Chasing wealth managers is a risky business

Private banks are fighting to advise billionaires who want a lot for their money

John Gapper

web_Swiss wealth management

Zurich is a sober and orderly city, so a fierce altercation near the Swiss National Bank between a banker to the world’s billionaires and a private detective who was trailing him is worthy of John Le Carré. It is all the more lurid that Credit Suisse ordered surveillance of Iqbal Khan after he left abruptly for its rival UBS.

Credit Suisse was worried that Mr Khan, who led an expansion of wealth management there, could take valuable clients and colleagues with him. Cut to Germany, where Deutsche Bank is hoping to recruit several hundred “relationship managers” — financial advisers to the wealthy — to compete with Switzerland’s private banks.

Whenever banks get overexcited about a profitable and expanding area of finance and embark on an expensive talent war, it usually leads to trouble down the road. So it is a fair bet that there will be fallout from this battle over wealth management, the activity that includes private banking.

The stampede is understandable. Swiss private banks went through tough times after the 2008 financial crisis and a US crackdown on offshore tax evasion that led to banks including UBS being fined hundreds of millions and having to loosen traditional bank secrecy rules. But they never lost their grip on a business that many rivals envy.

Traditional retail banking has been less profitable in the era of low interest rates and digital insurgency. Investment banking has been squeezed by regulations and caused a lot of trouble at European banks, notably Deutsche. When boards of global banks gather for strategy days, it can get gloomy.

Wealth management feels like a profitable one-way bet, by comparison. It does not require much capital to advise clients on how to conserve and invest their wealth, and the returns on equity are high. The rise of billionaire entrepreneurs and the super-rich, particularly in China and the rest of Asia, keeps the market growing.

This makes private bankers, particularly relationship managers with clients they have served for years, desirable. It is hard for an institution without a long history in private banking to expand without hiring them from other banks — the rule of thumb at one Swiss bank is that one manager can advise clients with a total of $1bn in assets.

Hence the unruly scene on the streets of Zurich and the poaching of bankers that is occurring around the world. Boris Collardi, who led the expansion of Julius Baer as chief executive, is now heading a hiring drive at Pictet, including the appointment of Tee Fong-Seng as head of wealth management in Asia.

But as banks offer millions to lure private bankers with desirable clients, they should consider a few things.

First, a relationship manager may not bring clients with them. The personal touch helps: private banks advise clients not only on investments but on sensitive matters such as family succession and trusts. But the expertise (and credit rating) of the bank also counts: “Assets are sticky and they take time to transfer. Sometimes they do not come at all,” one Swiss banker says.

The danger is that the hiring war will prove an expensive zero-sum game in which costs grow faster than revenues. McKinsey & Co, the consultancy, this week sounded a warning that profits fell by 8 per cent at private banks in western Europe last year, as rising costs squeezed their margins.

Second, private banking to the emerging class of ultra-wealthy in Asia is not free of risk. Under Mr Khan, Credit Suisse targeted Asia entrepreneurs with assets of about $500m, whose wealth tends to be tied up in their own companies, and who often want to borrow against these assets to buy houses in Mayfair or large yachts.

So far, banks that lend to wealthy clients have made money — one banker estimates that loan default rates have only been about 0.1 per cent. But those loans have yet to be tested in a global recession, with falling asset valuations. Only then Will we discover how profitable the business really is.

Third, despite rivalry among private banks, their ultimate competitors are the clients themselves. Wealth managers pitch themselves as trusted advisers but the ultra-rich with more than $100m are different from you and me — many employ their own investment advisers and lawyers in family offices.

There are now more than 10,000 single family offices, according to the consultancy EY, and the number is rising as more of the merely rich band together in multifamily offices. When it happens, private bankers are often excluded from the inner circle, where the most profitable decisions are made, and must pitch for smaller bits of business.

It is not a mystery that the richer someone is, the harder the bargain he or she tends to strike. The days of millionaires depositing money with Swiss banks and only occasionally visiting Lake Geneva to catch up with their bankers are in the past. Billionaires do not hand over cash lightly.

Wealth management is still an attractive business, given the alternatives. But before they start following bankers around the streets of Zurich and Singapore, banks should realise what they are rushing into. In finance, one-way bets are rarely what they seem.

Chile threatens Venezuela with blockade over crisis

Foreign minister demands free elections and warns refugee exodus could destabilise region

Benedict Mander in Santiago

Venezuelan migrants waiting at an immigration control point on the Ecuador-Peru border in June. The crisis in Venezuela has created a parallel refugee crisis that is affecting the whole region
The crisis in Venezuela has created a parallel refugee crisis that is affecting the whole region © AP

Chile’s foreign minister has vowed to work with allies to cut off Venezuela’s communications, shut down its air space and implement a naval blockade if Nicolás Maduro refuses to hold free elections.

Amid an escalating humanitarian crisis that is destabilising the region, causing more than 4m Venezuelans to emigrate, “ever stricter” measures must be taken to put pressure on Caracas to comply with demands to restore democratic order, Teodoro Ribera said.

“The solution to the crisis has to be soon . . . Venezuela is a problem for hemispheric security,” Mr Ribera told the Financial Times. He pointed out that some 400,000 Venezuelans now live among Chile’s 18m-strong population. “We have to make Maduro understand that it is preferable to call elections than not to call them.”

Sanctions have failed to persuade Caracas to heed calls for elections from the international community acting through the Inter-American Treaty of Reciprocal Assistance, whose members also include the US, Brazil and Argentina. Mr Ribera said that the “logical next steps” include blocking communications and access to the country by air and sea.

“All countries in the region have to advocate for forcing the Maduro government to call free, democratic elections, with international observers,” he said. Mr Ribera added that the opposition had to be pragmatic and recognise that democratic political transitions “demand reciprocal sacrifices. No one leaves power to go to hell voluntarily.”

Chile’s own transition to democracy after the 1973-90 dictatorship of General Augusto Pinochet was negotiated and drawn out, but also peaceful and did not harm the economy, said Mr Ribera. Human rights violators should be prosecuted, he said, but a “witch hunt” had to be avoided.

He warned that if the number of Venezuelan immigrants rose to 7-8m, as he fears could happen next year if action is not taken, “that will put very, very great pressure on countries in the region and it could have a destabilising effect”. The foreign minister emphasised that the solution had to be peaceful as military intervention could trigger “an explosion in immigration that we cannot cope with”.

Chile’s hardening stance towards Venezuela comes as Sebastián Piñera, the centre-right president, takes on a stronger leadership role in the region and beyond. Santiago is preparing to welcome delegates in December for the United Nations Climate Change Conference, known as COP25, after Brazil pulled out of hosting the event.

Chile, one of the countries most committed to free trade in the world, is also hosting the Asia-Pacific Economic Cooperation summit meeting next month amid fears expressed by Mr Ribera of a “deglobalisation” that threatens its open economy.

Observers expect the balance of power to shift in the region if the leftist Alberto Fernández is elected president in Argentina this month, as is widely expected, replacing the centre-right Mauricio Macri. Mr Macri has played a leading role in the region’s opposition to Mr Maduro and in supporting his rival Juan Guaidó.

In recent interviews, Mr Fernandez has resisted calling Mr Maduro a dictator and argued that his government was legitimate. Mr Fernandez did, however, express concerns about the Maduro regime’s authoritarian tendencies.

Mr Ribera suggested that a swing to the left in Argentina could be offset by the election of a centre-right government in Uruguay, which will also hold elections this month. Like Mexico, Uruguay’s leftist Broad Front, which has held power since 2005, has refrained from recognising Mr Guaidó as the interim president of Venezuela.

Banks Bounce, but Rates Still Exert Gravitational Pull

Beneath the surface of banks’ decent quarter are some troubling trends

By Telis Demos

Some negative effects of falling interest rates were visible in quarterly results at JPMorgan Chase & Co. and other big lenders. Photo: Victor J. Blue/Bloomberg News 

Beneath the surface of banks’ decent quarter are some troubling trends.

There were pockets of strength that helped drive a respectable kickoff to third-quarter earnings reports by big lenders.

JPMorgan JPM +4.33%▲ Chase & Co. recorded a jump in revenue from investment banking and trading, for example.

Citigroup C +1.87%▲ continued to benefit from a rise in revenue in its core U.S. card business.

Credit costs remain historically low.

But across three of the biggest banks—JPMorgan, Wells Fargo, WFC +3.55%▲ and Citigroup—many of the negative effects of falling interest rates and economic worry were visible.

Net interest income fell 2% across those banks in the third quarter from the second.

Total loans were essentially flat at those banks, and average net interest margin was 2.54%, down from 2.66% in the second quarter.

JPMorgan did raise its net interest income forecast slightly from when it last gave guidance, bringing up its full-year forecast to slightly below $57.5 billion from what it said in September, which was: “A lot closer to $57 billion.”

The bank told reporters that the improved forecast was predicated in part on moving from an expectation of two more Federal Reserve rate cuts this year to just one.

Given uncertainty about U.S.-China trade talks and the broader economy, that could easily change.

Consumers remain the bulwark for banks’ lending businesses.

Citigroup in particular is benefiting from the roll-off of promotional zero-interest offers on cards, which drove North American branded card revenue higher by 11% from a year earlier.

Revenue from JPMorgan’s card and auto-lending unit was up by 9%.

It remains to be seen how long the consumer can stay strong as business confidence falters.

Some of the improvement in investment banking may be temporary.

JPMorgan grew investment-banking revenue 8% from a year earlier, led by a 22% gain in equity capital markets despite the failure to launch WeWork’s big initial public offering in the quarter.

But the bank noted that it expected a decline for the fourth quarter both sequentially and year over year.

It is notable also that the bankers at Goldman Sachs GS +0.17%▲ didn’t have the same kind of quarter, with investment-banking revenue dropping 15% from a year ago.

Banks also already have made some big adjustments to their asset mix that they may not be able to do again regularly, or at the same magnitude.

At JPMorgan, for example, its average deposits with banks over the quarter dropped 35% from a year earlier, while it increased its average investment securities portfolio by 49%, capturing yields of 2.92% versus just 1.33% on that cash.

However, JPMorgan Chief ExecutiveJames Dimonacknowledged that fresh concerns about banks’ nimbleness with cash are well founded. He said that the bank’s required reserves prevented it from taking advantage of the spike in repo rates in mid-September.

“We could not redeploy [cash] in the repo market,” he said.

Overall, JPMorgan’s yield on interest-earning assets was up 0.03 percentage point from a year ago, even as Libor and other key borrowing rates moved lower.

Still, that was swamped by higher liability rates, in part due to corporate clients asking for better returns on their cash.

“We’re not going to lose valuable client relationships over a few ticks,” Chief Financial OfficerJennifer Piepszaksaid.

Despite it being a quarter in which many nonlending businesses outperformed, investors were bidding up shares of lenders JPMorgan, Citigroup and Wells Fargo on Tuesday morning, while selling Goldman Sachs, whose business is far more dependent on trading and investment banking.

That may be the wrong lesson for investors to take away from the quarter so far.

The People’s Republic of China at 70: Of Opium and 5G

By George Friedman


China celebrates the 70th anniversary of the founding of the People’s Republic of China today. It has been a great and terrible time for China, as history has been for most countries. But China is a nation on a scale that dwarfs other countries – and, therefore, both its greatness and tragedy dwarf those of other countries.

The story begins a century before the PRC’s founding. In the mid-19th century, British merchants approached China, as they approached most of the rest of the world. When they arrived in the 1840s, China was the largest economy in the world. Industrialization had only just begun, so the machinery did not yet define the size of an economy. Rather, it was defined by land and labor, and in these areas, China towered over most of the world. Meanwhile, Britain’s industrial revolution was accelerating, and it was searching for raw materials to fuel its industry and markets in which to sell its products. It was inevitable that British industrialism and mercantilism and Chinese pre-industrialism and mercantilism would meet, and meet violently.

The British wanted to sell more than just industrial products to China; they wanted to sell opium. The British were coming to dominate India, which had vast amounts of opium. The drug was banned by the Qing Dynasty that ruled China, so the British smuggled opium into China, first covertly and then by force of arms. The opium destroyed many lives in China, as it did in all countries, while the British made vast amounts of money from the trade. As they discovered China, they discovered potential markets for many goods and labor to produce them. They demanded that areas like Hong Kong be ceded to British rule to protect their economic interests. The Qing Dynasty, weakened by the British, had no choice but to concede. Over time the British were joined by the French, Germans, Japanese and Americans, among others.

By the 1990s and 2000s, China was the place for foreigners to go, hoping to make their fortune and find exotic adventure.

Foreigners operated along the coast, and the coast was tied to foreigners. They sold items to China, and in China, they manufactured items for sale in their home countries. The coast remained Chinese, but economically it faced outward to the world, not inward to the rest of China. The coast was where concessions were under the control of foreigners, and many Chinese who lived there prospered from this relationship. But over time, this generated complex systems of conflict. Chinese factions fought over relationships with foreigners. Foreigners conspired with each other. The central government was deeply divided and fought internally. Interior regions fought to secure some of the coastal wealth. It is hard to capture the complexity of the violence and the suffering it imposed. Coastal dwellers became wealthy. The peasants of the interior became, if anything, poorer.

The Chinese had cheap labor, which meant that manufacturing in China gave foreign companies a price advantage in their own markets. The Chinese were also hungry for foreign-manufactured products that they could sell in China or use to manufacture more complex products. Those Chinese who participated in this trade prospered enormously and therefore gained political power. But they depended on their foreign business relationships for trade. They had to subordinate themselves to the foreigners economically and politically to maintain that power. To do so, they had to reach out to the West to maintain an internal balance of power that focused on fighting each other rather than threatening their business interests on the coast.

This resulted in a multi-sided civil war, defined not by great issues like in the United States but numerous complex local issues, almost incomprehensible to any but those who lived as part of them. And caught in the middle was the vast number of Chinese who simply wanted to live, or live a little better, and found themselves surrounded by ruthless violence. This was not new to China. Such conflicts had been present long before the foreigners came, and when they exploded, dynasties fell. And so too did the hapless Qing Dynasty, giving way to the Republic of China under Sun Yat-sen, a Honolulu-educated Christian who represented to many Chinese the foreign influence that was tearing their country apart.

The Communist Party of China emerged from this situation. On the surface, it was a Marxist party, focusing on class struggle and the creation of a communist paradise. But that Marxism was intertwined with nationalism. The class struggle had to be against foreign interests and their Chinese partners. Therefore, class interest and national interest intersected. From the beginning, the CPC could not define itself except as a party committed to freeing China from foreign imperialism. Indeed, when Mao Zedong tried to stage a worker’s uprising, it failed. The workers had interests in common with the foreigners – they were wealthier than their cousins in the interior. Mao led the legendary Long March to the interior to raise a peasant army to resist the foreigners’ Chinese allies and expel the foreigners altogether. This appealed to the peasant class, and even if “Das Kapital” did not regard them as a revolutionary class, they were enemies of foreigners and the Chinese coast, and that was good enough.

Japan’s World War II defeat in China was followed by the defeat of the United States, who advised Chiang Kai-shek, a leader who sought to maintain the system founded a century before. Mao understood that China could never be secure while the concessions operated in any way. When China was engaged in global trade, parts of it became wealthy, other parts sank into worse poverty, and worst of all, China was divided and weak. Without internal strength and cohesion, China would always be exploited. Mao slammed the door shut on most trade and imposed the party’s will over internal decisions, rooting out alternative centers of power as best he could with the Great Leap Forward and the Cultural Revolution, designed to ensure that the bureaucracy would not usurp his power. He made China secure and united but terribly poor. China’s paradox was that it could be wealthy through trade but remain divided or be united by isolationism and remain poor. Mao pursued the latter path, into a kind of logic that ultimately looked more like madness.

Once Mao was dead, Deng Xiaoping made the great bet – that this time, China could open the doors to trade, become wealthy but remain united and avoid becoming dependent on foreigners. On the 70th anniversary of the founding of China, Deng’s bet is being called. The Chinese have once again become dependent on foreigners and foreign investment in the coastal regions’ factories. It is not the concession of the 19th century, nor is it the autonomy Mao wanted. As the United States presses its demands on China and China pretends to be impervious, the power of the foreigner is felt again. So too are the divisions. The tension between the wealthy coast and the poorer interior has reemerged. It has not yet resulted in conflict, and the government seeks urgently to relieve any tension.

The Opium Wars opened China. Mao tried to enclose China, and Deng reopened it. We are now, 70 years after the founding of the PRC, facing the question of whether a nation so constituted can long endure, or more precisely, endure without internal conflict. It is an old question in China and repeats itself in different ways. But in the end, it seems to terminate either in conflict or in ruthless suppression. Xi Jinping has signaled that he wishes to suppress conflict with minimal ruthlessness. The question is whether there is such a choice in China. The idea is that 5G and its brethren will allow China to leap over the question. Perhaps, but 5G will be sold to foreigners, and the customer has power. And in China, that power has always been dangerous.

Hong Kong in the Balance

After months of large-scale protests in Hong Kong, the city's future as a bridge between mainland China and the outside world is in serious jeopardy. Fortunately, all sides share an interest in pursuing more inclusive growth within the "one country, two systems" framework that has been critical to Hong Kong's success.

Michael Spence


MILAN – Hong Kong has long played an integral role in Asian and global economic development. But its future as a key nerve center for global business and finance is in serious jeopardy, as is its role as a bridge between mainland China and the outside world.

Hong Kong has long been a place where global companies are welcome, and disputes are adjudicated impartially, transparently, and according to the rule of law. If that is no longer the case, it represents a tremendous loss for China, for Asia, for global business and finance, and especially for Hong Kong citizens.

Hong Kong has experienced an unprecedented 17 weeks of mostly peaceful demonstrations (occasional episodes of violence have attracted disproportionate media attention). The trigger was a proposed extradition law that many feared would extend the mainland’s reach into Hong Kong’s judicial system. The absence of any plan to bring together various protest groups and the Hong Kong government has become a source of growing concern.

Such a plan would need to do at least two things. First, all parties (including China’s central government in this case), need to recommit to the “one country, two systems” framework.

Second, and perhaps more important, a coalition of representatives from government, business, and Hong Kong’s influential financial community should develop an aggressive plan for countering rising inequality and the disappearance of opportunities for those who are already struggling to make ends meet. Affordable housing for younger citizens is an especially urgent need.

Hong Kong is hardly unique in confronting the need to restore inclusive growth patterns. Many high-income economies have experienced years of rising economic inequality, which has been followed by social fragmentation and a broad rejection of established political parties and elites.

There is a striking similarity between the Hong Kong demonstrations and the “yellow vest” protests in France, which were triggered by a modest increase in tax on diesel fuel, but driven by a part of the population’s deeper anxieties about economic disparities and declining prospects.

Among the Hong Kong protesters’ demands are that the extradition law be formally withdrawn and that the rallies not be described as “riots.” They also want an independent inquiry into police tactics and brutality, the release of all detained demonstrators, and more control over the selection of their own leaders.

Notably absent from this list is any direct reference to the economic circumstances of Hong Kong’s people. The protesters most likely regard a greater role in choosing Hong Kong’s leaders as a step toward addressing inequality. The widely held perception among ordinary citizens is that Hong Kong’s political and economic elites have been more focused on pleasing the central government in Beijing than on achieving more inclusive growth patterns.

Under these tense conditions, some might view the Greater Bay Area (GBA) plan to develop an integrated regional economy in the Pearl River Delta as another potential encroachment on Hong Kong’s autonomy under the 1997 Basic Law, which established the city as one of two Special Administrative Regions for 50 years.

But the GBA could have a tremendous positive impact on Hong Kong and the already dynamic and innovative southern Chinese economy, and many believe that the plan can be implemented in a way that preserves the “one country, two systems” principle. Foreseeable obstacles, such as different rules governing data, should not be insurmountable.

For its part, China’s central government is justified in rejecting demands for full independence for Hong Kong. Only a small minority of the demonstrators supports those demands, which are inconsistent with the Basic Law and the principle of territorial integrity. The leadership in Beijing needs to maintain some role in the selection of Hong Kong’s political leaders, lest it end up having to deal with a vocally pro-independence government, as happens periodically in Taiwan.

China is also justified in worrying about foreign interference in Hong Kong, as any country would be. Requests for foreign support from the United States and Britain by a small subset of the protesters are counterproductive, at best. But China’s central government could help itself by voicing strong support for the principle of “two systems” and backing plans by the Hong Kong government to address distributional concerns and other economic issues.

There is no doubt that the Communist Party of China has exercised greater control over business, the economy, and society in mainland China in recent years. Some of those interventions may have spilled over into Hong Kong, exacerbating the tensions inherent in the “one country, two systems” framework. Chinese leaders now must be extremely careful not to undercut the authority of the Hong Kong government or the city’s fair and impartial judicial system, which has been a crucial asset in attracting business and finance from abroad.

Clear communication and responsiveness will be key to resolving the crisis. On this front, the Hong Kong government has underperformed. The millions of Hong Kong people who have taken to the streets need to know that their government is listening to them, understands their concerns and challenges, and is on their side, provided that their demands are consistent with the Basic Law. The Chinese authorities have exercised some restraint in their communications, presumably to avoid undercutting the authority of the Hong Kong government and its chief executive, Carrie Lam. But that makes it all the more important for the Hong Kong government to communicate effectively.

Finally, other countries, including the United States, should stay out of it. Hong Kong is far too valuable to be used as a pawn in a larger confrontation between great powers. And the people who live and work there deserve better.

Michael Spence, a Nobel laureate in economics, is Professor of Economics at New York University’s Stern School of Business and Senior Fellow at the Hoover Institution. He was the chairman of the independent Commission on Growth and Development, an international body that from 2006-2010 analyzed opportunities for global economic growth, and is the author of The Next Convergence – The Future of Economic Growth in a Multispeed World (Farrar, Straus and Giroux).

Stimulus, Inequality and the Chinese Dream

China’s economy is slowing but, without reforms, stimulus may just help the rich get richer in an already unequal society

By Nathaniel Taplin

Deng Xiaoping, who launched China’s economic reforms, famously said that it was fine for some people to get rich first. As long as everyone got rich eventually, it was a price worth paying for the communist leader.

That narrative, call it the original Chinese dream, was borne out for a long time. China’s opening to the world generated many millionaires and billionaires but also remade China overall into an upper-middle-income society.

There are increasing signs, however, that those Chinese who haven’t yet gotten rich will face a far harder time doing so in the future.

Following steep falls in the early 2010s, inequality is rising again while real income growth has flatlined.

Not only will that make it tougher for Beijing to address today’s slowdown but it could spell trouble for the region and even the world.

Two subtle changes in China’s economy tell the story. Following a long fall from 2008 to 2015, China’s Gini Coefficient, a measure of income inequality, has begun rising sharply again.

Second, since 2016 housing prices have mostly grown much faster than incomes, the opposite of the situation from 2011 to 2015. Young home buyers in China have sources of support that Americans lack; parents often contribute.

But they still face a steepening path and moving onto the housing ladder increasingly requires taking on debt, further eating into incomes.

Gavekal Dragonomics estimates that debt service hit 8.1% of household income in 2018, up from below 5% in 2010 and comparable to U.S. levels.

As in the U.S. prefinancial-crisis bubble economy that pumped up housing prices but also stoked indebtedness and inequality, policy is partly to blame.

Chinese policy makers have repeatedly dodged tough reforms since 2012—particularly to the nation’s dysfunctional banking system, which tends to channel cash into property and state enterprise coffers rather than to entrepreneurs.

Stimulus efforts in 2015 and 2018 boosted housing prices, helping people who already own homes but stoking indebtedness and doing little to arrest the long-term slide in China’s growth.

Policy makers, aware of the ugly side effects, have been far more restrained responding to this latest slowdown.

Worryingly, however, they continue to duck bold measures to fix the banking system or slim down the state sector.

More export-led growth could provide a solution, but Beijing’s unyielding approach to trade disputes—and President Trump’s erratic deal making—have undermined that, too.

Beijing knows it can’t afford nonstop rapid house-price appreciation, but it can’t allow a real property downturn either because that would tank its financial system.

Barring some radical free-market reforms or an unexpected productivity boom, the next decade could witness continually slower income growth and a further widening of the divide between the already-rich and everyone else.

For investors, this is a worrying and volatile mix.

Unless housing prices start dropping or financial troubles at state companies significantly worsen, China’s central bank seems likely to continue its drip feed of support rather than aggressive easing.

Tax cuts may help shore up consumption on the margin, but also mean more government-debt issuance hogging already limited credit supply.

Over the longer run, Beijing may turn even more to nationalism to paper over the cracks in a slower-growing, less-equal society. That could have grave consequences for growth and stability throughout Asia and the world.

Anglo American says copper mine will produce for 100 years

Group says new project in Peru is a ‘licence to print money’

Neil Hume, Natural Resources Editor

Anglo American’s $5bn copper project in Peru has the potential to be a “generational” asset with enough reserves to supply a century of production, according to the executive leading its development.

The reserves at Quellaveco have only been defined to a depth of 400m but drill samples suggest mineralisation could extend to 1,000m, according to a company presentation.

“This is not going to be a 30-year mine. My personal opinion is that it is going to be closer to 100 years,” said Tom McCulley, the head of Anglo American in Peru, at a briefing in Lima on Monday. “It will be a licence to print money for a long period of time.”

Quellaveco is the first new mine sanctioned by Anglo American since Minas Rio, an iron ore project that ran billions of dollars over budget and ultimately cost the company’s former chief executive Cynthia Carroll her job.

With Anglo now led by Australian executive Mark Cutifani, analysts say Quellaveco is a chance for the London-listed company to show it can deliver big projects on time and on budget.

Mr Cutifani, who took Anglo’s helm in 2013 and has transformed its fortunes, has said he will not leave the company until he has delivered the project.

Two adjacent copper mines have been in production for more than four decades at much greater depths than Quellaveco, which is located in the Moquegua region of Peru.

“We know this will continue to get bigger,” said Mr McCulley.

Copper is tipped by analysts to be one of the beneficiaries from the global shift to low carbon power because of its use in electric vehicles and renewable energy.

Quellaveco is due to start production in 2022. Once it reaches full capacity, it will produce an average 330,000 tonnes a year of copper in its first five years.

“This is high grade ore — over 1 per cent copper — it’s soft [so] it will go through the mill very easily,” said Mr McCulley.

Exploration outside the main project areas suggested there could be another major deposit close to Quellaveco on Anglo’s tenements.

“We actually have done a few drill holes recently and come across some of the best ore we have outside the pit,” he said. “We’ve seen enough to know that there is probably another Quellaveco out there.”

Mr McCulley said a 95km water pipeline and community relations were two of the biggest risks facing the project.

MMG, the Chinese controlled miner, said last week it would be forced to halve production at its giant Las Bambas project in Peru if protesters continued to block roads. Activists have also disrupted access to Peru’s main copper port this month.

Residents of Peru’s so-called southern copper belt are protesting against the government’s granting of a construction licence to another miner, Southern Copper Corp, to build its Tía María facility, Reuters reported, amid concerns over local water resources.

Our Nuts Are in Danger

John Mauldin


Life would be so much easier if we didn’t have to worry about our financial futures. Though I suppose we don’t have to worry. Animals don’t. Squirrels instinctively store away nuts and thus live through winter without much thought.

We humans have retirement winters, and we’re more sophisticated than squirrels. We generally outsource the job of managing our nuts/money to professionals. All well and good if we save enough and if the professionals do their jobs right. As we saw last week, the elected squirrels who run Social Security haven’t evolved to face changing conditions. Our Social Security nuts are in danger.

But the problem is even bigger. Today I want to continue this theme using some recent corporate news as our springboard. Economic changes have made future planning increasingly difficult for government retirement systems, private pension plans, and individual investors. How do you generate a reliable income stream for an uncertain but potentially lengthy lifespan in a world where interest rates are barely above zero and possibly below it?

The easy answer is “save more,” but that strategy has limits. We all have current expenses. Yes, we can live simpler lives, but we can’t save 100% of our income. Yet that’s what it will take in some scenarios.  

If you’re starting to envy the squirrels, you aren’t the only one.

Big Gaps

Remember “defined benefit” pensions? That is the kind of plan in which the employer guarantees the worker a set monthly benefit for life. They are increasingly scarce except for small closely held corporations.

My US accountant has set up well over 1,000 defined benefit plans, including two for me. His primary customers are dentists. The same rules apply for small closely held businesses as for large corporations. These plans can be great tools for independent professionals and small business owners.

But if you have thousands of employees, DB plans are expensive and risky.

The company is legally obligated to pay the benefits at whatever the cost turns out to be, which is hard to predict. The advantage is you can use some hopeful accounting to set aside less cash now and deal with the benefit problems later. The problem is “later” comes faster than you would like, and procrastination can be a bitch.

At some point, the risks outweigh the benefits, which is why few large companies have open DB plans these days. But the plans are often still in effect for older workers, and the amounts are large and frequently underfunded. Companies are slowly dealing with the problem.

And that brings us to the lesson for today. On October 7, General Electric (GE) announced several changes to its defined benefit pension plans. Among them:

  • Some 20,000 current employees who still have a legacy defined benefit plan will see their benefits frozen as of January 2021. After then, they will accrue no further benefits and make no more contributions. The company will instead offer them matching payments in its 401(k) plan.

  • About 100,000 former GE employees who earned benefits but haven’t yet started receiving them will be offered a one-time, lump sum payment instead. This presents employees with a very interesting proposition. Almost exactly like a Nash equilibrium. More below…

The first part of the announcement is growing standard. Employers prefer 401(k) plans because they transfer investment risk to the employees. Other than the matching payments—which end when the worker quits or retires—the company has no future obligations.

The second part is more interesting, and that’s where I want to focus.

Suppose you are one of the ex-GE workers (and I’ll bet I have some readers in that group) who earned benefits. As of now, GE has promised to give you some monthly payment when you retire. Say it’s $1,000 a month. What is the present value of that promised income stream? It depends on your life expectancy, inflation, interest rates and other factors. You can calculate it, though. Say it is $200,000.

Is GE offering to write you a generous check for $200,000? No. We know this because GE’s press release says:

Company funds will not be used to make the lump sum distributions. All distributions will be made from existing pension plan assets in the GE Pension Trust. The company does not expect the plan's funded status to decrease as a result of this offer. At year-end 2018, the plan's funded ratio was 80 percent (GAAP).

So GE is not offering to give away its own money, or to take it from other workers. It is simply offering ex-employees their own benefits earlier than planned. But under what assumptions? And how much? The press release didn’t say.

If that’s you, should you take the offer? It’s not an easy call. First, you are making a bet on the viability of General Electric. In September 2000, GE stock traded at $58+ per share. As I write this it is $8.45. The board has slashed dividends and the dividend yield is now only 0.47%.

As of April, GE had $92 billion in liabilities in its pension plan, on assets a little below $70 billion. Commendably, the company is “pre-funding” $4–5 billion into the DB plan. As we will see, however, this is chump change to the actual obligations.

In various ways, the choice GE pensioners face is one many of us will have to make in the coming years. GE isn’t the only company in this position.

You’re still affected even if you don’t have a DB plan. Lots of people are reaching retirement age to find they only have 80% (and often less) of their “fully funded” amount. They have to fill the gap somehow. Most often, that means reducing expenses or working longer, if you’re able.

Rising Pressure

When GE says its plan is 80% funded under GAAP, it necessarily makes an assumption about the plan’s future investment returns. Here’s what they say in the 2018 annual report.

Source: GE

I dug around and found the “expected rate of return” was 8.50% as recently as 2009, when they dropped it to 8.00%, then 7.50% in 2014, to now 6.75%.

So over a decade they went from staggeringly unrealistic down to seriously unrealistic. They still assume that every dollar in their pension fund will grow to almost $4 in 20 years.

That means GE’s offered amounts will probably be too low, because they’ll base their offers on that expected return. GE hires lots of engineers and other number-oriented people who will see this. Nevertheless, I doubt GE will offer more because doing so would compromise their entire corporate viability, as we’ll see in a minute.

In any case, more companies will do such things and affected workers won’t be happy. We’ll see the same in state and local government pensions, which are often even more underfunded and have even more absurd investment projections. These are becoming untenable and lump sum offers like GE’s help highlight that fact.

This, in turn, will raise pressure on plan sponsors to reduce those projections, which will increase the amounts they must contribute to their plans, which (for the corporate ones) will reduce earnings.

See where this is going?

We are right now entering an earnings season that may not be disastrous but doesn’t look too impressive, either. It is getting harder to justify the valuations investors place on many stocks.

If you take out the buyback activity from companies themselves, and the index funds and ETFs that buy indiscriminately as yield-starved investors give them more cash, who is really buying stocks in any major way?

And what happens when they stop buying?

If you’re holding stocks, you better have an answer.

Victoriously Breaking Even

In last week’s Social Security discussion, I noted a fatal flaw in ideas to convert the system into private accounts. Two flaws, actually: 1) Most people don’t know how to invest successfully and 2) now is a terrible time to learn.

(Note, that probably doesn’t include you. You’re reading this letter so you have at least some basic economic and financial literacy. But you represent maybe 5% of the population.)

I dislike saying “it’s different this time” but it really is. Today’s conventional investment wisdom came from an era when there was this thing called “risk-free rate of return.” Everyone could count on earning something, though perhaps not much, without risking it all. Inflation might erode your principal over time but you could at least see it coming.

Now there is no such option. Banks and Treasury securities pay zero, almost zero, or slightly below zero in some places. Don’t like it? Start adding risk. That is your only choice now.

We are in a world where simply breaking even counts as a victory… and that is a serious problem if you need to fund a long retirement.

My friend John Hussman’s September letter, Going Nowhere in an Interesting Way, is a fascinating and important read on this topic. (Over My Shoulder members can read my annotated version here.)

Hussman’s main point: It’s folly to assume stocks will continue performing the way they have in recent years. First, the last two decades haven’t been so great. The S&P 500 total return since 2000 was just 5.4% annually and getting there took the most extreme valuations in US history.

He calculates that assuming 4% nominal growth in economic fundamentals and a historically normal valuation 20 years from now, average annual gain for the next two decades will be -1.0%. Yes, that’s a negative sign.

Ok, that’s just stocks, you may say. I’m a bond guy. Fair enough. So maybe instead of -1.0% you’ll earn a positive 2%. That still makes real growth difficult.

Investment math is actually pretty simple if your return assumption is 0%. Calculate how much you need to retire, and save that much. Hussman does it more elegantly. 

Suppose an investor has accumulated a lump-sum of savings, and wants to finance a long-term stream of real, inflation-adjusted spending. How large must the initial “endowment” be, as a multiple of annual spending, to finance those future outlays, assuming that it’s passively invested in a conventional portfolio mix (60% S&P 500, 30% Treasury bonds, 10% Treasury bills)?

As a convention, we assume a 36-year horizon, representing a 64-year-old investor hoping to fund spending over a potential 100-year lifespan. There’s nothing special about that horizon, and we obtain similar results using any horizon beyond about two decades, because long-dated distributions have very little impact on the total present value.

The chart below presents our estimate of the Endowment to Spending Multiple going back to 1928. The equity market return estimates are based on the Margin-Adjusted P/E before 1950, and the ratio of nonfinancial market capitalization to corporate gross value-added after 1950. The bond market return estimates use the yield to maturity on long-term Treasury bonds at varying horizons.

You’ll notice that the current E/S Multiple is over 31, which basically says that if you insist on passively investing a lump-sum in a conventional portfolio mix in order to fund your retirement, you’d better already have nearly all the dollars you hope to spend, because the prospects for significant long-term capital growth from present valuations are dismal. Contrast this with 2009, when the estimated E/S multiple was 18, or with 1982, when the E/S multiple fell to a record low of 9.

A pretty dismal outlook: If you want to fund an income stream, your lump sum should be 31X the annual income you seek.

But Wait, There’s More

At the risk of sounding like Ron Popeil of Ronco fame (But Wait, There’s More!), whom readers of a certain age will remember nostalgically, there is more. Sadly, you can’t buy it on late-night television.

The reality is simple. Valuations are high and returns based on historical numbers do not suggest anything close to the 6.75% GE expects, let alone the ridiculous numbers public pension plans expect.

I asked mi buen amigo (I’m trying to learn Spanish) Ed Easterling of Crestmont Research to send me his latest numbers. Based on historical numbers using the Shiller model (other models would be slightly worse) it looks like this. We are currently in the top decile.

Get that? Historical returns based on 110-year models suggest future returns will be anywhere from -1.8% to +3.6%, from where we are today.

Note that 3.6% compound is the top end past historical performance. Also note that I have continually cited academic arguments that the debt situation that we are in today, both as a government and privately, preclude the potential for above-historical-average growth, suggesting lower growth is more likely.

Then quickly, let’s look at the seven-year projected returns from GMO:

Source: GMO

Note that these are real returns and not nominal returns. So GMO is actually projecting seven-year returns somewhere around -1.5%. Still quite ugly.

What happens when we have a recession? Remember those ugly things? Pension plan assets suffer a major hit and unfunded liabilities soar! Do you really think central banks can forestall recessions forever? When they are already at the zero bound? Look at the historical frequency, again from Crestmont Research.

Source: Crestmont Research

We are in the first decade to have no recession in, well, forever. Think we can dodge that bullet in the 2020s? Gods forbid, what happens if we have two? The stock market goes sideways for a really long time. Kind of like the 2000s. Then what does GE’s 6.75% return assumption look like? Especially in the zero-bound world of bonds? The answer is “burnt toast.”

Let’s generously assume a 2%+ dividend yield from where we are today. But the chance of a multiple expansion is damn near zero. The Shiller multiple is already 28.6%. (Yes, I get that you can spin P/E multiples numerous ways, but Nobel Laureate Bob Shiller does as well as anybody to reduce the spin.)

GE has $92 billion in pension liabilities offset by roughly $70 billion in assets, plus the roughly $5 billion they’re going to “pre-fund.” But that is based on 6.75% annual return. Which roughly assumes that in 20 years one dollar will almost quadruple. What if you assume a 3.5% return? Then you are roughly looking at $2, which would mean the pension plan is underfunded by over $100 billion—and that’s being generous. GE’s current market cap is less than $75 billion, meaning that technically the pension plan owns General Electric.

This is why GE and other corporations, not to mention state and local pension plans, can’t adopt realistic return assumptions. They would have to start considering bankruptcy.

If GE were to assume 3.5% to 4% future returns, which might still be aggressive in a zero-interest-rate world, they would have to immediately book pension debt that might be larger than their market cap.

GE chair and CEO Larry Culp only took over in October 2018. We have mutual friends who have nothing but extraordinarily good things to say about him. He is clearly trying to both do the right thing for employees and clean up the balance sheet. He was dealt a very ugly hand before he even got in the game.

GE needs an additional $5 billion per year minimum just to stave off the pension demon. That won’t make shareholders happy, but Culp is now in the business of survival, not happiness.

That is why GE wants to buy out its defined benefit plan beneficiaries. Right now, the company is on the wrong side of math. It doesn’t have anything like Hussman’s 31X the benefits it is obligated to pay. Nor do many other plans, both public and private. Nor does Social Security.

To be clear, I think GE will survive. Its businesses generate good revenue and it owns valuable assets. The company can muddle through by gradually bringing down the expected returns and buying out as many DB beneficiaries as possible. But it won’t be fun.

Pension promises are really debt by another name. The numbers are staggering even when you understate them. We never see honest accounting on this because it would make too many heads melt.

And again, a recession is probably coming in the next year or two. The Treasury yield curve has been inverted for three months now and Campbell Harvey, who pioneered that indicator, says it is “flashing code red.” This will further aggravate the pension problem.

If I am a GE employee who is offered a buyout? I might seriously consider taking it because I could then define my own risk and, with my smaller amount, take advantage of investments unavailable to a $75 billion plan.

We are like a football team facing a very tough schedule. Winning will take a solid team working together. Going it alone will be difficult in the 2020s.

Announcing “7 Deadly Economic Sins” Week

Regular readers know my “Things to Worry About” list is pretty long: unsustainable national debt, the fact that nearly 50% of all corporate bonds are teetering on the edge of the BBB cliff, power struggles between competing nations, the insanity of Modern Monetary Theory, a growing partisan split in the US and Europe, an exceedingly hostile US-China relationship, and the threat of negative interest rates.

I think all of these warrant taking a closer look, so October 14–20 will be “7 Deadly Economic Sins” Week at Mauldin Economics.

Seven of my closest friends and I will sit down for thoughtful conversations with our own Jonathan Roth. You probably already know them: Louis Gave, Grant Williams, Peter Boockvar, Lacy Hunt, George Friedman, William White, and Samuel Rines.

They’ll all give you their take on the root causes of the coming global economic crisis.

On Monday, we will start the week with me talking about the deadly economic sin of Lust. Please watch for my emails throughout the week so you won’t miss this special treat.

New York and Butterflies

Other than being in New York October 21 and thereabouts, I’m trying to stay close to home. And when I say home, I can now say that I have finally closed on my home here in Dorado Beach East, Puerto Rico. Getting a loan here is kind of like a Spanish soap opera unless you are willing to pay the going rates. I am paying close to 6%, a far cry from the 2.375% mortgage I had in Dallas. Seriously, there is an opportunity for a jumbo mortgage lender in Puerto Rico. Under 5%, you can sweep the market. Refi’s will line up. On solid loans.

The eye doctor says I am okay and so back to the gym tomorrow. Patrick Cox and Terry Coxon are coming this weekend to discuss funds focused on biotechnology investments. It will be a fascinating weekend of speculation.

And finally, one picture from the butterfly sanctuary my wife Shane has literally created in our home. Seriously, she is raising butterflies, mostly Monarch but also a few other species. It is fascinating to watch them go from eggs to caterpillars to cocoons to butterflies. Here is one of her babies…

And with that glorious image I will hit the send button. You have a great week while we all contemplate a lower-return future. And figure out how we beat the average.

Your creating a team to control our future analyst,

John Mauldin
Co-Founder, Mauldin Economics

Here’s one way to fix Brexit’s Irish border problem

The government has already conceded that some rules for Northern Ireland will be set by the EU

Martin Sandbu

Amid the fallout from the UK Supreme Court’s landmark decision on the suspension of parliament, it is easy to forget that Boris Johnson’s first significant engagement with Brexit as prime minister was in a letter to Donald Tusk, president of the European Council.

In it, he reneged on the UK’s December 2017 commitment to keep Northern Ireland aligned with the EU regulations and customs rules until other ways to avoid border infrastructure and controls could be agreed. This was formalised as the “backstop” for Northern Ireland only, later extended to an all-UK version at Britain’s behest.

The commitment, undertaken in the so-called EU-UK Joint Report, had been the EU’s precondition for entering talks on long-term trade relations. By reneging, the UK went back on something the EU took in good faith. From Mr Johnson, such behaviour is hardly shocking, even if it should be. More importantly, it is counterproductive. When the UK has asked to sort out border issues after Brexit, Irish leaders are at pains to emphasise that they cannot replace a legal guarantee with a promise. Given what happened to the earlier promise, who can blame them?

While not couched in these terms, the EU now insists on recommitting the UK government to the Joint Report. That is how we should read the overture by Jean-Claude Juncker, the president of the European Commission, to alternatives to the backstop if “all” its objectives can be met by other means than aligning with EU rules.

No such means have been identified. This reality is the same as that faced by Theresa May. So Mr Johnson’s premiership started by reverting to his predecessor’s late-2016 position only to turn into a fast-forward replay of her evolution towards a softer Brexit. The question is whether he will move far and fast enough towards EU demands in the limited time left and be able to sell the concessions this entails better than she did.

By accepting the notion of a single regulatory area for agrifood, Mr Johnson and his Democratic Unionist partners have already conceded that some rules for Northern Ireland will be set by the EU. That makes extending regulatory alignment to industrial goods a simple question of scope. There is no deep reason why Britain should refuse to accept for industrial goods what it accepts for agrifood — regulatory checks on boats crossing the Irish Sea — and the prime minister now hints he may do just that.

There is a problem of democracy, in that Northern Ireland will be governed by rules decided elsewhere. But this is a problem the EU is willing to ameliorate. The Joint Report explicitly provided for an economic border in the Irish Sea if Northern Ireland’s elected institutions agree. Mrs May’s withdrawal agreement includes a Joint Committee to oversee the backstop, on which those institutions could have representatives. And models exist: non-EU countries in the single market, such as Norway, have a system for adopting EU rules that preserves formal sovereignty while protecting the single market’s integrity.

Mr Johnson was therefore right to spot a “landing zone”. In substance, it looks much like where Mrs May ended up landing. (Northern Ireland will also have to stay in the EU’s value-added tax rules, but this is so technical as to escape politics.) The thorniest problem remains: customs.

Mr Johnson, like Mrs May, will accept regulatory differentiation but insists on one trade regime for the whole UK. For her, this meant an all-UK tie-in with the EU customs union. For him, it means Northern Ireland out of it. The customs border this entails is why customs is shaping up to be the one outstanding obstacle to a deal. Even accepting alignment on all other things would create two borders rather than just one.

The UK will not convince anyone that technology can substitute for border controls. But another rejected alternative may be worth revisiting. The “customs partnership” where the UK would have its own trade deals but enforce EU tariffs on imports destined for the single market was only ridiculed because it was unrealistic to identify which goods were headed for the EU when entering the UK customs area. But it is not quite as unrealistic to identify which goods cross into Northern Ireland and end up there or return to Great Britain.

The UK could offer to enforce EU customs rules on all goods crossing the Irish Sea, but where its own future tariffs were lower, it would rebate the difference for Northern Irish consumers — on the model of VAT refunds for travellers — or for re-exports back to Great Britain. Such tariff rebates could be managed via the tax system for individuals, so only Northern Irish residents would benefit, and via VAT tracking for re-exports. Since named individuals and firms would have to claim the rebate, fraud attempts could be detected.

While convoluted, such a system is not unworkable, and it would tick a number of important boxes. It would secure the correct tariff revenue for the EU and enforce its commercial policy. It would allow the government to promise — honestly — that Northern Ireland would share the benefits of trade deals. It would keep the Irish land border open.

The question for the UK government is not whether to concede but how to defend its concessions. A politically sellable customs solution is at the crux of whether it delivers a broken Brexit or an orderly one.