s,” he added.

Founded in 2010, TouchBistro pioneered the transformation of the restaurant industry through its award-winning iPad point of sale (POS) system. TouchBistro has since offered a suite of technology solutions that allow restaurant owners to save time on routine tasks, acquire new business and simplify their finances. Present in more than 16,000 restaurants in over 100 countries, TouchBistro is a global leader in the rapidly evolving restaurant industry.

 “This is a fabulous opportunity to partner with TouchBistro as it continues supporting its restaurant partners with innovative and market-leading software products,” said Mark Shulgan, Managing Director and Head of Growth Equity at OMERS.“The restaurant industry is a large market and can realize significant improvements in efficiency and profitability by adopting technology like TouchBistro’s,” he added. TouchBistro is the number one grossing iPad POS app in 37 countries and has processed more than US$11 billion in annual payments through its payments platform. “We are excited to build on OMERS strong relationship with TouchBistro, and look forward to supporting Alex Barrotti and his team,” said Mr. Shulgan.

“We are impressed with the tremendous growth that TouchBistro has achieved to date and believe that it is at the early stages of attaining a much larger share of the global restaurant technology market,” said Mark Redman, Executive Vice President and Global Head of OMERS Private Equity. “OMERS has been partnering with software businesses for over 20 years, with a long history of investing in innovative companies, including Shopify, Constellation Software, Inmar, Civica, Logibec, Rover and League. This investment demonstrates a long-term commitment to support exceptional companies through all stages of development,” Mr. Redman added.

Cikopo–Palimanan Toll Road shorthen as Cipali Toll Road is a toll road in Indonesia that connects the existing Jakarta–Cikampek Toll Road and Palimanan–Kanci Toll Road and is part of the Trans-Java toll road. The total length of the road is more than 1,167 kilometres (725 mi). The toll road is 40 kilometers shorter than through traditional North Coastal Main Road and predicted will cut 1.5 to 2 hours length of time.

"In developed countries, most families already have one or two cars. Your toll roads and other infrastructure projects typically grow with GDP, so your gross return will be GDP growth + CPI inflation. In developing countries like India (and Indonesia) where demographics are favorable, industrialization is taking place and lots of people still don't own cars, you can still collect very nice returns on toll roads. You will get GDP growth + CPI inflation + increases from tolls + as more people begin buying one or two cars, it will generate more traffic on these highways and profits will increase commensurately. It's a long-term project in a growing economy with great demographics."

The defined benefit (DB) pension model was created more than a century ago. During much of its early years the management and administration of these plans was in the hands of the insurance industry. Pension contributions by a company and its employees were used to purchase insurance policies – essentially deferred group annuity contracts. When an employee retired the insurance company would pay their pension out of the general assets of the company.

It was not until the mid-1960s that trust companies together with the money management industry came up with the idea of a pension plan sponsor establishing a trust, i.e. a “pension fund”, separate from the assets of the company. Pension contributions would go into the trust and be invested substantially in equities, as well as in bonds. Investment managers argued that by investing in equities, the pension fund would be able to earn a higher rate of return, which would then result in lower contributions and lead to increased earnings for the corporation. The idea caught on like wildfire. Today the assets of almost every DB plan – other than those which have been closed to new entrants – are invested substantially in equities.

In the early 1970s, economists took a look at the way pension funds were being invested, and they quickly came to the conclusion that it did not make a lot of sense from an economic or corporate finance perspective. It is reasonable, of course, to expect that equities, being riskier and more volatile than bonds, will on average over the long run provide a higher return than bonds, and that this should result in lower required pension contributions. But in the short to medium term a substantial investment of the pension fund in equities can also lead to substantial fluctuation in the funded status of the pension plan, requiring large, unanticipated increases in contributions and creating significant risk to the corporate cash flow and bottom line. The economists argued that not only would this not enhance shareholder value – because knowledgeable analysts and investors would simply apply a higher discount rate to the expected stream of higher but more volatile future earnings of the company – but rather it would actually decrease shareholder value. Why? Because the company would be taking on all of the risk of pension deficits, and be forced to make additional contributions, most likely in bad economic/market times, yet would enjoy only limited access to the rewards of pension surpluses in good times, by taking contribution holidays to the extent permitted. The company would not be able to withdraw surplus assets out of the fund to use for its own purposes.

What many companies, of course, have chosen to do is to fritter away those temporary “snapshot” picture of surpluses in good times to further enhance the benefits to plan members, leaving a subsequent generation of company management and shareholders to deal with the consequences of a richer and less affordable DB plan.

In other words, even if the strategy is successful – and I cannot stress this strongly enough – even if it results in lower pension contributions and higher corporate earnings in the long run, investing the assets of the pension fund in equities destroys shareholder value. In fact, if the company wanted to take the risk of investing in the equity market, it would be better off doing so by using its own corporate assets – taking out a bank loan or doing a bond issue, and investing the proceeds in equities. And if no company could or would see any justification for doing that, it should not see any justification for investing the assets of the pension fund in equities.

As far as economists are concerned, this is an issue that was settled a long time ago. All economists, across the ideological spectrum from liberal to conservative, agree that the assets of a DB fund should be invested in some combination of nominal and real return bonds in a way that maximizes, as far as possible, the matching of pension assets and liabilities and minimizes any fluctuation in the funded status of the plan.

The DB pension model has failed not because the model itself is inherently defective – in fact, it is a far better and cheaper way of providing employee pensions than the DC model – but because of the way in which the assets funding those DB obligations have been invested. Why is it that earlier in this century, DB pension plans went through two episodes of once-in-a-lifetime “perfect storms” within a decade, in which their funded status declined 30%-40% each time, whereas the insurance industry, with very similar long-term obligations in their annuity business, sailed through unscathed? Surely there is a lesson here for the pension industry.

Sun Life also has a bias to push companies to DC plans as I am pretty sure that they offer services to DC pensions, including asset management, administration, etc.

The author mentions that $158B in contributions were made. But he doesn't mention the nature of these contributions. They could have been because returns were below expectations but they also likely included contributions required to fund future service earned beyond 1999 and also changes to mortality tables as people are living longer than actuaries assumed 20 years ago. That does not indicate a problem with DB pensions, it just means that this risk was socialized to all members in the plan rather than each member having to bear this risk on her/his own.

Unless we see that $158B broken down then I don't think we can actually say that this proves the failure of DB corporate pensions.

But I do agree with him that the premise of a DB plan is somewhat flawed as you can think of it as a swap where the short leg is pension payments (which is essentially a long bond) and the long leg is the asset portfolio which has primarily been equities plus bonds and the bonds in the asset portfolio defease part of the pension liability. To make a long story short, the company is essentially issuing debt to invest in the stock market. As a shareholder of that company is that something that you should encourage? Probably not, but I think that DB pension are good for society as a whole as we need to make them work.

Here are some points for your consideration.

• The failure of corporate DB plans is best measured by the disappearance of DB plans in the private sector. Why do private sector DB plans disappear? Because, properly priced, employees don't want them and, improperly priced, shareholders don't want them. There is no value proposition for either employees or shareholders with interest rates this low (average 30 year RRB rate during the last 10 years = 0.7%). This isn't a Canadian phenomenon. It's a private sector phenomenon, at least in the developed world.
• I agree with Wayne's observation that traditional DB plans are, from a financial perspective, like employers issuing debt to their employees and investing in the stock market (or, more generally, in risk assets). To understand the consequences you must first specify the interest rate at which the debt is issued.
• In the private sector the debt is issued at AA corporate bond rates - say 3%. The pensions are quite expensive. Shareholders are not unhappy to see the corporation borrowing money from employees at 3%. However employees don't want to see their retirement savings earning a 3% rate of of return. Employees want higher returns at low risk. Shareholders don't want to borrow at above-market interest rates. The obvious compromise - replace the DB plan with a DC plan where employees decide how much risk they are prepared to take in pursuit of higher returns, and live with the consequences. This is as it should be.
• Contrast this with public sector DB plans - your gold standard. In the public sector the debt is issued at a 6% rate, the rate of return that the pension fund expects to earn on a portfolio heavily invested in risk assets. This is a great deal for employees... in a world where safe investments earn a 3% return they are guaranteed a 6% return. It's not such a great deal for taxpayers, who question the wisdom of issuing debt to employees at 6% when the government could just as easily borrow from the public at 3%, or less. Of course, the substance of the transaction is never shared with taxpayers.
• Public Sector DB plans do a great job for members and a poor job for taxpayers whose interests are ignored by those who are supposed to represent them. There is no magic here... just bad accounting and poor governance.

P.S. - I know that the story is a little more complicated for jointly sponsored plans but it comes down to the same thing. The plans succeed because taxpayers involuntarily subsidize members but in JSPPs, the subsidies are smaller.

This is an important debate. Quantifying risk I think is at the cornerstone of this conversation. The assertion that pension plans are invested in “risk” assets is routed in the concept of the near term and shorter term implications but I would humbly submit that it is the outcome of pooling across time that greatly reduces risk that is so simple and yet so misunderstood. Risk assets over 30 years will pay you a return with near certainty, even in Japan you would have done fine if well managed and risk balanced, I just don’t know which of the thirty years will be good and which will be poor therefore if I retire at the wrong time as an individual I might be in real trouble so why take that very real risk.

Secondly how much I need (how long will I live) is much easier to manage as a group than as an individual. It is the incredible and certain risk reduction (together we have much greater certainty) that pensions offer that underpins their use in our society (you would have to believe that risk assets of all sorts everywhere will no longer over decades pay a return for this not to be true and this has not been the case for all of human history). Putting these concepts together as a pooled saver you will with certainty earn a return over time and you can target your correct risk level as you know how much you actually need. The pension good or bad debate viewed through the lens of the short term is confusing, however viewed through the certainty of returns over the long term and in my view it is only the partisan that would not want to benefit by being a part of a well managed pooled saving strategy.

Just between you and I, do you have a reason for believing that pensions guaranteed by the federal government should be valued by discounting at something other than government bond interest rates, or do you just like the answer you get when you use higher rates?

FYI:

• If the federal government promises to pay someone $100 in 30 years and does not fund it, the government values the obligation by discounting at the government bond interest rate.
• If the federal government promises to pay someone $100 in 30 years and funds it with a 30 year zero-coupon bond, the government values the obligation by discounting at the government bond interest rate.
• If the federal government issues a 30 year zero-coupon bond at par, it values the obligation at the par value of the bond plus accrued interest, which equals the present value of the principal and interest payments at the government bond interest rate.
• If an employee leaves the federal government and elects to transfer the lump sum value of their pension to a personal RRSP, the lump sum is calculated by discounting the vested deferred pension at the government bond interest rate (plus about 1% according to the relevant standards/regulations).
• BUT, if the federal government promises to pay a public servant $100 in 30 years and funds it with a portfolio of risky assets that someone believes might earn a 6% return, then the government values the obligation using 6%, thereby cutting the reported value of the obligation in half even though the obligation itself - to pay $100 in 30 years - is unaffected by the government's funding and investment decisions. The obligation is, and remains, the responsibility of the federal government.

It's fine to say that you believe that federal employee pensions should be discounted at rates much higher than government bond rates, but what is the justification? Which, if any, of the five obligations described above should be valued at government bond interest rates? Which should be valued using a different interest rate... and why?

This is a big discussion and gets into MMT theory. My thinking is simple, a federal public pension plan isn't a corporation and therefore shouldn't be required to discount at the sovereign risk-free rate or the AA corporate bond rate.

Also, this whole debate that the members get all the rewards and bear none of the risk is misconstrued as society gets rewarded too when more people retire with certainty of income.

But it's a much wider discussion, your points are valid but IMHO, misconstrued.

Basically you are saying that corporations should be required to behave with integrity while governments invent any pension numbers they want. Discount at 3% or 6% or 9% or 12%...just pick the answer you want and let that dictate your discount rate!

It is true that society benefits when retired people have certainty of income but certainty of income is expensive. Why should society pay for the certainty of income enjoyed by federal public servants if the benefits flow primarily to federal public servants with only some small residual trickling down to the general population?

The government could guarantee all Canadians a 6% return on their retirement savings by offering to sell special non transferable bonds yielding 6% to those who wish to buy them with their RRSPs. The proceeds could then be turned over to the PSPIB, or some similar government agency, to work its magic. Then all Canadians, not just public servants, could have a risk free 6% return on their retirement savings. Why doesn't this happen? First, because it is ridiculous, but no more ridiculous than the federal government's employee pensions. Second, because the public service is quite prepared to have the public guarantee public service pensions, heroically volunteering to accept guaranteed incomes for the good of the Canadian economy. However the public service has no interest in picking up the public's investment risk or guaranteeing the public's pensions. If you don't believe me, look at the CPP. The federal government provides no guarantee and takes no risk. All the money comes from contributors and all the risk is borne by contributors or beneficiaries. That's not how pension plans covering government employees work.

I’m saying corporations are not governments, they’re private entities that cannot emit their currency to cover expenses so it’s ridiculous to treat governments like corporations or households. It has nothing to do with integrity!

You write: “The government could guarantee all Canadians a 6% return on their retirement savings by offering to sell special non transferrable bonds yielding 6% to those who wish to buy them with their RRSPs. The proceeds could then be turned over to the PSPIB, or some similar government agency, to work its magic.”

This argues in favour of my proposal to create a federally backed pension to properly manage corporate DB pensions using the governance model and investment strategy that Canada’s large public DB plans have adopted (as well as their shared risk model).

To my knowledge, CPP isn’t contingent on investment returns of CPPIB. I’m all for enhancing the CPP even if it’s not the best idea for the poorest Canadians.

I’d like to revisit this debate next week and take it public.

I fully agree with you and Wayne Kozun. Large DB pension plan funds invested on a long term basis in a properly diversified portfolio should not hesitate using 6% as the assumed average long term yield. Low interest rates normally play a very small role in such diversified funds.

This is a very academic argument and is a bit like comparing apples and oranges.

The first three examples are unfunded future liabilities of the federal government, so discounting them at the government borrowing rate is appropriate.

The third point about how lump sum transfers are calculated it another whole debate because the methodology creates a windfall for people leaving the plan. The logic behind this which was developed by the Canadian Institute of Actuaries (of which Malcolm was a senior member at the time) is that the amount calculated is based on what it would cost that person leaving to buy an annuity which would replicate their pension payment. This is ridiculous methodology because people pay into the plan based on the going concern discount rate and then when they leave the plan the money gets withdrawn at a much lower rate which results in them taking out much more money than they put in. And the money doesn’t come out of thin air, it comes from other plan members. If all members did this virtually every plan would run out of money. The point is, this is not a comparable situation at all.

It would only be appropriate to discount the future pension obligation if it were an unfunded liability of the federal government.

The difference with a pension plan is that the future obligation is funded through regular contributions from the employees and the employer. The question you are trying to answer is “how much money do we need to set aside to meet the obligation given a reasonable set of assumptions?” If you use any discount rate other than the best estimate of future returns on the portfolio you are going to overfund or underfund the obligation which brings up a whole series of intergenerational fairness issues.

Also, when we do valuations of companies we invest in, we don’t discount future cash flows using government bond yields, we us an estimate of the entire cost of capital. This is a standard market convention. If you applied a risk free rate – the government bond yield, you would massively overvalue the company. In the same way, if you used the risk free rate to discount the liabilities you massively overstate their value.

I would also say that this whole argument misses the point which is “what is the most efficient way to accumulate savings to fund retirements?” The answer is clearly DB plans. Pooling creates significant synergies that allow well run pension plans to produce a better outcome for the same cost or the same outcome at a lower cost.

For some reason Malcolm has had a "hate" on for DB pensions for a long time, which is strange since they fed him for many years.

I don't necessarily disagree with him about using government bond rates to discount pensions. It does seem silly that you can increase the discount rate used, and thereby decrease the pension liability, by changing your asset mix to a more aggressive mix.

But I don't think this is a huge issue in Canada as the pension plans tend to be rather conservative in their discount rates. This data is a couple of years old but I collected data on plans and here is what they were using for discount rates - OTPP 4.8%, HOOPP 5.5%, OMERS 6%, OP Trust 5.6%, CAAT 5.6%, OPB 5.95%, U of T 5.75%

The real issue is in the US. Remember how in Dec 2016 CalPERS voted to lower their discount rate from 7.5% to 7% over three years. 7% is still WAY too high, but this caused a huge outcry from California city governments, etc, as it increased their pension contributions. Using this discount rate CalPERS is about 70% funded - which is a very deep hole. Change their discount rate to something more realistic, say 5%, and the funded status would likely be 50%. (If you assume that assets are 70 and liabilities are 100 and if the discount rate drops by 2% with a liability duration of 20 then liabilities go up to 140 - hence 50% funded.) There is no way that you get from 50% funded to fully funded unless you have 10%+ returns for a decade or more, lots of inflation (and no indexing on liabilities) or you break the pension promise.

Thanks Wayne, I agree, the real issue is the US where chronically underfunded plans are one crisis away from insolvency. I do take issue with Malcolm’s insistence on using the government bond yield to discount liabilities, I think it’s silly to treat federally or provincially backed pensions and treat them like private corporations. Anyway, as you state, Canadian plans use very conservative discount rates.

But then how do you come up with a discount rate? Even for a provincial government plan? Should you use the Ontario Provincial bond rate as your discount rate for OTPP, HOOPP, OMERS, OPB, etc? If so then maybe the province should try to sewer its credit rating as increasing the spread over Canadas would really help the funded status of provincial plans. Leo de Bever and I used to joke that we should move OTPP to Newfoundland and we would move the plan to a huge surplus as the discount rate would increase!

If the shortfall risk is shared I would agree. The other practical issue is how long one has from a regulation respective to accumulate surpluses and and work out deficiencies.

Having flexibility to suspend indexation helps to smooth out the bumps. Given all of that, I would think that something like 4% makes more sense.

In discussing these things we make the assumption that the investment and economic environment and their associated risks will stay the same.

I am concerned that a more oligopolistic economic environment and the resulting concentration of profit and wealth will eventually result in a backlash that goes beyond fixing the real issues, which could reduce return on listed equity for a while, never mind a cyclical reset.

Have been busier than in any of my 8 formal job incarnations. In my 9th incarnation I am working to help along (as an advisor/investor/ board member) a number of innovative ideas that I see as desirable and profitable:

1. Nauticol, a methanol/fertilizer company with low emissions, water use and capital intensity.
2. Sulvaris, which makes slow-release fertilizer, and could lead the way to much more efficient sewage treatment.
3. Northern Nations, a first Nation co-operative in BC that is trying to forge JVs with non-indigenous nations to create employment and make life in the North more economically viable
4. Sustainable Development Technology Corporation, a Federal program to fund innovation
5. Vertical farming, and greenhouse agriculture production using waste heat through various channels.

Canada has a lot of people with great ideas. We have trouble quickly turning the viable ideas into products. There are lots of reasons for that, including lack of funding and resistance from the status quo.

So, life is good. I describe what I am doing as 'working with 70-year-olds to convince 30-year-olds not to behave like the typical 70-year-old.'

Canada needs to change fast, to stay internationally competitive. We are reasonably comfortable, but we cannot take that as a given. It does not help that polarized policy by soundbite is too simplistic to address real issues.

I have found 'kindred spirits', whom I have come to respect, because they believe that doing well and doing good can be profitable.

Must say that I am concerned that the Canadian pension funds are not as active in pursuing truly long-term innovative strategies as I wished they were. Lots of reasons for that too, not the least of which that benchmarks that judge long-term strategies by short-term outcomes can be dangerous to your career. Fear of failure is understandable, but as Gretsky said: I missed 100% of shots I never took. If you never failed at anything, you probably did not try much that was meaningful.

I’m glad to see young people in the UK jumping on the pension bandwagon. I’ve been harping on pension poverty for over a decade. Importantly, and the author nails it here, pension poverty disproportionately and ruthlessly strikes more women than men, so it does discriminate based on gender: “It is astounding that a woman that retires today will have a pension pot that is 1/3 the size of a man. This is mostly due to the numerous breaks in employment that a woman might ‘enjoy’ through child-rearing and caring for elderly relatives, typically later in their career. This is exacerbated by the gender pay gap which still exists across a lot of sectors.”

Joy Williams, a senior advisor at the climate change service provider Mantle314 who also chaired the Decarbonization Advisory Panel for the New York State Common Retirement Fund (see full report here), shared her thoughts on last week's PRI in Person conference:

Last week, I had the opportunity and privilege to address a theater full of finance professionals at the annual PRI in Person conference. The PRI stands for the Principles of Responsible Investing and is an investor initiative in partnership with UNEP Finance Initiative and the UN Global Compact. Its signatories number over 2250 financial firms representing just under $90 trillion USD AUM. The theme of the conference this year was “Responsible investing in an age of urgent transition” and the sense of urgency was very prevalent in discussions around the conference venue.

This year’s conference hosted over 1700 people in Paris. Topics ranged from broad issues such as policy to very specific issues such as reporting under the TCFD (Task force on Climate-related Financial Disclosures). Here are the key themes I took away from my 4 days there:

• Responsible investing in real assets has gone global. Here in Canada, where direct investing into infrastructure is more common, I’m used to having these discussions because the long life of these assets fit naturally with ESG topics such as climate change. However, this was the first year at PRI for an entire day on real assets and shows the growth of interest in responsible investing for this asset class. Some key touch points were investing for impact with infrastructure, social license and climate metric challenges.
• Climate change is both urgent and mainstream. Having the conference in Paris, the city where the historic climate agreement was created, made climate a natural topic. The depth and breadth of this discussion has matured substantially from even three years ago when people still weren’t sure whether the new G7 climate task force would produce anything meaningful. Today, we were debating options on how make useful decisions across portfolios that will have meaningful outcomes. Also, the PRI introduced a new climate tool in the Inevitable Policy Response – a forecast of the necessary policies that governments will need to meet the agreed upon targets. My own panel showcased three examples of investor action happening already.
• The overall tone was to move past “process” and to outcomes.The theme of focusing on outcomes was a general one across all ESG topics. Some speakers went so far as to propose that the focus on ESG data is not useful and in some cases, a misdirection. Rather, understanding the direction of trends and then managing for desired ESG outcomes was more useful and that data was not necessary to drive action towards those outcomes.
• Europe is making a significant headway on issues of global importance such as taxonomy, but it may not be fit for purpose in Canada. The EU Action Plan for Financing Sustainable Growth is a hot topic and will drive responsible investing to the next level. However, key actions such as setting an environmentally sustainable taxonomy do not appear to include any transitional fossil fuel activities such as switching to natural gas. Canada’s own expert panel on sustainable finance (ably represented by Barbara Zvan at this conference) has pointed to the need for tools that work for Canada in order to support a move to a green economy.

The PRI has come a long way from the high level discourse in the early years. I found there was value in detailed discussions among front line investment professionals and grains of wisdom from thought leaders pushing the boundaries, but at the end of the day, it will be up to individual organizations. There was an urgent call to practice responsible investing and it’s increasingly clear that responsible investing is becoming table stakes and investors may have to explain when they don’t practice responsible investing rather than when they do.

I thank Joy for sending me this brief synopsis of last week's PRI in Person conference in Paris. She covers the main points and I encourage my readers to contact her at Mantle314 for further information and expert advice.

I will see Joy, Barb Zvan and Kim Thomassin over the next couple of days at the CAIP Quebec & Atlantic conference in Mont-Tremblant where I am looking forward to listening to experts cover many topics, including responsible investing (see full agenda here).

Back in June, I covered Canada's Final Report of the Expert Panel on Sustainable Finance here. Keep in mind this is a work in progress but the authors provide great advice and insights on a complex topic.

In other important responsible investing news, CDPQ put out a press release today, Investors make unprecedented commitment to net zero emissions:

In one of the boldest actions yet by the world’s largest investors to decarbonize the global economy, an alliance of the world’s largest pension funds and insurers – responsible for directing more than US$ 2.4 trillion in investments – has today committed to carbon-neutral investment portfolios by 2050.

This commitment by the newly launched, United Nations-convened Net-Zero Asset Owner Alliance was announced today at the UN Secretary-General’s Climate Action Summit, which brought together governments, companies and civil society to strengthen commitments and accelerate the implementation of the Paris Agreement on Climate Change.

The Net-Zero Asset Owner Alliance is an example of investors stepping up to protect people and planet with the knowledge that companies that transform their businesses to deliver a low carbon economy will benefit most from the opportunities presented by climate change.

Inger Andersen, Executive Director of the UN Environment Programme (UNEP) said,

“There are no short-cuts to decisive climate action. We need to take a long-term view. I applaud the leadership of the investors in this Alliance. Their commitment sends a strong signal that financial markets and investors are listening to science, and moving us to a path of resilience and sustainability.”

Asset owners – so called because they are the principal holders of retirement savings or are insurance companies investing their customers’ premiums – represent some of the largest pools of capital on the planet. Their investment portfolios are highly diversified and exposed to all sectors of the global economy.

Concerned about the disruptive impacts that unabated climate change will have on societies and economies, now and in the future, responsible asset owners are powerful allies in global action to fight climate change and limit the rise in global temperature to no more than 1.5°C warming.

As long-term investors who must look far into the future to fund their liabilities, asset owners are keen to ensure that the global economy prospers, that climate-related risks are addressed, and that opportunities to invest in a cleaner tomorrow are captured.

The Alliance was initiated by Allianz, Caisse des Dépôts, La Caisse de dépôt et placement du Québec (CDPQ), Folksam Group, PensionDanmark and Swiss Re at the beginning of 2019. Since then, Alecta, AMF, CalPERS, Nordea Life and Pension, Storebrand, and Zurich have joined as founding members.

Convened by UNEP’s Finance Initiative and the Principles for Responsible Investment, the Alliance is supported by WWF and is part of the Mission 2020 campaign, an initiative led by Christiana Figueres, former Executive Secretary of the United Nations Framework Convention on Climate Change (UNFCCC).

“Mitigating climate change is the challenge of our lifetime. Politics, business and societies across the globe need to act as one to rapidly reduce climate emissions. We, as asset owners, will live up to our responsibility and, in dialogue with the companies in which we invest, steer towards low-carbon business practices. We’ve already started and, by 2050, our portfolios will be climate neutral,” said Oliver Bäte, Allianz’s CEO.

The members of the Alliance will immediately start to engage with the companies in which they are investing to ensure they decarbonise their business models. Initiatives such as the UN Global Compact “Business Ambition for 1.5°C — Our Only Future” campaign will be a clear partner in mobilising corporations to commit to net zero emissions. The Alliance will also collaborate with other initiatives, such as the Investor Agenda, Science Based Targets initiative, Climate Action 100+, and the newly announced 2050 Ambition Alliance.

The members of the Alliance will hold themselves publicly accountable on their progress by setting and publicly reporting on intermediate targets in line with Article 4.9 of the Paris Agreement. By committing to transitioning their investment portfolios to net-zero greenhouse gas emissions by 2050, asset owners are significantly raising the bar for other investors, industry associations and, importantly, the global economy.

“The Net-Zero Alliance is the recognition that institutional investors collectively have an important role to play in fostering the energy transition the world needs. For investors like CDPQ, there are so many opportunities to earn commercial returns by investing in low-carbon solutions and to work with portfolio companies to decarbonize,” said CDPQ CEO, Michael Sabia. “Combined with the necessary changes in public policies, investors’ actions will induce real change in every sector.”

To have maximum impact, existing Alliance members actively encourage additional asset owners to join them in their quest to decarbonise investment portfolios and achieve net zero emissions by 2050.

Notes to Editors

Magnus Billing, CEO, Alecta

“As investors we have a part to play in the climate transition, together with businesses, policy makers and society. Joining the Net-Zero Asset-Owners Alliance underlines Alecta’s commitment to strengthen our portfolio’s alignment with the Paris Agreement. We aim to use our voice as owners and engage with companies to increase climate disclosure and transition, to explore new investment opportunities that align good returns and positive climate impact, and to contribute to the development of tools and methods for integration of climate in Investment analysis.”

Johan Sidenmark, CEO, AMF Pension

“As a pension company, with customer relationships often lasting for decades, a long-term investment horizon is a natural and necessary approach for us. Integrating sustainability in our asset management – in particular risks and opportunities following climate change – is necessary if we want to fulfil our obligations not only today but also in fifty or a hundred years. Following our commitment to the Paris agreement, we want to be part of the transition towards a low-carbon economy and continuously work with alignment of our investment portfolio with the 1.5-degree target. Therefore, the goal of net-zero emission motivates us, and we look forward to being a part of this promising and timely initiative.”

Eric Lombard, CEO, Caisse des Dépôts

“For nearly 20 years, Caisse des Dépôts has been actively involved in the fight against global warming, with concrete and quantifiable results. As an institutional investor, it is proud to commit to a 1.5°C roadmap today. This ambition is strong and must be supported by a rigorous methodology, to which Caisse des Dépôts' teams will actively contribute. By joining this alliance, we want to take a further step in aligning our financings with the Paris Agreement objectives and send a strong signal to the companies in which we took participations, creating therefore a leverage effect on the whole economy.”

Marcie Frost, CEO, CalPERS

“CalPERS recognizes that climate change poses urgent and systemic risk given our responsibility to protect our members financial assets and provide the long term returns that can pay pensions for this and coming generations. The net zero alliance gives us the platform to drive the change needed to achieve the demanding goals of the Paris Agreement. We are committed to the advocacy, engagement and integration of climate risk and opportunity across our portfolio to meet that challenge as fiduciaries to nearly 2 million Californian public servants.”

Michael Kjeller, Executive Vice President and Head of Asset Management and Sustainability, Folksam Group:

“The Folksam Group has worked with responsible investments for nearly 20 years and we were part of the investor group that founded the UN PRI. Our good experience of collaborative engagements and the clear commitment we have signed set high expectations on the outcome of the Alliance. We believe in active ownership and that an asset owner can make a difference in the needed transition towards a 1.5 degree world. I wish that we in 2050, at the latest, can look back and see that companies have made the climate transition we have been part in pushing and encouraging them to do.”

Katja Bergqvist, CEO Nordea Life & Pension:

“Asset owners have an important role in the transition to a low-carbon and climate-resilient economy. We strongly believe that such a transition requires clear commitments, joint industry efforts and full transparency. We have joined the alliance because it represents a strong platform for enabling this.”

Torben Möger Pedersen, CEO, PensionDanmark:

“To achieve net-zero emissions in the real economy by 2050 we will need to enhance the impact we make ourselves as investors in new clean technologies, renewable energy infrastructure and sustainable buildings among others in order to provide realistic and feasible alternatives for the big CO2-emitters to change their businesses. Against this background the Alliance can act together as active owners and ask companies to transform their business models to comply with the Paris agreement and limit the temperature increase to 1.5C.”

Odd Arild Grestad, CEO, Storebrand:

“Our pensions, savings and investments are one of the most powerful tools we have at our disposal to address the massive challenges raised by the IPCC Reports. We can no longer overlook the impact we all can have if we move our resources towards a clean energy future. The Net-Zero Asset Owner Alliance is a great opportunity and a force for change. Sustainable investments are already generating good returns showing that a sound investment strategy is a win-win for people, planet and profit.”

Guido Fürer, Group Chief Investment Officer, Swiss Re:

"As an early mover to integrate ESG across our investment portfolio, committing to a net-zero GHG emissions by 2050 is a great extension to our approach.”

Urban Angehrn, Group Chief Investment Officer, Zurich Insurance Group:

“Our customers across the globe are facing the challenges associated with climate change already today. That is why we strongly believe that asset owners like Zurich must act now to tackle those challenges, in particular – by leveraging capital markets to fund solutions to the pressing environmental issues of our time. After signing earlier this year the UN Global Compact Business Ambition for 1.5°C pledge, we are delighted to join the Asset Owner Alliance, which is an important step in transitioning towards a low-carbon economy.”

Christiana Figueres, Convenor of Mission 2020:

“The urgency of the climate crisis demands decisive leadership, so it is encouraging to see asset owners flex their financial muscle and guide companies they're invested in towards a net-zero emissions world. The science is clear, we need to halve our planet warming emissions by 2030 to get on track. Investors are waking up to the enormous economic transformation that entails and starting to put their money behind it, but we are going to need more money, more scale and more speed if we are to deliver a liveable future for the young people calling for action from the streets.”

Fiona Reynolds, CEO, Principles for Responsible Investment:
“There is a tremendous urgency around addressing climate change. Pension funds and insurers who own large pools of assets are at the top of the investment chain in that they can direct/mandate the companies they invest in to move away from carbon intensive energy sources to more sustainable ones. They have the ability more than any other investors to move this agenda forward by outlining the material risks of climate change to those managing their assets.”

Margaret Kuhlow, Finance Practice Leader, WWF:
“This is welcome leadership from major asset owners. The message from the scientific community is clear, and as we experience the impacts of a warming Earth, it is more evident every day that we need to act more quickly. Limiting global temperature rise to 1.5°C is not about saving the planet as much as it is about saving the lives and livelihoods of our children and our grandchildren. Those who manage financial resources for our future have a vested interest in a more sustainable world and need to be strong advocates for public policy change.”

About United Nations Environment Programme Finance Initiative (UNEP FI)

UNEP FI is a partnership between United Nations Environment Programme and the global financial sector created in the wake of the 1992 Earth Summit with a mission to promote sustainable finance. More than 260 financial institutions, including banks, insurers, and investors, work with UN Environment to understand today’s environmental, social and governance challenges, why they matter to finance, and how to actively participate in addressing them.

More information: www.unepfi.org/about 

The €431bn civil service scheme ABP said in its ESG report for 2018 that SDG-related investments grew by €5.7bn to €55.7bn last year, equating to 14% of its entire assets. Its goal for next year is €58bn.

ABP has already exceeded its CO2 emissions reduction goal of 25% relative to 2014. Last year, it had reduced the carbon footprint of its equity portfolio by 28%.

It achieved this by setting stricter requirements for large carbon emitters in its investment universe, as well as easing the restrictions for sectors with limited emissions.

The scheme assessed 7,700 of 10,000 companies for their sustainable credentials, resulting in a better insight into the opportunities and risks of ABP’s long-term investments.

In addition, it has developed additional criteria for excluding companies from its portfolio and added 150 firms to its exclusion list. Last year, it divested from companies involved in tobacco and nuclear arms – banking a €700m profit in the process – and added South Sudan’s government bonds to its exclusion list.

“We believe hanging on to fossil fuel assets is a financial risk,” wrote Jagdeep Singh Bachher, the UC’s chief investment officer, and Richard Sherman, chair of the UC Board of Regents’ Investments Committee, in an op-ed in the Los Angeles Times.

Chief Executive Officers of the Investor Leadership Network (ILN) concluded their first meeting of the CEO Council on Diversity recently, hosted by Natixis Investment Managers, and are pleased to announce a commitment to continue to support and increase diversity at their organizations and in the broader financial industry, with an initial emphasis on advancing gender diversity. The meeting coincided with the conclusion of the G7 summit hosted in France, where gender equality was a central theme for discussions.

ILN members will improve representation of women in key roles and continue to take other concrete actions internationally

As institutional investors managing over $6 trillion in assets around the world, ILN CEOs have committed to work together to accelerate progress on gender diversity issues in the spheres where ILN investors can exert a collective influence. 

As part of that commitment, ILN members will aim to:

• increase the presence of women in key areas of their organizations. Specifically, all ILN organizations have committed to working toward increasing the number of women in investment and senior leadership roles;
• establish appropriate metrics, for a majority of members through third party certification, to guide, assess, and benchmark progress as well as inform strategic direction, hiring and advancement strategies for women;
• support the CFA Institute Young Women in Investment Program, which is designed to foster diversity and inclusion within the investment management profession. The partnership will support existing women’s programs in Mumbai and Bangalore, and will seek to expand programs to other regions with a goal of more than 400 program participants by 2021; and
• advocate for greater diversity and inclusion with public and private portfolio companies, external managers and the broader investment industry.

The collective focus of global investors on attracting and advancing women in the industry offers the potential to drive higher performance, promote fairness and lead to more sustainable decisions in leadership teams.

The participants agreed to convene a second CEO Council on Diversity meeting to coincide with the G7 meetings in 2020. 

The world’s biggest hedge funds anointed a clear favorite: Uber. They piled into the ride-hailing company, which had its initial public offering in May. Three Tiger Cubs—alumni of Julian Robertson’s Tiger Management—led the charge on a $1.4 billion wager. As they favored the shiny new thing, plenty of others cast off an old tech giant, Microsoft, turning it into the most disliked stock.

Winners. Losers. Buyers. Sellers. By Aug. 14, fund managers disclosed in regulatory filings the multi-million dollar moves they made in the U.S. stock market in the second quarter. The quarterly rite allows investors to gain some insight in an otherwise opaque arena dominated by some of the richest managers—from Bill Ackman to David Einhorn.

Here we parse the flood of data that was released to show you where the smart money placed wagers—and how those bets look, in hindsight.

The chart below gives you the big picture. It plots about 250 U.S. stocks, combining in each dot two measures: the change in the value of hedge fund positions and the performance of the equity in the first 45 days of the third quarter. Scroll over the dot for Humana, a popular stock with hedge funds like Glenview Capital and Maverick Capital in the second quarter. Shares of the health insurer surged after it boosted its outlook in July. Alcohol giant Constellation Brands, which sells beer and tequila from Mexico in the U.S., has had a tougher time. Hedge funds fled the stock as the Trump administration made trade and immigration threats against its southern neighbor.

Hedge funds kept their years-long infatuation for almost all of the FAANGs—Netflix, Amazon, Facebook and Google parent Alphabet. They jumped into the companies, as the chart below shows, with D1 Capital taking a new stake in Amazon and adding to its holdings in Netflix and Facebook. Meanwhile, funds ditched Apple amid slowing iPhone sales, and also Microsoft, just as the software giant deepens its partnership with Samsung. Big quant names like D.E. Shaw and AQR Capital trimmed their positions in the iPhone maker.

IPOs in the U.S. surged in the second quarter, raising the most capital in years, after a slow start to 2019. CrowdStrike, a software firm, has been one of the top performing offerings. Big hedge funds like Tiger Global, Element Capital and Melvin Capital got a piece of the CrowdStrike action. Chewy, an online pet store, was another favorite. Its stock got an early pop fueled by the firm’s robust growth. The shares have since settled down.

Hedge funds often move in clusters, crowding into or clearing out of the same stock at about the same time. The chart below displays the most and least popular stocks by the number of firms that bought or sold them in the second quarter. Disney was among the winners of the beauty contest, gaining fans as it makes an aggressive push into streaming video. Marshall Wace added to its stake and Suvretta Capital took a new position in the quarter. Chevron, which lost a takeover battle for an oil driller in May, was less appealing. More hedge funds sold Chevron than bought it.

The hedge fund industry’s boldfaced names—from Bill Ackman of Pershing Square to Andreas Halvorsen of Viking Global—made a splash in the quarter.

Big Names, Big Bets

Pershing Square took a new stake in Berkshire Hathaway, valued at about $749 million as of June 30. Berkshire’s shares may have taken a hit on weak earnings and a swoon in bank stocks as Warren Buffett builds up the firm’s financial holdings.

After ditching its Boeing stake in the first quarter, Viking Global built a new position in the jet manufacturer this go-around, worth about $1 billion at the end of June. 737 Max concerns continue to weigh on Boeing shares.

Appaloosa cut its Allergan stake by more than 50%, valuing the holding at about $217 million as of June. Shares of the drugmaker have been down slightly after an initial jump once AbbVie agreed to acquire it in June.

Elliott exited its $1.4 billion position in Sempra Energy after reaching an agreement in October to add two new directors to the utility’s board.

• Brace for a Bumpy Ride Ahead?
• Trade Wars Slamming Stocks?
• A Summer Melt-Up in Stocks?

I attended the CAIP Quebec & Atlantic conference in Mont-Tremblant over the last two days. You can view the full agenda here. Below, I go over the presentations, with more emphasis on some of the key ones.

Before I begin, let me first thank Geoffrey Briant, President & CEO of G2 Alternatives, and Gordon Power, Founder & CIO of Earth Capital, for sponsoring me to attend this conference.

I'd also like to thank the organizers of the conference as I found it excellent, relatively small and high quality speakers and attendants.

Special Keynote | Canada's Expert Panel Report on Sustainable Finance: What's In It For Asset Owners?

Tuesday, September 24, 2019, 8:30 AM - 9:30 AM

This special keynote will be of immense and necessary value to every pension fund in Canada — because the future investment portfolios of every single one of them will be affected by it.
In April 2018, the Government of Canada announced the formation of the Expert Panel on Sustainable Finance to consult with Canada’s financial market participants on issues related to sustainable finance. The panel released its final report on June 14, 2019. These findings will significantly impact the investment decisions of every pension plan in Canada.  In this interactive keynote, hear from two of the four members of that panel. They are, as Pension Pulse has noted, two of the most powerful women in Canada’s pension field in an elite club dominated by men.  This is a not-to-be-missed special keynote!

Moderator: Gordon R. Power, Owner & Chief Investment Officer - Earth Capital Ltd;
Speaker: Kim Thomassin, Executive Vice President, Legal & Secretariat - CDPQ
Speaker: Barbara Zvan, Chief Risk & Strategy Officer - Ontario Teachers' Pension Plan

Synopsis: This was the opening presentation and the most important one in terms of material. Gordon Power moderated and Barb and Kim took turns to go over main points from the Final Report of the Expert Panel on Sustainable Finance.

Barb Zvan kicked things off by stating Canada is known for "hockey, maple syrup, and cold winters." We are also known to be big polluters. We are the fourth largest oil and natural gas producer. She also noted Canada is the 2nd highest GHG emitter per capita in the G7.

She said the Canadian financial sector is very concentrated, with 5 big banks, 5 big life insurers and the 8 largest pensions account for 3/4 of the assets.

She noted the complexity of the regulatory system -- the Bank of Canada, OSFI, provincial regulators -- has not made change very easy.

Kim Thomassin discussed the process of writing the Interim and Final report with over 200 consultations in Canada and abroad, 11 thematic round tables and 57 written submissions:

They then went into the three pillars of the report, focusing on the 15 core recommendations:

I highly suggest you take the time to read the Final Report of the Expert Panel on Sustainable Finance. I asked Barb and Kim to send me some of the main points they wanted me to cover.

Barb was kind enough to send me this:

Some thoughts

• It would be great to set the stage that this is not just an environmental report. This is a finance report written for the finance / investments community.
• Also important to note that finance is not going to solve climate change, but it has a critical role to play in supporting real economy through the transition
• To do so we really need to channel the financial sector expertise, ingenuity, influence towards challenges and opportunities posed by CC
• The report is a PACKAGE of practical & concrete recommendations - addressing both adaptation and mitigation
• We thought of it as a systems approach - multiple things need to happen - by multiple groups - government, companies, investors & citizens

The 3 three themes of the report

• First our environmental and economic aspirations need to become one in the same because ultimately they are indivisible - we need to address climate change and live up to our international commitments to deliver our share of the global effort to reduce GHG emissions, but (and even more so) we also need to address climate change to remain competitive in a world that is increasingly concerned about environmental footprint
• A second theme is that we have some catching up to do, but we think Canada can be among the leaders in the global transition to a low emissions future as a trusted source of climate smart solutions and expertise - important for Canada to position itself as a decision maker rather than simply decision taker in the global market for sustainable products, markets and growth
• Third, if Canada is to realize its environmental and economic goals, sustainable finance needs to go mainstream. Sustainable finance needs to become simply finance.

The 3 pillars noted and the recommendations that you think may be of interest to your readership.

Under Pillar 1 - switching orientation from burdens to opportunity

• Mapping Canada’s climate goals into clear industry competitiveness vision - in short help spell out the the size and horizon of the investment opportunities (I guess you can’t make a link to McKenna’s speech today)
• Additional tax deduction to provide opportunity for Canadians to connect savings to climate objective (also will spur providers who will increase their expertise).

Under Pillar 2 - building the foundations

• Data & Insights - most pervasive issue across sectors. Biggest challenge, data & translation of data from climate insights to financial and business insights - thus recommendation to create a hub - Canadian Centre for Climate Information and Analytics. You may want to insert Joy’s point re not waiting for perfect data - it is a valid one.
• TCFD - ultimately better information and insights will support better decision making, better pricing of risk. But another benefit of TCFD is that is will spur organization focus. Also an opportunity to change the conversation in some key sectors. We recommended a comply and explain approach, ensure implementation is paced and staged for complexity and size of firm, consideration of safe harbour rule re scenarios when a thoughtful approach has been taken.
• Fiduciary Duty - really about ensuring clarity that climate change consideration are aligned with an investor’s fiduciary duty. We also note in our report that Canada should create a stewardship code like many other regions.
• Ecosystem - in addition to ensure that the experts, that many investors rely on, accelerate their learning and engagement, we did note our support for CPA to look at climate considerations in fair value of an asset.
• Regulation and Supervision - first it is great that Bank of Canada has taken first step and joined the Network for Greening the Financial System. We did note that we need more clarity from regulators on their role in the oversight of climate change. Also for them to support financial innovation.

Pillar 3 - specific products and markets

• Supportive Of Transition bonds to help access the deepest, pool of capital (fixed income market). Context that many of the green taxonomy (e.g. Europe) is based on what they need to do to become Green. Canada will have other needs not covered. Thus where we saw transition taxonomy fit in, an opportunity for Canada to lead. Assuming it is implemented, it is another way for a company to illustrate its commitment to transitioning.
• CleanTeach, Oil & Gas, Retrofit, Infra, Electricity - not sure how much detail you want to go into here, but the recommendations were all targeted to what we believed was holding back that specific market - some recommendations focused on removing barriers, creating new groups to fill in a gap (e.g. green bank) or changes need to have a supportive policy environment and ability to attract the capital needed (e.g. securitization in real estate, pipeline in Infrastructure etc).
• Asset Management - a key recommendation was for asset managers to assess their internal capabilities - as I noted, this could be around education (board or teams), thinking about the governance process, skills needed, tools already available that can be utilize in your investment process (whether to decide when to buy/hold a position but also while you own it (e.g. engagement and voting)). Commitment to TCFD for their own organizations as it will spur organizational focus as well as supporting initiatives that is asking for enhanced climate change disclosures by companies. This assessment would be specific for each company. They could also help by writing to government and saying they are supportive of the recommendations! 

For her part, Kim sent me a few key takeaways:

The role of financial markets in driving this change/transition has yet to be fully leveraged.

While finance alone is not going to solve climate change, it has a critical role to play in supporting the real economy and foster innovation thru the transition.

Our goal and wish is that sustainable finance in a short term is purely and merely finance.

One thing I did not stress enough was how the consumer preferences and behaviors are relevant - indeed, they are increasingly looking for services and products with a smaller environmental footprint. We (long term investors) feel that climate-smart innovations constitute massive global market opportunities and that they will yield high quality jobs.

Also, how both CDPQ and Teachers' are integrating sustainability into their investment strategy. As long-term global investors, we know that our performance will only be as sustainable as the world in which we invest.

I thank Barb and Kim for sending me over some of their thoughts.

At the end of their presentation, I asked them why they didn't recommend that all of Canada's large asset managers adopt hard targets on addressing climate change.

Barb noted "regulatory complexity" made it hard to make such a recommendation and that it's up to each organization to tackle this issue on their own.

Kim noted that the Caisse has met and exceeded its targets which are laid out in its 2018 Stewardship Investing Report. She went over these four pillars:

I thank Barb and Kim for their excellent insights and they did a wonderful job going over the 15 core recommendations of the Final Report.

Investment Opportunities with the Synergy between Climate Change and the SDGs

Tuesday, September 24, 2019, 9:30 AM - 10:00 AM

Speaker: Gordon R. Power, Owner & Chief Investment Officer - Earth Capital Ltd

Synergies between the Paris Accord and the UN’s 2030 Agenda for Sustainable Development align the climate change and SDG processes to create investment opportunities for institutional investors at the nexus between climate change, energy, food and water.  In this session, you will discover:

• Examples of how to invest successfully by aligning with both SDGs and climate action at global, regional and country levels to produce scalable investments for institutional investors
• How to measure the impact of investment opportunities to illustrate the social, environmental and financial metrics from the potential of synergistic and interlinked approaches that can be used to realize the objectives of the SDGs Agenda and the Paris Accord
• How to profit from these measures

Synopsis:Earth Capital was founded in 2008 by Gordon Power, Stephen Lansdown and Lord Stanley Fink. Its constituent firms manage over $1.5bn in Sustainable Private Equity assets with offices in Beijing, Guernsey, Hong Kong, London and Rio de Janeiro.

Here is a brief overview of Earth Capital (EC):

EC is a global private equity investment manager totally focused on Sustainable Development within the climate change nexus of energy security, food and water security. We invest capital globally in the commercialisation and deployment of proven, sustainable technologies, in various industries including agriculture, clean industry, energy generation, resource and energy efficiency, infrastructure, waste and water.

Our partners have a thirty-five-year extensive investment track record including turning around poor performers & managing the exit process. With our CIO, Gordon Power’s record of 28.5% IRR for a portfolio of 256 investments over 34 years and 45% IRR for a sub-portfolio of 33 sustainable investments made since 1984. In total, our global senior team have been working in the field of sustainable investment for over 330 years! We also have a long history of collaborative working together in the group, as well as in prior firms.

At EC we think of ourselves as industrialists, through the culture laid down by our founders whom themselves have founded substantial businesses, not just invested in them. As a result, we do not see ourselves as purely private equity investors, because through technology transfer we work with our companies to develop their businesses internationally and in turn increase their value.

Our Sustainability impact is measured through the Earth Dividend^™, which provides an annual measure of the contribution to Sustainable Development. The Earth Dividend^™ has been developed by EC's in-house Sustainability specialists following a detailed benchmark of international best practice approaches to the assessment, reporting and assurance of Environmental Social and Governance issues.

I must say, I've met Gordon Power a few times and he is very impressive and really knows sustainable investing (and has done this very profitably over the years).

Gordon went over the climate nexus which revolves around food, energy and water (see an earlier comment of mine on rethinking sustainable investing):

What I like about Earth Capital is the people, process and performance and in that order!

Their latest fund is already delivering an 18% IRR but it's the people and process which really stand out most for me (the entire culture of the firm is predicated on sustainable investing)

For example, Richard Burrett, Earth Capital's Chief Sustainability Officer, recently shared this with investors:

This report is Earth Capital’s first annual sustainability review since the launch of the Nobel Sustainability Fund (NSF). The sustainable finance and investment landscape is dynamic at present with leading companies increasingly looking at how they integrate issues such as climate change or the broader Sustainable Development Goals (SDGs) into their investment approach. This review highlights how we approach sustainable development and how we integrate sustainability thinking into all we do as a business. Sustainability drives our investment themes; is integrated in our investment decision making and is used to performance manage the businesses we invest in.

Our Earth Dividend process provides us with a holistic understanding of the sustainability performance of those investee businesses and clearly demonstrates that NSF makes a net positive contribution to Sustainable Development. As a growing number of measures do, it reflects the positive aspects of a business such as energy or water savings, but it goes further in highlighting for example where supply chain, end-of-product life or other negative issues are evident. These can include negative environmental footprint issues, or where companies talk of their engagement with local communities and contribution to local economic development yet fail to measure and report this in any systematic way. We look to work with the management of those businesses to improve that performance further, where it leads to commercial gain. The review highlights how we are looking at these issues from an individual company as well as portfolio perspective. We are proud of the work we do to ensure that our Earth Dividend process is implemented systematically and externally assured.

We highlight how we keep our thinking both current and forward looking through engagement with, amongst others, our Sustainability Council. This informs our thinking on emerging issues such as “just transition” or the continuing drive to implement the recommendations of the Taskforce for Climate Financial Disclosure (TCFD).

Interestingly, Gordon told us their Sustainability Council is completely "independent" and its input brings leading external stakeholder perspectives to Earth Capital’s approach on Sustainable Development.

He said the annual Earth Dividend process is completed by the investee company management/investment teams, internally audited by the Chief Sustainability Officer and presented to the Investment Committee:

I highly recommend you contact Gordon Power directly ( gordon.power@earthcapital.net) for more information on his fund and process. Here in Canada, you can also reach out to Geoffrey Briant (gbriant@g2alternatives.com) for more information.

Let's just say I think Earth Capital is light years ahead of its much larger, more well-known private equity peers when it comes to sustainable investing but it doesn't have "brand recognition" which is silly given its principals have a very long track record.

A Debate Between an Investor and a Consultant: Different Perspectives on Yield Expectations, Portfolio Optimization and Risk-Taking

Tuesday, September 24, 2019, 10:00 AM - 10:45 AM

What does it take to succeed in today’s challenging investing landscape? In this session, join a top consultant and a leading investment manager in a candid debate about alternatives. Dissect where the market is heading. Discover the risk and return expectations for alternative assets — as well as performance and compensation. You will walk away with an understanding of the key investment challenges from both sides and discover what each party can do to capitalize on opportunities through partnership and innovation. A not-to-be-missed session!

Moderator: Charles Quintal, President, Retirement Committee - Assembly of Quebec Catholic Bishops
Speakers:
Vincent Jacob-Goudreau, Director, CIO Group - Portfolio Construction - PSP Investments
Yusuke Khan, Director of Strategic Research (Investment), Canada - Mercer

Synopsis: I just met Vincent Jacob-Goudreau and his colleague, Anne Lefebvre, today at lunch. They're both very nice and smart. Vincent is an actuary who joined PSP nine years ago from Aon Consulting. He initially worked with my former boss at PSP, Pierre Malo, and former colleague, Mihail Garchev, on asset mix research before joining the office of the CIO.

He now works for Eduard van Gelderen who was appointed to the position of Senior Vice President and Chief Investment Officer at PSP in July 2018. Prior to joining PSP Investments, van Gelderen was Senior Managing Director at the Office of the Chief Investment Officer of the University of California. He also served as CEO of the Dutch financial service provider APG Asset Management and Deputy CIO of ING Investment Management (solid CIO with great credentials).

Anyway, I really enjoyed listening to Vincent to get the latest investment profile on PSP. Vincent said PSP is "close to 50%" allocation to private markets. The focus right now is on "portfolio management" as they have achieved their asset target returns or are close to it.

He said Eduard van Gelderen is looking at liquidity, leverage, and factor exposures by geography and other factors.

The 50% "alternatives" at PSP is in Real Estate, Infrastructure, Natural Resources (farmland and timberland), Private Equity and Private Debt.

The focus is on "Real Assets" for long-term inflation protection as Public Markets have adopted a diversified approach across Fixed Income and Equities.

He said PSP has developed platforms in every asset class to scale into specialized sectors. He gave a few examples of this including in Natural resources (platform for dairy?).

He said investments typically fall into "buckets" but when they don't fit nicely in any bucket, they are made in the complementary portfolio overseen by the Office of the CIO with input from various groups.

The complementary portfolio is also used to incubate new strategies (like AI) and invest in other assets that don't fit in traditional buckets. He gave the example of data centers which fall between real estate, infrastructure and private equity and preferred shares (falls between debt and equity).

In farmland, he said there's "creative thinking" where he gave the example of Mahi Pono, a farming venture between Pomona Farming and PSP which both purchased approximately 41,000 acres of agricultural farmland from Alexander & Baldwin late last year. "One tenth of the island was this sugar company" but through this venture, they transformed to produce cattle, coffee and other agricultural products (see details here).

In terms of where to invest now, Vincent said in "assets that allow you to withstand disruption or be part of it" (like AI and AI related investments).

I asked him given that all assets are over-valued right now, what is the best approach for PSP and other large institutional investors?

He said platforms are critical to access deal flows in infrastructure (like toll roads in India), farmland, but he said "private debt markets are a bit hot right now".

The key thing he stressed is given PSP's advantageous liquidity position, it can be patient all while "staying nimble and level headed". He added: "manager selection and partnerships are the key".

How to Effectively Capitalize on International and Domestic Real Estate and Farmland

Tuesday, September 24, 2019, 11:00 AM - 12:00 PM

Investing in international and domestic real estate can bring real value to alternative investors — if they are know what they are doing. Despite its illiquid nature and high valuations, real estate has served as a core performer for investors. Gather expert perspectives on current developments — and where real estate demands are heading in Canada, the U.S. and internationally. You will discover a broad range of strategies and property types to discover new opportunities in a crowded market.

Moderator: Francois Audet, Senior Director, Credit & Private Investment Risk - PSP Investments
Speaker: David Pappin, President - IAM Real Estate Group
Speaker: Joelle Faulkner, President - Area One Farms
Speaker: Rahul Idnani, Managing Director, Global Chief Operating Officer and Head of Portfolio Management Americas - Nuveen
Speaker: Daniel Marchand, Senior Vice President, Head of Investor Global Sales, Trez Capital

Synopsis: This was an excellent panel on real estate where the panelists really knew their stuff. Francois Audet did a great job moderating and I had the pleasure of meeting him and his colleaugue, Ian Nisbet, who works in Transversal Risk at PSP, the previous night after dinner. Both are very nice guys and I was pleasantly surprised to see the silos have been broken at PSP (PSP One is the focus) across Public and Private Markets (job of transversal risk) and even within Private Markets.

Francois Audetalso told me that they now rate all investments in Private Markets  using a loan rating system J-F Bureau, PSP's Senior Vice President and Chief Risk Officer, was using at the National Bank and expanded and improved at PSP.

He said that there is always a watch list presented to the Board every quarter based on this system and that even though the CRO reports to the CEO, he has a 15 minutes in camera sessions with PSP's Board every meeting (that's the way it should be).

Anyway, back to the real estate panel. David Pappin stresed diversification across products and not to focus too much on where we are in the cycle.

Rahul Idnani, who really impressed me, said that mutli-family and industrials are still the markets to invest in while retail remains "problematic" unless you have a great anchor tenant like Sobeys and really work the asset.

In the office space, they like medical office, life sciences and cyber rents as the traditional offices require a lot of expenditures.

Joelle Faulkner talked a lot aobut farmland and she really knows her stuff. She said it's not correlated, non-leveraged and you can get anywhere from 8 to 12% return (she cited development projects for higher returns). She said most Canadian farms are small (2000 acres on average) relative to Australia's massive farms (20,000 acres).

She prefers the equity partcipation model over the own and lease model and I asked her to come back to me on a blog comment to cover farmland in more detail.

Daniel Marchand was equally imressive. His firm focuses on markets like Dallas, San Antonio, Houston and various cities in Florida (not Miami which is overbuilt) where they see a lot of opportunities.

Francois Audet said opportunistic has become core plus and all the real estate commentators said risk are rising and it's reflected in valuations. Rahul said it used to be on an 8% return, 7% was income and 1% was appreciation and that's no longer the case.

Daniel said negative appreciation hasn't been seen in a decade and that reflects where bond yields right now. He added in Q2 2019, there was $400 billion of dry powder in co-mingled funds and another $400 billion in pension assets waiting to by top real estate assets.

You used to get 20% net in opportunistic real estate and now it's 15%. For value add, it used to be 12% net and now it's 10% or less (with leverage, see details and terms here).

Rahul said access to deals is harder but given Nuveen's size, they were able to stike big deals with top shops like Blackstone which they acquired a $3 billion logistics portfolio from.

I also asked Rahul Idnani and Daniel Marchand to consider writing a guest comment on real estate on my blog.

The Savvy Managers and Consultants Speak: Where is the Smart Money Being Invested?

Tuesday, September 24, 2019, 12:00 PM - 1:00 PM

How are savvy managers navigating high prices and growing competition in today’s frothy market to generate superior returns? Faced with uncertain financial markets and increasing disruption, what is the smartest money purchasing? In this session, you will hear from some of Canada’s leading institutional investors and asset managers give you their views on:

• How to achieve portfolio harmony in 2020
• Balancing your asset allocation and portfolio construction
• What will happen to the US equity and bond markets
• Targeting allocation strategies moving into 2020 and beyond
• Using technology to monitor your portfolio and manage risk
• Using un-correlated strategies for maximum gain

Moderator: Blair Richards, CEO - Halifax Port ILA/HEA
Speaker: Dominic Blais, Senior Risk Manager - The Canadian Medical Protective Association
Speaker: Anne Lefebvre, Director, Total Fund Strategy - PSP Investments
Speaker: Dr. Toby Goodworth, Managing Director, Head of Risk & Diversifying Strategies - bfinance

Synopsis: This was yet another interesting panel. There was some overlap between Anne Lefebvre and Vincent Jacob-Goudreau who spoke earlier but she was well aware of this and did a fine job at staying on message and pertinent.

Dominic Blais spoke about strategic asset allocation (SAA), stating they increased Privates from 25% to 40%, and increased Fixed Income and USD exposure (classic risk aversion hedge).

Toby said there's a clear shift away from equity into alternatives but he preferred liquid alternatives and diversification by style factors in Public Markets.

Blair Richards said 20 years ago, diversification for his small pension meant give 1/2 the money to one balanced fund manager and the other half to another. "Fast forward till today and we have come full circle as we don't know our managers as well as we did back then."

Annie said 50% pf PSP's assets is in Privates right nw and platforms are crucial for deal flow. In Real Estate, they have segregated managers. She stressed "being patient for the best deals, incorporate ESG and focus on internal capabilities."

At the end, I asked Dominic Blais how they broke the silos and he said that compensation was tied to total portfolio returns and they have bi-weekly meetings to stimulate discussions between Private and Public markets.

He added that it's still a work in progress because "privates are all about absolute returns and public markets are still largely about tracking error to some benchmark' but it's important to focus on total fund.

At the end, Blair Richards made me laugh. He said: "We are not only small, we're slow" and when it comes to making big decisions on strategic or even tactical asset allocation, he "sits in a dark room and cracks open a beer to ponder and if he can't figure it out, he calls the consultants to tel them 'they have a problem'".

Interestingly, Blair told me after his small company has a great pension and he read my comment criticizing Brent Simmon's Globe article and the follow-up comment which I need to repost because I lost it.

He said they offer DC and DB and are now giving their DC plan employees the option to buy back in to their DB plan and still have any remaining savings from their DC plan. He is someone else that I'd like to write a guest comment on what they did to maintain their DB plan.

Keynote | Fireside Chat - How CDPQ delivered Outstanding Results with Alternative Investments in 2018

Tuesday, September 24, 2019, 2:00 PM - 2:45 PM

Given the losses in the markets in 2018, some investors — like CDPQ — have managed to post a positive return because of their alternative investments portfolio. Discover what they did to make their portfolio more resilient, given market headwinds. What alternatives did they invest in — and how did they make that decision? And, importantly, how should a mid-sized pension fund go about it if it posted negative returns on other investments — and alternatives were not recommended by its consultants? In this exclusive and riveting session — by a senior member of CDPQ’s investment team in conversation with a prominent investing consultant, you will walk away with a wealth of knowledge!

Moderator: Eoin Ó hÓgáin. CEO, Power Pacific Investment Management, a part of Sagard China
Speaker: Maxime Aucoin, Executive Vice President, Investment Strategies & Innovation - CDPQ

Synopsis: This was another great presentation, one of the best fireside chats. I've met Maxime Aucoin before and he's not only very nice and smart, he is a great communicator. In fact, along with Macky Tall and Kim Thomassin, if I get asked again who would do a great job following Michael Sabia who will retire in less than a year, I'd include Maxime Aucoin's name in my short list of internal candidates (external candidates, I still stick with Louis Vachon but he will probably run a small family office managing his fortune and there are other men and women potential candidates I'd rather not share publicly on my blog).

Anyway, Maxime started off by stating he doesn't like the term "outstanding returns" because it implies they are taking "outstanding risk".

He also doesn't like the term "alternatives" and prefers strategies. He did say that htey are invested 44% in alternatives which generate 70% of the expected return.

He said when making a decision, they focus on three things: Diversification, Premium, and Fees:

"We try to maximize Diversification and Premium and minimize Fees."

He said they did a real estate development deal in Toronto (CIBC Tower) where they delivered "on time and on budget" to realize significant premium. By contrast, they own a top building in Manhattan where the remium is much lower.

When it comes to deals, there are three crucial elements: Focus, Expertise and Governance:

Then it's all about managing the assets which is boils down to two things: Value Creation and Governance:

He said there is a top-down quant process to mange risks but also a bottom up one to make sure managers aren't taking risks which skew their portfolio risks (he gave an example in Real Estate where the search for yield was leading to over-concentration in one area).

He said they like EM credit and Private Debt but are still pondering Natural Resources and Gold.

He went into a lengthy discussion on developing internal capabilities as opposed to going external and gave an example of mid-market private debt where they decided to go external and work with smaller managers.

But he said you to to balance internalizing with going external as the Caisse already has over 1000 employees all over the world. He gave the example of the Futures Fund in Australia which manages over $100 billion with only 75 employees (that's not what the Caisse wants to do).

What else? The ability to be "differentiated capital" is something they worked on a lot. "To be able to provide a $2-$3 billion cheque, you need to be comfortable with concentration risk."

They still want to focus on exporting their greenfield infrastructure expertise all over developed markets like New Zealand and the United States.

There is an organizational challenge as this requires a PR team and EM partnerships team (ie. more employees all over the world).

He ended by stating you need three things to be successful:

1. Have hard conversations
2. Focus on SAA: diversify returns and focus on portfolio construction
3. Manager selection/ consultants are critical to process, you need to develop solid relationships

I asked Maxime a simple question but one that has been bugging me: "With all this capital chasing deals in China, aren't you worried that it's a communist country? What about geopolitical risks?".

He said what Michael Sabia always tells them: "Focus on partners first, deals second" (I like that).

Maxime added: "You never go to a region without a local partner" who has intimate knowledge of the laws, regulations and cultural issues.

As far as geopolitical risks, he said there are risks everywhere, including the UK and US. Also, he made everyone laugh by stating over the last several years, he has seen many Powerpoint presentations titled: "Navigating a World of Uncertainty".

He said investors need to move away from the noise and focus on the long term.

As far as currency hedging he told me privately and then reiterated that while the Caisse doesn't typically hedge, they do hedge some currencies and even the US dollar because the marginal last dollars are not as cheap as the ones from a few years ago.

What he told me on the side, however, are long gone the years where the Caisse made huge active bets on currencies. "It's just not worth it and you can lose a lot of money and jobs doing what we used to do." Now it's more strategic and long term focus with some dynamic hedging.

The Value of Gold as a Strategic Asset Class

Tuesday, September 24, 2019, 2:45 PM - 3:15 PM

There is value in considering an allocation in gold in your institutional portfolio. Discover what leading experts will show you:

• The strategic case for gold - and the outlook for 2019 to 2020
• Gold's long-term performance versus traditional asset classes
• How investors are incorporating gold into their portfolios today
• Improving risk-adjusted returned in volatile markets

Speaker: Bobby Eng, Vice President, Head of SPDR ETFs Canada - State Street Global Advisors
Speaker: George Milling-Stanley, Vice President, Head of Gold Strategy - State Street Global Advisors
Speaker: Juan Carlos Artigas, Director, Investment Research - World Gold Council

Synopsis: This was actually the one presentation I was ready to skip but I am glad I stayed to listen to it. State Street presented an interesting analysis on why a 10% allocation to their gold ETF (GLD) is optimal and hedges against inflation and deflation risks (doesn't perform well in a disinflationary environment).

According to their analysis, a 10% allocation to the GLD improves the portfolio Sharpe ratio and returns for gold have been consistent over time.

I believe they said gold futures and ETFs trade $220 billion a day and GLD accounts for only 1% of total trading.

When looking at gold, it's better to use global CPI to understand its dynamics and trading patterns.

George Milling-Stanley said he believes we are "sewing the seeds of future inflation" with all this unconventional monetary polcy. He said Friedman stated inflation is about money supply and velocity and velocity has collapsed for now.

As my blog readers know, I'm not in the inflationista camp. I believe global deflation is coming but it's not around the corner and there will be backups in bond yields here and there but eventually, deflation is headed our way.

They gave a good analysis of GLD and talked about GLDM, a new ETF with lower fees which is base don 1/100 of an ounce as opposed to 1/10th of an ounce like GLD.

As an aside, I brought a copy of James Rickard's new book, Aftermath: Seven Secrets of Wealth Preservation in the Coming Chaos, up to Tremblant. He's way too gloom & doom for me but it's a great read and I highly recommend you take the time to read it even if you don't agree with him. Read the first pages here and you will see, he writes well and knows his stuff but I don't agree with him.

Risk Premia Investing: What is Underneath the Surface? A Closer Look at the Industry Drivers

Tuesday, September 24, 2019, 3:45 PM - 4:15 PM


Factor investing has become mainstream for investors to maximize diversification and uncorrelated returns. The ARP industry faced its first real test in 2018, leaving many wondering if it can really deliver on promises of uncorrelated performance. Understand what drove ARP’s performance from the past 3 years and learn how to avoid common mistakes by institutional investors in deploying factor investments to access sources of diversifying returns.

Speaker: Luc Dumontier, Partner & Head of Factor Investing - La Francaise Investment Solutions

Synopsis: A very interesting technical/ quant discussion on CTAs and factor investing. I highly recommend you reach out to Luc to discuss his findings in detail, he really knows his stuff. I need his slides to show you all his findings but it's well worth talking to him.

The Explosive Power of Enhancing Yields with Emerging Market Opportunities

Tuesday, September 24, 2019, 4:15 PM - 5:00 PM

Although they are more prone to extreme ups and downs, emerging markets as a whole typically grow at a faster pace than developed markets. In 2018, emerging markets expanded at a rate of 4.8% — more than twice the rate of developed markets. Technological advances, GDP growth, and demographic shifts are some of the key drivers of transformative change in emerging markets. But not all opportunities are created equal. How can you help clients tap into this growth story while being mindful of the risks? Hear industry veterans weigh in on this debate - and your investment decisions in this most interesting area will be vastly improved!

Moderator: Emma Radloff, Manager, Public Assets - NAV Canada
Speaker: Eoin Ó hÓgáin. CEO - Power Pacific Investment Management, a part of Sagard China
Speaker: Vito G. Dellerba, CFA, Director, Investments, Sovereign Debt, Fixed Income - Caisse de dépôt et placement du Québec (CDPQ)

Synopsis: Another great panel, Emma did a great job moderating and Vito and Eoin provided a lot of food for thought. I was actually very impressed with Vito Dellerba and later found out he worked at Cordiant Capital before joining the Caisse. He knew the late Carl Otto well, the founder of Cordiant and other investment shops and one of the toughest and most intelligent board of directors PSP has ever known.

Vito focuses on spread over sovereign focusing on emerging markets opportunities in quasi-government corporations (owned at least 50% by governments), securitization of royalty streams, PPPs and more.

He said the five factors of investing in his space are:

1. Interest rate risk
2. Sovereign risk
3. Sponsor or project risk
4. Liquidity premium
5. Complexity premium

They have a mix of internally managed and externally managed funds "across the spectrum, generally absolute return funds."

He said the Caisse focuses on five emerging markets: Brazil, India, China, Columbia and Mexico but his team focuses on all these except China.

They like dislocations where they can fund long term opportunities which need funding. "Some markets have funding opportunities that go out 7 years and then they fall off a cliff. We like those opportunities because we are patient, long-term capital."

He said they are "very methodical in their approach and leverage off the entire infrastructure of the organization." Due diligence is critical in their process.

He travels a lot to "pitch issuers looking for financing" and meets a lot of CFOs. They have a global network with local knowledge.

Eoin said there is $20 trillion in emerging markets, half of which is in China. "You need a dedicated approach."

Vito warned investors: "Emerging Markets are most complex and heterogeneous markets in the world. You need to respect that and use specialist managers."

He said ESG is used throughout their process and gave the example of Brazil where it's known "corruption is rampant."

Capturing the Strength and Momentum in Private Debt and Alternative Credit Growth: The Remarkable Achievements of a Small Asset Class

Wednesday, September 25, 2019, 9:15 AM - 10:15 AM

There are enormous opportunities to be found in private debt and alternative credit growth. In 2018, assets under management globally by private debt funds reached $638 billion, with aggregate capital raised surpassing the $110 billion mark. Hear about the latest developments in asset-back debt, direct lending, and alternative credit. Access the full spectrum of credit instruments to deliver absolute performance while limiting your duration risk and interest rate sensitivity.

Moderator: Vishnu Mohanan, Manager, Private Investments - Halifax Regional Municipality Pension Plan

Speakers:
Theresa Shutt, Chief Investment Officer - Fiera Private Debt
Ian Fowler, Co-Head North America Global Private Finance & President, Barings BDC - Barings
Larry Zimmerman, Managing Director, Corporate Credit, Benefit Street Partners

Synopsis: This morning, we all listened to an interesting panel on private debt, one of the hottest asset classes right now. I came a tad late when they were going over the pros and cons of sponsored versus non-sponsored deals.

In non-sponsored deals, you rely on third party data on quality of earnings and other data.

Theresa Shutt said they focus on corporate credit and companies with audited statements. "If there is trouble, we want to see how management behaves in a downturn, we have good covenants."

She said to ask private debt managers a simple question: "Tell me about your bad months." She added: "Our recovery has been quite high".

I like that, asked Theresa to write a guest comment for my blog on this hot asset class.

Ian Fowler focused a lot of alignment of interests and said to look at two things:

1. Target return
2.  Fee structure

1. Purpose risk analysis to determine liquidity constraints
2. Unsmoothing methodology to determine asset allocation
3. Path forward model to forecast expected returns

1. Adopted a hybrid DB/ DC model where if returns are over 7.5%, you're ok in DB model
2. Made ARC payments, made sure budget surpluses are used to pay pension payments
3. And most importantly, adopted conditional inflation protection where COLAs are partially lowered if the return target is not met (based 1/2 on CPi and 1/2 on return target).

• Why has sustainable finance become such a front-burner issue across the global financial community? 
• What are the 5 key trends changing the ESG landscape in 2019 to 2020?
• How are institutional investors - both large and small alike - successfully Integrating ESG considerations into their portfolios?
• How ESG considerations can mitigate risk - and provide higher ROI?
• What does every institutional investor need to do to understand and integrate ESG into its portfolio?
• The unique sustainable bond issue by Concordia University- and what every investor in Canada can learn from this ground-breaking development?

1. Governance: increasing standards you expect from managers incorporating ESG
2. Allocation: increasing impact investing diversifying based on all 17 UN principles, not just climate change.

The defined benefit (DB) pension model was created more than a century ago. During much of its early years the management and administration of these plans was in the hands of the insurance industry. Pension contributions by a company and its employees were used to purchase insurance policies – essentially deferred group annuity contracts. When an employee retired the insurance company would pay their pension out of the general assets of the company.

It was not until the mid-1960s that trust companies together with the money management industry came up with the idea of a pension plan sponsor establishing a trust, i.e. a “pension fund”, separate from the assets of the company. Pension contributions would go into the trust and be invested substantially in equities, as well as in bonds. Investment managers argued that by investing in equities, the pension fund would be able to earn a higher rate of return, which would then result in lower contributions and lead to increased earnings for the corporation. The idea caught on like wildfire. Today the assets of almost every DB plan – other than those which have been closed to new entrants – are invested substantially in equities.

In the early 1970s, economists took a look at the way pension funds were being invested, and they quickly came to the conclusion that it did not make a lot of sense from an economic or corporate finance perspective. It is reasonable, of course, to expect that equities, being riskier and more volatile than bonds, will on average over the long run provide a higher return than bonds, and that this should result in lower required pension contributions. But in the short to medium term a substantial investment of the pension fund in equities can also lead to substantial fluctuation in the funded status of the pension plan, requiring large, unanticipated increases in contributions and creating significant risk to the corporate cash flow and bottom line. The economists argued that not only would this not enhance shareholder value – because knowledgeable analysts and investors would simply apply a higher discount rate to the expected stream of higher but more volatile future earnings of the company – but rather it would actually decrease shareholder value. Why? Because the company would be taking on all of the risk of pension deficits, and be forced to make additional contributions, most likely in bad economic/market times, yet would enjoy only limited access to the rewards of pension surpluses in good times, by taking contribution holidays to the extent permitted. The company would not be able to withdraw surplus assets out of the fund to use for its own purposes.

What many companies, of course, have chosen to do is to fritter away those temporary “snapshot” picture of surpluses in good times to further enhance the benefits to plan members, leaving a subsequent generation of company management and shareholders to deal with the consequences of a richer and less affordable DB plan.

In other words, even if the strategy is successful – and I cannot stress this strongly enough – even if it results in lower pension contributions and higher corporate earnings in the long run, investing the assets of the pension fund in equities destroys shareholder value. In fact, if the company wanted to take the risk of investing in the equity market, it would be better off doing so by using its own corporate assets – taking out a bank loan or doing a bond issue, and investing the proceeds in equities. And if no company could or would see any justification for doing that, it should not see any justification for investing the assets of the pension fund in equities.

As far as economists are concerned, this is an issue that was settled a long time ago. All economists, across the ideological spectrum from liberal to conservative, agree that the assets of a DB fund should be invested in some combination of nominal and real return bonds in a way that maximizes, as far as possible, the matching of pension assets and liabilities and minimizes any fluctuation in the funded status of the plan.

The DB pension model has failed not because the model itself is inherently defective – in fact, it is a far better and cheaper way of providing employee pensions than the DC model – but because of the way in which the assets funding those DB obligations have been invested. Why is it that earlier in this century, DB pension plans went through two episodes of once-in-a-lifetime “perfect storms” within a decade, in which their funded status declined 30%-40% each time, whereas the insurance industry, with very similar long-term obligations in their annuity business, sailed through unscathed? Surely there is a lesson here for the pension industry.

Sun Life also has a bias to push companies to DC plans as I am pretty sure that they offer services to DC pensions, including asset management, administration, etc.

The author mentions that $158B in contributions were made. But he doesn't mention the nature of these contributions. They could have been because returns were below expectations but they also likely included contributions required to fund future service earned beyond 1999 and also changes to mortality tables as people are living longer than actuaries assumed 20 years ago. That does not indicate a problem with DB pensions, it just means that this risk was socialized to all members in the plan rather than each member having to bear this risk on her/his own.

Unless we see that $158B broken down then I don't think we can actually say that this proves the failure of DB corporate pensions.

But I do agree with him that the premise of a DB plan is somewhat flawed as you can think of it as a swap where the short leg is pension payments (which is essentially a long bond) and the long leg is the asset portfolio which has primarily been equities plus bonds and the bonds in the asset portfolio defease part of the pension liability. To make a long story short, the company is essentially issuing debt to invest in the stock market. As a shareholder of that company is that something that you should encourage? Probably not, but I think that DB pension are good for society as a whole as we need to make them work.

Here are some points for your consideration.

• The failure of corporate DB plans is best measured by the disappearance of DB plans in the private sector. Why do private sector DB plans disappear? Because, properly priced, employees don't want them and, improperly priced, shareholders don't want them. There is no value proposition for either employees or shareholders with interest rates this low (average 30 year RRB rate during the last 10 years = 0.7%). This isn't a Canadian phenomenon. It's a private sector phenomenon, at least in the developed world.
• I agree with Wayne's observation that traditional DB plans are, from a financial perspective, like employers issuing debt to their employees and investing in the stock market (or, more generally, in risk assets). To understand the consequences you must first specify the interest rate at which the debt is issued.
• In the private sector the debt is issued at AA corporate bond rates - say 3%. The pensions are quite expensive. Shareholders are not unhappy to see the corporation borrowing money from employees at 3%. However employees don't want to see their retirement savings earning a 3% rate of of return. Employees want higher returns at low risk. Shareholders don't want to borrow at above-market interest rates. The obvious compromise - replace the DB plan with a DC plan where employees decide how much risk they are prepared to take in pursuit of higher returns, and live with the consequences. This is as it should be.
• Contrast this with public sector DB plans - your gold standard. In the public sector the debt is issued at a 6% rate, the rate of return that the pension fund expects to earn on a portfolio heavily invested in risk assets. This is a great deal for employees... in a world where safe investments earn a 3% return they are guaranteed a 6% return. It's not such a great deal for taxpayers, who question the wisdom of issuing debt to employees at 6% when the government could just as easily borrow from the public at 3%, or less. Of course, the substance of the transaction is never shared with taxpayers.
• Public Sector DB plans do a great job for members and a poor job for taxpayers whose interests are ignored by those who are supposed to represent them. There is no magic here... just bad accounting and poor governance.

P.S. - I know that the story is a little more complicated for jointly sponsored plans but it comes down to the same thing. The plans succeed because taxpayers involuntarily subsidize members but in JSPPs, the subsidies are smaller.

This is an important debate. Quantifying risk I think is at the cornerstone of this conversation. The assertion that pension plans are invested in “risk” assets is routed in the concept of the near term and shorter term implications but I would humbly submit that it is the outcome of pooling across time that greatly reduces risk that is so simple and yet so misunderstood. Risk assets over 30 years will pay you a return with near certainty, even in Japan you would have done fine if well managed and risk balanced, I just don’t know which of the thirty years will be good and which will be poor therefore if I retire at the wrong time as an individual I might be in real trouble so why take that very real risk.

Secondly how much I need (how long will I live) is much easier to manage as a group than as an individual. It is the incredible and certain risk reduction (together we have much greater certainty) that pensions offer that underpins their use in our society (you would have to believe that risk assets of all sorts everywhere will no longer over decades pay a return for this not to be true and this has not been the case for all of human history). Putting these concepts together as a pooled saver you will with certainty earn a return over time and you can target your correct risk level as you know how much you actually need. The pension good or bad debate viewed through the lens of the short term is confusing, however viewed through the certainty of returns over the long term and in my view it is only the partisan that would not want to benefit by being a part of a well managed pooled saving strategy.

Just between you and I, do you have a reason for believing that pensions guaranteed by the federal government should be valued by discounting at something other than government bond interest rates, or do you just like the answer you get when you use higher rates?

FYI:

• If the federal government promises to pay someone $100 in 30 years and does not fund it, the government values the obligation by discounting at the government bond interest rate.
• If the federal government promises to pay someone $100 in 30 years and funds it with a 30 year zero-coupon bond, the government values the obligation by discounting at the government bond interest rate.
• If the federal government issues a 30 year zero-coupon bond at par, it values the obligation at the par value of the bond plus accrued interest, which equals the present value of the principal and interest payments at the government bond interest rate.
• If an employee leaves the federal government and elects to transfer the lump sum value of their pension to a personal RRSP, the lump sum is calculated by discounting the vested deferred pension at the government bond interest rate (plus about 1% according to the relevant standards/regulations).
• BUT, if the federal government promises to pay a public servant $100 in 30 years and funds it with a portfolio of risky assets that someone believes might earn a 6% return, then the government values the obligation using 6%, thereby cutting the reported value of the obligation in half even though the obligation itself - to pay $100 in 30 years - is unaffected by the government's funding and investment decisions. The obligation is, and remains, the responsibility of the federal government.

It's fine to say that you believe that federal employee pensions should be discounted at rates much higher than government bond rates, but what is the justification? Which, if any, of the five obligations described above should be valued at government bond interest rates? Which should be valued using a different interest rate... and why?

This is a big discussion and gets into MMT theory. My thinking is simple, a federal public pension plan isn't a corporation and therefore shouldn't be required to discount at the sovereign risk-free rate or the AA corporate bond rate.

Also, this whole debate that the members get all the rewards and bear none of the risk is misconstrued as society gets rewarded too when more people retire with certainty of income.

But it's a much wider discussion, your points are valid but IMHO, misconstrued.

Basically you are saying that corporations should be required to behave with integrity while governments invent any pension numbers they want. Discount at 3% or 6% or 9% or 12%...just pick the answer you want and let that dictate your discount rate!

It is true that society benefits when retired people have certainty of income but certainty of income is expensive. Why should society pay for the certainty of income enjoyed by federal public servants if the benefits flow primarily to federal public servants with only some small residual trickling down to the general population?

The government could guarantee all Canadians a 6% return on their retirement savings by offering to sell special non transferable bonds yielding 6% to those who wish to buy them with their RRSPs. The proceeds could then be turned over to the PSPIB, or some similar government agency, to work its magic. Then all Canadians, not just public servants, could have a risk free 6% return on their retirement savings. Why doesn't this happen? First, because it is ridiculous, but no more ridiculous than the federal government's employee pensions. Second, because the public service is quite prepared to have the public guarantee public service pensions, heroically volunteering to accept guaranteed incomes for the good of the Canadian economy. However the public service has no interest in picking up the public's investment risk or guaranteeing the public's pensions. If you don't believe me, look at the CPP. The federal government provides no guarantee and takes no risk. All the money comes from contributors and all the risk is borne by contributors or beneficiaries. That's not how pension plans covering government employees work.

I’m saying corporations are not governments, they’re private entities that cannot emit their currency to cover expenses so it’s ridiculous to treat governments like corporations or households. It has nothing to do with integrity!

You write: “The government could guarantee all Canadians a 6% return on their retirement savings by offering to sell special non transferrable bonds yielding 6% to those who wish to buy them with their RRSPs. The proceeds could then be turned over to the PSPIB, or some similar government agency, to work its magic.”

This argues in favour of my proposal to create a federally backed pension to properly manage corporate DB pensions using the governance model and investment strategy that Canada’s large public DB plans have adopted (as well as their shared risk model).

To my knowledge, CPP isn’t contingent on investment returns of CPPIB. I’m all for enhancing the CPP even if it’s not the best idea for the poorest Canadians.

I’d like to revisit this debate next week and take it public.

I fully agree with you and Wayne Kozun. Large DB pension plan funds invested on a long term basis in a properly diversified portfolio should not hesitate using 6% as the assumed average long term yield. Low interest rates normally play a very small role in such diversified funds.

This is a very academic argument and is a bit like comparing apples and oranges.

The first three examples are unfunded future liabilities of the federal government, so discounting them at the government borrowing rate is appropriate.

The third point about how lump sum transfers are calculated it another whole debate because the methodology creates a windfall for people leaving the plan. The logic behind this which was developed by the Canadian Institute of Actuaries (of which Malcolm was a senior member at the time) is that the amount calculated is based on what it would cost that person leaving to buy an annuity which would replicate their pension payment. This is ridiculous methodology because people pay into the plan based on the going concern discount rate and then when they leave the plan the money gets withdrawn at a much lower rate which results in them taking out much more money than they put in. And the money doesn’t come out of thin air, it comes from other plan members. If all members did this virtually every plan would run out of money. The point is, this is not a comparable situation at all.

It would only be appropriate to discount the future pension obligation if it were an unfunded liability of the federal government.

The difference with a pension plan is that the future obligation is funded through regular contributions from the employees and the employer. The question you are trying to answer is “how much money do we need to set aside to meet the obligation given a reasonable set of assumptions?” If you use any discount rate other than the best estimate of future returns on the portfolio you are going to overfund or underfund the obligation which brings up a whole series of intergenerational fairness issues.

Also, when we do valuations of companies we invest in, we don’t discount future cash flows using government bond yields, we us an estimate of the entire cost of capital. This is a standard market convention. If you applied a risk free rate – the government bond yield, you would massively overvalue the company. In the same way, if you used the risk free rate to discount the liabilities you massively overstate their value.

I would also say that this whole argument misses the point which is “what is the most efficient way to accumulate savings to fund retirements?” The answer is clearly DB plans. Pooling creates significant synergies that allow well run pension plans to produce a better outcome for the same cost or the same outcome at a lower cost.

For some reason Malcolm has had a "hate" on for DB pensions for a long time, which is strange since they fed him for many years.

I don't necessarily disagree with him about using government bond rates to discount pensions. It does seem silly that you can increase the discount rate used, and thereby decrease the pension liability, by changing your asset mix to a more aggressive mix.

But I don't think this is a huge issue in Canada as the pension plans tend to be rather conservative in their discount rates. This data is a couple of years old but I collected data on plans and here is what they were using for discount rates - OTPP 4.8%, HOOPP 5.5%, OMERS 6%, OP Trust 5.6%, CAAT 5.6%, OPB 5.95%, U of T 5.75%

The real issue is in the US. Remember how in Dec 2016 CalPERS voted to lower their discount rate from 7.5% to 7% over three years. 7% is still WAY too high, but this caused a huge outcry from California city governments, etc, as it increased their pension contributions. Using this discount rate CalPERS is about 70% funded - which is a very deep hole. Change their discount rate to something more realistic, say 5%, and the funded status would likely be 50%. (If you assume that assets are 70 and liabilities are 100 and if the discount rate drops by 2% with a liability duration of 20 then liabilities go up to 140 - hence 50% funded.) There is no way that you get from 50% funded to fully funded unless you have 10%+ returns for a decade or more, lots of inflation (and no indexing on liabilities) or you break the pension promise.

Thanks Wayne, I agree, the real issue is the US where chronically underfunded plans are one crisis away from insolvency. I do take issue with Malcolm’s insistence on using the government bond yield to discount liabilities, I think it’s silly to treat federally or provincially backed pensions and treat them like private corporations. Anyway, as you state, Canadian plans use very conservative discount rates.

But then how do you come up with a discount rate? Even for a provincial government plan? Should you use the Ontario Provincial bond rate as your discount rate for OTPP, HOOPP, OMERS, OPB, etc? If so then maybe the province should try to sewer its credit rating as increasing the spread over Canadas would really help the funded status of provincial plans. Leo de Bever and I used to joke that we should move OTPP to Newfoundland and we would move the plan to a huge surplus as the discount rate would increase!

If the shortfall risk is shared I would agree. The other practical issue is how long one has from a regulation respective to accumulate surpluses and and work out deficiencies.

Having flexibility to suspend indexation helps to smooth out the bumps. Given all of that, I would think that something like 4% makes more sense.

In discussing these things we make the assumption that the investment and economic environment and their associated risks will stay the same.

I am concerned that a more oligopolistic economic environment and the resulting concentration of profit and wealth will eventually result in a backlash that goes beyond fixing the real issues, which could reduce return on listed equity for a while, never mind a cyclical reset.

Have been busier than in any of my 8 formal job incarnations. In my 9th incarnation I am working to help along (as an advisor/investor/ board member) a number of innovative ideas that I see as desirable and profitable:

1. Nauticol, a methanol/fertilizer company with low emissions, water use and capital intensity.
2. Sulvaris, which makes slow-release fertilizer, and could lead the way to much more efficient sewage treatment.
3. Northern Nations, a first Nation co-operative in BC that is trying to forge JVs with non-indigenous nations to create employment and make life in the North more economically viable
4. Sustainable Development Technology Corporation, a Federal program to fund innovation
5. Vertical farming, and greenhouse agriculture production using waste heat through various channels.

Canada has a lot of people with great ideas. We have trouble quickly turning the viable ideas into products. There are lots of reasons for that, including lack of funding and resistance from the status quo.

So, life is good. I describe what I am doing as 'working with 70-year-olds to convince 30-year-olds not to behave like the typical 70-year-old.'

Canada needs to change fast, to stay internationally competitive. We are reasonably comfortable, but we cannot take that as a given. It does not help that polarized policy by soundbite is too simplistic to address real issues.

I have found 'kindred spirits', whom I have come to respect, because they believe that doing well and doing good can be profitable.

Must say that I am concerned that the Canadian pension funds are not as active in pursuing truly long-term innovative strategies as I wished they were. Lots of reasons for that too, not the least of which that benchmarks that judge long-term strategies by short-term outcomes can be dangerous to your career. Fear of failure is understandable, but as Gretsky said: I missed 100% of shots I never took. If you never failed at anything, you probably did not try much that was meaningful.

I’m glad to see young people in the UK jumping on the pension bandwagon. I’ve been harping on pension poverty for over a decade. Importantly, and the author nails it here, pension poverty disproportionately and ruthlessly strikes more women than men, so it does discriminate based on gender: “It is astounding that a woman that retires today will have a pension pot that is 1/3 the size of a man. This is mostly due to the numerous breaks in employment that a woman might ‘enjoy’ through child-rearing and caring for elderly relatives, typically later in their career. This is exacerbated by the gender pay gap which still exists across a lot of sectors.”

You are wrong to assume that the CPP is unaffected by investment returns. If the returns are poor the 9.9% contribution rate cannot be sustained. If the Chief Actuary reaches this conclusion the federal government and the provinces must decide how to adjust contribution rates and/or benefits to address the shortfall. There is a default mechanism (higher contributions, less indexing) if they can't agree. The federal government does not guaranty the benefits nor does it acknowledge any liability for funding shortfalls. In other words, the CPP is not a DB plan. It is a target benefit plan.

"Risk assets over 30 years will pay you a return with near certainty..."

"Large DB pension plan funds invested on a long term basis in a properly diversified portfolio should not hesitate using 6% as the assumed average long term yield. Low interest rates normally play a very small role in such diversified funds."

"The question you are trying to answer is “how much money do we need to set aside to meet the obligation given a reasonable set of assumptions?” If you use any discount rate other than the best estimate of future returns on the portfolio you are going to overfund or underfund the obligation which brings up a whole series of intergenerational fairness issues."

"But I don't think this is a huge issue in Canada as the pension plans tend to be rather conservative in their discount rates. This data is a couple of years old but I collected data on plans and here is what they were using for discount rates - OTPP 4.8%, HOOPP 5.5%, OMERS 6%, OP Trust 5.6%, CAAT 5.6%, OPB 5.95%, U of T 5.75%"

These might be important points if I was advocating the use of government bond interest rates to fund public sector pension plans. I am not now, nor have I ever, advocated this. I have criticized public sector employers for the way they account for the cost of pensions. I have criticized public sector employers for the way they price pensions as an element of employee compensation. I have criticized the injustice of giving public employees 100% of the risk premium when the public, not the plan members, bears most of the risk. I have, on occasion, criticized plans for ignoring the heroic reduction in interest rates during the last 15 years in setting their return expectations, but I suggested only that they lower their expectations, not that they adopt government bond rates. The following quotation comes from the introduction to the report Philip Cross and I wrote for the Fraser Institute last year.

"Canada’s public sector DB plans have done a superb job for their members. The plans are capably and efficiently administered by boards operating at arm’s length from government. These boards faithfully represent the interests of plan members. They collect contributions, maintain records, pay pensions, and manage investments. Their practices, as described in the World Bank study, are exemplary.

Canada’s public sector DB plans deliver extraordinary pensions at an affordable price. They are well funded. Their investments perform well relative to other pension plans and relative to the benchmarks they set for themselves. They operate efficiently by exploiting economies of scale. Most importantly, they enjoy the confidence and support of their members."

Our criticism is the use of a discount rate equal to the expected return on assets to put a price on the pensions that employees earn as part of their compensation. Using this discount rate, as opposed to the yield on long term government bonds, cuts the estimated cost of the pension in half. By so doing, it distributes 100% of the expected reward for risk taking to members who bear at most half, and in some instances none, of the risk. I thank Wayne, Michael, Bernard, Jim and Leo for their comments. They are welcome to their views of how one should fund public sector pension plans and how one should estimate the future returns on a pension fund. These things have nothing to do with my criticism of public sector pension plans.

Let me repeat my criticism as it relates to the most egregious abuser, the federal government. The pension fund managed by the PSPIB is not a trust fund. The plan members have no right to the assets in, or the returns on, the pension fund. The pensions are not paid from the pension fund. Basically, it is public money set aside in a "shoe box". The directors have a statutory duty to represent the interests of plan members in setting investment policy but the benefits owed to plan members are not influenced in any way by the performance of the pension fund. The benefits are a statutory obligation of the federal government. What then is the purpose of the pension fund? It is to allow the federal government to cut the reported cost of the pension plan in half by giving the chief actuary an excuse for using a 6% (4% real) interest rate, which he or she does. The reduced "price" helps only members, who are paid more and contribute less. Consequently the reward for risk taking goes to the members while the public bears the risk. Perhaps someone could comment on this.

I don't hate public sector pension plans. I hate the way they are being used.

Finally, let me comment on Jim's attempt to compare the valuation of guaranteed pensions to the valuation of risky investments.

"Also, when we do valuations of companies we invest in, we don’t discount future cash flows using government bond yields, we us an estimate of the entire cost of capital. This is a standard market convention. If you applied a risk free rate – the government bond yield, you would massively overvalue the company. In the same way, if you used the risk free rate to discount the liabilities you massively overstate their value."

I am not advocating the use of government bond rates to value risky investments. I advocate the use of government bond rates to value safe pensions the cost of which is guaranteed by the public. If a pension is tied to fund performance, I have no objection to using the expected fund return to price the benefit because the pensioner, not the taxpayer, is bearing the risk. Jim, on the other hand, wants to price pensions using the fund rate of return no matter how much of the risk is borne by the public. He believes that HOOPP deserves to be rewarded for taking investment risk... that it is his job to make sure that HOOPP is rewarded for taking investment risk. Then he rejects any suggestion that the public should be rewarded for the risk that it bears. This, not the choice of a funding discount rate, is where we disagree.

Contrary to what Malcolm points out below, the CPP is not a target benefit plan because in case of underperforming investments, only the indexation might be reduced, not whatsoever the accrued benefits.

Between 2000 and 2010 a number of public employee pension plans in Ontario made the indexation of benefits contingent on the funded status of the plans. In each case, the contingent indexation only applies to initial benefits based on service after contingent indexation was introduced. Thanks to 1997 amendments to the CPP, the indexation of base CPP benefits can be eliminated if the base benefits fail to meet their required financial test and finance ministers cannot agree to correct the financial problems through increased contributions.The elimination of indexation does not distinguish between base benefits earned before and after the 1997 amendments to the Plan. All indexation is eliminated until the financial problems are corrected

The newly created additional benefits have a different financial test. If they fail their test, accrued benefits not yet in pay and indexation will both be reduced by equal degree.

Contrary to what Bob Baldwin states above, the current CPP2 regulations may reduce only benefit indexation in case of CPP2 financial hardship, not the accrued benefits. Besides, it is intended to eventually revise these regulations for possibly the eventual reduction of CPP2 accrued benefits.

In October 2018, the Office of the Chief Actuary (OCA) issued Actuarial Study Number 20, Technical Paper on the Additional Canada Pension Plan Regulations. The purpose of the Report was to explain the new sustainability regulations. The steps to be taken if the Plan does not pass its sustainability test are summarized on page 43 and I present them below:

The benefits in pay are adjusted by reducing indexation for six years following the end of the review period, with resumption to regular indexation thereafter, and benefit multipliers lower than 1 are applied to new benefits for all beneficiaries who start their benefit after the end of the review period.  

In February of 2019 the former Chief Actuary, Jean Claude Menard summarized the default adjustments in a presentation to the CD Howe Pension Policy Council. The contents of his slide are below. 

Main adjustment mechanisms

• Adjusting benefits of current beneficiaries 
• Modify indexation of benefits in pay for a specified period (6+ years) 
• Limits on indexation adjustment: 60% -200% of CPI • Benefits are not reduced from one year to the next
• Adjusting benefits of future beneficiaries (current contributors) • Multiplying starting amount by “benefit multiplier” (depends on the year of uptake)
• Benefit multiplier is aligned with the value of extra/forgone indexation 
• Increasing additional contribution rates – last resort in the case of deficit

The documents I cited are available on the website of the OCA.

Bernard is right that the regulations are not yet in force. The federal government has adopted them but is still awaiting the necessary degree of provincial approval.

We can note however, that when CPP benefit reductions were introduced in legislation passed in 1997, most of the reductions applied to benefit calculations starting in 1998. Accrued benefits that had not begun to be paid were not protected. To my knowledge this is the only actual example of a benefit reduction in the history of the CPP.

• On CPP benefit reductions, much has been written about what the CPP can and cannot do. Is it not clear that, with the support of the provinces, the federal government can amend the legislation to change the benefits? The benefits have been improved on many occasions. Did we not reduce the pensions of those retiring after the mid 1990s by changing from 25% of the 3-year average YMPE to 25% of the 5-year-average YMPE? Can we not increase the age at which people draw full benefits from 65 to something greater? I suspect that we can do almost anything that is sensible, even if it is not what the plan administrators imagine we will do.
• On the need for better pension plans in the private sector, what Jim seeks (see below) is essentially what Keith Ambachtsheer proposed 10 years ago - the Canada Supplementary Pension Plan (CSPP). The CSPP was set aside when the federal government decided to increase the Canada Pension Plan instead. The new, improved Canada Pension Plan is now being implemented. As is often the case in Canada, the improvements are deemed inadequate as soon as they are introduced. Then the search begins for another, even better, government program to supplement all the previous programs (OAS, GIS, the original CPP, the CPP expansion, RPPs, RRSPs, RRIFs, TFSAs, PRPPs, etc). You would think that we had a terrible problem with senior poverty in this country but I haven't seen anything suggesting that today's seniors have a materially lower standard of living than working Canadians. Yes, some seniors are poor... but many working age Canadians are poor as well.

I agree with Malcolm in that it is inappropriate for federal employee pensions to be a statutory obligation of the federal government. This setup is out of touch with the current reality.

We have drifted away from the original topic of the viability of corporate DB plans. There are many reasons why corporations are no longer offering DB plans. Accounting, the nature of the workforce being more portable, and the long life nature of pension plans all contribute to this exodus from DB plans. All these factors probably make this an unstoppable trend.

There is a significant body of evidence that shows that people are much better off being part of pooled arrangement for retirement savings. What we need to think about is how to come up with a solution that works for employers and keeps employees in DB like arrangements.

I would offer that structures like HOOPP May be where the solution lies.

HOOPP doesn’t only manage the pension plan for employers, we take the obligation away from the employers as well. HOOPP pensions are an obligation of the HOOPP trust fund. They are not guaranteed by the employers or the Province. If HOOPP became underfunded it would be up to our Board to deal with the problem. In this light, under public sector accounting standards HOOPP employers use DC accounting which appropriately reflects the relationship between HOOPP and the employer.

Employees also get the benefits of scale, pooling and risk sharing that come with being part of a plan like HOOPP. Being part of a plan like HOOPP allows members to accumulate a better more secure pension at a lower cost.

We will all be better off if in the end there is a larger pool of pension assets accumulated so that people don’t end up on social welfare in their retirement which is without a doubt the most expensive way to fund people’s retirement.

Also, something that should not be lost as part of this discussion is that the closing of corporate DB plans really is about transferring the risk to the individual and the social welfare system. This is a risk that taxpayers should be worried about.

As members of the federal government’s expert panel on sustainable finance, we recently published our final report on how to mobilize Canada’s financial sector in the transition to a low-carbon, climate-smart economy.

Our recommendations seek to connect the dots between Canada’s climate objectives, its economic ambitions and its investment imperatives. At its essence, if Canada is to meet its long-term environmental and economic objectives, sustainable finance needs to go mainstream.

As stewards of Canadians’ retirement and long-term savings, our role is to promote stability and sustainability. This entails designing portfolios that will respond to evolving climate risks and profiting from new clean growth opportunities over time. Yet, as a whole, climate change remains a fuzzy notion in asset management. Why?

Because market factors need certain economic basics in place to reach mainstream, and we are not there yet on climate risk. These basics define how markets understand, price, measure and manage risk and opportunity. They are essential to sound and informed long-term investment decisions.

We dedicated the second pillar of our report to these Foundations for Market Scale, recommending the following:

1. Issue a statement from the Minister of Finance that the consideration of climate factors is firmly within the remit of fiduciary duty, and consider judicial guidance to that effect. At the market level, we ask government and industry to collaboratively explore a Canadian stewardship code outlining principles for climate risk management.
2. Establish a new Canadian Centre for Climate Information and Analytics as an authoritative, interoperable portal to Canada’s consortia of public and private climate-related and financial data centres. The C3IA will curate user-based data sets and decision tools, bridging the gap between data and intuitive analysis. This is a powerful step and a potential competitive edge for Canada.
3. Implement a mandatory ‘comply-or-explain’ approach for adopting the recommendations of the task force on climate-related financial disclosures in Canada, phased in by organizational size and content complexity. Investors can’t make informed decisions about the security of their investments without knowing their degree of exposure to the costs of climate change.
4. Promote a climate-savvy financial support ecosystem. The financial sector relies on a professional network for specialized business intelligence and consultation. We recommend targeted funding assistance for these businesses to build capacity on key climate themes. For example, we specifically call on the Chartered Professional Accountants of Canada to develop a climate lens for Canadian accounting practices.
5. Embed climate risk into the supervision of the financial system, including monitoring, regulation and legislation. Climate change will have transformative economic impacts and requires close assessment from both a prudential and systemic risk management perspective.
6. Convene a taxonomy technical committee to develop sustainable finance standards for a resource-based economy like Canada. Similar taxonomy efforts are underway around the world, and early precedents have emerged. The rub — most energy- and carbon-reduction initiatives in emissions-intensive sectors fail the existing ‘green test,’ even if their reduction impacts are significant. We recommend designing a ‘transition bond’ to finance these essential activities and introducing a range of temporary fiscal incentives to accelerate the supply and liquidity of these and other ‘green’ fixed income products in Canada. Our asset managers can invest directly in these bonds, use them as a cost-effective debt-financing source for portfolio companies or issue their own.
7. Offer an incentive for Canadians to invest in accredited climate-conscious products through their individual registered retirement saving plans or pension contributions. It would include additional contribution space and a ‘super deduction’ (>100 per cent) for every dollar invested in eligible investments. This would give individual investors a tangible stake in financing the transition to a low-carbon economy.
8. Finally, the asset management community should reflect on its current climate change competency and fill in necessary gaps. Investors have an instrumental role to play in changing the climate change narrative while investing directly to address it. Asset managers should also work collaboratively to engage our country’s largest emitters. Similar global engagements, such as Climate Action 100+, have been successful, but its Canadian coverage is limited.

With the emissions-intensive nature of Canada’s economy, we can’t ignore the challenges that climate change poses to our financial system. Nor can we overlook the immense opportunity for competitive advantage in new, cleaner growth markets and the jobs that advantage could yield. In either case, success will require committed investment, financial ingenuity and leadership — the cornerstones of our world-class financial sector.

Our long-term investors manage trillions of dollars, with assets and influence around the world. How these players navigate the nexus of climate change and institutional investment will influence our country’s transition journey and future economic playing field. We have the opportunity to leverage these institutions’ resources and reach to tackle some of the world’s defining issues in a manner that benefits society and the bottom line.

As a matter of good governance (and business), climate change should be on high on the radar of our boards. It should be core to our investment, governance and risk strategies and an active, non-negotiable conversation topic with portfolio companies, policy-makers, regulators and peers. It is time to take a long view, ask tough questions and invest our way toward a sustainable, resilient and competitive economic future.

Kim Thomassin is executive vice-president of legal affairs and secretariat of the Caisse de dépôt et placement du Québec and Barbara Zvan is chief risk and strategy officer of the Ontario Teachers’ Pension Plan. They are both members of the federal government’s expert panel on sustainable finance.

Special Keynote | Canada's Expert Panel Report on Sustainable Finance: What's In It For Asset Owners?
Tuesday, September 24, 2019, 8:30 AM - 9:30 AM

This special keynote will be of immense and necessary value to every pension fund in Canada — because the future investment portfolios of every single one of them will be affected by it.

In April 2018, the Government of Canada announced the formation of the Expert Panel on Sustainable Finance to consult with Canada’s financial market participants on issues related to sustainable finance. The panel released its final report on June 14, 2019. These findings will significantly impact the investment decisions of every pension plan in Canada.  In this interactive keynote, hear from two of the four members of that panel. They are, as Pension Pulse has noted, two of the most powerful women in Canada’s pension field in an elite club dominated by men.  This is a not-to-be-missed special keynote!

Moderator: Gordon R. Power, Owner & Chief Investment Officer - Earth Capital Ltd;
Speaker: Kim Thomassin, Executive Vice President, Legal & Secretariat - CDPQ
Speaker: Barbara Zvan, Chief Risk & Strategy Officer - Ontario Teachers' Pension Plan

Synopsis: This was the opening presentation and the most important one in terms of material. Gordon Power moderated and Barb and Kim took turns to go over main points from the Final Report of the Expert Panel on Sustainable Finance.

Barb Zvan kicked things off by stating Canada is known for "hockey, maple syrup, and cold winters." We are also known to be big polluters. We are the fourth largest oil and natural gas producer. She also noted Canada is the 2nd highest GHG emitter per capita in the G7.

She said the Canadian financial sector is very concentrated, with 5 big banks, 5 big life insurers and the 8 largest pensions account for 3/4 of the assets.

She noted the complexity of the regulatory system -- the Bank of Canada, OSFI, provincial regulators -- has not made change very easy.

Kim Thomassin discussed the process of writing the Interim and Final Report with over 200 consultations in Canada and abroad, 11 thematic round tables and 57 written submissions:

They then went into the three pillars of the report, focusing on the 15 core recommendations:

I highly suggest you take the time to read the Final Report of the Expert Panel on Sustainable Finance. I asked Barb and Kim to send me some of the main points they wanted me to cover.

Barb was kind enough to send me this:

Some thoughts

• It would be great to set the stage that this is not just an environmental report. This is a finance report written for the finance / investments community.
• Also important to note that finance is not going to solve climate change, but it has a critical role to play in supporting real economy through the transition
• To do so we really need to channel the financial sector expertise, ingenuity, influence towards challenges and opportunities posed by CC
• The report is a PACKAGE of practical & concrete recommendations - addressing both adaptation and mitigation
• We thought of it as a systems approach - multiple things need to happen - by multiple groups - government, companies, investors & citizens

The 3 three themes of the report

• First our environmental and economic aspirations need to become one in the same because ultimately they are indivisible - we need to address climate change and live up to our international commitments to deliver our share of the global effort to reduce GHG emissions, but (and even more so) we also need to address climate change to remain competitive in a world that is increasingly concerned about environmental footprint
• A second theme is that we have some catching up to do, but we think Canada can be among the leaders in the global transition to a low emissions future as a trusted source of climate smart solutions and expertise - important for Canada to position itself as a decision maker rather than simply decision taker in the global market for sustainable products, markets and growth
• Third, if Canada is to realize its environmental and economic goals, sustainable finance needs to go mainstream. Sustainable finance needs to become simply finance.

The 3 pillars noted and the recommendations that you think may be of interest to your readership.

Under Pillar 1 - switching orientation from burdens to opportunity

• Mapping Canada’s climate goals into clear industry competitiveness vision - in short help spell out the the size and horizon of the investment opportunities (I guess you can’t make a link to McKenna’s speech today)
• Additional tax deduction to provide opportunity for Canadians to connect savings to climate objective (also will spur providers who will increase their expertise).

Under Pillar 2 - building the foundations

• Data & Insights - most pervasive issue across sectors. Biggest challenge, data & translation of data from climate insights to financial and business insights - thus recommendation to create a hub - Canadian Centre for Climate Information and Analytics. You may want to insert Joy’s point re not waiting for perfect data - it is a valid one.
• TCFD - ultimately better information and insights will support better decision making, better pricing of risk. But another benefit of TCFD is that is will spur organization focus. Also an opportunity to change the conversation in some key sectors. We recommended a comply and explain approach, ensure implementation is paced and staged for complexity and size of firm, consideration of safe harbour rule re scenarios when a thoughtful approach has been taken.
• Fiduciary Duty - really about ensuring clarity that climate change consideration are aligned with an investor’s fiduciary duty. We also note in our report that Canada should create a stewardship code like many other regions.
• Ecosystem - in addition to ensure that the experts, that many investors rely on, accelerate their learning and engagement, we did note our support for CPA to look at climate considerations in fair value of an asset.
• Regulation and Supervision - first it is great that Bank of Canada has taken first step and joined the Network for Greening the Financial System. We did note that we need more clarity from regulators on their role in the oversight of climate change. Also for them to support financial innovation.

Pillar 3 - specific products and markets

• Supportive Of Transition bonds to help access the deepest, pool of capital (fixed income market). Context that many of the green taxonomy (e.g. Europe) is based on what they need to do to become Green. Canada will have other needs not covered. Thus where we saw transition taxonomy fit in, an opportunity for Canada to lead. Assuming it is implemented, it is another way for a company to illustrate its commitment to transitioning.
• CleanTeach, Oil & Gas, Retrofit, Infra, Electricity - not sure how much detail you want to go into here, but the recommendations were all targeted to what we believed was holding back that specific market - some recommendations focused on removing barriers, creating new groups to fill in a gap (e.g. green bank) or changes need to have a supportive policy environment and ability to attract the capital needed (e.g. securitization in real estate, pipeline in Infrastructure etc).
• Asset Management - a key recommendation was for asset managers to assess their internal capabilities - as I noted, this could be around education (board or teams), thinking about the governance process, skills needed, tools already available that can be utilize in your investment process (whether to decide when to buy/hold a position but also while you own it (e.g. engagement and voting)). Commitment to TCFD for their own organizations as it will spur organizational focus as well as supporting initiatives that is asking for enhanced climate change disclosures by companies. This assessment would be specific for each company. They could also help by writing to government and saying they are supportive of the recommendations! 

For her part, Kim sent me a few key takeaways:

The role of financial markets in driving this change/transition has yet to be fully leveraged.

While finance alone is not going to solve climate change, it has a critical role to play in supporting the real economy and foster innovation thru the transition.

Our goal and wish is that sustainable finance in a short term is purely and merely finance.

One thing I did not stress enough was how the consumer preferences and behaviors are relevant - indeed, they are increasingly looking for services and products with a smaller environmental footprint. We (long term investors) feel that climate-smart innovations constitute massive global market opportunities and that they will yield high quality jobs.

Also, how both CDPQ and Teachers' are integrating sustainability into their investment strategy. As long-term global investors, we know that our performance will only be as sustainable as the world in which we invest.

At the end of their presentation, I asked them why they didn't recommend that all of Canada's large asset managers adopt hard targets on addressing climate change.

Barb noted "regulatory complexity" made it hard to make such a recommendation and that it's up to each organization to tackle this issue on their own.

Kim noted that the Caisse has met and exceeded its targets which are laid out in its 2018 Stewardship Investing Report. She went over these four pillars:

.

It was nice to see you at CAIP earlier this week. Kim & I have another important initiative milestone that we wanted to highlight to you. A group of 12 institutional investors (representing over $5T USD) - known as Investor Leadership Network (www.investorleadershipnetwork.org) came together and created a TCFD handbook about our learnings as we worked on our TCFD reporting. We are hoping that other institutional investors will benefit from our diverse approaches taken, the challenges faced, and the reasons behind the choices we made.

We launched this handbook this week during climate week at an event at the UN. Please feel free to share this handbook with your network. An overview of the content included in the handbook can be found here.

I hope you find this handbook to be a valuable resource. Please let me know if you have any questions or wish to discuss.

To mark #ClimateWeekNYC, we are releasing a comprehensive report on implementing recommendations from the TCFD. Our members have collaborated to offer this behind-the-scenes view of experiences and lessons learned #ClimateChangehttps://t.co/LDxAJG9P4Ppic.twitter.com/b7GfdVcI2Y

— Investor Leadership Network (@ILNinfo) September 26, 2019

Chief Risk & Strategy Officer Barb Zvan introduced the @ILNinfo report on implementing recommendations from the TCFD yesterday at the @UN. We’re proud to support this important initiative. Learn more: https://t.co/E05tGqF6Cm#climateweekpic.twitter.com/ttIauAYyAb

— OTPP (@OtppInfo) September 27, 2019

“The Trillion Dollar Shift”: 5 Key Trends Changing the ESG Investing Landscape in 2019 - 2020

Wednesday, September 25, 2019, 11:00 AM - 12:05 PM

The “Trillion Dollar Shift” is the winner of the Gold Axiom Business Book Award for 2019. And for good reason: natural disasters triggered by climate change have doubled since the 1980s, violence and armed conflict now cost more than 13% of GDP, social inequality and youth unemployment is worsening around the world and climate change threatens the global population with tremendous environmental and social problems. Opportunities now abound for business and capital to unlock markets which offer endless potential for profit while working towards sustainable development goals. Astute institutional investors realize this is the way of the future — and that ESG is an essential component of every investment decision. In this session, learn:

• Why has sustainable finance become such a front-burner issue across the global financial community? 
• What are the 5 key trends changing the ESG landscape in 2019 to 2020?
• How are institutional investors - both large and small alike - successfully Integrating ESG considerations into their portfolios?
• How ESG considerations can mitigate risk - and provide higher ROI?
• What does every institutional investor need to do to understand and integrate ESG into its portfolio?
• The unique sustainable bond issue by Concordia University- and what every investor in Canada can learn from this ground-breaking development?

Moderator: Deborah Ng, Director, Strategy & Risk - Ontario Teachers' Pension Plan
Speaker: Marc Gauthier, Treasurer & Investment Officer - Concordia University
Speaker: Erica Barbosa, Director of Solutions Finance - The J. W. McConnell Family Foundation
Speaker: Katharine Preston, VP, Sustainable Investing - OMERS
Speaker: Hannah Skeates, Global Head of Environmental, Social & Governance - Wells Fargo Asset Management

Synopsis: Lastly, the big panel discussion on the trillion dollar shift moderated by Deborah Ng of Ontario Teachers'. It was the first time I met Deborah and Katherine Preston and was extremely impressed, they are both super nice and very dedicated and smart professionals.

I was also impressed with Marc Gauthier who spoke eloquently about impact investing and governance. Hannah Skeates also raised great points but I didn't get to chat with her befor eor after the panel discussion.

Katharine began by stating OMERS decided to take sustainable investing seriously because it realized it represents a major headline risk and there is a cultural shift going on driven by millennials and Gen Zers.

Marc Gauthier said "divesting is backward looking" and sustainable investing is forward looking. He talked about "sustainable investing bonds versus green bonds but said the market wasn't there yet".

Katharine said the traditional approach to sustainable investing was fulfilling PRI framework and being an active investors on proxy voting. She said "sustainable investing 2.0" is evolving now where investors are taking a deep dive looking at how trends impact companies "and how do you think about these issues". Adaptation is critical, understanding these risks through an enterprise risk management framework.

Hannah said it's about looking at these risks and beyond these risks.

Marc then went on to discuss Responsible Investing focusing on two issues:

1. Governance: increasing standards you expect from managers incorporating ESG
2. Allocation: increasing impact investing diversifying based on all 17 UN principles, not just climate change.

All the panelists agreed measurement is a challenge and you need to balance returns and addressing members' concerns.

In terms of trends that will change the ESG landscape over the next few years, Katharine said what about the "S" in ESG? The transition to a lower carbon economy can displace jobs, we have to think about addressing the social consequences. She gave the example of coal workers in Ontario which lost their job and had to be retrained.

Marc said "impact investing is still in its infancy" and "TAA will need to integrate ESG". He also talked about due diligence and co-investments.

Hannah talked about decarbonization goals and "more diagnostics which will hopefully lead to more action."

I asked the panel of the politicalization of sustainable finance at public pensions and their fiduciary duty. Katharine said it's not a violation of fiduciary duty to think about ESG.

Deborah Ng chimed in and stated: "We are fiduciaries to all our members across all generations. It's all about how to sustain a pension plan over the long run."

I will leave it on that note. Once again, I thank all the participants who attended this CAIP conference, I really enjoyed meeting them and hearing their views and great insights. I’d also like to thank Charles Quintal for doing a superb job chairing this conference.

Last week, I had the opportunity and privilege to address a theater full of finance professionals at the annual PRI in Person conference. The PRI stands for the Principles of Responsible Investing and is an investor initiative in partnership with UNEP Finance Initiative and the UN Global Compact. Its signatories number over 2250 financial firms representing just under $90 trillion USD AUM. The theme of the conference this year was “Responsible investing in an age of urgent transition” and the sense of urgency was very prevalent in discussions around the conference venue.

This year’s conference hosted over 1700 people in Paris. Topics ranged from broad issues such as policy to very specific issues such as reporting under the TCFD (Task force on Climate-related Financial Disclosures). Here are the key themes I took away from my 4 days there:

• Responsible investing in real assets has gone global. Here in Canada, where direct investing into infrastructure is more common, I’m used to having these discussions because the long life of these assets fit naturally with ESG topics such as climate change. However, this was the first year at PRI for an entire day on real assets and shows the growth of interest in responsible investing for this asset class. Some key touch points were investing for impact with infrastructure, social license and climate metric challenges.
• Climate change is both urgent and mainstream. Having the conference in Paris, the city where the historic climate agreement was created, made climate a natural topic. The depth and breadth of this discussion has matured substantially from even three years ago when people still weren’t sure whether the new G7 climate task force would produce anything meaningful. Today, we were debating options on how make useful decisions across portfolios that will have meaningful outcomes. Also, the PRI introduced a new climate tool in the Inevitable Policy Response – a forecast of the necessary policies that governments will need to meet the agreed upon targets. My own panel showcased three examples of investor action happening already.
• The overall tone was to move past “process” and to outcomes.The theme of focusing on outcomes was a general one across all ESG topics. Some speakers went so far as to propose that the focus on ESG data is not useful and in some cases, a misdirection. Rather, understanding the direction of trends and then managing for desired ESG outcomes was more useful and that data was not necessary to drive action towards those outcomes.
• Europe is making a significant headway on issues of global importance such as taxonomy, but it may not be fit for purpose in Canada. The EU Action Plan for Financing Sustainable Growth is a hot topic and will drive responsible investing to the next level. However, key actions such as setting an environmentally sustainable taxonomy do not appear to include any transitional fossil fuel activities such as switching to natural gas. Canada’s own expert panel on sustainable finance (ably represented by Barbara Zvan at this conference) has pointed to the need for tools that work for Canada in order to support a move to a green economy.

The PRI has come a long way from the high level discourse in the early years. I found there was value in detailed discussions among front line investment professionals and grains of wisdom from thought leaders pushing the boundaries, but at the end of the day, it will be up to individual organizations. There was an urgent call to practice responsible investing and it’s increasingly clear that responsible investing is becoming table stakes and investors may have to explain when they don’t practice responsible investing rather than when they do.

Trying to get investors to sign up for a less carbon-intensive world is still an uphill battle. That is only changing slowly. The spirit may be willing but the flesh is weak. Lots of reasons for that.

Decarbonization is still mostly a passion of entrepreneurs in small companies.

Canada has a big shortage of capital to take these companies to scale.

Conservative silos within investment firms and pension plans make them hesitant to take risks on small companies.Big investment entities take comfort in working with well-known companies that can deploy large amounts of capital, i.e. the modern equivalent of not getting fired for buying from IBM.

The notion of ‘moving the needle’ also keeps cropping up, i.e. why bother with small investments that do not affect your immediate return?

The answer is that a well-structured portfolio of investments in small companies will move the needle in the long run, as some become successful and large.

However, the long run is still mostly talked about, instead of applied to investment allocation of risk capital.

It is tough to make investment decisions that are good for your investment entity, but may not pay off during the ~4-6 years you expect to be there.

I have been trying to make innovative lower carbon investments look more like lower-risk infrastructure in terms of reliable contracted cash flows, but you run into the greenfield issue, i.e. the risk of first having to build on time and on budget whatever you are investing in.

Large pools of capital should arbitrage their low cost access to information on the technology of decarbonization (or anything else that is new). The payoff can be very significant, but you will stick out from the crowd.

With hindsight, I wished that as a CIO and CEO I had focused more on attracting real engineering expertise, and evaluation of executive team capacity to carry out their strategy, as opposed to just relying on spreadsheet models.

The ‘tyranny of Excel’ facilitates getting to ‘no’ just because you did not invest in access to the right information.

Over the forty years that I have served as a pension specialist inside the trade union movement and outside of it since 2005, debates about the relative merits of defined benefit (DB) and defined contribution (DC) pension plans have been a prominent part of pension discourse. The intensity of the debate has ebbed and flowed over the years but has been more intense in recent years as there has been a shift from DB to DC plans that has been particularly notable in workplace pension plans (WPPs) in the UK and US and to a lesser but clear degree in Canada as well. This shift has been much stronger in the private sector compared to the public sector and includes a shift from registered DC plans to group RRSPs (See: Appendix 1 and Baldwin, 2015). This shift has left the remaining members of DB plans feeling threatened and for many the sense of threat has been compounded by the emergence of target benefit (TB) plans which they see as an inferior alternative to DB.

As happens in many intense debates, participants tend to become advocates for particular points of view and confirmation bias sets in. People take in information that seems to confirm their opening, big picture view of what is best, and find reasons to dismiss non-conforming evidence. Recent discussions of DB, TB and DC provide ample evidence of confirmation bias at work.

DB plans are often revered by their supporters on the grounds that they can provide benefits that are more predictable than DC plans and they are capable of providing adequate retirement incomes. Moreover, if things go wrong financially, the employer will pay to right the financial ship. There are important elements of truth in this characterization of DB plans. But this popular characterization also obscures features of DB plans that are less flattering. (Unless otherwise noted adequacy will refer to the ability of pension plans to replace pre-retirement earnings. More technically it refers to the ratio of retirement income to pre-retirement earnings also known as the gross replacement rate (GRR)). Discussions of DB, TB and DC in the abstract tend to obscure basic issues related to the similarities and differences among these plans that should be taken into account. 

The abstract discussions also provide little or no guidance of how to address pension design issues in a context where the economic, financial and demographic context have created difficulties for all forms of pension plan. Unfortunately, plan sponsors often react to current circumstances by reflexively turning to pure DC without considering the full range of alternatives, and plan members dig in in defence of DB plans where they still exist – unwittingly exposing young plan members to considerable risks by doing so.

My hope is to provoke an examination of some of these issues free from the hyperbole that is widely invoked in partisan debates about DB and DC.

Diversity under each of the DB and DC umbrellas

In debates about the general merits of DB and DC, proponents of DB plans tend to have a particular type of DB and DC plan in mind. The DB plan implied in much of the commentary is a “Best or Final Average Earnings” plan with benefits that are indexed to inflation after benefits begin to be paid. On the DC side it is implied that we are dealing with a plan in which investments are “self-managed” during the pre-retirement period and the run down of assets during retirement is also “self-managed”. If these types of DB and DC plans were the only types that existed, the preferential views for DB noted above would be easy to accept more or less at face value.

But the reality is that DB and DC plans come in quite a variety of shapes and sizes and not all of the DB plans include the virtues commonly ascribed to DB.

The world of DB includes plan designs that may fall quite short on income adequacy and to a lesser degree, on predictability. A member of a career average earnings (CAE) plan that includes no upgrade in the earnings base used to calculate benefits will likely provide inadequate benefits in periods of strong wage growth and benefits that will not be predictable until close to retirement. The same problem can arise with flat benefit (FB) plans. These DB plans can be managed so that benefits are predictable and adequate. But there is nothing inherent in the plan design that makes them so. But note: these are DB plans.

In an era when retirement periods commonly span 20 or more years, post retirement adjustments to reflect price or wage increases become increasingly important. Over a twenty year time span, annual inflation at the 2 per cent rate targeted by the Bank of Canada will reduce the purchasing power of a pension that provides no protection against inflation by one third. About one third of Canadian DB plans with just under half of DB plan members provide no automatic adjustments in the post retirement period. In these plans, benefits may be predictable at the date of retirement, but their purchasing power after retirement is not predictable. (See: Appendix 2) (Only one in five DB plan members gets full protection from inflation as measured by the Consumer Price Index (CPI). The remainder get some form of partial protection against inflation).

On the DC side, a similar problem arises.

The self-managed plans not only involve a high degree of uncertainty with respect to the benefits they will provide, but the contribution levels may be inadequate to provide adequate retirement income in low return environments like the current one. Self-managed DC plans also impose decision-making responsibilities on people who have little time to do the work required to make good choices and who don’t have appropriate investment expertise.

Over long time frames the adequacy problem can be addressed through higher contribution rates. The predictability problem can also be addressed through the choice of a specific plan designs that do not rely on self-management.

Prior to the early 1980s most DC pension plans in Canada provided benefits based on the purchase of deferred annuities. DC plans organized in this way provide much greater predictability than self-managed plans but will fall between self-managed DC plans and BAE or FAE DB plans in terms of predictability. Whether they produce adequate benefits conceived of in GRR terms will depend on a variety of factors including the contribution rate, the interest rates embedded in the annuities and the earnings trajectory of the plan members.

There are also a number of Canadian DC plans that provided DB guarantees in 1990 – the time of our last major reform to the tax rules governing pensions and RRSPs. The plans of this sort that were in existence at the time were allowed to keep operating but new plans of this sort could not be registered with the Canada Revenue Agency. These plans provide the same downside protection as DB plans while offering the upside investment risk associated with DC plans. They provide the same if not greater opportunity to provide adequate incomes.

Looking beyond the Canadian border, there are many examples of DC plans that provide minimum rate of return guarantees. The downside protection offered by these plans is similar to a career average adjusted plan like the Canada Pension Plan (CPP) while offering upside investment opportunities.

It is worth noting too that plans don’t always get administered in the way that the basic benefit design might suggest they should be. In the 1980s and 1990s both stock and bond returns were high and it was common for DB plans to be in a surplus position (i.e. plan assets exceeded plan liabilities). In many cases where DB surpluses existed, the surpluses were used in whole or in part to finance benefit improvements. To the extent that plans were managed in this way, they were managed as if they were collective DC plans with strong minimum DB guarantees! The DB formulas were guaranteeing a minimum level of benefits and surpluses were paying for enhancements.

The main point to be made here is that abstract debates about the virtues of DB and DC plans are of limited value. There is too much variation in the specifics of plan design under each heading. WPP design is more like a spectrum of choice rather than a binary choice between DB and DC. What is of most importance is to assess the retirement income risks faced by the plan members and make sure they are addressed in a way that is fair among plan members and is reasonable in terms of the level and volatility of required contributions. Some of the issues related to fairness and required contributions are addressed below.

What are we trying to achieve?

Generally workplace pension plans are designed to allow people to maintain their standard of living after they leave paid employment. As was noted above, this post employment period can be a long one. Recent annual reports of the Ontario Teachers’ Pension Plan draw attention to the fact that the average retirement period under that plan is greater than the average period of employment as a teacher.

Discussions of pension plans adequacy often focus exclusively on what plans produce in the retirement period and the consideration of adequacy is usually cast in terms of the GRRs they will produce. This perspective is too limited.

Pension plans affect living standards in both the pre-retirement period and the post-retirement period. In the post-retirement period we will be interested in the extent to which the pension replaces pre-retirement earnings. But in the pre-retirement period we have to be concerned with the extent to which the pension plan is depressing the ability of plan members to buy goods and services prior to retirement.

Ideally, the pre-retirement sacrifice will combine with post retirement benefits so that living standard will be the same in both periods. If too little is given up prior to retirement, living standards will drop in retirement. If too much is given up, living standards in the pre-retirement period will be depressed below their post-retirement level. (It is possible to have too much pension)! Neither over contributing/saving nor under contributing/saving is inherently desirable. Unfortunately, for reasons that will become clear below, it is impossible to get the balance of pre-retirement sacrifice and post-retirement benefits right for all member of a DB plan. This does not detract from the fact that the objective of continuity of living standards should be sought.

In thinking about getting the balance right, three additional things need to be considered.

First, in describing the objective of maintaining living standards in retirement, so far I have referred exclusively to the role of WPPs in achieving this goal. In most high income countries, publicly administered pension plans will also contribute to meeting this objective. Given the structure of Canada’s publicly administered pension plans (OAS, GIS and CPP), the objective of maintaining living standards in retirement will be met for Canadians with lower earnings - half average wages and salaries and below – by the publicly administered plans alone. But above that level of earnings, income from privately administered sources will be needed in order to maintain living standards in retirement and the need will grow quite rapidly through the middle and upper middle earnings ranges.

Second, it has been a tradition in both public policy discourse and retirement planning to argue that a retirement income amounting to 70 per cent of pre-retirement earnings is a reasonable benchmark for being able to maintain living standards in retirement. Recently this approach to assessing retirement income adequacy has been subject to two types of challenge.It has been argued that this benchmark too high for the middle earners who are of key policy interest. (See: Mintz, 2009). GRRs in the range of 50 to 60 per cent are becoming more common among pension experts in Canada.

It has also been argued that gross pre-retirement earnings and retirement income are weak indicators of living standards in the pre and post retirement periods. In the pre-retirement period, a significant wedge between gross earnings and the consumption possibilities of a pension plan member can be created by the need to support children, mortgage payments, taxes and, of course, pension contributions. In the post retirement period many of the factors that are relevant in the pre-retirement period will cease to be relevant for most pension plan beneficiaries (e.g. mortgage payments, transfers to children, etc). But taxes will still be relevant for most. Also some adjustment to income to take account of the value home equity is appropriate. The adjustment could take the form of imputed rent or annuitization. The presence and economic situation of a spouse is also important.

Recognizing that living standards are not well defined by gross earnings and pension income gives rise to a number of adjustments that give rise to a net replacement rate measure. A given gross replacement rate may translate into a range of net replacement rates. Within a DB plan that is designed to generate a given replacement rate (e.g. 70 per cent after 35 years of service) there will be a wide range of net replacement rates after 35 years of service reflecting differences among the members in terms of their family situations and whether they own their own home. The fact that DB plans are designed to generate GRRs rather than NRRs forces us to recognize that NRRs may cover a wide range and won’t be perfect for all members. However, this reality does not allow us to ignore the importance of NRRs.

Once it is accepted that pension contributions depress pre-retirement living standards and increase NRRs, an important question arises: what contributions should be entered into the calculation of pre-retirement living standards. For plan members who have deductions made from their paychecks to support a pension plan, the most obvious contributions to take into account are the deductions from each paycheck. But should employer contributions be ignored?

There is good reason for including some portion of employer contributions in the calculation of what plan members give up in order to get their pension benefits. In most situations it is fair to surmise that an employer is most worried about total labour costs not the component parts of the cost. To the extent this is true, a rational employer will discount other elements in the compensation package of employees to take account of the contributions to the pension plan that are predictable. Thus the economic burden of employer contributions will be shifted from employers to employees – rather like sales taxes being shifted from vendors to consumers. In DC plans the required contributions will usually be predictable but this will less often be the case in DB plans.

In DB plans contributions are unpredictable (more on this below). There may be situations where an employer is confronted with unexpected need to make special contributions to a DB plan based on an actuarial deficit showing up in an actuarial valuation report. The employer may find it impossible to shift the burden of the special payments to employees in the short term due to labour market conditions and/or contractual obligations to employees.

All things considered it would be a mistake to ignore employer contributions in considering what plan members give up in order to earn DB benefits.

Some changes that have affected retirement savings plans

It is a basic axiom of all types of pension plan that the effects of the plan will depend not only on the benefit and financing rules in the plan but also on the way the rules interact with an ever changing labour market, demographic, financial and economic environment. A stable set of plan rules does make the plan stable in terms of the benefits it will provide or the cost of providing the benefits. Some of the variables that affect the outcomes of pension plans are quite unpredictable over short and even longer time frames. This is especially true of investment returns which play a central role in the financing of pre-funded pension plans.

Any number of changes in the labour market, demographic, financial and economic environment have affected to operation of workplace pension plans in recent years. But three merit particular attention: investment returns, life expectancy and entry and exit ages from the labour force.

As was noted above, returns on both stocks and bonds were very strong in the 1980s and 1990s. Since 2000, returns have been weaker. The high returns of the 1980s and 1990s were important in their own right and their contribution to pension finance was accentuated by slow growth in wages and salaries. Slow wage and salary growth meant that earnings replacement targets were growing relatively slowly. In DB plans, plan liabilities were growing more slowly than would have been the case with rapid wage growth. At that time providing retirement incomes proved quite inexpensive. Changes in the financial environment have made retirement incomes more expensive. (More on this below). (See: Appendix 3)

Regarding life expectancy, in the 14th Actuarial Report on the Old Age Security (OAS) program, the Office of the Chief Actuary (OCA) points out that the average life expectancy of a 65 year old Canadian has increased by roughly six years between 1966 and 2016. By 2060, average life expectancy at 65 is likely to increase by another four years. (OCA, 2017) This is, of course, a very welcome development. But to state the obvious, it also means that if people keep starting their pensions at the same age, the pensions will be paid out over longer periods of time and will be more expensive.

Low returns in general - and lower interest rates in particular - have combined with increasing life expectancy to raise the cost of providing a dollar of annual retirement income. Thus, in establishing a lump sum value of a dollar of DB benefits in workplace pension plans, Statistics Canada estimates that the cost of an indexed benefit has increased over the relatively short period from 1999 to 2016 by 60 per cent.

These developments have put upward pressure on DB contribution rates (See: Appendix 4). They have also contributed to the shift from DB to DC forms of workplace pension plan – especially in the private sector. In the public sector they have contributed to a shift from pure DB to plans that are largely DB but place some financial risk on the benefit side of the plan by making the indexation of benefits in pay contingent on the funded status of the plan. Target benefit plans have also been introduced in the public sector in response to the financial difficulties of pure DB plans.

Another development meriting comment is changes in the ages of entry and exit from the labour force. There has been a general trend in recent years for the average age of both entry and exit to go up – with the increased age of exit being more clear than the entry age in the aggregate data. At the same time that the average age has been going up, entry and exit ages for the society/economy as a whole have been becoming more diverse. For public pension plans like OAS and C/QPP, these developments raise important questions about the appropriate age of eligibility for pensions and whether the role of specific chronological ages should continue to be the dominant criterion for eligibility. Should a person who enters the labour force at 18 qualify for benefits at the same age as someone who enters at age 30?

The entry and exit ages for specific workplace pension plans are likely to vary from the society/economy wide norms – in some cases quite significantly. The entry and exit ages in each plan need their own study and analysis. One question worth asking in the context of plans with special early retirement provisions is what portion of new entrants will qualify for them under the conditions when they first become available. In the case of the federal public service superannuation plan, between the 1980s and early 2000s, there was a significant decline in the portion of new plan members who would qualify for special early retirement benefits when they first become available. (See: Baldwin, 2012.)

What allows DB benefits to be predictable?

There is an accounting identity that applies to all types of pension plans:

Benefits = contributions + investment returns – expenses.

Given that the basic building blocks of all types of pension plans are the same, an obvious question arises: what allows a DB plan to provide more predictable benefits than a DC plan. The answer lies in two related but distinct features of DB plans.

First, the contributions to DB plans are adjusted on a regular basis so that retirement income objectives that are embedded in the DB benefit formulae can be met. In the Canadian context these adjustments will be made based on actuarial valuation reports that must be prepared with a frequency no greater than three years.

The second feature of DB plans that allows them to provide predictable benefits is cross subsidies within and between various cohorts of plan members. The regular adjustments to DB contribution rates mean that different cohorts of plan members get different effective rates of return on their pension contributions – hence the overlap between the cross-subsidies issue and the adjustments to the contribution rate.

There is also a wide range of cross-subsidies within cohorts. Those with short periods of retirement subsidize those with long periods of retirement, early entrants to the plan subsidize late entrants and so on.

There has been some interest in and measurement of cross-subsidies across cohorts among pension analysts (See for example: Cui, deJong and Ponds, 2011 and Kortleve and Ponds, 2010). Less interest has been shown in cross-subsidies within cohorts. An exception is provided by Young, 2012 who identifies a limited number of cross-subsidies and provides a measure of their impact. Blommestein et al, 2009 identify a number of cross-subsidies within cohorts but don’t provide a measure of their impact.

The level of contribution rates to a pension plan is important in determining both post-retirement benefit levels and the pre-retirement loss in consumption possibilities. But investment returns commonly account for two thirds to three quarters of benefit payments. By their nature, investment returns are unpredictable and the way that the returns are shared within and between cohorts in a DB plan is important in determining who is subsidizing whom.

In context, it is worth noting that both plan members and employers who sponsor DB plans face parallel dilemmas in terms of the degree of financial risk that should be accepted in order to get higher investment returns. Plan members would like to maximize the benefits they get from their contributions which would tend to push them to seek higher returns which in turn would mean higher levels of risk. But they also want benefit security which would push them in the opposite direction. Employer plan sponsors would like to minimize required contributions for promised benefits which would tend to push them toward higher risk investments. But they would also like predictable contributions which would push them in the opposite direction.

Some related transparency problems in DB

The reality of cross-subsidies within DB plans is not a problem in and of itself. Cross-subsidies are inherent in any form of insurance and people do place positive value on insurance – even when they know that they may get less of a “return” on their insurance premiums than other purchasers of the same insurance. Unfortunately the cross subsidies in DB plans are not always recognized and seldom if ever measured. As a result, it is very difficult for plan members to assess their impact and make an informed decision on whether they are “worth it.”

It is conjecture on my part, but my sense is that plan members have a dim sense of some cross-subsidies and accept them within limits without having a clear sense of their financial impact. Others are less clearly perceived and may not be as welcome if they were clearly perceived. An example of the former would be the cross-subsidy from members with short retirement periods due to early death to those with long lives and hence long retirement periods. This is an interesting cross-subsidy because it is constrained in many DB plans by the presence of a guaranteed minimum period of payments. The presence of minimum guarantee periods raises a question about the willingness of plan members to be an open-ended source of subsidization.

A source of cross-subsidy in final and best average earnings plans that is less clearly perceived is the cross-subsidy from plan members whose earnings are flat or declining as they approach the age of pension receipt to those whose earnings are increasing rapidly. It is a moot point whether this particular cross-subsidy would garner substantial plan member support if it was perceived and its financial effect was known.

The point here is not to argue that cross-subsidies are wrong. But, as far as possible, they should be identified and measured so that plan members can have some sense of whether they are “worth it.”

DB plans have a key premise and that is that the sponsor of the plan (and/or the plan members) has (have) an unlimited willingness and ability to contribute more to the plan. This is an implausible premise. As long as labour market, demographic and financial circumstances remain within limited boundaries, the implausibility of the premise will not be clearly visible. But in circumstances like those of the early 21st century, the difficulty with the premise becomes clear. This creates a transparency problem: plan governors do not articulate the outer limit of acceptable levels of contribution and don’t explain to plan members what happens if that limit is reached. This becomes an increasing problem as increases in the contribution rate run the risk of pushing pre-retirement living standards below post-retirement levels.

Lurking beneath the surface of much of the discussion in this note is a reflection on the extraordinary range and degree of risks in trying to provide an adequate and predictable retirement income. It seems simple enough to promise a 30 year old that for each year of service they put in under a DB plan, they will get payments amounting to 2 per cent of their best five years earnings for their retirement period and a smaller payment to a surviving spouse during their lifetime. In fact this is a promise that is full of uncertainties: the best 5 years’ earnings are unknown, the start date of payments is unknown, the end date of payments to the plan member and their spouse are unknown and the size of any post-retirement adjustments to reflect inflation are unknown. Moreover, we don’t know the rate of return that any money set aside today to help make the payments will earn. This money set aside today may or may not be sufficient to pay future benefits. The pervasiveness of these uncertainties dictates the need for regular financial assessments of DB plans.

These key sources of uncertainty are addressed in traditional financial reporting but they are addressed in ways that tend to divert attention from the uncertainties associated with the variables. Traditional financial analysis of pension plans relies on the projection of key variables at fixed rates through time. In other words, they rely on fixed rates of wage growth, fixed rates of return and so on through time. This form of modelling of the financial future of pension plans is known as deterministic modelling. Modelling in this form can answer basic “yes/no” questions such as: are the “normal” contributions high enough to cover the cost of the newly emerging benefits, are the assets in the plan sufficient to cover the cost of the benefits that have accrued to date?

The problem with this traditional approach is that it fails to capture all of the uncertainties that arise through time with the full range of variables. It may be true on the basis of single-valued assumptions about the future that are chosen for the purposes of analysis that a plan’s assets are sufficient to pay benefits promised to date. But, it may also be true that there is a reasonable chance that shortfalls will arise in the future and prompt the need for contribution rate increases or benefit reductions. These possible consequences of uncertainties are accentuated in plans that have risky investment portfolios and are mature plans. The potential need for these types of adjustments is not clearly brought into focus in traditional analysis.

In DB plans, the assumptions about the future that underpin the financing of a plan are made clear in actuarial valuation reports. In DC plans the assumptions about the future that underpin the plan may not be formalized but may be implicit in claims that contributing to the plan at a certain rate will generate a retirement income amounting to some per cent of pre-retirement earnings. In the case of both types of plan, there is a possibility – indeed a likelihood - that the future will be mis-estimated. In the case of a pure DB plan, the mis-estimations are corrected entirely through changes to the contribution rate and in a pure DC plan through changes in the benefits.

DB and TB

So far I have focused attention on the historic debate about the virtues of DB and DC. More recently, debates have also emerged about the virtues and vices of target benefit (TB) plans compared to DB.

TB and DB plans have a logic that has a common point of departure. Unlike DC plans both DB and TB plans promise plan members a benefit that will be paid for each year of service in the plan. Key risks are pooled in both types of plans so that there is a reasonable expectation that promised benefits will be paid. Using broadly similar actuarial methods, both types of plans establish a contribution rate required to pay the benefits promised by the plan. (In many if not most cases, the benefit level that is promised will reflect a limit that the plan sponsor or tax law will impose on required contributions and/or maximum benefits. To the extent this happens, it introduces a DC element into the logic of DB and DC).

The main thing that distinguishes DB from TB plans is what happens when financial problems arise.

In pure DB plans, when things go wrong financially, there are two options for correcting the problem:

1) Increase contributions;
2) Reduce future benefit accruals.

In TB plans these two options are available as is one more:

3) Reduce accrued benefits.

Option 3 is generally not available for DB plans because pension benefits law in all Canadian jurisdictions other than the federal jurisdiction prohibit the reduction in accrued benefits. 

It is important to note that the difference between DB and TB has different implications for different cohorts of plan members. The options open to DB plans create no risk for retired members and little risk for members close to retirement age. But they expose the young and future plan members to most of the financial risk of DB plans. The TB options expose all cohorts to financial risk that will vary depending on the specifics of the plan.

As is the case with DB and DC plans, there can be a range of specific designs of TB plans. Two variables in the design of TB plans are crucial:

1) Is there any room for variability in the contribution rate; (the more variability there can be in the contribution rate, the more TB will perform like DB);
2) To what extent is positive experience used to recoup benefit losses in earlier time periods (the higher the priority that is given to this use of surplus, the more TB will perform like DB),

TB plans have been operating in Canada for many years. These plans have been created at union initiative to provide pensions to workers in industries with large numbers of small employers in which it would not be practical to establish DB plans at each workplace. These plans are generally known as multi-employer plans (MEPPs).

MEPPs have several characteristics that are worth noting:

1) Contributions to them are fixed during the term of collective agreements that require employers to contribute to them;
2) Regulatory law includes specific provisions that apply to MEPPs and allows accrued benefits to be reduced;
3) Regulatory law requires that half of the governing body of a MEPP be made up of plan member representatives.

Until recently, TB plans have been restricted to the MEPP context. Several provincial jurisdictions have adopted or are considering legislation to permit single employers to adopt TB plans.
Regulatory changes to permit single employer TB plans have become particularly controversial in the federal jurisdiction. The federal government has introduced legislation (Bill C-27) to permit the registration of single employer TB plans. The changes have been vociferously opposed by some unions and retiree groups that would potentially be affected by the legislation. There are important respects in which Bill C-27 needs to be altered to protect plan member rights. But its general direction is consistent with the shared theme of the Ontario Expert Commission and the Joint Expert Panel on Pensions in Alberta and BC that Canada’s regulatory and tax law needs to be amended to accommodate plans that embody elements of DB and DC.

Concluding thoughts

I want to conclude this paper by summarizing what I see as key points made above. But, I also think it would be helpful to put the foregoing discussion that focuses of WPPs in context.

Canada’s RIS is structured in a way that middle and upper earners have to get income from either WPPs or individual savings plans in order to achieve a standard of living in retirement that is comparable to what they had beforehand. Based on evidence of a variety of types, this basically means participation in a WPP – preferably one with a DB element to it. While the success of WPPs is of primary importance to the well being of people coming to retirement age, it has wider importance too. (See: Baldwin and Moore, 2015, Baldwin, 2017 and Baldwin and Shillington, 2017) With a growing portion of the population being made up of retirees, the success of WPPs will also be important to maintain robust domestic demand for goods and services and success will also have a positive effect on fiscal balances in the future.

The declining participation in WPPs and the shift away from plans with DB elements are discouraging with respect to the potential role of WPPs in providing retirement income. Looking beyond these recent developments, another longer term reality needs attention. WPPs have never been widely available in the small employer context. Indeed most small employers lack the scale and expertise to serve as an adequate platform for administering a pension plan. Bearing in mind that the financial services industry has not come up with adequate solutions to this problem, finding an effective organizational platform for small employers is an important challenge. It is unlikely though, that plans that satisfy this need will be of a pure DB type. Hence there is a further need to keep exploring the space between pure DB and pure DC.

The need to keep exploring plan designs coupled with the need to adapt plans to a changing environment raises another issue. The regulatory law that governs WPPs was crafted at a point in time when most members of WPPs in both the public and private sector belonged to DB plans. The objective of the law was to protect DB plan members from errors and/or abuse by employers. The need for the regulatory law to be more flexible with respect to plan design was an important theme of the Ontario Expert Commission on Pensions and the Joint Expert Pension Panel created by the governments of Alberta and British Columbia. I would strongly endorse this theme and argue that it needs to be complimented by more flexibility to adapt to changing circumstances. But this latter adaptability needs to be made safe for plan members by encouraging joint plan member/employer governance as in the Jointly Sponsored Pension Plans in Ontario.

In previous sections of this paper I have argued a few key points:

1) There is enough variation in specific plan designs under each of the headings of DB, DC, and TB that there is little value in arguing the virtues and vices of plan design at that abstract level.
2) Too little attention has been paid to:

a. the impact of plan design on pre-retirement living standards.
b. the impact of changes in the socio-economic environment on pension plan benefits and costs.
c. the impact of financial risk in DB plans both in the aggregate and for specific cohorts of plan members.

3) DB plans have transparency problems in not identifying what happens when things go wrong, what cross-subsidies are embedded in the plans and what financial risks are embedded in the plans.

I don’t wish to end on a negative note. For plans that have DB elements I would recommend the following:

1) Establish a clear appreciation of current and future plan members’ financial needs throughout the retirement period.
2) Balance retirement income needs with impacts on pre-retirement living standards with a view achieving continuity of living standards.
3) Be aware and sensitive to differences within the membership group (working from averages and medians is never adequate).
4) Understand the risks in providing the benefit promises and who gets the rewards and burdens associated with the risks.
5) Be as clear as possible about cross-subsidies within and between cohorts of plan members.
6) Be clear about what will happen if things go wrong.

As noted above, pension plan design is more like a spectrum of choice rather than a binary choice between clearly defined DB and DC plans. The position of plans on the spectrum will be established by the way that financial risk is allocated between contribution and benefit rate variability and between and within cohorts of plan members and employers – to the extent that the latter bear financial risk.

References


Baldwin, Bob, 2016. Assessing the Retirement Income Prospects of Canada’s Future Elderly: A Review of Five Studies. (Toronto: CD Howe Institute).

Baldwin, Bob, 2015. “The Economic Impact on Plan Members of the Shift from Defined Benefit to Defined Contribution Pension Plans” in Canadian Labour and Employment Law Journal, Vil. 19 No1. (Toronto: Lancaster House).

Baldwin, Bob, 2012. The Federal Public Service Superannuation Plan: An Agenda for Reform. Montreal: Institute for Research on Public Policy).

Baldwin, Bob, 2017. The Pensions Canadians Want: The Results of a National Survey. (Toronto: Canadian Public Pension Leadership Council).

Blommestein, Hans, Pascal Janssen, Niels Kortleve and Juan Yermo, 2009. Evaluating the Design of Private Pension Plans: Costs and Benefits of Risk-Sharing. (Paris: Organization for Economic Cooperation and Development).

Canadian Institute of Actuaries (CIA), 2015. (Ottawa: CIA).

Cui, Jiajia, Frank deJong and Eduard Ponds, “Intergenerational Risk Sharing within funded pension schemes” in Journal of Pension Economics and Finance Volume 10, Issue1. (Cambridge: Cambridge University Press.

Dimson, Elroy, Paul Marsh and Mike Staunton, 2018. Credit Suisse Global Investment Returns Yearbook 2018: Summary Edition. (Credit Suisse Research Institute).

Kortleve, Niels and Eduard Ponds, 2010. How to close the Funding gap in Dutch Pension Plans? Impact on Generations. (Boston, Center for Retirement Research).

Landon, Stuart and Constance Smith, 2019. Managing Uncertainty:The Search for a Golden Discount-Rate Rule for Defined-Benefit Pensions. (Toronto: CD Howe Institute).

MacDonald, Bonnie-Jeanne, Lars Osberg and Kevin Moore, 2014. How Accurately does 70% Final Earnings Replacement Measure Retirement Income (In)Adequacy? (Toronto: International Centre for Pension Management).

Milligan, Kevin and Tammy Schirle, Rich Man, Poor Man: The Policy implications of Canadians Living Longer. (Toronto: CD Howe Institute).

Mintz, Jack, 2009. Summary Report on Retirement Income Adequacy Research. (Ottawa:Department of Finance).

Office of the Chief Actuary (OCA), 2017. 14th Actuarial Report on the Old Age Security Program as at 31 December, 2015. (Ottawa: Office of the Chief Actuary).

Ontario Teachers’Pension Plan (OTPP), 2018. Plan Sustainability: Annual Report for 2017. (Toronto: OTPP).

Organization for Economic Cooperation and Development, 2017. Pensions at a Glance 2017: OECD and G-20 Indicators. (Paris: OECD).

Pesando, Jim, 2008. Risky Assumptions: A Closer Look at the Bearing of Investment Risk in Defined Benefit Pension Plans. (Toronto: CD Howe Institute).

Rachel, Lukasz and Thomas D. Smith, 2015. Secular drivers of the global real interest rate. Staff Working Paper No. 571. (London: Bank of England).

Vettese, Fred, 2016. How Spending Declines with Age, and the Implications for Workplace Pension Plans. (Toronto: CD Howe Institute).

Wolfson, M, 2011. Projecting the Adequacy of Canadians’ Retirement Incomes: Current Prospects and Possible Reform Options. (Montreal: Institute for Research on Public Policy).

Young, Geoffrey, Winners and Losers: The Inequities within Government-Sector, Defined Benefit Pension Plans. (Toronto: CD Howe Institute).

I believe large corporations shouldn't be in the DB plan business (apart from some exceptions I cited previously). They don't get it and are incapable of fulfilling the pension promise. Businesses should focus on their core business and let pensions to the experts.

Moreover, I fundamentally believe we can offer Canada's corporations real, long-term solutions to their workers' pension needs not by de-risking them and doing away with them, but by bolstering them and creating a national plan that covers all workers properly just like CPPIB covers all Canadians properly.

As I stated last week: "If we want to improve corporate DB plans, all we need to do is look at the success of Canada's large public DB plans and model something based on their governance and investment approach."

No surprise, Bob Baldwin has once again produced a magnificent paper on pensions. His analysis of the DB, DC and FB pensions is as usual thorough and as objective as can be. All explanations are provided with deep scientific rigour and the few opinions expressed in the paper are identified as such, politically impartial and not taking side for either the pension plan members and sponsoring employers. Bob’s paper deserves to be read by all Canadian pension actuaries.

Bob has an understandable DB bias given his long history with organized labour. In this paper he objectively examines the DB vs. DC debate and explains why it is virtually impossible to take that debate to a clear, unambiguous conclusion. There are too many employers (public sector, private sector, big, small,...), too many employees (married, single, young, old, male ,female, low income, high income, financially literate, financially illiterate...), too many economic environments (high inflation, low inflation, high interest, low interest...), too many plan designs (DB, DC , TB, hybrid...) and too many complications (How much do retired Canadians really need? How much do DB plans really cost? How should we trade off risk and return, low contribution vs. stable contribution, etc?).

Finding the best design for both employees and employers in every circumstance is too great a challenge. Bob did the reasonable thing. He sets out the reasons why designing a pension plan is difficult and warns people about the dangers of cutting corners or becoming wedded to a particular solution. Remember the old saying...

"To the man with only a hammer everything looks like a nail."

Readers hoping for a "magic bullet" solving all our problems will be disappointed, but this is as it should be. They have set their sights too high.

Personally, I would have spent more time on the following:

• The importance of viewing pensions as a compensation element. Who should pay for the cost of the pension plan and how should the cost be measured for this purpose?
• The link between cost, risk taking and risk bearing - how does the taking and bearing of risk affect pension cost? How should we price pension plans if we want to treat both employees and employers fairly?
• What accounts for the large difference between public and private sector pensions?

Philip Cross and I addressed these topics in our paper for the Fraser Institute (Leo here: see my comment on the dirty secret behind Canada's pensions and more on Canada's dirty pension secret).

When both the CPP and the three public pension plans covering the members of the federal public service, the Canadian Forces and the RCMP started investing their net contributions in private market (January1998 for the CPP and April 2000 for the public plans), the real rate of return assumed on the underlying funds for purposes of the triennial statutory actuarial reports was 4%.

Since then, 4% was tweaked a little bit (slight increases) a few times to come back after a while essentially to 4%.

Despite the disastrous negative return of 14% return on the CPP fund in 2008, the prescribed 9.9% contribution rate could until now be securely maintained each year since 1998. Likewise, even if the plan covering the federal public servants was subject to a significant 9.4% (of plan liabilities) deficit as at March 31, 2011, the plan had as early as March 31, 2014 developed a 3.9% (of liabilities) surplus.

In other words, following the 2008 extreme downturn, by far the worst economic downturn since 1929, two well designed and properly governed DB pension plan proved they could well survive without having to make any change to their DB design/structure. This tells me that if anything needs to be changed to the DB plans, it is their governance, particularly the financing policies, e.g. contribution holidays should be fully prohibited, severe measures should apply when the special contributions required following a deficit are not paid, valuation assumptions should be set on a realistic basis erring on the safe side, etc.

With such proper financing policy, the fluctuations in the level of contributions are normally minor and of short duration. If this would still be a major concern for a sponsoring employer, there would then be a case to offer to the plan members whether they are interested in taking over the underlying small financial risk pertaining to such fluctuations in the contribution rate.

Bernard must have forgotten the reasons why the CPP and the the public service pension plan (PSPP) performed so well in 2008:

• The CPP had no problem because it was only 20% funded. The losses were small because the CPP had so little to lose relative to its liabilities. Even if the entire pension fund had been lost, a return of -100%, the contribution rate would have increased by less than 2 percent of covered payroll. What can we learn from this? Badly funded pension plans shine in bear markets because they have little to lose.
• The PSPP had no problem because the assets supporting benefits earned prior to 2000, 75% of the pension fund in 2008, were held in a superannuation account earning a guaranteed (by the federal government) 7% return. Only 25% of the pension fund was actually invested in the capital markets. What can we learn from this? It's nice to have the federal government guaranteeing a 7% return on 75% of your pension fund in a catastrophic bear market.

The CPP and PSPP excelled in 2008 due to poor funding and government guarantees. Good design and exemplary governance had nothing to do with it. In fact, neither is evident.

Let me first clarify that my observations exclusively pertained to:

• FPSPP2 implemented on April 1, 2000 subject to a fully funded financing policy, as opposed to FPSPP1 implemented on 1954 subject essentially to a pay-as-you-go (i.e. no or 0% funding) financing policy. FPDPP1 deals with pension accruals from 1954 to March 31, 2000 while FPSPP2 deals with post March 31, 2000 accruals. Actually, the sole difference between FPSPP1 as at March 31, 2000 and FPSPP2 as at April 1, 2000 is the financing policy, i.e. no funding vs. 100% funding, respectively. Some FPSPP2 provisions were amended/modified on a few occasions after April 1, 2000, but the financing policy was not.
• CPP1, i.e. the existing 1966-implemented CPP, which is subject to a partially funded (about 20%) financing policy since 1998, as opposed to CPP2, which was approved in 2016 to become effective in 2019 subject to a fully funded financing policy.

As Malcolm’s comments on the FPSPP pertain as a whole to both FPSPP1 and FPSPP2, while mine pertain exclusively to FPSPP2, Malclom’s conclusions are not relevant as a rebuttal of my observations. By converting FPSPP1 into FPSPP2 on April 1, 2000, the federal government was successful in correcting as well as anyone could have the inadequacies of the pay-as-you-go financing method. Once you recognize being responsible of a problem (FPSPP1 paygo financing) that you have caused by addressing it as well as could be (FPSPP2 full funding policy), you have to live with the unchangeable reality and stop repeatedly conveying that you regret having caused it, as no more can be done to address it.

If CPP1 actual demographic and economic experience had in aggregate been less favourable than its statutory assumptions from 1998 to now, the 9.9% contribution rate would have had to be increased and/or the prescribed level of pension indexation benefits would have had to be decreased. Neither happened because experience was better than the well-set assumptions (investment return being the most impacting one) and because of the quality of CPP1’s designed and explicit partial-funding financing policy. True, in case of extreme financial hardship, e.g. no investment earnings at all, the CPP1 9.9% contribution would need to be increased by no more than 2% of contributory earnings. Besides, if this was to happen, it would be a problem, even if CPP1 is only 20% funded, not only because any big or small, temporary or permanent, increase in the contribution rate is the main reason why we are having that “DB Pension Plan Model Failure” discussion but also because CPP1 would not be meeting the objectives of its 20%-partial-funding financial policy. 

The failure to meet the objective(s) of a DB pension plan’s financing policy is always a problem irrespective of the targeted funding level. If CPP1 had been implemented on a full funding basis in 1966, the contribution rate would be no more than 6% rather than the actual 9.9%. Any increase beyond 9.9% would be most unwelcome as a major financial problem for employers and workers and a major political problem for the federal and provincial governments.

When it comes to public pension plans' assumed rates of return, what is rare today was quite common less than 10 years ago.

Only three (correction: it's six) of 129 public plans tracked by the National Association of State Retirement Administrators have assumed rates of return at 8%.

In 2010, by contrast, 59 plans had assumed rates of return of 8% and another 30 had rates higher than 8%, said Alex Brown, NASRA's research director. As recently as 2015, NASRA reported that 24 plans had rates of 8% and four had rates exceeding 8%.

A common theme for reducing the assumed rates of return has been the low-interest-rate environment, said Mr. Brown, referring to a February 2019 NASRA report that analyzed trends for assumed rates of return.

"The sustained period of low interest rates since 2009 has caused many public pen- sion plans to re-evaluate their long-term expected returns, leading to an unprecedented number of reductions in plan investment return assumptions," the report said.

From February 2018 to February 2019, the report said 42 plans, or 33% in the NASRA database, reduced their return assumptions. Ninety percent have done so since 2010.

Among the plans tracked by NASRA, the median assumed rate dropped to 7.25% this year from 8% in 2010 and 7.5% in 2015.

"There's wide variations but there is a fair amount of clustering" among return assumptions in the NASRA database, Mr. Brown said. Three-fourths of the state plans have rates ranging from 7% to 7.5%.

8 is enough

The Ohio Police & Fire Pension Fund, Columbus, has had its 8% return rate assumption since Jan. 1, 2017, down from 8.25%. The change "was made as a part of a regularly scheduled five-year review of all actuarial assumptions," David Graham, the $15.5 billion fund's communications director, wrote in an email.

"In the review that resulted in our moving to an 8% assumed rate, our independent actuary and investment consultant agreed that over a 30-year period we would have a slightly better than 50% chance of meeting that return," Mr. Graham wrote.

"While returns in the short term (10 years) may be expected to be lower, the 30-year look provided a better probability," Mr. Graham added. "Our next study of assumptions will be in 2021 and we will take these findings into consideration when discussing a potential change at that time."

The pension fund had a funded status on an actuarial basis of 69.9% as of Jan. 1, 2018.

"We continue to meet the state of Ohio's requirement that all unfunded liabilities be paid within a 30-year time frame," Mr. Graham wrote. "We are currently at 28 years."

For the fiscal year ended Dec. 31, 2018, the pension fund had a net return of -2.4%, which was better than the benchmark of -2.67%.

Three-year annualized returns of 7.16% topped the benchmark of 6.83%. Five-year annualized returns of 5.53% exceeded the benchmark of 4.98%. Ten-year annualized returns of 9.54% outpaced the benchmark of 8.89%.

Reasons for 8%

Texas County & District Retirement System, Austin, has chosen an 8% rate for several reasons, such as investment style, said Kathy Thrift, chief customer officer, in an email.

"When compared to the average public pension plan, our asset mix is very different," Ms. Thrift wrote. "The major difference in our portfolio is that we have a very small percentage — 3% — allocated to investment-grade bonds."

She added that the pension system "has used other asset classes with better return characteristics to offset risk in the portfolio," including hedge funds and strategic credit.

Emphasizing that 8% "is a long-term target," Ms. Thrift wrote that market volatility means the pension system won't hit 8% every year.

The system "has other measures in place to manage risk, including a $1 billion reserve fund — as of Dec. 31, 2018 — that may be used to offset future adverse experience," she explained.

The retirement system's board "in good years," can "set aside earnings rather than pass them through to the individual employer plans," she explained. "The reserves are invested with the plan assets. This tool has helped us keep employer rates stable over time."

The $31.9 billion retirement system completed its most recent review in December 2017 to assess its economic and demographic assumptions.

"Two independent outside actuarial firms both concurred that the investment return assumption is reasonable," Ms. Thrift wrote. "We conduct a full review of our assumptions every four years."

Ms. Thrift illustrated the system's long-term investment strategy by noting that members work an average of 18 years and are retired for 20 years or more. The 30-year return is 8% and the benchmark is 6.9% as of the fiscal year ended Dec. 31.

"Every year, we update our capital market assumptions, which are forward-looking expectations of the return, risk and correlation of each of our asset classes," she wrote.

"We then model a portfolio targeted to meet our long-term expected return goal with an acceptable level of risk," she added. "If we do not think our portfolio can be constructed to achieve our goal with an acceptable level of risk, we will adjust our expectations."

The system has a funded status of 88.5% on an actuarial value basis, or 91% when reserves are included, as of Dec. 31.

The return, net of fees, for the fiscal year ended Dec. 31 was -1.86%, but still better than the benchmark of -3.31%. The three-year annualized return was 6.57%, topping the benchmark of 6.16%. The five-year annualized return of 5.13% surpassed the benchmark of 4.1%. The 10-year annualized return was 9.02%, exceeding the benchmark of 8.06%.

The other plan in the NASRA database with an 8% assumed rate of return is the Arkansas State Highway Employees' Retirement System, Little Rock. The plan had $1.5 billion in assets and a funding ratio of 83.51% as of June 30, 2018, according to the latest actuarial valuation report

Additional details were not available. Robyn Smith, executive director, didn't respond to requests for information.

‘Unrealistically high'

The latest plan to leave the 8% club is the Connecticut Teachers' Retirement Fund, Hartford. Thanks to a law signed in late June by Gov. Ned Lamont, the plan's assumed rate dropped to 6.9% effective July 1, the beginning of its fiscal year, as part of a major restructuring.

"Eight percent was unrealistically high," Shawn T. Wooden, the state treasurer, said in an interview. He is the principal fiduciary of the $36 billion Connecticut Retirement Plans & Trust Funds, Hartford, of which the teachers' pension fund is the largest component at $18.4 billion as of June 30.

The lower assumed rate and the restructuring "will move the plan to something that is more realistic and sustainable," Mr. Wooden said. "We will move the fund on a long-term path to fiscal responsibility. Inflated assumptions distort unfunded liabilities."

The restructuring includes a special capital reserve fund "to serve as adequate provision for bondholders, to meet the requirements of the bond covenant, which allowed for the re-amortization of the Teachers' Retirement unfunded pension liability over 30 years," said an email from the treasurer's office.

The teacher's retirement fund had a funded ratio of 51.7% on an actuarial valuation basis as of June 30, 2018.

For the fiscal year ended June 30, 2019, the pension fund had a net return of 5.85% vs. a benchmark of 6.84%.

Annualized returns over three years were 9.03%, just below the 9.23% benchmark. The annualized five-year return of 5.96% lagged the benchmark of 6.09%. The 10-year annualized return of 8.84% trailed the benchmark of 9.01%.

Alaska Public Employees' Retirement System, with $16.9 billion in defined benefit assets, and the Teachers' Retirement System, with $8.3 billion in defined benefit assets, both cut their assumed rates of return this year to 7.38% from 8%. Both are managed by the Alaska Retirement Management Board, Juneau.

The board and its actuaries "review actuarial assumptions annually and the investment return assumption was reduced to 7.38% in 2019 to reflect lower prospective investment returns," Stephanie Alexander, the board's liaison officer, wrote in an email.

The board approved the rate change on Jan. 11.

The board "has adopted an asset allocation consistent with this long-term return assumption," she said.

For the 12 months ended March 31, the public employees' pension system had a net return of 5.25%. Three-year annualized returns were 9.34% and five-year annualized returns were 6.58%, according to the website of the Alaska Retirement Management Board, which uses the new 7.38% assumed rate of return as a comparison. The Alaska Public Employees' Retirement System had a funding ratio of 64.6% on an actuarial valuation basis as of June 30, 2018, according to a June 2019 report to the trustees of the Alaska Retirement Management Board.

The teachers' pension fund had the same returns over the same three periods using the same assumed rate as a benchmark. It had a funding ratio of 76.2% on an actuarial basis as of June 30, 2018, the report to the trustees said.

The discount rate US public pensions are using is still too high but states are reluctant to lower it for the simple reason that to do so would require increasing the contribution rate and possibly other politically unpalatable measures.

In Canada, large public pensions are using much lower discount rates and even though many are fully funded, they're still lowering their discount rate further to build a reserve cushion (eg., CAAT Pension Plan, OMERS, OPTrust, OTPP, and HOOPP).

There are other structural flaws impeding many US public pensions which Canada's large public pensions have addressed by adopting good governance and a shared risk model.

Good governance means pensions can pay their employees very competitively to manage more assets internally, lowering the overall fees while delivering strong long-term returns. Shared risk means the cost of the plan is shared more equitably among employers and employees so in the case of a deficit, they can increase contributions, lower benefits (typically through conditional inflation protection), or both until the plan's fully funded status is restored.

The problem is most US public pensions haven't adopted either of these measures which explains why they're in such a dire situation. The ones that have, like Wisconsin, are doing well and will survive the coming pension crisis.

Unfortunately, when the next crisis rolls around, many chronically underfunded US public pensions will be hit so hard that politicians will be forced to take very difficult decisions to keep these plans afloat.

For some reason Malcolm has had a "hate" on for DB pensions for a long time, which is strange since they fed him for many years.

I don't necessarily disagree with him about using government bond rates to discount pensions. It does seem silly that you can increase the discount rate used, and thereby decrease the pension liability, by changing your asset mix to a more aggressive mix.

But I don't think this is a huge issue in Canada as the pension plans tend to be rather conservative in their discount rates. This data is a couple of years old but I collected data on plans and here is what they were using for discount rates - OTPP 4.8%, HOOPP 5.5%, OMERS 6%, OP Trust 5.6%, CAAT 5.6%, OPB 5.95%, U of T 5.75%

The real issue is in the US. Remember how in Dec 2016 CalPERS voted to lower their discount rate from 7.5% to 7% over three years. 7% is still WAY too high, but this caused a huge outcry from California city governments, etc, as it increased their pension contributions. Using this discount rate CalPERS is about 70% funded - which is a very deep hole. Change their discount rate to something more realistic, say 5%, and the funded status would likely be 50%. (If you assume that assets are 70 and liabilities are 100 and if the discount rate drops by 2% with a liability duration of 20 then liabilities go up to 140 - hence 50% funded.) There is no way that you get from 50% funded to fully funded unless you have 10%+ returns for a decade or more, lots of inflation (and no indexing on liabilities) or you break the pension promise.

Thanks Wayne, I agree, the real issue is the US where chronically underfunded plans are one crisis away from insolvency. I do take issue with Malcolm’s insistence on using the government bond yield to discount liabilities, I think it’s silly to treat federally or provincially backed pensions and treat them like private corporations. Anyway, as you state, Canadian plans use very conservative discount rates.

The collapse in global bond yields is the biggest story of the year when it comes to pensions.

Repeat after me: Pensions are all about matching assets with liabilities. Period. It's not about who has the highest returns, it's all about the funded status.

And since pension liabilities are long dated (going out 75+ years), their duration is bigger than the duration of pension assets.

This is why I keep harping on how plunging yields wreak havoc on pensions, because they disproportionately impact pension liabilities and swamp any gains from pension assets.

The real pension storm is a 2008 type of crisis when yields collapse and pension assets get clobbered concurrently, a double-whammy for global pensions.

But here is the real kicker, something Jim Leech, OTPP's former CEO and co-author of The Third Rail, once told me: "The starting point matters a lot...pension deficits are path dependent."

Why am I bringing this up? Because, to put it bluntly, while fully funded Canadian public pensions won't escape the next crisis, many chronically underfunded US public pensions falling short of their return expectations this year simply can't afford another 2008 crisis, it will eviscerate them. At that point, one of two things will happen:

1. Benefits will need to be cut which is constitutionally illegal or
2. The contribution rate will need to be hiked which will be met with resistance from public-sector unions and cash-strapped state and local governments who will be forced to emit more pension bonds and hike real estate taxes to meet their pension payments (that's not a long-term solution). 

This is why when I wrote my comment on deflation headed to America a couple of years ago, among the seven structural factors that led me to believe we are headed for a prolonged period of debt deflation was the global pension crisis:

1. The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
2. Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
3. The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
4. Excessive private and public debt: Rising government and consumer debt levels are constraining public finances and consumer spending.
5. Rising inequality: Hedge fund gurus cannot appreciate this because they live in an alternate universe, but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
6. Globalization: Capital is free to move around the world in search of better opportunties but labor isn't. Offshoring manufacturing and service sector jobs to countries with lower wages increases corporate profits but exacerbates inequality.
7. Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create.

These are the seven structural factors I keep referring to when I warn investors to temper their growth forecasts and prepare for global deflation.

"...the majority of pension funds are hoping -- nay, praying -- that we won't ever see another 2008 for another 100 years. The Fed is doing everything it can to reflate risks assets and introduce inflation into the global economic system. Pension funds are also pumping billions into risks assets, but as Leo de Bever said, this is sowing the seeds of the next financial crisis, and when the music stops, watch out below. Pensions will get decimated. That's why the Fed will keep pumping billions into the financial system. Let's pray it works or else the road to serfdom lies straight ahead. In fact, I think we're already there."

In today's blog entry there are a number of criticisms of my alleged view that public sector pension plans should be funded using government bond interest rates to discount liabilities. Let me remind you that these are bogus criticisms leveled by critics who struggle to distinguish pension accounting from pension funding. Specifically I wrote, and you circulated, the following:

"Risk assets over 30 years will pay you a return with near certainty..."


"Large DB pension plan funds invested on a long term basis in a properly diversified portfolio should not hesitate using 6% as the assumed average long term yield. Low interest rates normally play a very small role in such diversified funds."

"The question you are trying to answer is “how much money do we need to set aside to meet the obligation given a reasonable set of assumptions?” If you use any discount rate other than the best estimate of future returns on the portfolio you are going to overfund or underfund the obligation which brings up a whole series of intergenerational fairness issues."

"But I don't think this is a huge issue in Canada as the pension plans tend to be rather conservative in their discount rates. This data is a couple of years old but I collected data on plans and here is what they were using for discount rates - OTPP 4.8%, HOOPP 5.5%, OMERS 6%, OP Trust 5.6%, CAAT 5.6%, OPB 5.95%, U of T 5.75%"

These might be important points if I was advocating the use of government bond interest rates to fund public sector pension plans. I am not now, nor have I ever, advocated this. I have criticized public sector employers for the way they account for the cost of pensions. I have criticized public sector employers for the way they price pensions as an element of employee compensation. I have criticized the injustice of giving public employees 100% of the risk premium when the public, not the plan members, bears most of the risk. I have, on occasion, criticized plans for ignoring the heroic reduction in interest rates during the last 15 years in setting their return expectations, but I suggested only that they lower their expectations, not that they adopt government bond rates.

The following quotation comes from the introduction to the report Philip Cross and I wrote for the Fraser Institute last year.

 "Canada’s public sector DB plans have done a superb job for their members. The plans are capably and efficiently administered by boards operating at arm’s length from government. These boards faithfully represent the interests of plan members. They collect contributions, maintain records, pay pensions, and manage investments. Their practices, as described in the World Bank study, are exemplary.

Canada’s public sector DB plans deliver extraordinary pensions at an affordable price. They are well funded. Their investments perform well relative to other pension plans and relative to the benchmarks they set for themselves. They operate efficiently by exploiting economies of scale. Most importantly, they enjoy the confidence and support of their members."

Our criticism is the use of a discount rate equal to the expected return on assets to put a price on the pensions that employees earn as part of their compensation. Using this discount rate, as opposed to the yield on long term government bonds, cuts the estimated cost of the pension in half. By so doing, it distributes 100% of the expected reward for risk taking to members who bear at most half, and in some instances none, of the risk. I thank Wayne, Michael, Bernard, Jim and Leo for their comments. They are welcome to their views of how one should fund public sector pension plans and how one should estimate the future returns on a pension fund. These things have nothing to do with my criticism of public sector pension plans.

Let me repeat my criticism as it relates to the most egregious abuser, the federal government. The pension fund managed by the PSPIB is not a trust fund. The plan members have no right to the assets in, or the returns on, the pension fund. The pensions are not paid from the pension fund. Basically, it is public money set aside in a "shoe box". The directors have a statutory duty to represent the interests of plan members in setting investment policy but the benefits owed to plan members are not influenced in any way by the performance of the pension fund. The benefits are a statutory obligation of the federal government. What then is the purpose of the pension fund? It is to allow the federal government to cut the reported cost of the pension plan in half by giving the chief actuary an excuse for using a 6% (4% real) interest rate, which he or she does. The reduced "price" helps only members, who are paid more and contribute less. Consequently the reward for risk taking goes to the members while the public bears the risk. Perhaps someone could comment on this.

The Ontario Teachers’ Pension Plan and BCG Digital Ventures are tackling technological disruption with a new venture incubator called Koru:

Ontario Teachers’ Pension Plan is launching a venture incubator with a twist – it’s focused exclusively on building novel ideas with the companies in its own portfolio. Koru is designed to create, test and build scalable new digital businesses.

“Koru is a clear demonstration of Ontario Teachers’ partnership model of investing. It provides us with an entirely new way to work alongside our portfolio companies and help protect them against disruption by finding opportunities to add significant mutual value along the way,” said Ziad Hindo, Chief Investment Officer, Ontario Teachers’.

Koru is already generating ideas in sectors including healthcare, utilities and transportation.

Its first venture, Elovee, has the ability to bring the comfort of a familiar face and voice to dementia sufferers in the middle of the night, or at other times when those closest to them cannot be physically present.

This advanced conversation software, which digitizes the voice and likeness of family members, was designed with Ontario Teachers’ portfolio company Amica Senior Lifestyles. It is currently being piloted in two of Amica’s Canadian locations.

“Amica is proud to be working with Koru on Elovee,” said Douglas MacLatchy, Chief Executive Officer, Amica Senior Lifestyles. “Drawing on innovative technologies and Amica’s in-house expertise in cognitive-wellbeing, this venture is well positioned to enrich the lives of people with dementia and their loved ones.”

Wholly-owned by Ontario Teachers’, Koru is a partnership with BCG Digital Ventures - the global corporate venture, investment, and incubation arm of Boston Consulting Group.

“Our collaboration with Ontario Teachers’ is inspiring because we are able to draw upon our unique methodology for corporate innovation and experience in launching more than 90 ventures to help them create this new capability for venture building. The potential it has for igniting innovation in—and accelerating the growth of—its portfolio companies is very exciting,” said Anthony Koithra, Managing Director and Partner, BCG Digital Ventures.

To spearhead operationalizing Koru, Bryan Marcovici, BCG Digital Ventures' Venture Architect Director, will officially join Koru as the incubator’s General Manager and Managing Partner.

“We are pleased to have Bryan on board, with his expertise including the industry know-how he has built during his time at BCG Digital Ventures” added Mr. Hindo.

Koru is headquartered in Toronto and plans to hire 35 people. It is currently recruiting a multi-disciplinary team of entrepreneurs, product managers, engineers, marketers, designers, and startup operators. The venture incubator already has three new ventures in the pipeline this year, with plans to launch four more in 2020.

About Ontario Teachers'

The Ontario Teachers' Pension Plan (Ontario Teachers') is Canada's largest single-profession pension plan, with $201.4 billion in net assets at June 30, 2019. It holds a diverse global portfolio of assets, approximately 80% of which is managed in-house, and has earned an annual total-fund net return of 9.7% since the plan's founding in 1990 (all figures as at Dec. 31, 2018 unless noted). Ontario Teachers' is an independent organization headquartered in Toronto. Its Asia-Pacific region office is located in Hong Kong and its Europe, Middle East & Africa region office is in London. The defined-benefit plan, which is fully funded, invests and administers the pensions of the province of Ontario's 327,000 active and retired teachers. For more information, visit otpp.com and follow us on Twitter @OtppInfo.

About BCG Digital Ventures

BCG Digital Ventures is a corporate innovation, incubation, and investment firm. They invent, launch, scale, and invest in industry-changing new businesses with the world’s most influential companies. Their diverse, multidisciplinary team of entrepreneurs, operators, and investors work cross-functionally, rapidly moving from paper to product to business in less than 12 months. Founded in 2014 as a subsidiary of Boston Consulting Group, they have Innovation Centers and satellite locations in four continents and continue to expand their footprint across the globe.

I thank Lori McLeod, OTPP's Director of External Communications, for bringing this latest venture to my attention.

I asked Lori if this new venture is part of Teachers' Innovation Platform (TIP) headed up by Olivia Steedman and she responded:

TIP and Koru will be separate although there is potential for them to collaborate with one another.

Here’s a bit more by way of explanation:

• Koru is an incubator that will partner exclusively with our infrastructure and private equity portfolio companies– it focuses on building and launching new ventures. Koru’s mandate is to build businesses leveraging the assets of our existing portfolio companies.
• TIP is focused on deploying capital to external, late stage ventures and venture capital funds and growth equity opportunities that are not already in our existing portfolio of companies.

"OTPP has over 90 portfolio companies in private equity, infrastructure and natural resources across various sectors and geographies. Koru will help generate greater growth. It is a unique differentiator which we have experimented with over the last year. Basically, disruption is pervasive in traditional companies and rather than waiting for disruption to hit our portfolio companies, we are going on the offense with Koru, incubating new digital ideas along with our partner, BCG Digital Ventures."

WeWork bonds plunging today as it becomes evident that debt holders aren't going to get bailed out by equity investors in the near term. Also, the company needs to raise money somehow, so there are questions of how they plan to do it. https://t.co/nkAOrugWmxpic.twitter.com/EmLl8ZBLv3

— Lisa Abramowicz (@lisaabramowicz1) September 30, 2019

According to terms of this deal, CPPIB will have 45 percent ownership stake in Platform 16 while Boston Properties will have a 55 percent ownership stake. This is the second joint venture between Boston Properties and CPPIB following the Santa Monica Business Park campus in Santa Monica, California in 2018. Boston Properties is a developer, owner and manager of U.S. office properties.

Boston Properties, Inc. (NYSE: BXP), the largest publicly traded developer, owner and manager of Class A office properties in the United States, and Canada Pension Plan Investment Board (CPPIB) have formed a joint venture to develop Platform 16, a 1.1-million-square-foot Class A urban office campus near Diridon Station in downtown San Jose, California.

Boston Properties entered into a 65-year ground lease for Platform 16 in November 2018. As part of that ground lease, the Company secured the right to purchase all of the underlying land during a 12-month period commencing February 1, 2020 at a purchase price of approximately US$134.8 million.

CPPIB will have a 45% ownership interest in the Platform 16 joint venture. Boston Properties will retain the remaining 55% ownership stake and provide customary development, property management and leasing services. This agreement is the second joint venture between Boston Properties and CPPIB following the Santa Monica Business Park campus in Santa Monica, California in 2018.

Located on a 5.4-acre site, Platform 16 is adjacent to Google’s planned eight-million-square-foot transit village and Diridon Station, the largest multi-modal transportation hub in the Bay Area, consisting of Caltrain, VTA light-rail, the ACE train, and the planned BART and high-speed rail lines.

“We are pleased and honored to have Canada Pension Plan Investment Board as our partner on this exciting development, expanding the relationship between BXP and CPPIB,” commented Owen D. Thomas, CEO of Boston Properties. “We look forward to bringing this project to market and broadening our footprint on the West Coast.”

“Platform 16 is ideally located in one of the largest technology hubs in the country. With easy access to public transportation, as well as local housing, culture, food and entertainment, Platform 16 will help companies attract and retain the talent they need to support their growth,” stated Aaron Fenton, Vice President, Development for Boston Properties.

This joint venture partnership between CPPIB and Boston Properties will support the development of the planned three-building campus. The partners expect the buildings to feature large floorplates ranging from approximately 25,000 to 90,000 square feet, 15-foot floor-to-floor heights, 16 large outdoor terraces that give the project its name, along with multiple indoor and outdoor workspaces, and on-site amenities including a large fitness and wellness facility and conference center. Platform 16 will have immediate access to the adjacent Guadalupe River Park and various retail and restaurant amenities.

“Partnering with Boston Properties on the Platform 16 development is a great example of our real estate strategy in the United States. We are very pleased to further our relationship with a best-in-class owner and operator and we look forward to expanding our office portfolio in the dynamic Bay Area,” said Hilary Spann, Managing Director, Head of Real Estate Investments, Americas at CPPIB.

Boston Properties has secured approvals and entitlements for the development of Platform 16, completed design plans and begun to clear the site. Construction could commence in the next six months, depending on market and other conditions.

More information about Platform 16 can be found at www.platform16sj.com.

About Boston Properties
Boston Properties (NYSE: BXP) is the largest publicly-held developer and owner of Class A office properties in the United States, concentrated in five markets - Boston, Los Angeles, New York, San Francisco and Washington, DC. The Company is a fully integrated real estate company, organized as a real estate investment trust (REIT), that develops, manages, operates, acquires and owns a diverse portfolio of primarily Class A office space. The Company’s portfolio totals 50.9 million square feet and 193 properties, including 12 properties under construction. For more information about Boston Properties, please visit our website at www.bxp.com or follow us on LinkedIn or Instagram.

About Canada Pension Plan Investment Board
Canada Pension Plan Investment Board (CPPIB) is a professional investment management organization that invests the funds not needed by the Canada Pension Plan (CPP) to pay current benefits in the best interest of 20 million contributors and beneficiaries. In order to build diversified portfolios of assets, CPPIB invests in public equities, private equities, real estate, infrastructure and fixed income instruments. Headquartered in Toronto, with offices in Hong Kong, London, Luxembourg, Mumbai, New York City, San Francisco, São Paulo and Sydney, CPPIB is governed and managed independently of the Canada Pension Plan and at arm’s length from governments. At June 30, 2019, the CPP Fund totaled $400.6 billion. For more information about CPPIB, please visit www.cppib.com or follow us on LinkedIn, Facebook or Twitter.

The housing affordability crisis is coming to a head, inhibiting employers seeking workforce housing and prompting city officials to change zoning laws.

High-cost markets such as Washington, D.C., Boston, Los Angeles, San Francisco and San Jose, California, cite affordability as a critical issue and not just for lower-income households. “The missing middle — medium-density housing filling a key market niche as well as the affordability gap — is a concern in those markets, as it is for San Diego and Jacksonville, as well as for Cleveland and Detroit,” the report states.

Some large employers are taking matters into their own hands. In a highly publicized move, Microsoft announced a three-year, $500 million investment to spur housing development across the Puget Sound markets. A 21 percent increase in jobs this decade had stressed a housing stock that had grown by only 13 percent, resulting in a massive rise in home prices and rents. The company’s program contains components addressing low-income housing, middle-income housing, and programs for the homeless. Redmond, Kirkland, and Bellevue are pursuing a “cooperative strategy” with private firms, but Seattle has demurred under opposition from local community groups.

When conditions exacerbate housing affordability, some jurisdictions turn to rent control at a time when about half of American renters—over 21 million households—spend more than 30 percent of their income on housing. This has been the case in Oregon, which passed a statewide rent-control law early in 2019. The California legislature was grappling with proposals to cap rents under various formulas as it met during summer 2019. New York State, in June, expanded its rent protection laws just as they were about to expire. Politics? Sure. But the politics only arise as a result of the market conditions. (New York even has a party with the name “The Rent Is Too Damn High.”)

Whatever the populism behind the politics, investors are taking note.

One opportunistic investor immediately reacted to the New York State legislation by withdrawing from multifamily acquisitions in Brooklyn, observing, “There is a new ‘class’ of legislators and other elected officials, elected by populists from both ends of the political spectrum. This can create bad policy and bad law.” The head of investment sales for a major brokerage said, “Complex issues are more and more reduced to sound bites, and this potentially can lead to big mistakes in the rush to judg-ment.” A sophisticated West Coast fund manager pointed out, “With effective demand constrained as rents hit a practical limit, rent control is now a national/international wave.”

Most in the real estate industry regard rent regulation unfavorably. One major institutional investment manager takes a more tempered point of view, though. “Rent control may become more prominent and hurt upside return potential, but could also provide for more steady, reliable investments to emerge.”

Renters are not simply looking to government for solutions, and probably do not have the time to wait for legislative edicts. Co-living is observably a more frequent phenomenon, as our focus group in Southwest Florida noted, saying that “this is starting to drift into adult living arrangements.” There is even a pop-culture reference for this trend: the “Golden Girls” model. Several firms are promoting advantages beyond just costs—such as an increased experience of community, mutual decision-making, and even shared ownership.

If we are at a critical moment for housing, perhaps that is not entirely such a bad thing. After all, adaptation is the key survival skill in a world of Darwinian evolution. The real estate industry can be counted on to adapt, and the trend in housing is almost assuredly not the “same old” extension of the direction taken in the decade just past.

The nation’s biggest pension manager has increased its private debt investments from C$5.1 billion ($3.4 billion) in 2011, to C$32.7 billion at the end of March, its annual report shows. Investments in private credit were virtually zero in 2006. The growth of its allocations in less liquid assets has borne fruit, said its senior managing director and global head of credit investments John Graham.''

CPPIB, with more than C$400 billion of assets, is pushing further into private debt -- where borrowers bypass traditional capital markets -- to make up for dwindling yields elsewhere. With concerns about a new global economic slowdown causing interest rates to plunge, and about $15.6 trillion of global debt paying less than zero, it’s increasingly urgent for portfolio managers to find new sources of returns. CPPIB has also boosted assets in private equity and real estate, and is looking further afield for gains, targeting growth in emerging markets and Asia.

“Getting paid for the lack of liquidity is certainly something that we’ve been very successful at in the credit side,” Graham said in an interview.

Liquidity Issues

Graham currently oversees about C$40 billion in credit investments, with around 80% of that speculative grade. This includes corporate, real estate and structured deals.

While it’s benefited CPPIB, Graham is cognizant of the risks, as demand leads to a deterioration in deal terms. Investors could also get saddled with losses if credit conditions sour and they can’t unload under-performing assets.

“We’re seeing less and less liquidity across the board, and in some of these markets I’m not sure if there is liquidity at all,” he said. “Whether or not it’s a big issue is going to be very institution specific.”

CPPIB returned 1.1% in the quarter ended June 30, as net assets grew C$8.6 billion to top C$400 billion for the first time. Pension funds invest in a variety of assets including low-risk government bonds. While that means they profit from fixed-income rallies, falling yields have also driven up future liabilities -- threatening their ability to meet obligations.

The Ontario Municipal Employees Retirement System is also planning to increase its private credit investments amid a push into private markets more broadly, Mark Redman, its global head of private equity, said in an interview with Bloomberg TV. The C$97 billion pension fund currently allocates about 50% of its investments to non-public markets, he said.

“You have to be more creative, private markets give more opportunities to add value,” he said. From a valuation perspective, these assets suffer less volatility, which means returns can be managed more effectively, he said.

Middle Market

CPPIB remains bullish on the U.S. middle-market, where it invests through Antares Capital, which has about $24 billion in assets. Antares is prepared to swoop in to buy assets from cash-strapped lenders when the cycle turns, its chief executive officer said in July.

“We really do try to get deep diligence on every single deal,” Graham said. He added that CPPIB sees good opportunities to invest in companies that will survive a downturn in the credit cycle.

The credit team, numbering just under 100 employees in Toronto, New York, London and Hong Kong, is currently focused on growing in Asia and emerging markets. The fund is looking to grow particularly in China, India and Brazil. Emerging markets account for around 10% of the credit portfolio.

“These are markets that are going to grow, they are going to be increasingly relevant in the global economy and it makes sense to spend time to build out capability and the infrastructure to invest,” he said.

Capturing the Strength and Momentum in Private Debt and Alternative Credit Growth: The Remarkable Achievements of a Small Asset Class

Wednesday, September 25, 2019, 9:15 AM - 10:15 AM

There are enormous opportunities to be found in private debt and alternative credit growth. In 2018, assets under management globally by private debt funds reached $638 billion, with aggregate capital raised surpassing the $110 billion mark. Hear about the latest developments in asset-back debt, direct lending, and alternative credit. Access the full spectrum of credit instruments to deliver absolute performance while limiting your duration risk and interest rate sensitivity.

Moderator: Vishnu Mohanan, Manager, Private Investments - Halifax Regional Municipality Pension Plan

Speakers:
Theresa Shutt, Chief Investment Officer - Fiera Private Debt
Ian Fowler, Co-Head North America Global Private Finance & President, Barings BDC - Barings
Larry Zimmerman, Managing Director, Corporate Credit, Benefit Street Partners

Synopsis: This morning, we all listened to an interesting panel on private debt, one of the hottest asset classes right now. I came a tad late when they were going over the pros and cons of sponsored versus non-sponsored deals.

In non-sponsored deals, you rely on third party data on quality of earnings and other data.

Theresa Shutt said they focus on corporate credit and companies with audited statements. "If there is trouble, we want to see how management behaves in a downturn, we have good covenants."

She said to ask private debt managers a simple question: "Tell me about your bad months." She added: "Our recovery has been quite high".

I like that, asked Theresa to write a guest comment for my blog on this hot asset class.

Ian Fowler focused a lot of alignment of interests and said to look at two things:

1. Target return
2.  Fee structure

He warned "investors are overpaying for beta" and said you can expect 6-8% unlevered return but as the market gets hot, spreads are being compressed, managers are making higher risk loans to meet targeted return, and skimming is occurring where they are using investors' money to generate income on their platform."

Larry Zimmerman also warned investors to beware of private debt managers "building syndication deals".

Theresa Shutt warned not to just talk to principals, "ask about compensation, focus on culture". She said they use ESG in all their underwriting criteria.

I asked the panel how to prepare for another 2008 crisis and they told me to "focus on first not second lien loans" and remain highly diversified, avoiding deep cyclical sectors.

Interestingly, in the US, non bank private debt funds have been very active in the middle market and act to stabilize the market in case of a downturn.

Ian Fowler told us to look at average debt spread, style drift, and leverage.

I need to cover private debt in a lot more detail but Ian told me after that average PE multiples are priced at 12x so there is no room for error. "It's the same thing in private debt, you need to see how deals are being priced and beware of alignment of interests as spreads get compressed and managers try to fulfill their target return".

Vito focuses on spread over sovereign focusing on emerging markets opportunities in quasi-government corporations (owned at least 50% by governments), securitization of royalty streams, PPPs and more.

He said the five factors of investing in his space are:

1. Interest rate risk
2. Sovereign risk
3. Sponsor or project risk
4. Liquidity premium
5. Complexity premium

They have a mix of internally managed and externally managed funds "across the spectrum, generally absolute return funds."

He said the Caisse focuses on five emerging markets: Brazil, India, China, Columbia and Mexico but his team focuses on all these except China.

They like dislocations where they can fund long term opportunities which need funding. "Some markets have funding opportunities that go out 7 years and then they fall off a cliff. We like those opportunities because we are patient, long-term capital."

He said they are "very methodical in their approach and leverage off the entire infrastructure of the organization." Due diligence is critical in their process.

He travels a lot to "pitch issuers looking for financing" and meets a lot of CFOs. They have a global network with local knowledge.

Vito warned investors: "Emerging Markets are most complex and heterogeneous markets in the world. You need to respect that and use specialist managers."

He said ESG is used throughout their process and gave the example of Brazil where it's known "corruption is rampant."

“For the first time in CPPIB’s history we are going to have all of our credit investors in one department,” says Graham. “Credit as an asset class is one of the largest globally and this change is going to provide the opportunity to have all of the experts together to build a global, diversified credit portfolio that maximizes value for CPPIB.”

The shift is crucial to support our strategic mandate to become an increasingly global investor and properly respond to the opening of credit markets in China, India and Latin America.

Graham notes those markets are less developed than credit markets in North America and Europe, and makes viewing credit through a broad lens increasingly important.

“We are going to have a mandate across the credit spectrum from investment grade to non-investment grade, and corporate to asset-backed lending,” he says. “It’s a broad mandate and we are currently developing a go-to-market strategy for new geographies, leveraging the breadth in a deliberate and methodical way.”

Graham adds this new approach to credit investing will differentiate CPPIB from organizations that house credit within regional departments, asset class groups (such as real estate), or separate it based investment grade and non-investment grade.

“When you invest in emerging markets, the lines between these asset classes – or these segments of the asset classes – are very blurred,” he says. “Having all investors within one department allows us to look beyond product labels and focus on the underlying risk/return trade-off.”

Graham says the department will continue to be a fundamental credit investor and ensure CPPIB is focusing on the credit worthiness of each individual investment.

These recent commitments include capital raised for Northleaf’s mid-market infrastructure and private credit programs, as well as significant new commitments to mid-market private equity and secondaries custom mandates managed on behalf of two of Canada’s largest institutional investors. Building on the firm’s strong growth momentum, this new capital brings Northleaf’s private equity, private credit and infrastructure commitments raised to more than US$13 billion.

“Our mid-market global private markets platform continues to create long-term value for our investors,” said Stuart Waugh, Managing Partner at Northleaf. “We appreciate the confidence that both existing and new investors have placed in our team, track record and investment strategies.”

As part of this most recent capital raise, Northleaf has grown its successful custom private equity and secondaries investment mandates on behalf of Canada Pension Plan Investment Board (CPPIB) and Caisse de dépôt et placement du Québec (CDPQ), respectively. Northleaf has extended its longstanding private equity investment partnership with CPPIB through an innovative evergreen fund structure that will offer CPPIB access to the Canadian private equity market. Northleaf has also expanded its customized global secondaries investment partnership with CDPQ which focuses on mid-market private company secondary transactions.

“We are very pleased to grow our longstanding partnerships with CPPIB and CDPQ, providing truly customized mid-market private equity solutions that leverage Northleaf’s deal flow, execution capabilities and active portfolio construction,” said Michael Flood, Managing Director and Head of Northleaf’s Private Equity team. “Our integrated focus on secondary market transactions, fund investments, direct minority investments and co-investments provides investors with differentiated access and exposure to mid-market private company value creation.”

Since its spin-out from TD Bank Group 10 years ago, Northleaf has continued to grow as an independent global firm, leveraging the proprietary insights and deal flow generated by its integrated private markets platform. Northleaf’s commitments under management have grown by more than fivefold to US$13 billion, its employee count has more than tripled to 140 teammembers and its global office network now extends to seven locations around the world. Northleaf is focused exclusively on sourcing, evaluating and managing private equity, private credit and infrastructure investments, and its portfolio includes more than 350 active investments in 34 countries, with a focus on mid-market companies and assets.

Northleaf now has more than US$12 billion in private equity, private credit, and infrastructure commitments under management on behalf of institutional and high-net-worth investors, including pension funds. Private credit is a general term for loans made to companies by lenders other than banks.

Stuart Waugh, Northleaf’s managing partner, said a large portion of the latest US$800 million capital raise is not destined for a typical closed-end fund that requires a long-term commitment with few liquidity options. Instead, Northleaf Senior Private Credit, which has more than US$500 million in investor commitments so far, will accept new investments each quarter and allow for earlier payouts than a traditional closed-end fund.

“We’ve seen some really good take-up from that,” Waugh said, adding that the open-ended investment fund plans to build a portfolio of senior secured loans to mid-market private companies in a variety of sectors across North American and Europe.

“The bulk of our investment activity is in the U.S. and Europe,” Waugh said, adding that the focus on senior secured debt is appealing to smaller funds and other investors that find the “safest” tranches of the credit stack more desirable.

Northleaf launched the private credit program a few years ago to create an integrated private markets platform with the firm’s existing investment strategies for private equity and infrastructure.

The market is in a slow melt-up mode on Friday.

There was a volume spike at 11:30 a.m. as European markets closed and as the S&P 500 passed the earlier highs of the day at 10:00 a.m. ET, a technical move in-line with typical momentum action, JP Morgan’s Marko Kolanovic noted in remarks to clients: “If the market can move ~50bps higher during the day, it could spark a significant rally driven by the trend followers (CTAs) [Commodity Trading Advisors] and the same put options that helped push the market lower earlier in the week.”

Behind the rally: a jobs report sufficient to cool down some, but not all, of the talk about a recession in 2020.

The other big question: Did it cool the Fed’s likely path to cutting rates again at the end of October? Most feel it did not and the Fed will still likely cut for the third time this year.

“It’s not strong enough to allay fears that there isn’t a slowdown, but not weak enough to confirm the bear narrative,” Alec Young, managing director, global markets research at FTSE Russell told me. “We need stronger data to get the recession risk off the table.”

What’s next? Trade and tariffs. The president confirmed a China delegation will be in Washington next week to resume negotiations. Expectations are low, but there is an urgency due to the recent weaker economic stats.

After next week we get earnings reports, and there will be comments on how the fourth quarter is looking, beginning with J.P. Morgan Chase and Wells Fargo on October 15th.

In a note to clients this morning, Morgan Stanley’s bank analyst team, led by Betsy Graseck, noted that the third quarter was difficult for banks, marred by rate pressure, trade tensions, and a slowing global economic growth outlook. The team noted that a half-point decline in 10-year bond yields would weigh on bank results, though consumer loan growth and mortgage applications were strong.

Rounding out the first big week of earnings is Johnson & Johnson, also on October 15th, IBM on October 16th, and large global Industrial names Honeywell and Textron on the 17th.

Amid signs that the global economy is slowing, America's labor market nonetheless remains strong.

In September, the unemployment rate fell to 3.5%, the lowest rate since December 1969, as employers added 136,000 jobs to the US economy. There were many signs of strength, including robust hiring in health care, transportation, professional services and state and local government.

But overall, the pace of hiring has slowed considerably since 2018, when the economy added an average of 223,000 jobs per month. The September jobs report comes in the same week as several other reports that showed the US economy is slowing.

Activity in American's factories has declined for two straight months, and the biggest piece of the economy, the services sector, is growing at its weakest pace in three years. Businesses expressed concern about tariffs, a shortage of workers and the direction of the economy.

Against that backdrop, economists and investors took the jobs report as a neutral sign. It was neither strong enough to disprove fears of a weakening economy, nor weak enough to confirm with certainty the Federal Reserve may have to cut interest rates at its October meeting, in a measure to boost growth, said Thomas Simons, an economist and senior vice president at Jefferies. Stocks nevertheless posted strong gains following the report, but overall, are still down for the week.

President Donald Trump noted the drop in the unemployment rate in a tweet shortly after the release, adding "wow America, lets impeach your President (even though he did nothing wrong!)"

This is not the first time Trump has violated the one-hour rule that says federal employees outside the Labor Department staff that issue the report cannot publicly comment on it in the first hour after the release.

Signs of strength

Despite cracks showing in the economy, hiring has long been a bright spot. As companies fight for talent, paychecks have grown, giving more spending power to consumers. Consumer spending has kept the economy growing even as the trade war hurts US manufacturing and farming.

This most recent report from the Labor Department showed some encouraging signs: July and August's jobs reports were revised higher by a combined 45,000 jobs. Hispanic unemployment fell to 3.9%, setting a record low, while black unemployment remained at a record low of 5.5%. Minority unemployment has been tracked by the Labor Department since the early 1970s.

The nation's underemployment rate, which looks at people who are unemployed as well as those who are working part time but would prefer full-time work, fell to 6.9%. That's the lowest reading for that measure since December 2000.

The unemployment rate for adults with less than a high school education fell to 4.8%, the first time that measure has ever been below 5% on data going back to 1992.

The economy also benefited from 1,000 new positions from the US Census. However, the massive GM strike, in which about 50,000 people joined picket lines, was not counted in this month's report.

Worries about wages

A bleaker point in the report came from wages.

Average hourly wages didn't grow between August and September. Over the past year, wage growth ticked up just 2.9%, which was lower than expected and the weakest annual growth since July 2018.

Still, on the whole, "this is not that weak of a report, despite the ebbing in job growth," Sal Guatieri, senior economist at BMO, wrote in a note to clients.

That said, weakening domestic and foreign demand in light of the trade war will add uncertainty for companies and increasingly weigh on job growth, Guatieri added.

The Federal Reserve's next meeting on interest rates is scheduled to conclude on October 30. In the meantime, investors are closely watching other economic indicators for clues as to whether the central bank will cut rates again.

Following the jobs report on Friday, Fed Chairman Jerome Powell said the economy is in "a good place."

"Our job is to keep it there," he added.

The September PMI^® registered 47.8 percent, a decrease of 1.3 percentage points from the August reading of 49.1 percent. The New Orders Index registered 47.3 percent, an increase of 0.1 percentage point from the August reading of 47.2 percent. The Production Index registered 47.3 percent, a 2.2-percentage point decrease compared to the August reading of 49.5 percent. The Employment Index registered 46.3 percent, a decrease of 1.1 percentage points from the August reading of 47.4 percent. The Supplier Deliveries Index registered 51.1 percent, a 0.3-percentage point decrease from the August reading of 51.4 percent. The Inventories Index registered 46.9 percent, a decrease of 3 percentage points from the August reading of 49.9 percent. The Prices Index registered 49.7 percent, a 3.7-percentage point increase from the August reading of 46 percent. The New Export Orders Index registered 41 percent, a 2.3-percentage point decrease from the August reading of 43.3 percent. The Imports Index registered 48.1 percent, a 2.1-percentage point increase from the August reading of 46 percent.

Back in 2012, the world’s best-managed pension market was thrown a lifeline by the Danish government to help contain liabilities. That was when interest rates were still positive.

Seven years later, with rates now well below zero, even Denmark’s $440 billion pension system says the environment has become so punishing that it may be time for a change in European rules.

Henrik Munck, a senior consultant at Insurance & Pension Denmark, an umbrella organization, says the way liabilities are currently calculated “could cause a negative spiral” that forces funds to keep buying low-risk assets, drive yields lower and the value of liabilities even higher.

The warning comes as pension firms across Europe struggle to generate the returns they need to cover their growing obligations. Profitability remains under pressure despite steps to switch customers to products with lower or no guarantees, according to supervisors. In Denmark, some funds saddled with legacy policies guaranteeing returns as high as 4.5% have had to use equity to meet their obligations.

To calculate liabilities, pension firms use a complex mathematical formula constructed by the European Insurance and Occupational Pensions Authority (EIOPA). The formula is intended to shield funds from erratic market swings that artificially inflate or hollow out balance sheets. But with negative rates more entrenched, there are signs the EIOPA curve, as it’s called, may not be working as intended.

“When pension funds across Europe de-risk simultaneously, it may actually become pro-cyclical: it increases the price movements, and it could result in yet more downward pressure on the EIOPA yield curve, exacerbating the problem,” Munck said.

The curve is comprised of several elements. Its backbone -- the euro interest-rate swap curve -- has sunk since its implementation about four years ago, driving up the value of liabilities.

Sinking Swap Rates

The European Commission has started reviewing the regulatory framework around insurers -- Solvency II -- with a view to proposing improvements by the end of next year. Insurance Europe, an industry group, is urging the commission to address the curve in its evaluations.

In the meantime, pension funds have been coping by buying up riskier assets. The Dutch, ranked with Denmark as the world’s best performing pension providers by Mercer, have complained to the European Central Bank about the fallout on the industry.

And Then...

And then there’s the headache of what’s called the volatility adjustment (VA), which is set on a country-by-country basis and is designed to cushion the impact of erratic markets. According to Bloomberg Intelligence senior analyst Charles Graham, there’s “widespread” agreement that VA is “flawed.”

“It is something that EIOPA is considering recommending changing, but the challenge is still what to replace it with, or how to fine tune it,” Graham said.

Earlier this year, EIOPA unexpectedly slashed Denmark’s VA to roughly a third its previous level, causing considerable alarm in the industry.

According to Anders Damgaard, the chief financial officer of Denmark’s biggest commercial pension fund, PFA, which has about $100 billion in assets, EIPOA’s reason for the adjustment made sense:
PFA, like many Danish pension funds, started scaling back guaranteed products for retirees many years ago. That’s given it a buffer to help absorb some of the shock of growing liabilities. But not everyone’s as well prepared. “If the discount curve is more volatile and you can’t hedge it, you can -- if you don’t have enough capital -- be forced to lower risk on the more hedgeable space, to compensate,” Damgaard said.

Olav Jones, deputy director general of Insurance Europe, says the pension industry “does not see any need to change the way the risk-free curve is generated, but there is a need to improve how the VA is generated.” Right now, it’s “generally too low and generally leads to liabilities that are inflated” and creates artificial volatility in insurers’ balance sheets, he said.

In Denmark, where interest rates have been below zero longer than anywhere else, regulators are increasingly worried that pension funds are shifting more risk over to their customers. In August, the head of the Danish financial regulator said there are signs that retail investors are being forced to accept more risk than they understand.

Jim Keohane, President & CEO of HOOPP, was kind enough to share this with me on ATP:

"I know they had a very high return which has to do with how they manage their liability hedge portfolio. Their liabilities are different than a regular pension plan. Every Danish working citizen makes an annual contribution. They take 80% of that contribution and hedge it forward in the interest rate swap market and based on the yield they get on the swap they promise a future cash flow stream. So on the asset side of the balance sheet their entire liability hedge portfolio is long term swaps. Based on the move to negative rates in Europe they would have a huge gain on the swaps - hence the high return, but the present value of the liabilities would also go up by a similar amount so there is probably no change in their funded ratio. The asset return is only half the picture."

Jim added this: "I would also add that it is a good thing that they run a liability matched portfolio otherwise they would have gotten killed. It is a very well-run organization."

Another explanation for ATP's record performance was provided to me by Marc-André Soublière, Senior VP Fixed Income and Derivatives at Air Canada Pension Fund:

"Another explanation is 30 bps move they made on 30 yr swap spreads! 30 year swaps spreads not swaps. They could have bought 30 yr German bonds, or futures. The spread between both was over 50 bps in January. To tie this in with what Jim Keohane wrote. If they discount their liabilities with a swap rate then there is no mismatch. However, in Canada, most liabilities are discounted using AA corporate yield. Using swaps to get your duration creates a mismatch or a basis risk. I am not familiar with ATP's LDI strategy...."

“That’s really where the main challenge is for us,” Damgaard said. “We have an unhedgeable component of the yield curve -- which is actually active on the entire yield curve -- and you can’t hedge it, which means that the balance sheet posts are very volatile.”