Tighten Disclosure Rules for Middlemen?

Marc Lifsher of the L.A. Times reports that CalPERS board votes to tighten disclosure rules for middlemen:

The beleaguered board of the California Public Employees' Retirement System tightened rules requiring outside investment managers to disclose information about the sales intermediaries who help them do business with the $200-billion pension fund.

Today's unanimous vote comes as CalPERS tries to contain growing controversy over the huge fees paid to the middlemen, so-called placement agents.

New York Atty. Gen. Andrew Cuomo's investigation of placement agent activities resulted in the issuance of criminal charges against several state officials and political operatives. Parallel investigations are underway at the U.S. Securities and Exchange Commission and the California attorney general's office, while CalPERS conducts its own internal probe.

The CalPERS inquiry in part focuses on more than $70 million in fees paid by fund managers to a former CalPERS board member, Alfred J.R. Villalobos, for assisting at least four private equity and real estate investment funds to win billions of dollars in commitments from CalPERS.

The new CalPERS policy would expands on a disclosure plan created in May that required fund managers to detail whether they used placement agents, the fees paid to them and their contractual relations. Today's action would make fund managers list all campaign contributions or gifts made to board members by placement agents, putting CalPERS rules in line with a new state law that applies to all government worker pension funds.

At the same time, the 13-member board, meeting as the Investment Committee, rejected a proposal that external fund managers be hit with big monetary penalties if they fail to fully disclose the existence or details of their dealings with placement agents.CalPERS' principal investment advisor, Wilshire Associates Inc. of Santa Monica, formally suggested to the board that fund managers who don't fully disclose their placement agent relationships be penalized with a fine based on a percentage of the CalPERS financial commitment.

"We think that some sort of penalty upfront is likely to get people's attention and force them to comply with the policy," Wilshire's Andrew Junkin told the board.But another of CalPERS' consultants, Michael Moy of Pension Consulting Alliance Inc., disagreed about the need for fines, contending that losing the opportunity to do business with the big public pension is a strong disincentive.

Joseph Dear, CalPERS' chief investment officer, agreed that the loss of a relationship with CalPERS is "a more than adequate" punishment.

The board, however, did not rule out endorsing possible penalties at some future date and asked legal and investment staff to further research the issue.

In addition to requiring increased information about placement agents, the board also is in the early stages of considering a recommendation from its president, Rob Feckner. He has proposed state legislation that would require placement agents doing business with CalPERS to register as lobbyists. They would be governed by the same rules as advocates who work at the state Legislature and most government agencies.

The proposal, which has not been drafted yet, is also backed by state Treasurer Bill Lockyer and state Controller John Chiang, who sit on the CalPERS board.

In the meantime, Feckner has urged fellow board members not to meet with placement agents until all new disclosure policies are in place. In April, New York State Comptroller Thomas P. DiNapoli ordered his own ban. The SEC is considering a similar action.

I have already shared with you my thoughts on so-called middlemen. For the most part, they are financial parasites who add very little value to the institutional clients looking to make decisions on which funds to invest with. I would simply ban them altogether.

There are some exceptions, but they are few and far between. Either way, disclosure rules for middlemen should be mandatory for all public pension funds. Everything should be disclosed, including board minutes and benchmarks governing public AND private investments.

Risks Rising at the PBGC?

Kim Dixon and John Crawley of Reuters report that weak companies are raising the risk for U.S. pension agency:

Weakness in the auto and airline industries, as well as retail and service sectors, has more than tripled the potential risk to the U.S. pension insurance system.

The Pension Benefit Guaranty Corporation (PBGC) on Friday said its potential exposure to future pension losses from financially weak companies had increased to about $168 billion in fiscal 2009 from $47 billion a year earlier.

It also reported a doubling of its deficit in the year that ended September 30, and said future shortfalls from retirement account defaults could be worse than forecast.

"Exposure to possible future terminations means that we could face much higher deficits in the future," Vincent Snowbarger, the agency's acting director, said in a statement.

The agency, which insures pensions covering 44 million workers and retirees, said its annual deficit grew from $11.2 billion in fiscal 2008 to $22 billion in fiscal 2009.

The deficit figure was an improvement over mid-year projections as the agency's balance sheet benefited from an improved economy and rebounding investments.

In addition, the government arranged for General Motors and Chrysler to maintain their major pension plans in bankruptcy.

The agency's deficit is the difference between assets under its control and payout obligations. PBGC assets reflect the value of terminated plans.

"We won't fail to meet our obligations to retirees, but ultimately we will need a long-term solution to stabilize the pension insurance program," Snowbarger said.

Companies with junk credit ratings are put on watch for pension plan troubles.

Automakers and their parts suppliers as well as airlines account for most of the risk. Service sector and retail companies are also a concern.

The PBGC this year has assumed responsibility for pension plans at auto parts supplier Delphi Corp, retailer Circuit City Stores, IndyMac Bank, Lehman Brothers Holdings Inc and textile maker Dan River Inc, among others.

The financial health of the company-funded agency has been a hot button topic in recent years as faltering companies, particularly airlines, shed pension obligations in bankruptcy.

The PBGC and pension experts say the agency has plenty of cash to make payments for the next decade or more. Assumption of fully funded plans will not increase the PBGC deficit. But the recent trend has been for bankrupt companies to turn over underfunded accounts.

"These are all companies who do represent some serious risk, and historically those who do go under get significantly worse deficits before they actually go," said Douglas Elliott, a former investment banker and an expert on financial institutions and the economy at the Brookings Institution.

The PBGC is reviewing the investment strategy for its assets, having put aside a proposal to become more heavily exposed to equities. The agency has been directed by the Obama administration to "prudently rebalance" its portfolio.

"We will announce any new investment policy when it is adopted by the board," PBGC spokesman Jeffrey Speicher said.

The job of "prudently rebalancing the portfolio" now falls under PBGC's new director, Joshua Gotbaum, a private equity executive:

Mr. Gotbaum is currently an operating partner at Blue Wolf Capital Management L.L.C., a New York-based private equity firm. During the Clinton administration, Mr. Gotbaum held a variety of positions, including executive associate director and controller in the Office of Management and Budget, as well as assistant secretary for economic policy at the Treasury Department and assistant secretary at the Department of Defense.

During the Carter administration, Mr. Gotbaum served on the White House staff and at the Department of Energy.

He also was an investment banker at Lazard Freres in New York for more than a decade.

Senate confirmation is required. The position has been vacant since January.

Are you wondering what I am wondering? Why would a private equity partner want to become the director of the PBGC? Want to take a stab on where they're going to rebalance their portfolio? I can already see PE funds lining up to fill out the requests for proposals.

Another thing I can tell you is that the PBGC's ongoing deficits will require a massive bailout down the road. That's why Uncle Ben will let this bubble blow for as long as he possibly can.

Feds Show Caisse How it's Done?

Peter Hadekel reports in the Montreal Gazette that Feds show Caisse how it's done:

Critics have plenty of reasons to dump on the performance of Quebec's pension investment agency, the Caisse de dépôt et placement.

One more reason came yesterday, when quarterly results were released by the Caisse's counterpart in the rest of Canada, the Canada Pension Plan Investment Board.

The CPPIB enjoyed a modest 4.6 per cent gain in the second quarter. It has earned $13 billion in investment income this year and is taking full advantage of the rebound in the Canadian stock market.

The same can't be said of the Caisse, which is missing the boat on the recovery. Finance Minister Raymond Bachand confirmed this week the Caisse will underperform other big pension funds in 2009 because it had a smaller weighting in stocks at the start of the year.

Of course, that's not the only difference to note between the CPPIB and the Caisse.

An obvious one is the very fact the CPPIB reported its quarterly results at all. The federal agency follows a policy of regular disclosure, while the Caisse sticks stubbornly to the practice of reporting its results just once a year.

The predictable result is an almost constant climate of rumour and conjecture surrounding the Caisse.

This week, La Presse quoted unnamed sources as saying the Quebec fund is on track for just a five or six per cent return this year - about half what other large Canadian pension funds will earn.

True or not? The Caisse won't say.

But while the feds leave the CPPIB to fend for itself, Quebec cabinet ministers regularly must rush to the Caisse's defence.

Another big difference is that the CPPIB avoided the disastrous market for asset-backed commercial paper, while the Caisse got heavily entangled in it and suffered several billion dollars in losses when the financial crisis hit.

That mess caused a liquidity squeeze, forcing the Caisse to sell stocks and reduce its equity exposure. The Quebec fund also racked up losses on its trading in the Canadian dollar, which again forced it to lower stock holdings and left it on the short end on the market rally that began this year.

The biggest discrepancy is the one that matters most: performance.

The Canada Pension Plan is adequately funded to meet future obligations if it can earn an annual return of 4.2 per cent. If it does that, it won't need to raise contribution rates to provide retirees with the pension benefits they've been promised.

The Quebec Pension Plan, by contrast, looks like a ticking time bomb. It will need double-digit annual returns to make up lost ground.

Even before the Caisse reported a 26-per-cent overall loss for 2008 for all its depositors, the Quebec Pension Plan was facing trouble because of unfavourable demographic trends. Add a $9-billion loss in assets in the QPP because of last year's meltdown at the Caisse, and the mountain to climb looks even steeper.

There are several reasons why the Canada Pension Plan is in better shape: Population growth in the rest of Canada is higher; average income is higher; average age is younger; people are retiring later, on average.

In an analysis published this year, the C.D. Howe Research Institute stated the Quebec government will have to take immediate steps to deal with the problem.

The choices are not pleasant. If pension benefits are to remain the same, Quebec will have to hike the contribution rate from the current 9.9 per cent of pensionable earnings to 11.1 per cent (split equally between employers and workers).

That change, a C.D. Howe analyst calculated, could amount to an extra burden of $1.25 billion a year on the province's economy.

The other option is to cut benefits or limit their indexation to inflation. But the political price on that might be too high.

In the meantime, one thing Quebec can fix is the risk-taking, cowboy culture at the Caisse. That process is already under way under new boss Michael Sabia.

Give him some more time. This year's results, if they do fall below average, won't be his fault, as he inherited a bad asset mix at the start.

Mr. Sabia inherited a big mess but he has cleaned house and put together his team. And to be sure, the Caisse will underperform its peers that are more weighted to public equities.

But let's step back a second and understand a few things. Unlike the CPP which is a partially funded plan, the Caisse manages the assets of mature, fully funded pension plans so it needs to emphasize risk management in order to closely match its assets to their liabilities. After a disastrous year like 2008, the mismatch between assets and liabilities really got exacerbated, so they need to regroup and rethink their strategy going forward.

On Friday, Bloomberg reported that the Caisse may sell C$8 billion in bonds by 2010:

Caisse de Depot et Placement du Quebec, Canada’s biggest pension-fund manager, plans to sell as much as C$8 billion ($7.6 billion) of bonds in Canada, the U.S. and Europe by the end of 2010.

The bond sales would replace part of Caisse’s short-term borrowing program with longer-term debt and won’t increase leverage, Montreal-based Caisse said today in a statement. Foreign-currency-issued debt will reduce the need to hedge against swings in the Canadian dollar, it said.

“They’ve had a short-term borrowing program and they may want to extend it out to fix it, which is understandable given the low interest-rate environment,” said Benoit Lalonde, vice president of fixed income at Laurentian Bank of Canada in Montreal. “I would imagine there’s an issue coming soon.”

The Caisse, which oversaw C$120.1 billion after reporting a record loss of C$39.8 billion for 2008, is set to post a return on investments of about 5 percent to 6 percent this year, compared with an average gain of 10 percent to 12 percent for Canadian pension funds, La Presse newspaper reported on Nov. 11, citing unidentified people familiar with the matter.

The Bank of Canada held its benchmark interest rate at a record low 0.25 percent at its Oct. 20 meeting and pledged to keep it there through June 2010, barring changes in the outlook for inflation.

Commercial Paper

CDP Financial Inc., the Caisse’s financing arm, will carry out the sales in series with terms up to 30 years, DBRS Ltd., a Toronto-based rating company, said in a statement. Proceeds will be used to “significantly reduce” the amount of commercial paper outstanding, DBRS said. It expects the debt to be AAA, its highest rating, pending a review of final documents.

“Investors will consider that paper similar to senior bank debt,” Lalonde said. “The Caisse de depot is not an institution that’s in any danger of folding.”

Caisse will “meet with several investors in the weeks to come,” spokesman Maxime Chagnon said in an interview. He wouldn’t comment on timing of the debt sales.

“Because of today’s historically low interest rates it’s a good time to lock in” long-term financing, he said.

The refinancing will provide “better asset-liability term matching” for the Caisse’s U.S. real-estate portfolio and other assets, DBRS said.

Bertrand Marotte of the Globe and Mail added this in his article on the Caisse's refinancing program:

The new long-term debt will be used to replace some of the institution's short-term debt, a move the Caisse says will increase the stability of financing sources.

“By limiting our exposure to the uncertainties inherent in short-term funding and by better matching the duration of our sources and uses of financing, the refinancing program is another important element of our plan to reduce financial risks and to strengthen the foundations of the Caisse,” the fund's president and chief executive officer Michael Sabia said in a news release.

“In addition, this initiative will contribute to our effort to improve returns over the medium term by locking in financing at today's historically low interest rates” he said.

The Caisse has been hit hard by the global financial meltdown and under the recently appointed Mr. Sabia it has been moving to boost its risk-management safeguards and reduce its exposure to high-risk areas.

Quebec Finance Minister Raymond Bachand said on Wednesday that the Caisse missed out on the initial stock-market rally earlier this year and will likely underperform its peers in 2009.

The Caisse last year reported a huge $40-billion loss on its investments, equal to a negative return of 25 per cent, compared with an average return for its Canadian pension fund rivals of minus-18 per cent.

In a financial update in August, the Caisse said it had to take $5.7-billion in writedowns related to risky commercial real estate loans and private equity bets.

Credit-rating agency DBRS said Friday that the new $8-billion refinancing program “will provide better asset-liability term matching for investments such as the U.S. real estate portfolio.”

DBRS said it expects to rate the new notes to be issued by the Caisse as AAA, barring any intervening events.

The rating agency said it maintains its overall AAA credit profile of the organization.

Basically the refinancing program provides better asset-liability term matching, it reduces leverage and acts as a natural hedge for foreign currency exposure. This is a smart move.

As for disclosure, I already mentioned that CPPIB only discloses the performance of public markets on a quarterly basis, not that of private markets. Moreover, unlike the Caisse, CPPIB does not clearly disclose the benchmarks governing their private markets (real estate, private equity and infrastructure). There are just some vague and complicated references to them in their annual report, but no clear disclosure.

As mentioned in the article above, the Caisse already announced hefty writedowns in commercial real estate loans and private equity bets. I am curious to see what writedowns, if any, CPPIB will report in private markets at the end of their fiscal year (March 31st).

Finally, let me emphasize that what counts is risk-adjusted returns and alpha. For example, a wiser (risk-adjusted) asset mix move on the part of pension funds would have been to have gone overweight AAA corporate bonds at the start of 2009 and lock in big returns as spreads came in from historic highs. Many big funds did exactly that.

But the big moves in stocks and corporate bonds have already taken place. With a tsunami of liquidity chasing yields across the globe, spreads have tightened back to pre-crisis levels.

Heading into 2010, pension funds will have to focus on relative value - ie. true alpha generation - to add value to the policy portfolio (beta portfolio). And if that is the case, there is no doubt in my mind that the Caisse will show its peers "how it's done".

Beta Boosts CPPIB's Q2 FY2010 Results

CPPIB released its second quarter results for fiscal year 2010. The CPP Fund is up $7.2 billion to $123.8 billion:

The CPP Fund ended the second quarter of fiscal 2010 on September 30, 2009 at $123.8 billion compared to $116.6 billion at the end of the first quarter on June 30, 2009. The $7.2 billion increase in assets after operating expenses this quarter consisted of $5.4 billion in investment income, reflecting a 4.6 per cent rate of return, and $1.9 billion in CPP contributions not needed to pay current pension benefits.

For the six-month fiscal year-to-date period, the CPP Fund has increased by $18.3 billion from the $105.5 billion level of the prior fiscal year end of March 31, 2009. This increase in assets after operating expenses is comprised of $5.4 billion in CPP contributions and $13.0 billion in investment income reflecting a 12.0 per cent rate of return. The CPP Fund is now above the previous highest year-end level which was recorded on March 31, 2008.

“The continued strength in the public equity markets has been the major factor in the CPP Fund’s increase of over $13 billion of investment income since March 31, 2009,” said David Denison, President and CEO, CPP Investment Board. “We are pleased with the Fund’s performance this quarter and year to date. At the same time, we remain focused on performance over the long term in line with our long investment horizon.”

“In the second quarter we continued to execute our long-term strategy and were able to capitalize on current market conditions by making a number of significant public, private and real estate investments. We expect these investments will be a strong source of investment income over the long term.”

In just over 10 years since the CPPIB began investing in April 1999, the Fund has generated $37.2 billion in investment income reflecting an annualized rate of return of 5.2 per cent. Another relevant measure is the four-year annualized investment rate of return through September 30, 2009 which was 2.3 per cent representing $8.3 billion in investment income.

Long-term Sustainability

In July 2009, the Chief Actuary reaffirmed that the CPP is sustainable throughout the 75-year timeframe of his 2007 report; the Chief Actuary will publish a new projection for the CPP in 2010.

The Chief Actuary of Canada estimates that a 4.2 per cent real rate of return, or approximately 6.2 per cent on a nominal basis, over the span of the 75-year timeframe covered by his 2007 report, is required to sustain the plan at the current contribution rate.

“Although our four-year results are currently below this long-term rate of return, we remain confident the CPP Fund will generate returns in excess of this 4.2 per cent threshold over its long investment horizon,” said Mr. Denison.

Asset Mix

At September 30, 2009, equities represented 55.8 per cent of the investment portfolio or $69.2 billion. That amount consisted of 44.6 per cent public equities valued at $55.3 billion and 11.2 per cent private equities valued at $13.9 billion. Fixed income, which includes bonds, money market securities, other debt and debt financing liabilities represented 30.7 per cent or $38.1 billion. Inflation-sensitive assets represented 13.5 per cent or $16.6 billion. Of those assets, 5.6 per cent consisted of real estate valued at $6.9 billion, 4.8 per cent was infrastructure assets valued at $5.9 billion, and 3.1 per cent was inflation-linked bonds valued at $3.8 billion.

CPPIB's strong results in Q2 of FY2010 is all about beta. The rally in stocks boosted the returns of most pension funds that are overweight stocks in their asset mix. CPPIB happens to have 45% of its assets in public equities so we shouldn't be surprised with these results.

There were a few articles that covered these results. Karen Mazurkewich of the National Post reports that markets boost Canada Pension Plan's return:

After navigating the public equities turbulent waters at the beginning of the year, the Canada Pension Plan Investment Board has eased into calmer waters. Its second quarter results reveal a $5.4-billion growth in investment income which represents an overall 4.6% rate-of-return.

While fixed income "has done well," the growth was largely due to public equities markets, according to David Denison, president and chief executive of CPPIB. The public equities market has had a significant run-up, but those returns were moderated somewhat from foreign exchange effects, he added.

The fund, which also added $1.9-billion of contributions this quarter, now reports that the overall assets under management have hit $123.8-billion, which exceeds the level the fund reached before the economic crisis.

"We are happy that returns are positive, but we weren't unduly influenced by the commentary of last year's performance because we had the conviction of our strategy," said Mr. Denison.

While it's too early to determine how valuations of the fund's private-equity and real estate holdings have fared to date, Mr. Denison said they are seeing more of their private-equity partners working through public offerings of their underlying investments.

CPPIB is hoping to benefit from the IPO of Dollar General Corp. which if it raises close to US$800-million will be one of the largest IPO's this year. CPPIB has a direct holding in Dollar General and is also invested in the U.S. private-equity firm KKR, which took Dollar General private in 2007.

Meanwhile, CPPIB is still trolling for infrastructure assets, said Mr. Denison, adding that despite market improvements, there are still opportunities in the asset class.

Earlier this month, CPPIB and the Ontario Teachers' Pension plan made a A$6.7-billion over for the Australian toll-road operator Transurban Group. That offer was rejected by Transurban as “incomplete, highly conditional and non-binding." No doubt the Canadian pension plans are sharpening their pencils for a second go around. Mr. Denison would not comment on the offer.

Weren't unduly influenced by the commentary of last year's performance because you had conviction in your strategy? What strategy? What conviction? With an asset allocation of 45% in public equities and 11% in private equities - by far one of the more aggressive asset mixes among the large pension funds - it's all about beta. If equity markets tank next quarter, so will CPPIB's performance.

To hammer in the point on beta, which is not unique to CPPIB, I note that Bloomberg reports the following:

Canadian pension funds posted investment gains of 14.3 percent in the first nine months of the year, RBC Dexia estimated. Canada’s benchmark Standard & Poor’s/TSX Composite Index rose 9.8 percent in the quarter, and surged 51 percent from a March 9 low.

“I don’t think any market observer, us included, would predict the same level of equity-market appreciation over the next three or six months as we’ve seen over the past six months,” Denison said. “But we’re all seeing positive signs of economic recovery on a global basis.”

As far as private markets, CPPIB does not report the performance of these assets on a quarterly basis so we will have to wait until the end of their fiscal year (March 31st) before we find out how they fared in real estate, private equity and infrastructure investments.

Reuters reports that Canada Pension Plan sees acquisition opportunities:

"We do see continued opportunities for us to make investments, particularly in the private market, private equity, infrastructure and real estate," CPPIB President and Chief Executive David Denison told Reuters in an interview after the fund's quarterly results were released.

"We have seen infrastructure assets that come available in large part because some of those assets were overleveraged in their existing structures and need fundamentally to be restructured. We think there are more of those that we'll have an opportunity to look at," he said.

"We think there is opportunity in real estate yet to come to the market, particularly in the United States, so we'll be focused on that."

There will be plenty of opportunities to snap up US commercial real estate but I would really appreciate it if CPPIB can clearly publish its benchmarks governing all asset classes, including private markets.

If Canadians' pension contributions are going to used to compensate CPPIB's senior managers for performance, let's make sure they're being evaluated against proper benchmarks that accurately reflect the risks they're taking in all asset classes, especially in private markets. And let's pay senior managers bonuses for delivering alpha, not beta.

Caisse Lagging its Peers?

I was going to wait for CPPIB to post their quarterly results, but I am going to go ahead and discuss some of the articles that came out on the Caisse today.

Bertrand Marotte of the Globe and Mail reports that Quebec's Caisse lags its peers:

The Caisse de dépôt et placement du Québec will likely lag other major pension funds this year because it missed out on the stock market rebound, says the province's Finance Minister.

“I don't expect the Caisse to outdo the markets this year,” Raymond Bachand said Wednesday in an interview with Radio-Canada television.

“The Caisse was underweight in stocks, and given that stock markets have rebounded considerably, the Caisse's results will certainly not exceed those of competing pension funds or industry peers,” he said.

The comments were made after La Presse reported Wednesday that the Caisse is in line to post a return on investments of about 5 or 6 per cent for 2009, compared with an average increase of 10 to 12 per cent for Canadian pension funds. The article cited unidentified sources.

The Caisse reported a staggering $40-billion loss on its investments last year, equal to a negative return of 25 per cent, compared with an average return of minus 18 per cent for its rivals.

Stung by its sizable exposure to currency and futures contracts, as well as the decimated third-party commercial paper market, the Caisse under new chief Michael Sabia moved to install more stringent risk management systems.

It also made major management changes and did not hire a new chief investment officer until July of this year, months after the big rebound in the stock market.

In August, the Caisse reported that it suffered a difficult first half of the year, with $5.7-billion in writedowns related to risky commercial real estate loans and private equity bets.

The writedowns wiped out the 5 per cent return the Caisse had earned on other investments to June 30, resulting in a “neutral” performance overall up to that date.

Mr. Bachand said he continues to have full confidence in Mr. Sabia and the corrective measures he has taken at the pension fund giant.

The Caisse is expected to report its 2009 results in February.

Bloomberg also reported that the Caisse’s 2009 Return Set to Trail Canadian Funds, adding:

Stock markets have climbed this year amid growing investor optimism that the world economy is poised to emerge from recession. As of the close of trading yesterday, the Dow Jones Industrial Average gained 17 percent this year, while Canada’s benchmark Standard & Poor’s/TSX Composite Index rose 27 percent.

Canadian pension funds earned an average 14 percent on investments in the first nine months of 2009, according to a survey by RBC Dexia Investor Services. Pension funds polled by RBC Dexia manage a combined C$310 billion.

As of the end of 2008, the Caisse had about 22 percent of its net assets invested in stocks, or C$26.4 billion, and 12 percent in private equity. Caisse spokesman Maxime Chagnon didn’t immediately return a message today seeking comment on Bachand’s remarks.

Finally, this evening the CBC reported that the Caisse denies it missed market rebound:

Canada's largest pension fund manager rejected criticism Wednesday that it's lagging behind the rest of the country because it missed out on the strong stock-market rebound.

The Caisse de dépôt et placement du Québec had 34 per cent of its assets in the market at the end of September, compared with 22 per cent at the end of 2008, a spokesman for the Quebec-based manager said.

Maxime Chagnon declined to divulge the Caisse's yield up until Sept. 30 but denied a report in the La Presse newspaper that said it is expected to pull in a five or six per cent return on investment for all of 2009 while other Canadian pension funds are on target for an average of 10 to 12 per cent.

"We have rebuilt our position on the stock markets," Chagnon said of the pension fund manager's approach since the arrival of CEO Michael Sabia in mid-March.

Chagnon said the Caisse transferred $8.5 billion of its fixed-income investments, primarily bonds, into shares between the end of March and the end of September.

In August, the Caisse announced it would revamp its real estate arm and abandon riskier commercial loans after $5.7 billion in losses wiped out other gains during the first half of 2009.

The pension fund manager said $4 billion of the losses were in real estate, including $1.7 billion in other less liquid, riskier, investments.

As of June 30, it also lost $1.3 billion from private equity and $400 million in asset-backed commercial paper.

Chagnon also brushed off La Presse's argument that Sabia's tighter risk management style is to blame for the losses.

Here are my comments. I read the article in La Presse (Caisse delivers mediocre results in 2009) and it was pathetic. This is a perfect example of sloppy reporting which totally distorts what is really going on at the Caisse.

The article cites Mr. Sabia's focus on risk management as the reason behind its "lagging performance". True, Mr. Sabia is focusing on risk. But what the article neglects to mention is that the Caisse is focusing on risk-adjusted returns and looking carefully at how all their internal and external portfolio managers are correlated, stress-testing their portfolios for liquidity events.

Mr. Sabia is also cutting risk in private markets. It's hardly surprising to see the bloated private equity team being trimmed down. You can't pay people if they're not delivering the results. They're regrouping and focusing their attention on making money without taking stupid risks.

As far as overall results, I don't know how the Caisse will perform relative to its peers, nor do I really care. In order to properly compare pension funds' performance, we need transparency in benchmarks and risk budgets.

I've said it before and I'll say it again, there is this parochial mentality in some segments of Quebec's establishment that is just anachronistic and self-destructive. I was there when Quebec's media made a huge splash about Henri-Paul Rousseau and how he was going to "save the Caisse". The "savior" ended up getting roasted at Quebec's pension hearings.

What's truly mediocre in Quebec is the media's pathetic coverage of the Caisse under Michael Sabia. If he isn't having second thoughts, it means he's ready to deliver on his promise and deal with his critics, which includes Quebec's media mafia.

I wish him all the best. He's going to need nerves of steele to put up with all the bullshit they're going to throw his way.

A Fair Value Shake-Up?

Glenn Gottselig of the IMF Survey Magazine reports that experts warn that financial system risk are still high:

Opening the November 5-6 research conference, IMF Managing Director Dominique Strauss-Kahn remarked on the positive effects of the timely and effective policy interventions at the global level that have helped stave off an even worse outcome to the recent global crisis.

Strauss-Kahn noted that macro-financial linkages are at the heart of the two-way interactions between the real economy and the financial system. “One of the most important lessons we painfully learned is that we need to have a much better understanding of macro-financial linkages,” he said. “At the IMF, we will utilize the results of recent research on macro-financial linkages in order to help our membership devise policies that promote global financial stability and economic growth.”

The Economic Forum, chaired by IMF Chief Economist Olivier Blanchard, wrapped up the 10^th Jacques Polak Annual Research Conference in Washington, D.C. Since it was first launched, the research conference has become one of the major international forums for researchers and policymakers to exchange their views about issues related to the global economy.

Graceful exit

Around the world, discussions are under way on how to best move toward unwinding public sector support. Of all the measures of public support implemented thus far—fiscal and monetary policy, interventions to specific institutions, and government support programs—perhaps the one most delicate to unwind will be monetary policy.

Former Federal Reserve governor, Laurence Meyer, explained that exit for the United States will mean raising the federal funds rate; withdrawing the reserves that were put in by the various programs; and shrinking the balance sheet by selling previously purchased assets—such as, mortgage-backed securities—or letting short-term assets “run off” as the various facilities or programs are scaled back or shut down.

Meyer predicts the federal funds rate will not be increased until the middle of 2011, saying the Federal Reserve would, however, tighten earlier if another asset bubble developed. Despite having just emerged from a collapse in the housing market, Meyer believes, “we are already on bubble alert.” He points to market concerns of an emerging bubble in the corporate bond and other markets, noting credit spreads have disappeared, equity prices are increasing, and housing market prices are slowly rising.

Market concern over long-term inflation expectations might also lead to a tightening, as might a collapse in the dollar. “If there was freefall in the dollar, even if the short-term economic conditions weren’t very good, the Fed would have no choice but to raise rates,” he said.

Policy overhaul

When it comes to redesigning monetary policy, there is disagreement as to how this might best be accomplished. Wharton finance and economics professor Franklin Allen believes more checks and balances could be built into the Federal Reserve System. “We need to have a third mandate—a financial stability mandate,” he said.

But more importantly, he says, outsiders should be checking the Federal Reserve. Allen favors a financial stability board, which would be independent from the Fed, with members sitting on the Federal Open Market Committee, not with a majority, but perhaps a substantial minority, so that given a dissent in the Board, they would be able to provide a counter effect.

Allen sees quantitative easing as an extremely risky policy, and as something that has been undertaken with very little discussion in policy or academic circles: “The notion is that you print money and buy up long-term bonds, but what happens if inflation ticks up?” Selling the bonds and reversing the liquidity could be problematic and, he argues, central banks need a mechanism to check what is going on and prevent such risky moves.

On the other hand, both Meyer and former Federal Reserve governor, Randall Kroszner, believed this might compromise the widely cherished independence of central banks. “If you ask a central bank whether it should intervene directly in an asset bubble, they would say, ‘yes’, but we have additional tools to do that,” said Meyer “we don’t want to compromise monetary policy being supervised in regulatory policies.” Panel chair Blanchard summed up the essence of the discussion, asking, “How can you balance this central bank independence and avoid misbehavior? If you think of monetary policy as a set of tools, then it seems wrong to have two decision makers. The need for coordination and information means there can only be one institution using these tools optimally.”

Too broad a mandate could also risk overloading central banks, particularly in emerging markets, a view held by Brookings Senior Fellow and Cornell professor, Eswar Prasad. Where a central bank has a well-defined mandate, he believes it could be possible to incorporate many of these issues within that mandate. “Although the world has changed in many ways,” he said, “we should not be throwing out everything that we thought we knew.”

What to watch for

Picking up and building on one of the potential risks referred to earlier by Meyer, Allen noted that while a run on the U.S. dollar might be less likely, there are other advanced economies where the risks are greater, particularly those that followed policies of quantitative easing and purchased large amounts of financial assets. “If there is a run on the currency, it is going to be very difficult for [the central bank] to sell these assets back into the market without substantially raising rates.”

Global imbalances are again beginning to raise concerns. Pressures remain in many economies around the world, says Prasad, where many economies, such as China, Japan and Germany, ride the coat-tails of the United States. In China, Prasad noted that just in the first six months of 2009 China’s state banks had pumped $1 trillion of lending into mostly state-owned enterprises. But the huge stimulus could result in a problem of overproduction that would again lead to imbalances with the need to export surplus output. Both Prasad and Allen worry that the crisis may have also incentivized emerging markets to continue with a policy of amassing huge stocks of reserves.

Allen points to countries such as Korea and some others across Asia that may have come through the crisis in good shape and avoided the large decrease in GDP and increases in unemployment experienced by other export-oriented countries. He suggests these countries will conclude, rightly, that they need more reserves. Prasad says a number of countries thought to have had vast reserves saw them depleted very quickly during the height of the crisis. Here, they both agree that changes to the international architecture—through better Asian representation at the IMF—would be helpful, but these changes need to move more quickly than they are at present.

Emerging markets are moving out of the crisis with a new perspective, argues Prasad, where they now recognize better the importance of strengthening financial systems, but doing so in very limited contexts. Prasad sees a new path developing as emerging markets move forward with their financial development and broadening financial access, one that emphasizes the importance of regulation.

“Perhaps ultimately what we should hope for is a convergence of the emerging markets moving toward more sophisticated, but better regulated, financial systems and perhaps the United States move toward a less sophisticated, in some ways, but more stable financial system.” But with no agreement yet among experts on what are the optimal regulatory structures for less developed financial markets, he sees a need for a great deal of work to be done in the area.

The IMF, the OECD and the World Bank need to study macro-financial linkages more closely. In particular, they need to understand the symbiotic relationships between pension funds, insurance funds, sovereign funds, investment banks, hedge funds and private equity. Once this is examined, they can better understand how the shadow banking system influences monetary policy and the credit cycle.

International institutions also need to understand the correlations between various public and private asset classes. With all this liquidity chasing yields all around the world, asset classes are a lot more correlated now more than ever. The world is one big correlation trade and as long as it keeps humming along, everything will go smoothly. But if there is a hiccup, watch out, it will reverberate around the world.

Speaking of hiccups, Rachel Sanderson and Nikki Tait of the FT report that Brussels is warning on fair value shake-up:

Brussels has warned that a radical overhaul of rules on how banks value their assets could lead to greater volatility in their accounts, undermining broader financial stability.

European Commission officials have sent a letter to the International Accounting Standards Board criticising the rule-setting body’s proposals for financial institutions, the first stage of which is scheduled to be published this week.

The IASB’s standards are used or are being adopted by more than 110 countries, including India, Japan, South Korea, Canada and those of the European Union. The IASB rule proposals could provide a blueprint for its US counterpart which is considering amending its own rules. IASB and US officials are aiming for convergence of their standards by June 2011.

The IASB overhaul is aimed at addressing criticism of so-called “fair value” accounting, the system of valuing assets at market prices which some banks and policy makers believe exacerbated the credit crisis by increasing volatility in banks’ accounts. When markets fell sharply, banks were forced to mark down the value of their assets, leading to heavy losses.

The IASB reforms will allow more flexibility in determining which bank assets must be marked to market and which can be valued according to so-called amortised cost accounting, which smooths out market volatility. But Commission officials believe the overhaul does not go far enough to limit the use of fair value accounting. Analysts say some European banks with large investment banking activities would be hit disproportionately.

In the letter to the IASB, Jörgen Holmquist, director general of Internal Markets at the European Commission, said more assets might be marked to market under the new system than even under existing rules. He urged the IASB “urgently” to consider further changes.

“It would seem that the current draft may not yet have struck the right balance between ‘fair value’ accounting and ‘amortised cost’ accounting,” he says. The letter, dated November 4, comes as a Brussels committee is expected to meet on Wednesday to discuss its response to the overhaul. The near final draft already includes a number of changes demanded by Brussels in September.

Those changes include applying fair value more flexibly than in earlier proposals.

Initially, the IASB proposed that if an asset earned predictable cash flow such as a loan, then it could be valued by amortised cost accounting. If it delivered an unpredictable return such as a share portfolio or derivative, then it had to be marked to market.

Under the new proposals, accounting experts say the IASB has given banks and insurers more flexibility on some specific financial instruments.

The IASB also unexpectedly decided to delay a rethink of how banks account for liabilities until next year, allowing financial institutions to continue the disputed practice of marking debt to market. This allowed banks to book gains when the value of their debt traded in the market fell sharply on concerns over their financial health.

It's not only banks and insurers that will be looking at the new accounting rules. Pension funds will also be scrutinizing them, trying to gauge the impact on their private market assets and other less liquid assets.

Finally, Reuters reports that the total pension deficit of UK corporate pension funds fell by more than a third in October, despite a dip in stock markets, mainly due to changes in the method of assessing pension liabilities:

The Pension Protection Fund (PPF), the agency set up in 2005 to pay compensation to the members of underfunded pension funds when their sponsors goes bust, said on Tuesday the aggregate deficit fell to 97.6 billion pounds from 148.9 billion pounds in September. The deficit was 77.6 billion pounds in October last year.

Over the month, pension assets decreased due to a fall in both UK and global equity markets. The FTSE All Share Index fell by 1.9 per cent in October. Pension liabilities also rose on the back of lower gilt yields, the PPF said.

The PPF said the new actuarial assumptions reflected "more accurate" figures provided by schemes and reduced liabilities by about 7 percent in October.

Had the actuarial change not occurred, aggregate funding deficit would have worsened over October to 168.8 billion pounds, it added.

The number of schemes in deficit in October fell to 5,867 from 6,174 in September.

Last week the PPF said its deficit more than doubled to 1.2 billion pounds in the 12 months to end-March.

Et voila! Change the rules and shave off billions in toxic assets and pension deficits! Don't you love accounting rules and actuarial assumptions? Who said capitalism is rigged?

Keeping an Eye on Inflation Expectations?

William Rees-Mogg of the London Times asks which will come out on top: paper or gold?:

Last week the price of gold rose to $1,100, the highest ever recorded. Gold is still an important measure of the world economy. The theory of the 19th-century gold standard was that gold was “real money” in the same way as landed property was “real estate”. All types of paper money are capable of being created by banks or governments, so the supply is potentially unlimited. It was observed that gold holds its purchasing power over centuries, whereas paper money tends to depreciate towards the value of zero.

Of course, the rise in the gold price reflects the weakness of the dollar as well the strength of gold. I have been writing about the significance of the gold price since the early 1970s. The latest rise in price reflects the significance of gold as part of the world’s monetary reserves.

The immediate cause of the rise was a purchase of 200 tonnes of gold bullion by the Reserve Bank of India from the International Monetary Fund. The Indian purchase is quite large in terms of the gold market, but not particularly large in terms of the Indian reserves. India’s reserves now amount to $277 billion, of which this new purchase of gold amounts to only $6.7 billion.

The significance of the purchase is that it may be the start of a new phase in the struggle between gold and paper. Since 1971, when President Nixon ended the convertibility of the dollar into gold under the Bretton Woods Agreement, the world’s central banks have tended to be net sellers of gold and net buyers of dollars. Now the Indians have decided that they have more dollars than they want.

Already Sri Lanka has followed the Indian lead, with a purchase of five tonnes of gold. If the new fashion spreads, and particularly if it is joined by China, then Asia would have decided that it is better to have gold which is rising in value than an unlimited supply of dollars which are falling in value.

In the 19th century, bankers trusted gold precisely because they did not trust other bankers, or the paper that other bankers issued. They could hold gold in their own vaults; it would not be dependent on other people’s debts or on the printing of paper money. Most central bankers still believe that the purchasing power of money is ultimately determined by the quantity that is created.

Asian bankers know that the West, and particularly the US, has been creating new money in huge and unprecedented quantities. They must assume that this increase in the creation of dollars will result in a fall in the purchasing power of the dollar itself. China may or may not join in the movement to buy gold, but the logic of the market would justify it doing so. Why should China go on losing in dollars when the gold price is rising?

This new logic extends outside gold and outside currencies. The real struggle between gold and paper is a struggle for power. If paper money is the dominant form of currency, as it is at present, then the ultimate governors of the world economic system are the bankers who have the power to create money.

If, however, gold is regarded as the ultimate standard, as “real money”, then the market decides the valuation. The floating rate system which emerged after 1971 depends on relatively stable relationships between different currencies. If countries develop a preference for gold over paper, then paper currencies will have to demonstrate that they have a stable value in gold, as they did in the years before 1971.

This may help to explain the strange events that occurred in the G20 finance meeting at St Andrews. In the 1970s, an American economist, James Tobin saw very clearly the speculation that would arise after Nixon ended the convertibility of the dollar into gold. Tobin, who later won a Nobel Prize, knew that gold had been the standard by which other currencies were valued. Once that was removed, he feared a growth of excessive speculation, such as the inflation of the 1970s, or the successive bubbles of recent years. He thought that this speculation could be controlled if it were taxed. He advocated a new transaction tax.

At St Andrews, Gordon Brown unexpectedly advocated the adoption of a global Tobin tax. He was immediately repudiated by Timothy Geithner, the US Treasury Secretary, and by Dominique Strauss-Kahn, the head of the IMF. The proposed global Tobin tax has the support of Oxfam and of some left-wing economists, but without American support, it does not have the least chance of being adopted.

The Swedes experimented with a national transaction tax in the 1980s. It did not work because bankers avoided paying tax by transferring transactions to markets in which it was not imposed. The tax had to be abandoned in the early 1990s. This negative history must have been known to Mr Brown; perhaps the clumsiness of his diplomacy reflects the pressure he is feeling.

In Britain, there is an urgent need for a new tax base. One can take almost any very large figure as the sum needed to balance the budget. At some point, Britain will have to raise taxes and cut expenditure. It is hard to see where this additional revenue can be found.

No doubt it would be helpful to Mr Brown if the other governments of the world would join him in policing a worldwide transaction tax on the banks. Britain would be a major beneficiary. Like the US, Britain has a combination of very large bank debts with a very large budget deficit. As a response to the recession, large sums of money have been injected into these economies. That has eroded global confidence in the pound and dollar.

If there is no Tobin tax, it will be difficult to rebuild confidence in these currencies, and the Tobin tax is not going to happen, if only because it would not work. Two factors emerge. Gold will be a stronger reserve currency than paper, and the market will increasingly decide national policies. “You can’t buck the market”, whether in taxes, in dollars or in gold.

I thought all you gold bugs would enjoy reading the article above. But there is another thing worth tracking in these markets. Matt Phillips of the WSJ writes as the rally rolls, keep an eye on inflation expectations:

For clues on inflation expectations in this carry-trade-crazed market, Tuesday’s auction of some $25 billion in 10-year treasury notes is something to pay attention to.

Last week’s Fed statement signaled all clear for the carry trade. And last weekend’s G-20 confab confirmed that the stimulus spigots at central banks will be open for the foreseeable future. But the Fed noted in its statement that it’s still going to be paying close attention to inflation expectations in the marketplace

An auction of some $40 billion in three year notes on Monday went well, and the equities market rally ratcheted up in response afterward, suggesting that some participants are keeping a close eye on the bond market. But the shorter end of the curve is anchored by the Fed’s near zero policy. Inflation worries are more likely to crop up in some of the longer-dated debt from Uncle Sam.

And there’s already some signs that worries about inflation are floating around out there. For one thing 10-year breakevens — that gap between the yield on 10-year Treasury Inflation Protected Securities (TIPS) and the yield on plain-vanilla 10-years — have been inching higher, a somewhat inflationary sign, although we’d need more evidence to confirm that inflation expectations are starting to break out.

“The tougher part for the Treasury will be selling (Tuesday’s) 10-year and Thursday’s 30-year auctions in light of the growing inflation expectations as measured by the TIPS, among other signs,” writes Peter Boockvar, of Miller Tabak.

If those auctions don’t go so well, and the yield on the longer end of the curve jumps, that might prompt more serious soul searching at the Fed. And uncertainty about how long the Fed will keep the spigots gushing liquidity could push some who’ve been betting on the weak dollar/rising risk trade to take a bit of money off the table.

Those auctions will go very well. In fact, on Monday, Treasuries prices moved steadily higher after solid 3-year note auction:

U.S. government debt prices rose on Monday after a record-sized Treasury note auction drew strong demand and investors bet other debt sales this week would get a similar reception.

The three-year note sale won a rousing bid as investors stood to gain an extra 0.50 percentage point yield over two-year notes for taking on slightly more interest rate risk.

"I would call the auction stunning," said William O'Donnell, head of U.S. Treasury Strategy at RBS Securities in Stamford, Connecticut.

"I like to focus on the bid-to-cover ratio and just looking at that it was the best bid-to-cover ratio for the 3-year Treasuries since November 1990."

The Three-year Treasury note US3YT=RR was trading 1/32 higher with the yield at 1.36 percent, down from 1.37 percent late on Friday.

Benchmark 10-year notes US10YT=RR were trading 10/32 higher in price to yield 3.46 percent, down from 3.51 percent late on Friday, while 30-year bonds US30YT=RR were 15/32 higher to yield 4.37 percent from 4.40 percent.

Following the three-year auction, the Treasury will sell $25 billion in benchmark 10-year notes on Tuesday and $16 billion in 30-year bonds on Thursday as part of this week's $81 billion quarterly refunding.

"Two-year notes are already through their resistance level, so I think the very steep slope of the curve is going to help the bond auctions tomorrow and Thursday," added O'Donnell.

Before Monday's note auction, Treasuries appetite was curbed by a pickup in stocks and other riskier assets in the wake of a Group of 20 pledge to stick with measures to bolster the global economy.

We'll see how the auctions go this week but my feeling is that Treasuries will be snapped up fast. Moreover, it will take a lot more of this liquidity rally to sustain a higher shift in inflation expectations. Given the slack in the global economy, inflation expectations will be capped for at least another year and possiby for a lot longer.

Fed Herding Investors to the Slaughter?

In his market blog, Simon Avery of the Globe and Mail asks whether the Fed is herding investors to the slaughter?:

Why do the markets enjoy the hardship of others?

Specifically, why does news that last month 190,000 jobs disappeared in the U.S. and another 43,200 vanished in Canada spur stocks? North American markets rose in early trading before going almost flat before noon. So how sadistic are these capitalists?

Well, for one good explanation it’s worth turning to the Pragmatic Capitalist, a much-loved blog on the markets. PC argues that the U.S. Federal Reserve’s policy of anemic interest rates is forcing investors to incur greater risk because traditional safe havens like insured bank accounts and government bonds don’t offer any return to speak of. Fed chairman Ben Bernanke is essentially pushing investors into the stock markets to find any sort of returns. As the markets keep rising, investors are buying into “Bubbly Ben’s” idea that a country can print its way to prosperity.

“The real question investors need to ask themselves is this: if we truly are in the middle of a Fed-induced liquidity rally where the fundamentals simply don’t matter, do you buy now or wait it out for the inevitable bust?”

There are plenty of perma-bears who share this view. Chief among them is Bob Prechter who says that stocks and commodities are topping and the US dollar is set to rally:

“I think stocks are topping out, commodities are topping out and the dollar is making a bottom,” says Robert Prechter, president of Elliott Wave International and author of “Conquer the Crash“.

According to Yahoo Finance - Tech Ticker, Prechter also makes the seemingly counterintuitive argument that the dollar will rally because there’s so much debt, rather than being doomed because of it. “If the economy turns sour again in 2010, as he predicts, Prechter says the dollar will benefit as more dollar-denominated IOUs get called by creditors seeking to shore up their own balance sheets, as was the case in 2008.

“A sustained rally in the dollar would have devastating consequences for stocks, emerging-market assets, high-yield debt and commodities. But gold might be the exception, because it represents ‘real money’ and more people are questioning the global paper money system, Prechter says.”

It might be a good time for all of you to review the three triggers of the global gold bubble and read the views of Dr. Doom vs. the Investment Biker on asset bubbles summed in the Globe and Mail by Simon Avery:

Nouriel Roubini, dubbed Dr. Doom for his prescient call on the economic meltdown, warns that global investors are inflating an asset bubble that could lead to a spectacular bust.

With oil prices up 80 per cent this year, gold up 24 per cent and commodity indexes up nearly 50 per cent, prices have risen “too soon, too fast,” the New York University professor said Wednesday.

“It is very hard to justify oil going from $30 (U.S.) to above $80 based only on the fundamentals of supply and demand,” Mr. Roubini said at the Inside Commodities Conference in New York.

Those predictions didn't sit well with Jim Rogers, the chairman of Singapore-based Rogers Holdings who is widely known for calling the commodities rally of 1999.

“What bubble?” Mr. Rogers said in an interview Wednesday on Bloomberg television. He was responding to a question about whether he agreed with Mr. Roubini's forecast. “It's clear Mr. Roubini hasn't done his homework, yet again.”

Mr. Rogers noted that many commodities are not yet near their record highs and he boldly predicted that the price of gold will double to $2,000 an ounce, or more, in the next decade. He said he remains pessimistic on the value of the U.S. dollar.

“It's not a bubble if something is up 100 per cent this year, but down 70 per cent from it's high. That's not a bubble, that's a good year,” he said, adding that equity markets are not about to crater.

However, Mr. Roubini, who is also chairman of the New York research and advisory firm Roubini Global Economics, thinks that the greenback is due for a major “snap back” that will see it rise as much as 20 per cent within the next year.

In an interview with CNBC television on Wednesday, he said that investors are executing the “mother of all carry trades” by borrowing dollars to buy commodities. Specifically, they are getting great rates on the weak dollar and investing in emerging markets, fuelling a bubble. He foresees the dollar swinging up when the asset bubble bursts.

“It's eventually going to occur, but it's going to be six months from now, a year from now,” he said.

As for gold hitting $2,000? “Utter nonsense,” Mr. Roubini said.

Mr. Rogers, in turn, didn't agree with Mr. Roubini's call on emerging markets.

“I don't know any emerging market stock markets that are so high I'd call them a bubble,” Mr. Rogers said. “They're certainly all up a lot, maybe they're too high, but being too high is not a bubble for anyone who knows financial markets.”

My views have not changed in the last six months. We got a coordinated, unprecedented liquidity injection in the global financial system and severe performance anxiety propelling risks assets higher.

The key question now is how long can this last? If history of the markets has taught us anything, the answer is a lot longer than what most investors think.

The biggest problem is trying to figure out liquidity. The linkages in the global financial system are a lot stronger in 2009 than they were in 1920. Moreover, with the advent of shadow banking and sovereign wealth funds, the financial system plays a dominant role in the real economy. Unlike past crises, the synchronized global downturn happened when banks stopped lending and global trade came to a grinding halt.

Then, as central bankers pumped trillions into the global financial system, banks made a killing off trading profits. And now, the message from the Fed is clear, let the bubble blow. The Fed is telling the banks to go ahead and bid up risk assets because we need to combat the perceived threat of deflation.

Of course, it would be highly irresponsible of the Fed or any central banker to come out and say they want inflation, but that is what they and the world's power elite want. The interesting thing is how they're going about it. The Fed is giving the banks the green light to go ahead and trade away, bid up risk assets and hopefully an asset bubble will lead to real economic inflation.

So, we can expect more bubble trouble as another bubble forms sooner than we think. Will this end badly, slaughtering investors down the road? Not necessarily. Think about Schumpeter's creative destruction and read Mort Zuckerman's recent op-ed in the Financial Times which argues that the free market not up for the job of creating work.

Its not all gloom and doom. I see a positive secular story developing in renewable energy, emerging markets, healthcare, infrastructure, nanotechnology and other technologies. But there is no doubt that the sea change will be disruptive to hundreds of millions who will face hard times before we restore sustained confidence and integrity in our global economy and financial system.

Push for a Voluntary Pension Fix?

CBC reports that Canada's pension plans post improved Q3 returns:

The financial picture for Canada's pension plans got a bit brighter in the July-to-September period of 2009, but not by as much as managers might think, according to a report released this week.

Pension experts Towers Perrin said improving stock markets helped boost the performance of Canadian retirement plans by more than five per cent in the third quarter of 2009 versus the April-June period of the same year.

But compared to December 2008, the investment returns for these retirement vehicles were still about one per cent lower at the end of the third quarter.

"A lot of people are relieved [by the third-quarter fund performance]. But, they might find things haven't improved as much as they thought," said Karen Figueiredo, a principal in the Toronto office of Towers Perrin.

Happier returns

Towers Perrin publishes a quarterly index of pension funds that essentially measures investment performance of these retirement vehicles but not their solvency, she said.

Accordingly, the company's benchmark funding ratio stood at 69.1 per cent in the third quarter of 2009 compared to 65.7 per cent in the second quarter.

But the same ratio was greater than 70 per cent at the end of December 2008.

Throughout much of 2009, stock markets worldwide and in Canada rose, boosting the overall returns posted by pension plans.

For example, if a pension plan held 60 per cent of its investments in higher risk stocks and 40 per cent in lower risk bonds, Towers Perrin estimated that its portfolio yielded a return of almost seven per cent in the third quarter and 13.6 per cent so far for all of 2009.

Revenge of the discount rate

But in its benchmark calculation, Towers Perrin also included the discount rate, a crucial number used to calculate the plan's payout to retirees. That rate fell during the first nine months of 2009, Figueiredo said.

The reduction was because the discount rate rises and falls in line with yields on corporate bonds, she said. And those yields dropped in 2009 versus 2008.

A lower discount rate essentially increases the amount of cash a firm needs to cover pension payouts.

"Still, have things gotten better or worse? They have gotten better," she said.

Lower bankruptcy threat

The conclusion that Canada's pension plans are in better financial shape was mirrored by the mid-year survey conducted by the federal government's Office of the Superintendent of Financial Institutions.

OSFI's sounding of 400 private pension plans, covering the period between June 2008 and June 2009, noted that pension plan assets were 12 per cent less than the amount necessary to cover their liabilities.

But that result represented an improvement versus June 2008, when pension assets were 15 per cent less than the cost of providing retiree benefits.

There is no doubt that pension plans are in better shape after the huge rally in global equities but they still have ways to go before they recoup the losses from 2008.

Some provinces are not waiting for the federal government to fix pensions. The National Post reports that Evans pushes voluntary pension fix (hat tip JP):

Alberta Finance Minister Iris Evans, pictured, says she's prepared to step up efforts to persuade the federal government the best way to tackle the country's pension woes is to establish a voluntary, supplementary plan atop the Canada Pension Plan.

"I don't want to be pushy here, but I really believe it's time for movement forward," Ms. Evans said in an interview with Canwest News Service. If the Conservative government doesn't want to play ball, Ms. Evans said, there is growing support for establishing voluntary provincial or regional pension plans for the seven of 10 Canadians who don't have private pension plans.

Alberta and British Columbia argue a national approach that supplements an individual's CPP and private savings is the best solution to the unfolding pension crisis. The two provinces are prepared to go it alone if Ottawa and the other provinces cannot agree.

Will Alberta and British Columbia spearhead pension reforms in Canada? It sure looks that way but I do hope the federal government takes the lead pushing for a national summit on pensions. The worst thing is to think that the markets will correct the pensions crisis. That's a fool's paradise.

CPP Flexes Buyout Muscle?

Paul Vieira of the National Post reports that CPP flexes buyout muscle in deals worth US$11B:

The Canada Pension Plan's investment arm threw its weight behind two deals worth US$11-billion Thursday, joining forces with a U.S. buyout titan in the largest North American private-equity deal of the year, and helping to launch an unsolicited takeover bid for Australia's biggest toll-road operator.

Even though it has been initially rebuffed in its Australian foray, the moves by the Toronto-based pension fund are cementing its reputation as one of the largest and shrewdest private-equity players in the world, say people who follow the leveraged buyout field.

The deals -- a $5.2-billion bid for IMS Health Inc. with TPG Capital, and a US$6.2-billion offer for Australia's Transurban Group Ltd. in conjuction with the Ontario Teachers Pension Plan Board -- follow aggressive moves in the communications sector in which it acquired Australia's Macquarie Communications Infrastructure Group and a 15% stake in Internet telephony-provider Skype.

Mark Wiseman, head of Canada Pension Plan Investment Board's private-equity team, said the fund is "active" in the marketplace as it is capitalizing on certain advantages, among them "ample" liquidity and a first-class research team.

"We are in a unique position today," the fund's senior vice-president for private investments said. "We are looking for situations, carefully, where we can use those comparative advantages to our benefit."

The pension fund has $116-billion in assets, and reported a 7.1% rate of return for the three-month period ended on June 30.

CPPIB first surprised markets with word it had joined with TPG Capital, one of the world's leaders in private equity, to acquire IMS Health Inc. for US$5.2-billion. The two investors said they were prepared to pay US$22 a share for the Norwalk, Ct.-based company that provides prescription data to drug makers and analysts. The transaction, as structured, will be financed through equity investments from TPG and CPPIB, with Goldman Sachs & Co. providing debt financing.

Given TPG's heft, it could have partnered with a number of funds to purchase the health company. TPG was recognized this year as the world's top private-equity fund after raising US$52.3-billion in capital over the last five years, outpacing other noteworthy giants such as Carlyle Group and Kohlberg Kravis Roberts. It is noted for its success in buyout deals involving J. Crew, Burger King and Continental Airlines.

It approached CPPIB a few months ago about working on the IMS acquisition.

"TPG probably didn't want, or couldn't, speak for all of the equity on its own. And rather than calling the other usual suspects, they are partnering with CPPIB," said David Snow, New York-based executive editor of PEI Media, a firm that follows the private-equity industry. "They are calling on a group that has the money, but also the ability to execute such a deal because you have to perform the due diligence in a professional way and a short manner of time whereas most [private-equity] funds aren't equipped to do that."

Mr. Wiseman said CPPIB and TPG have a long-standing relationship, as CPPIB is an investor in some TPG funds and the two have worked together in previous transactions. Further, he added IMS was an attractive target as it is the only global player in its field, has robust cash flow and long-term contracts with clients.

Mr. Wiseman would not disclose how much equity it is contributing, although noting it would be a "significant minority" investor should the deal close. Analysts reckoned the deal was likely heavily tilted toward equity, as debt financing is difficult to obtain in this marketplace.

Meanwhile, CPPIB also moved, in conjunction with the Ontario Teachers Pension Plan Board, to table a US$6.2-billion offer for Australia's Transurban Group. Transurban said the offer was "incomplete," but was willing to discuss "bona fide proposals which provide appropriate value and certainty to [shareholders]."

Mr. Wiseman would not elaborate further beyond what is included in a joint CPPIB-Teachers statement, which said the offer represented a premium of up to 25% based on the average volume-weighted value of Transurban's shares over the last three months.

Mr. Snow said the Transurban deal in noteworthy because CPPIB is garnering a reputation as one of the world's best, and influential, investors in the infrastructure field.

I love the way the media blows things way out of proportion. I've met Mark Wiseman. He's a nice guy but the only "comparative advantage" CPPIB has is deep pockets. TPG is partnering up with them because they see them as a "perpetual funding machine", to borrow an expression used by one of the private equity guys I used to work with.

Let me put it more crudely. A senior portfolio manager in public markets once told me "when you're writing $100 or $200 million tickets to private funds, they all want to blow you."

So while the media is all enamored by CPP's private equity prowess, the reality is that when you're as big as they are, you can easily co-invest with the TPGs of this world, reducing your fees and gaining big exposure to some of the better funds out there.

I don't get impressed by flashy news articles. I'd rather see these guys put their heads down, do their jobs and leave the chest pounding theatrics to Céline Dion. At the end of the day, show us your cash on cash returns from all these big private equity deals. And more importantly, make sure you show us the benchmarks you're using to get compensated for all this "alpha" you're producing.