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Publication Date: 10 Mar 2023
Publication Site: Treasury Department
Category: Investments
U.S. Asset Managers Fear Federal Reserve Rate Hikes Will Cause Recession
Excerpt:
A significant portion of U.S.-based asset managers think further Federal Reserve rate hikes would lead to a recession or some disruption in global financial markets, according to research last month by London-based CoreData Research.
The greatest anticipated risk of continued Federal Reserve rate hikes is a possible recession. Overall, 59% of survey respondents took a neutral look at a recession scenario, that there would be “a moderate recession in 2023, followed by a gradual recovery as central bank policies bring down inflation over time,” while 14% opted for a bull case, defined as “a mild recession in the first half of 2023, followed by a strong recovery, falling inflation and rising equity markets [in the second half of 2023],” and 27% said they agree with a bear case, defined as a scenario in which “stagflation and a deep recession [occur] in 2023, accompanied by a 10-20% fall in the equity markets, as central banks struggle to defeat inflation which remains high.”
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Within fixed income, 36% of respondents said they are increasing allocations to investment-grade corporate bonds, the most of any fixed-income subtype, and 33% are set to increase allocations to government bonds. A further 23% of respondents said they plan to cut their exposures to emerging-market debt as a consequence of higher yields domestically.
Author(s): Dusty Hagedorn
Publication Date: 24 Feb 2023
Publication Site: ai-CIO
What the Madoff Series Left Out
Link: https://reason.com/video/2023/02/21/what-the-madoff-series-left-out/
Excerpt:
And yet, nothing in the series leads the viewer to the conclusion that the SEC needed a bigger budget to catch Madoff. In fact, outsiders were sounding the alarm without access to government funding or regulatory muscle. In 2001, Barron’s journalist Erin Arvedlund reported that many Wall Street investors were suspicious that Madoff was engaged in foul play.
And the SEC received its first complaint that Madoff was running “an unregistered investment company” “offering ‘100%’ safe investments” in 1992. In 1999, a derivatives expert named Harry Markopolos, who worked at a competing firm, started to alert the SEC that Madoff’s investment returns were virtually impossible. In 2005, Markopolos sent the agency an infamous 25-page memo explaining why “The World’s Largest Hedge Fund is a Fraud.” The SEC opened an investigation in 2006, and then closed it the following year because the “uncovered violations” were “remedied” and “those violations were not so serious as to warrant an enforcement action.”
So how is this tale of epic failure on the part of a government agency the fault of deregulation?
Instead of making lazy allusions to the evils of free market capitalism, to better understand the lessons of the Madoff saga, director Joe Berlinger should have consulted the work of the free market economist George Stigler, who won the Nobel Prize in part for his work on “regulatory capture.”
Author(s): ZACH WEISSMUELLER AND DANIELLE THOMPSON
Publication Date: 21 Feb 2023
Publication Site: Reason
EBSA Secretary Defends ESG Rule as Legislative, Litigation Battles Continue
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Excerpt:
The Department of Labor’s assistant secretary of labor for employee benefits security, Lisa Gomez, defended the DOL’s final rule allowing the consideration of ESG factors in retirement plan investments at a webinar hosted Monday by Ceres, a sustainability advocate.
The rule, which took effect on January 30, permits, but does not require, the use of ESG considerations in investment selection by retirement plan fiduciaries. There is a pending lawsuit in Texas challenging the legality of the rule.
Gomez explained that this rule is “not a per se requirement” to use ESG and clarifies that ESG factors may be considered as part of a fiduciary’s ordinary risk-return analysis. She also explained that this new rule does not allow fiduciaries to sacrifice the financial health of a plan to pursue other goals: A fiduciary may consider the risks and opportunities of climate change and other ESG factors.
Gomez dubbed the rule “a return to neutrality.”
According to Gomez, the previous rule, passed during the administration of President Donald Trump, which required only “pecuniary factors” to be used in investment selection, had a “chilling effect” on the consideration of ESG factors. Gomez said the word “pecuniary” neither appears in the text of the Employee Retirement Income Security Act, the governing statute for both rules, nor does it occupy a “long-standing place in employee benefits law.”
Gomez briefly discussed one of the more nebulous provisions of the new rule when she said participant preferences for investments can be considered in menu selection on the grounds that it can increase plan participation and deferral rates, thereby increasing retirement security. She did not comment on how fiduciaries should determine adequate participant interest or how much economic gain could be compromised in exchange for increased participation, if any.
Eric Pitt, a climate finance consultant at Ceres who moderated the webinar, asked Gomez how a fiduciary should consider a hypothetical ESG large-cap stock fund for a plan menu: Should the fiduciary compare it to other similar ESG funds or the entire universe of large-cap funds? Gomez answered that there is no special treatment for ESG funds, and a fiduciary should look generally at the risk and return for any and all large-cap equity funds available, whether they use ESG considerations or not.
Despite the branding of the rule as neutral, Republicans in Congress have increased their organized opposition to the use of ESG considerations in retirement-plan investing.
Representative Patrick McHenry, R-North Carolina, chairman of the House Financial Services Committee, announced the creation of a “Republican ESG working group” on Friday. The purpose of the working group is to “combat the threat to our capital markets posed by those on the far-left pushing environmental, social, and governance (ESG) proposals.”
Author(s): Paul Mullholland
Publication Date: 6 Feb 2023
Publication Site: ai-CIO
Public Pension Funding Status Rose in 2022, NCPERS Says
Link: https://www.ai-cio.com/news/public-pension-funding-status-rose-in-2022-ncpers-says/
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Excerpt:
Capital markets had a tough time in 2022, but public pension funds managed to increase their funded status, according to a report from the National Conference on Public Employee Retirement Systems
The funded ratio at public pension funds increased to 77.8% last year, compared with 74.7% in 2021, per a survey of almost 200 funds conducted by NCPERS, the largest trade association for public funds in the U.S. and Canada, in partnership with Cobalt Community Research.
The vast majority of survey respondents, 92%, represent defined benefit plans, 8% defined contribution plans, 10% combination plans and 5% cash balance plans. The total exceeds 100% because of multiple responses, according to NCPERS.Public pension programs scored an average one-year return of around 11.4%. By contrast, the S&P 500 was down around 19% and the Bloomberg US Agg, which tracks bonds, was off 13% in 2022. Heavy concentration in real estate and private equity were the key to the funds’ outperformance, the report says.
The study’s findings highlight public pensions’ “resiliency in the face of volatile markets, rising interest rates, and disruption in the workforce during the COVID-19 pandemic,” said Hank Kim, NCPERS executive director and general counsel, in a statement. “It’s clear that public pensions remain dedicated to maximizing returns while managing risks in order to efficiently deliver retirement benefits to public servants all over the country.”
Higher contribution income helped. Investment returns were the largest component of the gains, accounting for slightly more than two-thirds of them, but the stronger average member and employer contributions also played a role. Each rose by one percentage point, to 9% and 24%, respectively.
Author(s): Larry Light
Publication Date: 6 Feb 2023
Publication Site: ai-CIO
Appeals panel agrees IL police and firefighter pension consolidation doesn’t violate state constitution
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Excerpt:
A state appeals panel has affirmed a ruling that the Illinois state constitution holds no barrier to a law consolidating hundreds of local police and firefighter pension boards into two statewide funds.
In December 2019, Gov. JB Pritzker signed Senate Bill 1000, which amended the Illinois Pension Code to create the Police Officers’ Pension Investment Fund and the Firefighters’ Pension Investment Fund, built through the consolidation of more than 650 otherwise independent downstate and suburban funds.
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Although some union leaders supported the move, dozens of police and firefighter pension boards and individual members sued the state and the new funds to stop the consolidation. Kane County Circuit Court Judge Robert Villa granted summary judgement to the state, prompting an appeal to the Illinois Second District Appellate Court.
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Although the panel agreed the protection clause covers more than just the payment of pension money, it said past Illinois Supreme Court rulings invoking the clause involved benefits that “directly impacted the participants’ eventual pension benefit,” McLaren wrote. But being able to vote for board members, or have a local board control investments, he added, “is not of the same nature and essentiality as the ability to participate in the fund, accumulate credited time, or receive health care, disability and life insurance coverage.”
“Voting for the local board is, at best, ancillary to a participant’s receipt of the pension payment and other assets,” McLaren continued. “The local boards were entrusted with investing the contributions so that payments could be made to participants. However, choosing who invests funds does not guarantee a particular outcome for benefit payments. The local boards also did not have any say in the actual method of funding; contribution requirements were set in the Pension Code.”
Author(s): Scott Holland
Publication Date: 7 Feb 2023
Publication Site: Cook County Record
Chicago Municipal pension fund posts net -11.7% return for 2022
Excerpt:
Chicago Municipal Employees’ Annuity & Benefit Fund returned a net -11.7% for the fiscal year ended Dec. 31.
The $3.2 billion pension fund’s return equaled its policy benchmark return of -11.7% for the period, according to an investment report on its website.
For the three, five and 10 years ended Dec. 31, the pension fund returned an annualized net 3.5%, 4.1% and 6.5%, respectively, compared to the respective benchmarks of 3.8%, 4.8% and 6.5%.
Author(s): Rob Kozlowski
Publication Date: 8 Feb 2023
Publication Site: P&I
Collateralized Loan Obligation – Stress Testing U.S. Insurers’ Year-End 2021 Exposure
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Excerpt:
The stress test analysis found that 1,114 U.S. insurers, with a surplus of about $1.2 trillion, held some
amount of CLO tranches modeled. Similar to last year’s stress testing results, we found that the losses on
insurers’ CLO investments that were modeled, even in the stressed scenarios, were highly concentrated.
To understand the impact of potential losses on insurers, principal loss (compare with Table 7) for
scenarios A, B, and C was divided by each insurer’s year-end 2021 total surplus. For each scenario, the
principal loss as a percentage of total surplus for each of the 1,114 insurers was sorted from highest to
lowest. Then the insurer with the largest percentage loss was referenced as “Insurer 1,” the insurer with
the second largest percentage loss was referenced as “Insurer 2,” and so on until the smallest percentage loss, which was referenced as “‘Insurer 1,114” (x-axis). Please note the difference in the scale of the y-axis
in Charts 1, 2, and 3.
Chart 1 shows the distribution of losses as a percentage of surplus for December 2021’s Scenario A.
Although the bulk of insurers show no losses, 49 of the 1,114 insurers experienced losses in this
scenario. Intuitively, the losses were derived primarily from CCC-rated CLO tranches. The largest loss as
a percentage of surplus under Scenario A was 9.72%. Similar to the analysis for year-end 2020, no
insurers experienced double digit losses.
Author(s): Jean-Baptiste Carelus, Eric Kolchinsky, Hankook Lee, Jennifer Johnson, Michele Wong, Azar Abramov
Publication Date: Jan 2023
Publication Site: NAIC Capital Markets Special Reports
GOP-led House committee launches working group to combat ESG proposals
Link: https://www.pionline.com/washington/republican-led-house-committee-launches-anti-esg-working-group
Excerpt:
Congressional Republicans on Friday took another step in their quest to dismantle the Biden administration’s environmental, social and governance rule-making initiatives.
The House Financial Services Committee has formed a working group to “combat the threat to our capital markets posed by those on the far-left pushing environmental, social and governance proposals,” the committee’s Chairman Patrick McHenry, R-N.C., announced.
The group will be led by Rep. Bill Huizenga, R-Mich., and include eight other Republican committee members.
Among its priorities, the group will examine ways to “rein in the SEC’s regulatory overreach;” reinforce the materiality “standard as a pillar of the nation’s disclosure regime;” and hold to account market participants who “misuse the proxy process or their outsized influence to impose ideological preferences in ways that circumvent democratic lawmaking,” according to a news release.
“This group will develop a comprehensive approach to ESG that protects the financial interests of everyday investors and ensures our capital markets remain the envy of the world,” Mr. McHenry said in the news release. “Financial Services Committee Republicans as a whole will continue our work to expand capital formation, hold Biden’s rogue regulators accountable, and support American job creators.”
Author(s): Brian Croce
Publication Date: 3 Feb 2023
Publication Site: Pensions & Investments
Investing Novices Are Calling the Shots for $4 Trillion at US Pensions
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Excerpt:
In the US, a lineup of unpaid union-backed reps, retirees and political appointees are the vanguards of a $4 trillion slice of the economy that looks after the nation’s retired public servants. They’re proving to be no match for a system that’s exploded in size and complexity.
The disparity is dragging on state and local finances and — together with headwinds that include a growing ratio of retirees to workers and lenient accounting standards — gobbling up an increasing share of government budgets. Precisely how much it’s costing Americans is hard to say. But a Bloomberg News analysis of data from CEM Benchmarking, which tracks industry performance, indicates that the price tag over the past decade could run into the hundreds of billions of dollars.
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The disconnect was on display at a 2021 investment committee meeting of the California Public Employees’ Retirement System, which provides benefits to more than 750,000 individuals. An external adviser warned board members that the boom in blank-check companies was a sign of froth in financial markets.
“I had never heard of those,” chairwoman Theresa Taylor told her fellow directors of the then-sizzling products known as SPACs, according to a transcript of the meeting.
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Systems are underfunded partly because public officials face greater pressure to fulfill today’s demands than to fund obligations 20 or 30 years away. And because hikes in taxes and contributions are unpopular, there’s an incentive to downplay the problem.
Instead, plans are investing in higher risk assets, which make up about one-third of holdings, according to data from Preqin. That allocation has more than doubled since just before the 2008 financial crisis as plans have poured $1 trillion into alternatives.
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Many pension advisers make smart recommendations: the guidance that CalPERS should stay away from SPACs, for one, was proven sound once regulators ramped up scrutiny of that market, which has all but ground to a halt. Yet it remains unclear how closely individual directors evaluate investments that get put in front of them.
“I served with one director for about 15 years and never saw him ask a question” about his system’s investments, said Herb Meiberger, a finance professor who sat on the board of the $36 billion San Francisco Employees’ Retirement System until 2017. A spokesman for the system said it takes governance and fiduciary duty very seriously, and that board members receive training to help them execute their duties.
Harvard finance professor Emil Siriwardane has researched why some US plans have put more money into alternatives. It wasn’t the worst-funded or those with the most aggressive performance targets. “By a factor of eight-to-ten,” the closest correlation is the investment consultants that pension plans hire, Siriwardane found.
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Canada’s detour from the American-style model began in the late 1980s, when Ontario’s government and teacher federation decided to reboot a plan that was invested in non-marketable provincial bonds. They set up the Ontario Teachers’ Pension Plan in 1990, concluding the province could save $1.2 billion over a decade by operating more like a business.
Ontario Teachers’ first board chairman was a former Bank of Canada governor and its first finance chief was a corporate finance veteran. It soon began investing directly in private markets and infrastructure, opened offices in Europe and Asia and acquired a large real estate firm. The system pays its board members close to what corporate directors make, and manages 80% of its investments internally. Those practices have put it on a solid financial base: Ontario Teachers’ says it’s been fully funded for the past nine years, with a current funding ratio of 107%.
Until the 2008 financial crisis, boards in the Netherlands — where traditional public sector pensions are common — looked a lot like those in the US. Then the country’s central bank was given authority to assess candidates. It looked at directors’ combined risk management, actuarial and other expertise.
Many smaller Dutch funds didn’t make the cut. The regulatory hurdles helped set off a wave of mergers that, over the past decade, has reduced the number of plans by over two-thirds. The system has sprouted professional directors who serve more than one at a time.
Few US boards are following suit. Only 19 of 113 funds studied made changes to their board composition from 1990 to 2012, a paper published in The Review of Financial Studies in 2017 found.
“A lot of funds in the US like the idea of transforming, want to transform, but don’t have the political fortitude to do it,” said Brad Kelly of Global Governance Advisors, a Toronto-based firm that works with US and Canadian pension funds.
Author(s): Neil Weinberg
Publication Date: 3 Jan 2023
Publication Site: Bloomberg
How an insurer in Iowa became the most coveted asset on Wall Street
Link: https://www.ft.com/content/b4261b75-f0cd-4d23-9253-8c392a5e0ba9
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Excerpt:
American Equity Investment Life last week rebuffed an unsolicited $4bn offer from a rival controlled by Paul Singer’s Elliott Management, capping a tumultuous year during which Bhalla also antagonised his company’s largest shareholder, Canada’s Brookfield Asset Management.
Underpinning the boardroom drama is Bhalla’s determination to keep AEL, one of the few independent annuities operators left, out of the wave of consolidation sweeping through the industry as private equity groups hoover up insurance assets.
The bad blood between Bhalla and Brookfield is a product of a deal that AEL entered into in November with start-up fund manager 26North, founded by the former longtime Apollo Global executive Josh Harris.
Bhalla had first turned to Brookfield in 2020 as it sought a white knight to fend off an earlier hostile bid from Apollo, where Harris worked at the time. Now with the Elliott bid out in the open, AEL and its $70bn of assets are in the crosshairs as a clutch of Wall Street investment titans circle the company.
Apollo, Brookfield, KKR, Carlyle Group, Ares and Sixth Street are among the many groups that could be bidders in a potentially frenzied auction next year.
Author(s): Sujeet Indap and Mark Vandevelde
Publication Date: 29 Dec 2022
Publication Site: Financial Times
Cultural stereotypes of multinational banks
Link: https://cepr.org/voxeu/columns/cultural-stereotypes-multinational-banks
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Excerpt:
Previous studies (e.g. Guiso et al. 2006, 2009) have used aggregate survey data from Eurobarometer to show that the volume of flows between pairs of countries is importantly affected by bilateral trust. A limitation of such country-level evidence is that average levels of trust are almost certainly correlated with unobserved characteristics of country pairs. To rule out confounding factors, we therefore develop a bank-specific measure of trust.
For this purpose, we model banks as hierarchies (as illustrated by Figure 1). Strategic decisions such as whether or not a bank should invest in a country are generally taken at bank headquarters. Portfolio managers working in the headquarters country or elsewhere are then responsible for implementing those decisions. Because we are concerned with investment decisions undertaken by headquarters, we focus our analysis on the extensive margin of sovereign exposures – whether or not a bank invests in the bonds of a country, as opposed to exactly how much it invests.
Given this framework, cultural stereotypes in subsidiaries can shape the soft information that subordinates transmit up the hierarchy to headquarters, where the broad parameters guiding portfolio investment decisions are set. They can affect how that soft information is received by directors, because the latter share the same stereotypes, reflecting the extent to which banks hire and promote internally across borders, such that the composition of bank boards and officers reflects the geography of the bank’s branch network. We provide empirical support for this framework by showing that multinational branch networks help predict the national composition of high-level managerial teams at bank headquarters.
Author(s): Orkun Saka, Barry Eichengreen
Publication Date: 23 Dec 2022
Publication Site: VoxEU