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Ripple Effects... Fallout
The ripple effects continue…
Longtime readers may recognize a theme in many of our missives. A theme we unintentionally started. But it’s our way of explaining what you’re seeing in the financial markets.
They’re about the consequences of a “free money” world. How the world of finance got distorted due to 0% — and in many cases negative — interest rates.
Mike and I ultimately decided to call this ongoing topic our ripple effects series.
Here are a few posts if you’re looking to catch up (we’ve had to upload a couple of them to Substack. Which is why the dates aren’t chronological):
We’re still seeing ripple effects cascade.
Asset prices are going down. Valuations are compressing. Job losses are increasing. Bankruptcies picking up.
But now we’re starting to see some of the fallout. This time in pension funds.
Canada’s second-largest pension fund, Caisse de Dépôt et Placement du Québec (CDPQ), invested in Celsius Network — a crypto lending platform that turned out to be Ponzi-ish
CDPQ manages over $300 billion.
So it’s not unusual to see them invest in private companies.
However, you’d be right if you thought crypto investing is just a bit too risky for a pension fund. One who’s sole fiduciary duty is to make sure their pensioners get paid when it’s time to retire.
Ideally they wouldn’t. Yet, the traditional 60/40 bond-to-equity portfolio doesn’t cut it for pensioners when interest rates are 0%.
When 60% of your intended investment class (bonds) have 0% interest rates… you’ve got to find something that can make up the yield.
So CDPQ and the vast majority of pensions are forced to take on risk to make sure they can “deliver” on whatever they promised for distribution (many times it’s 6%+ yields).
Here’s what we wrote to longtime Mighty readers back in July 2019 in our note Pensions Are In For A Rude Awakening (emphasis added):
CALPERS is the largest U.S. pension program. It manages about $390 billion for about two million current and former California public servants.
News broke last week that CIO - Ben Meng - resigned after less than two years managing the fund after he missed return targets.
Meng managed just a 4.7% return for the 2019-2020 fiscal year vs. the 7% benchmark it needs to sustain full payments to the pensioners…
Interest rates pushed to zero and negative forced hundreds of billions - even trillions - of dollars into safe assets. Bond prices went up. Yields went down.
The question today still remains - where do pension funds invest to earn 7%?
U.S. Treasury yields aren't it. 10 year bonds earn 2%. 30 year treasuries earn 2.5%. Top rated corporate bonds aren't much better. Sovereign bonds around Europe and Japan are negative.
This means pension funds have to "reach for yield."
They're investing in junk bonds - all in search for yield. Whether that's a company with shaky finances. Or a local, state, national bond - like Turkey - with high yielding interest.
Most pensions would avoid Turkish bonds. But not all...
This is why U.S. pensions are roughly 70% funded - closing in on $1 trillion total. They can't "safely" earn 7% year-over-year to pay out what they've promised.
CALPERS - one of the largest U.S. pensions with $375 billion in assets - has over $130 billion in unfunded liabilities.
Stocks have been their savior. But how long do we think that's going to last? Pensioners around the country are in for a rude awakening. They're having to work longer or see their pension checks cut.
We're already seeing it today.
Here's a recent article from PBS: "More than half the states in the U.S. now require people to work longer or retire later before they can claim their benefit. For example Colorado, which overhauled its pensions earlier this year, raised the retirement age for new hires after 2020 to 64 years, from 60 and 58 for state employees and teachers, respectively."
Pushing yields down forced everyone to hunt for yield.
Now there is none. If you have a pension, check its prospectus. You might not want to get all of your retirement income from the pension.
Times haven’t changed.
CDPQ announced they were leading a $400 million investment in Celsius Network back in October 2021.
This round gave Celsius a valuation of more than $3 billion.
CDPQ believed Celsius would “shake up the financial industry.” They claimed they did months of due diligence.
Turns out Celsius was just a function of the “free money” era.
It was promising double-digit yields for users depositing tokens onto their platform.
Like a traditional bank, Celsius was earning the spread between the amount it lent out and the amount it paid its depositors.
But it couldn’t keep up with the model as crypto soon crashed and people wanted their money back. Celsius didn’t let them.
.@CelsiusNetwork is pausing all withdrawals, Swap, and transfers between accounts. Acting in the interest of our community is our top priority. Our operations continue and we will continue to share information with the community. More here: link.medium.com/w9VZMLOyOqb
— Celsius (@CelsiusNetwork)
2:10 AM • Jun 13, 2022
Year to date, Celsius’s token has dropped from over $4 to around $0.80 — an 80%+ drop. And 90%+ since CDPQ’s investment.
CDPQ is now down hundreds of millions of dollars on its investment in just the last 8 months alone.
That’s hundreds of millions in hard-earned money which pensioners expected to be paid out. Now it’s gone.
Hundreds of millions is a drop in the bucket for a pension managing $300+ billion.
But that’s not the point.
The point is CDPQ probably would never have invested in a company like Celsius had interest rates been anywhere higher than 0% over the past 13 years.
How many other private investments did CDPQ make at unwarranted valuations? How much “unnecessary” risk did they take elsewhere?
What about other pensions?
As we pointed out in our June 21st post The Fed Isn't Going To Stop..., the Fed is hellbent on making asset prices go down in order to tackle inflation.
Pensions having been forced to go out on the risk curve to supplement their pension obligations will likely see their unfunded obligations get worse.
That, of course, hurts the people who need it most: the working class.
Expect more fallout from the ripple effects.
Good investing,
Lance