Pension Pulse

South Carolina Throwing in the Towel on Alts?

2012-02-10T15:19:00.014-05:00

Follow-up to hedges with few edges. While North Carolina shoves billions into hedge funds, South Carolina Treasurer Curtis Loftis is singing a different tune. Below, he speaks with Deirdre Bolton on Bloomberg Television's "Money Moves", discussing governance of state pension funds.

Love what he says: " South Carolina is like most states, we are all chasing unrealistic high rate of return. As we all diversify, we are going to have problems. We are guaranteed high fees but not guaranteed high success. Pension plans send a lot of money to New York and we got to be careful about what we buy."

And he's right, there isn't much transparency in hedge funds and private equity. South Carolina is at 50% allocation in alternatives. Holy cow! Listen to Curtis Loftis, he knows what he's talking about. Those who don't listen and keep piling into alternatives, praying for a miracle, will suffer the same fate as Apollo Creed. Ding! Ding! Time to throw in the towel on alternatives.

Hedges With Few Edges?

2012-02-10T10:01:00.012-05:00

Alistair Blair of Investors Chronicle reports, Hedges with few edges:

Performance data on individual hedge funds will trickle out over the next month or two, but last week Hedge Fund Research - the industry's key index publisher - finalised its 2011 figures. They're dreadful. The HFRX Global Hedge Fund Index, which tracks 40 large funds, fell 8.8 per cent. For an investment that is supposed to deliver an "absolute return", that's pretty dismal. Especially since the S&P 500 index of leading US shares was down just 0.7 per cent and US investment-grade corporate bonds were up 4.1 per cent.
Of course, you should never put too much emphasis on a single year, but 2011 was the third year in a row in which the HFRX index underperformed both equities and bonds, and it's more than 10 years since the HFRX was a real standout.
In 1999, the S&P 500 returned 21 per cent and bonds fell 3 per cent, but hedge funds trounced them both with 27 per cent. The following year, equities headed south while bonds recovered, but hedge funds again came out on top by a handsome margin. Sayonara. HFRX occupied the bottom slot for six of the subsequent 11 years, and never recovered the top slot.
My chart shows what this boils down to in terms of cumulative performance. If your had put one dollar in each of these three sectors every year since 1997 (coinciding with the launch of the HFRX) you would have invested $14 per sector. Your equity pot and your hedge fund pot would both now be worth $17 (in fact, the equity pot fractionally more) and your bond pot would be worth $24. The only hedge fund investments you would feel remotely happy with would have been those made in 2000 or earlier, and even these would still have trailed your bond pot by a mile.
This of course is the average picture across all hedge funds (weighted by their assets - there are about 7,000 hedge funds, but I estimate that about 90 per cent of all hedge fund investments are accounted for by the top 200 funds). Within the average were high profits earned by a few celebrated funds, including John Paulson and George Soros, but there were obviously some pretty dire performances by other funds, including total blowouts such as Peloton and Amaranth.
Nevertheless, the past 10 years have been extremely prosperous for hedge funds. In January 2000, the total value of all hedge funds was about $200bn. But the excellent turn-of-the-century performances resulted in institutional investors throwing money at the sector. Hedge fund assets doubled to $400m within 18 months and motored to $2 trillion by 2007. After redemptions and losses, they currently stand at around $1.6 trillion.
It is hard to imagine that institutional investors are proud of these decisions, especially because hedge funds charge such high fees - I estimate in the region of four to eight times the fees charged by more conventional investment managers. These fee levels undoubtedly account for the poor performance of the hedge fund sector over the past decade as depicted in the chart.
But inside hedge funds the picture has been very different. In 2000, the total fees charged by all funds and funds of funds were about $15bn. Subsequently they rose to $70bn and currently stand at around $35bn.
Much of the data above is from a new book on hedge funds, The Hedge Fund Mirage by Simon Lack. It contains a series of sensational tables analysing how hedge fund profits have been split between hedge fund managers and their clients. However, the tables are difficult to interpret and have been attacked by representatives of the hedge fund industry. That alone makes them worth of a closer look.

A closer look? The entire industry needs to be massively regulated. Hedgies will scream and bitch at me for saying this but that's how I feel. You have massive unemployment, people are struggling and these hedge fund hucksters are getting away with murder by donating millions to super PACs.

Worse still, the figures above do not take into account survivorship bias where only the funds still operating report their returns. Clients are also weary, asking themselves where are their yachts, questioning why they're getting eaten alive on hedge fund fees. But institutional investors remain fully committed to hedge funds, especially after the strong start to the new year. In fact, hedge fund exits hit a record low after a bumper January. Hedge funds are thrilled to death, for now.

Only sovereign wealth funds are turning away from hedge funds, but they still invest a huge chunk of money in them. And U.S. public pension funds are going ballistic trying to allocate more to hedge funds. North Carolina's main state public pension fund is set to add billions of dollars to its hedge fund allocation:

Having won legislative approval to almost double its hedge fund investments last year, the $71.8 billion North Carolina Retirement System is set to take advantage with a series of new searches for credit and equity hedge funds. No requests for proposals will be issued, with managers picked and hired on an "as needed basis," spokeswoman Julia Vail told Pensions & Investments.

The system plans to invest as much as $2 billion in new stock hedge funds over the next three to five years, a 6% allocation. North Carolina will focus on long/short strategies, Vail said.

It will also invest about $360 million in credit funds over the next two years.

North Carolina currently has about $2.44 billion invested in hedge funds, or 3.4% of its assets.

The system is also planning to invest a 2.5% increase in its broadly diversified, non-equity-based hedge fund strategies allocation allowance in private equity.

Stock hedge funds? Most of them are momentum driven beta chasers, all part of Malakia Capital Management. Not that the other strategies are any better. Just look at credit, where strong fund flows are fueling a junk bond bubble. Admittedly, so long as companies avoid default, investors can pile into the high-yield sector and gain returns that are less prone to the volatility that affects equities, but flows into credit worry me.

But money keeps pouring into hedge funds. I tweet about it almost every day. According to HFMweek, the Texas County & District Retirement System (TCDRS), which has $17.7bn in assets, has allocated $305m between two hedge funds, two months after making an extra $885m available to the space:

TCDRS, which upped its hedge fund target allocation from 20% to 25% at the start of this year, has hired, Asian Century Quest and Graham Global Investment Fund for $130m and $175m respectively.

The two new hires join a 28-strong line up, which includes hedge fund giants Winton and Brevan Howard.

TCDRS, which is advised on its investment decisions by Cliffwater Associates, now has a roughly $2.8bn hedge fund portfolio, leaving around $1.6bn open for potential new searches.

The decision to increase hedge fund exposure was swiftly kick started by a $200m allocation to Highfields Capital IV, a Boston based investment management firm, HFMWeek reported at the time.

Now, I'm not a fan of pension consultants but Cliffwater seems to know what they're doing. I can tell you Brevan Howard and Winton are two of the best hedge funds in the industry. My only concern with consultants is they charge a lot of money to "advise" clients and many have conflicts of interests where they invest in hedge funds they are recommending. That is another scandal in the pension world that rarely gets covered.

Again, I am not against hedge funds. There are excellent hedge funds but the media hypes them up too. For example, I read an article on where five top hedge funds made money in the stock market in January and I chuckled because I'm up 55% YTD in my PA, trouncing all of them, betting heavily on a recovery in solar stocks.

And if you do your homework, you too can learn a lot by tracking the activity of top funds like T2 Partners and Pershing Square. It's all discussed in my piece on Malakia Capital Management but I will circle back to spoonfeed you some more as Q4 2011 13-F filings come out. When you become good at the game, you don't even need to wait for them to come out, you anticipate where top hedgies are investing before public records come out.

Speaking of malakies, SAC Capital's Steve Cohen was seen dining Tuesday with New Jersey Gov. Chris Christie at Manhattan steakhouse Quality Meats (I loved the Prime Grill, thx Jonathan!). Speculation is running amok that Cohen, feeling the heat from the Feds, is cozying up to Republicans, but just like Sabia's séjour chez Desmarais, I think this is much ado about nothing. Just more gossip for Charlie Gasparino and those 'hard hitting' reporters at Fox Business News (see below).

Pension Funds Queasy Over Private Equity?

2012-02-09T20:07:00.009-05:00

Cristina Alesci and Devin Banerjee of Bloomberg Businessweek report, Pension Funds Get Queasy over Private Equity:

Mitt Romney’s campaign for the Republican Presidential nomination may be creating funding headaches for his former colleagues in the private equity industry. Romney’s opponents have characterized Bain Capital—the firm he helped found in 1984 and left in 1999—and other buyout managers as corporate looters who enrich themselves at the expense of ordinary workers. The issue is likely to remain in the news should Romney win his party’s nomination and face President Obama in the general election.

With public scrutiny focused on private equity funds, pension funds are more reluctant to invest and may ask for more details on job creation and push for lower fees, according to officials and trustees at public pensions. “Pension funds have boards. They don’t want to be giving money to an industry that has a taint,” says Tony James, president of Blackstone Group, the world’s largest private equity firm. “Similarly, boards of directors don’t want to sell their company to organizations they don’t view as respectable. So it could be very damaging for the industry.”

The debate comes as the industry is competing for a shrinking pool of investor dollars. Fundraising has fallen off sharply since the onset of the global financial crisis, staying below $100 million each quarter, according to London-based researcher Preqin. In the second quarter of 2007, at the peak of the leveraged buyout boom, private equity firms raised almost $214 billion. In the fourth quarter of 2011, they raised $52.4 billion.

Public and private pension funds in the U.S. provide 42 percent of the capital for all private equity investments, according to the Private Equity Growth Capital Council in Washington. Public employee pension funds, which must answer to ordinary workers, are sensitive to protracted debates about managers’ compensation and whether buyouts create value and jobs, says one official who asked not to be named because he wasn’t authorized to speak on the topic.
“The political attacks against Romney and Bain will definitely come up when firms pitch us their new funds,” says William R. Atwood, executive director of the Illinois State Board of Investment, which oversees $10.4 billion in pension funds. “You’d be crazy not to bring it up.” The Illinois pension board had $621.3 million, or 6 percent of its assets, in private equity as of Dec. 31, according to its website.

Bad publicity has hurt private equity firms in the past. Last year, Blackstone lost out on a deal to manage hedge fund investments for New York City’s public pension funds after the company’s chief strategist suggested retiree benefits were too generous.

Bain tends to be less reliant on pension funds than its rivals. When Romney set out to raise Bain’s first fund in 1984, he steered clear of pension funds, pursuing high-net-worth individuals who contributed about $37 million, according to a person who worked with Romney at the time. Kohlberg Kravis Roberts’s co-founders, by contrast, received early capital from Oregon’s and Washington’s pensions, with the latter contributing $12 million to KKR’s first fund in 1982.

The success of Bain’s first fund, which generated a 61 percent average annual return, according to marketing documents from 2004 obtained by Bloomberg, allowed Bain to charge a premium for its investment services. Bain collects 30 percent of the profit on its investments, the highest in the industry. Pensions historically have been less willing to pay the higher performance fees. In a recent fund, Bain relied on pensions for about 9 percent of client assets. Alex Stanton, a spokesman for Bain, declined to comment.

One Bain executive expects the storm to blow over. “Our limited partners have been with us for 28 years, many of them,” Bain Managing Director Stephen Pagliuca said in an interview at the World Economic Forum in Davos on Jan. 27. “We just keep our heads down and try to build value.” Pagliuca also said that pensions will come to rely more on private equity to meet their growing obligations to workers because traditional assets like stocks and bonds won’t return enough.
Still, with Romney’s candidacy keeping the spotlight on the industry, Atwood of the Illinois State Board of Investment says there’s bound to be an impact. “We all know that private equity managers make a lot of money, and we know how they do their business,” he says. “But when it’s on the front page, it causes us to think twice when making investment decisions. Private equity is more lucrative when it’s kept quiet.”

The bottom line: Pension funds, which provide 42 percent of the private equity industry’s capital, may pull back amid criticism of Romney and Bain.

Will pension funds pull back from private equity? Absolutely not. But they are taking more concentrated bets with fewer GPs. Yesterday, I wrote about CalSTRS going the Texas Teachers' route, considering making large separate-account commitments to private equity firms.

This morning I had a chance to speak with Neil Petroff, CIO of the Ontario Teachers' Pension Plan (OTPP). Neil is extremely sharp and knows his stuff in both public and private markets as well as hedge funds. Bob Bertram, his predecessor, was equally sharp. Great pension plans have smart CIOs allocating risk across all investment portfolios.

Anyways, we talked a lot about private equity. Neil told me these separate accounts in PE are the same as the ones used for hedge funds. Ontario Teachers' doesn't use them because even though they're less expensive than paying the traditional 2 & 20, they still cost 1 &10. OTPP prefers investing directly into private equity or co-investing, paying no fees.

He repeated what Jim Leech said at Davos, namely, Ontario Teachers' does do a lot of direct deals, getting into auctions bidding on deals. But he also told me they do not compete with the brand name PE funds, but will co-invest alongside them on deals, just like other large Canadian public pension funds. The key point is that they do not pay 2 & 20 or any fees on directs and co-investments, their teachers get that money.

We talked a lot about the private equity model and how pensions are better suited than PE funds to do private market deals that require a very long time horizon. Unlike PE funds that lever up and try sell a company after 4 or 5 years to realize gains and move on to their next fund, at Ontario Teachers' they have some direct PE investments that go back 18 years. And unlike PE funds, they spend most of their time on deals, not marketing.

At one point, I asked him about industry trends and how all these public pension funds moving into private equity will change the landscape. "It will increase competition and increase multiples". In other words, as all this pension money flows into private equity, it will decrease the expected return of the asset class.

Then we talked about CalTRS getting fully funded in 52 years and ATP being one of the best pension/ hedge funds in the world. Neil told me that U.S. pension funds use their expected investment return to discount their liabilities. So, let's say CalSTRS lowers their expected investment return from 7.75% to 7.5%, it will still be 200 basis points above the discount rate Ontario Teachers' uses.

"If U.S. pension funds used our discount rate, they'd be insolvent." To understand why, for every 100 basis decline in real rates, the present value of future liabilities goes up by $25 billion. Neil added: "In order to achieve their investment target, U.S. pension funds are taking more risk in private markets."

As for ATP, Neil told me their liabilities are nominal, not inflation-indexed. This means they bought bonds to match their liabilities -- and long bonds delivered outstanding double digit returns in 2011 -- and since they're fully funded, they can take more risk than OTPP or other pension plans that have a deficit. The same goes for Healthcare of Ontario Pension Plan (HOOPP), which he expects will be among the top-performing large Canadian DB plans in 2011.

On hedge funds, he told me it is a question of allocating risk internally and externally. They do a lot of relative value strategies internally but also allocate to external managers who have the skill set to deliver alpha in strategies that are not easily replicated internally. Ron Mock, the guy running hedge funds and bonds at Teachers', knows what he is doing. He told me something a long time ago that stuck with me ever since: "Beta is cheap; true alpha is worth paying for."

Institutional investors piling into Malakia Capital Management should think carefully about that last statement. Ron and Neil know all about the nonsense in the hedge fund industry. I'll write some more on hedge funds in my next comment. Will end by thanking Neil Petroff for taking some time to chat with me this morning.

Below, Scott Sperling, THL Partners, explains why he is increasingly optimistic about investing in North American companies and offers his view on private equity now.

Sabia's Séjour Chez Desmarais?

2012-02-09T08:56:00.016-05:00

Kevin Doughterty of the Montreal Gazette reports, Sabia-Desmarais meeting was "friendly", not lobbying, Caisse de dépôt says:

A spokesperson for the Caisse de dépôt et placement du Québec, which invests more than $150 billion in Quebecers’ public-sector pension and insurance plans, said Tuesday that a weekend visit by Caisse CEO Michael Sabia to Sagard, the family compound of Montreal’s powerful Desmarais family, was “friendly.”
Maxime Chagnon said Sabia did not discuss business matters with Power Corp. president André Desmarais during a weekend stay at Sagard, in the mountainous Charlevoix region, and the visit conformed with the Caisse code of ethics.
“We are very at ease,” Chagnon said.
Opposition parties are clamouring for Sabia to explain what he and Desmarais talked about during his visit to Sagard last August.
Quebec’s lobbying commissioner is also looking into the matter to determine whether Desmarais was engaged in lobbying the Caisse without registering as a lobbyist, which would contravene Quebec law.
Nicolas Girard of the Parti Québécois – with the backing of François Bonnardel, finance critic for the Coalition avenir Québec – has called on Sabia to explain his actions before a committee of the National Assembly.
Citing “ethical and moral problems,” Bonnardel said Sabia must explain himself.

Quebec' main unions are up in arms over Sabia's séjour at the Desmarais compound, and some are demanding a seat on the Caisse's board of directors (not a bad idea). Madelaine Michaud, president of l’Association québécoise des retraité(e)s des secteurs public et parapublic (AQRP), put out this statement, showing they're not too pleased:

«Après les pertes colossales de 2008, monsieur Sabia s’était engagé à prendre ses distances avec l’administration de monsieur Henri-Paul Rousseau, qui a quitté la Caisse pour Power Corporation. Or, aujourd’hui encore, les Québécois ont de sérieuses réserves concernant la façon dont la Caisse gère leur bas de laine et rend des comptes à la population. Dans ce contexte, nous estimons que la présence de monsieur Sabia à la résidence du président de Power Corporation est minimalement un grave manque de jugement »

My take on all this? Much ado about nothing. More Quebec petty politics. André Desmarais is one of the richest, most powerful men in the world. The Desmarais family is secretive and they do not need the Caisse or this press coverage.

Was it a smart move on Sabia's part? Probably not given that Quebec's media loves jumping on this stuff to stir up conspiracy theories. And even though Sabia is independently wealthy, he should have exercised more common sense. But when André Desmarais invites you to Sagard, you don't refuse, you go, enjoy yourself and engage in interesting discussions with one of the most powerful and successful financiers in the world.

Quebec's media is truly pathetic. In fact, over dinner last night, along with former colleagues who all worked at the Caisse in the past, we discussed some scandals that the media never bothered uncovering. Like how the hell did the senior Caisse trader who lost over $22 billion investing in non-bank asset backed commercial paper (ABCP) land a cushy job as a senior investment officer at Fondaction CSN in charge of seeding Quebec hedge funds and other investments? How are other snaky slimeballs with questionable reputations still surviving and thriving at the Caisse?

That is the stuff that makes my blood boil. I couldn't care less if Michael Sabia spent three days at Sagard with André Desmarais. Good for him. What I care about is senior pension fund managers on the take, splitting commissions with brokers, getting kickbacks from external managers, setting themselves up on easy street through allocations to external managers.

That's the stuff that infuriates me and that is the stuff that Quebec's media should be covering. Maybe now that Arianna Huffington launched Quebec's French-only Huffington Post, we can get back to serious investigative journalism in this province. Leave it to us Greeks to stir up some shit and uncover the truth. Bravo Arianna, your timing is perfect!

Hedge Fund Managers Thrilled to Death?

2012-02-08T21:37:00.009-05:00

Mia Lamar of the WSJ reports, Hedge Funds Added Small Gains in January:

Hedge-fund performance perked up in January, although continued to lag the major stock indexes, according to industry adviser Hennessee Group.

Hennessee's hedge fund index rose 2.5% for the month of January, less than the Standard & Poor's 500 and Dow Jones Industrial Average, which posted gains of 4.4% and 3.4%, respectively. The Nasdaq Composite Index climbed 8% last month.

Still, the advancement in January comes after a dismal 2011 for the hedge industry, which has been battered by swiftly changing sentiment on Europe's sovereign-debt crisis and other macro concerns around the world. Hennessee's hedge fund Index fell 4.27% in 2011, marking the worst year for hedge funds since 2008.

"It is encouraging to see a respectable gain even with managers conservatively positioned," said Lee Hennessee, managing principal of Hennessee Group.

Equity long/short strategies were among the best-performing strategies last month, as the Hennessee Long/Short Equity Index advanced 2.47%. Stocks pushed higher in January, led by technology and financials, as U.S. economic data continued to show signs of improvement.

It's hardly surprising to see Equity long/short funds posted the best returns as stock markets rocketed up in January. In other words, once more, it's all about beta stupid!

There is however more good news for hedgies. Harriet Agnew of Financial news reports, Long/short hedge funds to gain from correlation decline:

Stock correlation within sectors has dropped significantly this year as markets have rallied, providing a boon for long/short equities managers who buy and sell companies based on fundamental analysis of their individual merits.
Giles Worthington, a portfolio manager at RiverCrest Capital, said: "Correlations are falling with quite a powerful force and diversity in stock returns is rising. This is good news for stock-pickers as once again investors are considering the difference between a high-quality and a low-quality company.”

The attached chart, published yesterday on Business Insider, illustrates the 21-day stock correlation within the Russell 1000 Index. It shows that correlation has fallen from a peak of about 0.75 in September to about 0.2.

Worthington said that the key short-term driver of this has been the European Bank's three-year provision of liquidity through its Long Term Refinance Operation that was announced in December.

He said: "The LTRO has significantly reduced the tail risk in the markets. The huge risk of financial implosion has gone away for the time being. Last year the markets were dictated by macro calls and now they are focusing on stocks."

For many managers, the drop in correlation is a welcome respite from the high correlations driven by macroeconomic newsflow that characterised the markets for much of last year.

Looking at valuations alone would have created the wrong idea: defensive growth stocks trading at high multiples performed well, while cheap cyclical stocks perceived as value investments suffered losses.

At times company share prices moved not on individual valuations but on the perceived country risk or currency risk of the issuer. Late last year, for example as investors became more concerned about France's triple-a rating potentially being downgraded, French stocks were sold off indiscriminately, in line with the market's perception of an inherent risk of investing in France.

According to data provider Hedge Fund Research, the average hedge fund gained 2.63% in January, with equity strategies leading the way, up 3.84%.

Among long/short equity managers, many of last year's biggest losers rebounded strongly in January. Crispin Odey's Odey European fund is up double digits this year, while Lansdowne Partners' UK fund gained 5.7% in January, investors said.

Worthington said that although stock selection detracted from his fund's performance in December, by January it accounted for 60% of the returns.

However, he also sounded a note of caution. He said: "The market always starts the year quite buoyant as companies invariably come out with good expectations and they have a full year to disappoint.

"There's been bit of a 'dash for trash' too - in the US, for example, the top-performing stocks this year underperformed by 40% on average in 2011. A lot of the highly-leveraged, high-cyclical companies have bounced as portfolio managers have rotated out of more defensive names."

According to Credit Suisse strategists, the rotation ratio in January was 76%. This means that around three quarters of sectors either outperformed in January 2012 after underperforming in 2011 or vice versa, the highest level of rotation since 2001. Banks are the most striking example of this, they said.

The chart was first reported by Business Insider blog.

In other news, Finalternatives reports that Goldman Sachs' former special situations chief will launch his new firm's maiden hedge fund next quarter along with another Golman and Tudor vet:

Richard Ruzika, global head of special situations at Goldman between 2007 and last year, founded Dublin Hill Capital in Connecticut with Lance Bakrow and Joe Howley. The Connecticut-based firm will unveil its Global Macro Fund in an effort to take advantage of the strategy's current popularity, HFMWeek reports.

Ruzika was co-head of global macro trading and global head of commodities at points during his 29-year career at Goldman.

Bakrow, another Goldman Sachs veteran, is a founder of Greenwich Energy Partners. Howley, a Tudor Investment Corp. veteran, was managing director of natural gas trading at Sempra Energy.

Whenever you read veterans from Goldman and Tudor are getting together to start a global macro fund, it's worth meeting them and discussing their new fund. Ask them lots of tough questions but this is the type of new fund I like investing in.

I've been tough on hedgies lately. Someone accused me of "waging war against them". Nothing can be further from the truth. While I've seen many "malakies" in the hedge fund industry, including nonsense within pension funds investing in hedge funds, I still believe that excellent hedge funds are worth investing with.

Do I believe in paying 2 & 20? A lot less than I used to. Why? Because most hedge funds are mediocre and the large ones are mostly asset gatherers. Moreover, institutions can replicate a lot of hedge funds strategies internally and if you're a large pension fund like ATP, you got a large enough balance sheet to beat them at their own game at a fraction of the cost. It's stupid to get eaten alive by hedge fund fees, making them rich for gathering assets.

Tonight I had dinner with some former colleagues. We all worked in hedge funds before. We were discussing how stupid it is for large public pension funds to pay millions in fees to hedge funds instead of developing alpha internally. These guys are sharp money managers and know all about hedge funds. One of the guys can slice and dice any hedge fund strategy and reverse engineer it. The other is a credit specialist who has done his share of due diligence on hedge funds and knows all about alpha and managing money.

We all feel that too many institutions are wasting their money on hedge funds. Save your money, develop alpha talent internally and don't waste your time and resources chasing hedge funds. And if you are going to venture into hedge funds, seed some alpha managers who are performance driven but don't take an equity stake!!!

All these institutions investing in hedge funds, including the Caisse and Ontario Teachers', should publicly disclose how much they've disbursed in fees since inception of their hedge fund programs. My guess is hundreds of millions. Sure, they've invested in some great funds, made money, but also got clobbered in others which you'll never hear about. The point is would they have been better off taking the ATP approach, investing in internal hedge funds? Results speak for themselves.

Below, Ann Pettifor, George Kapopoulos and Matina Stevis discuss the prospect of a Greek default on Al-Jazeera. Debt discussions in Greece have stalled on pension dispute. If Greece defaults, you'll see macro news take over again, and correlations rise across all asset classes (except bonds).

If all hell breaks loose, hedge funds will suffer. If a deal is struck, watch out, a massive liquidity rally could mean many hedge funds will underperform. Both scenarios would be bad for hedge funds, especially the former one. At the end of the day, most hedge funds are a lot more like mutual funds and pension funds in that they desperately need the big beta boost to make money.

CalSTRS Going the Texas Teachers' Route?

2012-02-08T14:27:00.004-05:00

Gregory Roth of Reuters reports, California pension eyes commitments to PE firms:

The $145 billion California State Teachers' Retirement System, the nation's second-largest pension fund, is actively considering making large separate-account commitments to private equity firms, a senior investment official at the fund told Reuters Buyouts Magazine.
The development comes on the heels of similar commitments made by the Texas Teachers' Retirement System and the New Jersey Division of Investment. "We're definitely looking at separate managed accounts," said Pascal Villiger, a private equity portfolio manager at CalSTRS. "It's definitely something that I think all large institutions are seriously looking at."
Late last year, two giant commitments shook the private equity world. The first, by Texas Teachers', involved committing $3 billion each to separate accounts managed by private equity shops Apollo Global Management and Kohlberg Kravis Roberts & Co.
A few weeks later, New Jersey pledged $1.5 billion to The Blackstone Group for three separate accounts covering a variety of investment strategies. This was in addition to $1 billion that New Jersey had already pledged to Blackstone Group in 2011 for its regular slate of private equity and real estate funds.
Separate accounts are different from typical private equity funds in that the investments are not commingled with money from other investors. Rather, they consist of customized investments for just one investor. Their advent represents a sea change in the way public pension funds, the largest sources of private equity money, use their huge size to drive down fees and negotiate better terms.
The trend toward separate accounts is also likely to help accelerate the ongoing transformations of the largest private equity firms into generalist asset managers equipped to offer their clients a wider scope of investments beyond private equity. Blackstone Group, for instance, now manages $137 billion in fee-earning assets, yet only 27 percent of its assets ($37 billion) are invested in private equity. The rest is invested in real estate, hedge funds and credit offerings.
Even though large separate accounts are relatively new in private equity, CalSTRS's Villiger said there were already a variety of flavors. "At one extreme, it's just basically co-investments alongside a commingled fund with reduced economics. At the other extreme, in terms of Texas Teachers', it's a very highly customized solution."
CalSTRS's move to consider large separate accounts was strongly hinted at in late January, when the pension publicly posted proposed changes to its investment policy that would allow such investments. The pension's board was scheduled to discuss the policy changes at its February board meeting.
In making its case, the proposal highlighted the advantages of separate managed accounts, among them "discounted fees and preferred terms," adding that "almost always, management fees will be lower and sometimes carried interest will be lower, too."
Under the proposed policy, each separate account would be limited to 10 percent of CalSTRS's private equity portfolio. But since CalSTRS has $21.3 billion in private equity holdings, it is feasible that separate account commitments could amount to as much as $2 billion each.
To be sure, separate managed accounts would probably represent just a fraction of CalSTRS's overall private equity program. Villiger said that with 14.7 percent of its overall portfolio in private equity, CalSTRS was already over its 12 percent target allocation. That said, he predicted that CalSTRS would probably spend between $2.5 billion and $4 billion on private equity each year.
"A sustainable pace is probably a number closer to $4 billion," he said.
Kelly DePonte, a fund marketer at Probitas Partners, said the recent moves by big pension funds to consider separate accounts represent much more than a desire to save on fees. "It's also a wish for more control," he said, "so that there is more of a conversation between the GP and LP about each individual investment."

Separate accounts make a lot of sense for large U.S. public pension funds. Not only do they get to lower fees, they can have more control over their investments and obtain significant knowledge leverage with their GPs.

I think you will see an increase in these type of separate account arrangements in the alternatives space because large investors are increasingly conscious of fees and trimming their GP relationships. You'll see this not just in private equity but in real estate and hedge funds too.

In Canada, such arrangements are rare because our large public pension funds prefer investing direct in private equity, co-investing only when it makes sense for them. Ive discussed these trends here and here. Below, some CNBC interviews with Steve Leblanc of Texas Teachers' and Jim Leech of Ontario Teachers' discussing their private equity strategy.

Will Austerity Lead to Another Greek Crisis?

2012-02-08T07:00:00.011-05:00

Ekathimerini reports that the leaders of Greece’s three coalition parties received on Wednesday morning the text of the outline agreement for a new bailout and are due to meet in the afternoon in an effort to reach consensus on the measures the government will have to adopt.

The drafts, which contain 32 pages setting out the reforms and fiscal targets the leaders will have to agree to, were delivered to the headquarters of PASOK, New Democracy and Popular Orthodox Rally (LAOS) at about 9 a.m. The document also contains some extra pages explaining some of the measures proposed.
A meeting between PASOK’s George Papandreou, ND’s Antonis Samaras and LAOS chief Giorgos Karatzaferis with Prime Minister Lucas Papademos has been scheduled for 3 p.m. but this could change.
Papademos was involved in talks late on Tuesday with the representatives of the European Commission, the European Central Bank and the International Monetary Fund -- known as the troika -- on the steps it would take to save 3.3 billion euros.
One of the stumbling blocks that emerged on Tuesday was the troika’s new demands for cuts to basic pensions, which start at 360 euros per month, as well as supplementary ones.
New Democracy had wanted auxiliary pensions to drop no lower than 300 euros but it is believed that the troika proposed that if this level is to be maintained then basic pensions should be cut. The reductions on basic pensions may apply just to those above a certain level.
In an interview with Dow Jones Newswires on Tuesday, Samaras indicated he was unwilling to accept more cuts to pensions. My enemy is recession,» he said. «Pensions have already been cut. Slashing them further will lead to even deeper recession."
It is also though that the draft agreement proposes a 22 percent reduction to the minimum wage of 751 euros per month, which may be passed on to private sector employees who earn more than this amount.
If the party leaders agree on Wednesday, then the troika officials are likely to hold talks with each of them individually to obtain their explicit commitment to the measures. It was not clear if this would involve written guarantees.
The new loan agreement would be submitted to Parliament on Friday and voted on two days later.
The Eurogroup of eurozone finance ministers is due to meet on Thursday to assess any potential agreement in Greece.

Of course, the reduction in minimum wage means an automatic drop in pensions:

What the party leaders are about to sign up to – again, if reports are correct – is the substantial reduction of the minimum wage and the abolition of the principle of metenergeia, or nachwirkung as its known in German law. In other words, if employers and unions manage to agree on new collective contracts, the baseline will be 20 percent lower than before, thereby affecting all the wage brackets above it. If the two sides don’t agree on new deals, employers will be free to negotiate individual deals with their employees. The basis for these agreements? The new, 20-percent-reduced, minimum wage.
While some of the political leaders will proclaim their role as saviors of Greeks’ hard-earned crusts by protecting the 13th and 14th salaries, it seems that all they have managed to achieve is swap a 15 percent reduction, which would have occurred if those monthly wages were lost, with a 20 percent one that will come with the slashing of the minimum wage and the terms under which collective contracts apply. Rather than two monthly salaries, Greek private sector workers are set to lose three.
The fact that some people are portraying this as a victory for their negotiating technique means that either they are woefully misinformed or, as is more likely, they are being intentionally duplicitous.

Others are more hopeful but cautious. "There is a path here for Greece, there is a way out for Greece, if it wants to take it, but there’s no denying this will be tough,” Grant Lewis, an economist at Daiwa Capital Europe Ltd. in London, said in a radio interview with Bloomberg’s Ken Prewitt yesterday. “You are talking about multi-year austerity packages against a backdrop of an economy that’s shrinking very rapidly.”

How tough will it be? Just look at the dramatic drop in budget revenues:

Budget revenues were found to be lagging by a considerable 1 billion euros in the year’s first month, provisional January data compiled by the Finance Ministry showed on Tuesday.
Revenues posted a 7 percent decline compared with January 2011, while the target that had been set in the budget provided for an 8.9 percent annual increase.
Worse still, value-added tax receipts posted an 18.7 percent decrease last month from January 2011 as the economy continues to tread the path of recession: VAT receipts only amounted to 1.85 billion euros in January compared to 2.29 billion in the same month last year.
The VAT revenue data represent a particular worrying sign regarding the depth of recession for 2012, while even more painful measures are expected to lead to a reduction in salaries and therefore a further drop in consumption. This is the vicious cycle that the government will have to tackle by way of additional fiscal measures this summer.
According to the current data, the 2012 budget will certainly have to be revised soon, given that the original estimate for a contraction of 2.8 percent is now raised to 3.5-4 percent of gross domestic product.
Finance Ministry officials attribute the slump in VAT receipt figures to the major cash flow problems that enterprises are facing. Some of the latter are choosing not to pay for their VAT in order to plug other holes caused by liquidity problems.
At the same time the crisis is seriously hurting the competitiveness of Greece’s economy, resulting in a considerable drop in entrepreneurship. Finance Ministry data showed that some 111,000 companies shut down in 2011, against just 75,000 new businesses being set up. In fact the majority of new start-ups are not actual enterprises but newly self-employed professionals.
This is attributed to the dramatic fall in market turnover and the insecurity that entrepreneurs feel, dissuading them from getting engaged in the local business field.
The consequence of that is the reduction of state revenues from corporate tax.

Must admit my first thought after reading about the dramatic drop in budget revenues was they are lying to make their case for less austerity. But it is possible that they're telling the truth and that austerity has reached the point where tax revenues are declining dramatically.

In any case, a new poll shows that the the Democratic Left has attracted the support of a large segment of austerity-weary Greeks:

Dissent-ridden socialist PASOK is on a downward spiral and conservative New Democracy is maintaining its popularity while the Democratic Left has attracted the support of a large segment of austerity-weary Greeks, according to the results of a new opinion poll that also show that nine in 10 Greeks are unhappy with Prime Minister Lucas Papademos’s coalition government.
The new poll, carried out by Public Issue for Skai, showed ND to have inched forward to 31 percent, consolidating its growing popularity, while PASOK continues to languish in fifth place with 8 percent.
The poll, carried out on a sample of 1,002 people last week, showed the Communist Party (KKE) and the Coalition of the Radical Left (SYRIZA) to be holding firm at 12.5 and 12 percent respectively. But the Democratic Left has surged in popularity, garnering 18 percent of the public vote (up 4.5 percent since last month).
All together, the leftist parties garner an impressive 42.5 percent, but as KKE has ruled out cooperating with other parties, the figure is misleading.
Support for the right-wing Popular Orthodox Rally (LAOS), the third party in the tripartite coalition, slipped to 5 percent -- from 8 percent during its heyday in 2010 -- while the extreme-right Chrysi Avgi (Golden Dawn) has surged to 3 percent, hitting the threshold for entering Parliament.
The poll’s results for parties are broadly reflected in the support for the politicians that lead them. Democratic Left leader Fotis Kouvelis tops the list, attracting the support of 56 percent of respondents, followed by 41 percent for SYRIZA’s Alexis Tsipras and ND chief Antonis Samaras with 31 percent.
Respondents were divided on Papademos, with 48 percent expressing a negative opinion and 46 percent a positive one. Respondents were virtually unanimous though in their criticism of his government’s achievements, with 91 percent expressing disappointment.

What this tells me is that even if Samaras wins the next elections, he'll be heading a minority government and will face stiff opposition from leftist parties. That's one of the reasons why they're trying to finalize the agreement with troika as soon as possible.

What remains to be seen is whether all these austerity measures will succeed or throw the country deeper in recession and ultimately, into a much more severe crisis.

Below, Grant Lewis, an economist at Daiwa Capital Europe Ltd., talks about the European sovereign-debt crisis, the outlook for private-sector involvement in Portuguese debt and the risk of contagion. He speaks with Maryam Nemazee on Bloomberg Television's "The Pulse."

Also, Yanis Varoufakis, professor at the University of Athens, told CNBC, "this bailout is certainly not the right answer for anyone, for Greece, for the euro zone, for the world. Here we have a typical bankruptcy problem, the first time around we decided to treat it like an illiquidity problem, it wasn't." Varoufakis thinks Greece should default "instantly, immediately" and remain in the eurozone.

Malakia Capital Management?

2012-02-07T17:51:00.030-05:00

A follow-up on my previous comment on why it's time to pull the plug on hedge funds. Ever wonder how those super secretive, 'elite' hedge funds make a killing? I'll go through it with you below, poking some fun at the hedge fund industry.

Let's say we wanted to start a hedge fund. First, we'll choose a name. Since we know the industry is full of malakes, we'll call it MCM, short for Malakia Capital Management. We'll fill out all the paper work, rent some fancy offices, hire some cute administrative assistants to get things off the ground.

Then, we'll hire a couple of Russian physicists, Igor and Yuri, to program malakies all day and help us out with our marketing material. They are used to make our hedge fund look legitimate and sophisticated so when institutional investors come around, we pass their due diligence and bombard them with all sorts of fancy risk metrics and eye-popping risk-adjusted 'pro forma' returns.

Speaking of eye-popping, we'll also hire Yuri's cousin, Tatiana, a smart and sexy Russian salesperson. Here she is below.
Tatiana is polished, highly educated, very sharp, and very hot. She knows all the hedge fund 'lingo' and more importantly, she's a shark. We'll send her off to all those silly hedge fund conferences in London, New York and Geneva where she'll work the crowd, targeting lonely institutional investors horny for hedge funds.

She'll peddle our "niche strategy" and "high Sharpe ratio". Hell, as long as the suckers show interest, she'll peddle any ratio they want over dinner and drinks. She's very cunning and can charm the toughest client. And if things get sticky, she can play dirty (bribes, prostitutes, whatever it takes to close the deal).

If things go well, our assets should be mushrooming in no time. We choose to run a legitimate operation. No Bernie Madoff scams for us. We'll get a reputable hedge fund administrator and hire some more quants to help Igor and Yuri 'reverse engineer' the portfolios of all the elite hedge funds (more malakies).

Except we won't be doing any reverse engineering at our shop. Instead, we're going to track the 13-F filings of elite hedge funds and try to go long or short their holdings. The data is delayed, typically coming in 45 days after end of quarter, but if you use the information wisely, you can make money leeching off these top funds.

To illustrate, let's take the institutional holdings of Peak 6 Investments, one of the best L/S equity hedge funds. You'll notice at the end of Q3, they reported holding 1,684 positions with a total market value of $3.5B.

Admittedly, these are only their equity positions with a delay. Some large hedge funds do all sorts of complicated strategies using OTC derivatives, high-frequency trading and churn their portfolios many times in a quarter, but we'll keep things simple just to illustrate.

First, look at their top holdings (click on image to enlarge):

Then, click on the top of the second column (value of shares) twice to get their top dollar-weighted positions (click on image to enlarge):

Lo and behold, sometime in Q3 2011 when the shit hit the fan, this elite fund cranked up the risk, went long the market (bought a ton of S&P 500 ETF) and bought sizable positions in tech shares of Ciena (CIEN), Akamai Technologies (AKAM), NetApp (NTAP), Microsoft (MSFT) and other "high beta" stocks which handily outperformed the overall market since the end of September.

That, in a nutshell, is how 'elite' hedge funds make money. That's why while most hedge funds are mediocre, the top funds are worth tracking closely. Here I used Peak 6, but we can track many more funds, including hedge funds that are closed and top long-only funds, and cross reference their holdings.

Importantly, forget what Bill Gross, George Soros, Jim Rogers and other 'gurus' are saying on CNBC and focus on what top funds are actually buying and selling. Words mean nothing, show me their actual book!

It's not perfect, there are lags, but if you track the right funds, you'll get plenty of ideas on where you should be taking opportunistic risk and you don't have to pay 2 & 20 to any of them!

Ok, now that I shared some insights with you, who wants to invest in Malakia Capital Management? Too late, most of you are already investing in them, getting eaten alive on fees. Funny thing is that the world's best hedge fund is actually a pension and they're wisely avoiding all these malakies.

Below, a classic scene from Boiler Room. Unfortunately, it's not just unsuspecting doctors that are getting scammed. In these markets, the biggest sharks are charging 2 & 20, ripping off institutional clients in all sorts of hedge fund strategies.

Buyers beware, when the next crisis hits, you don't want to end up being the biggest malaka on the block, left holding your nuts!

Time to Pull the Plug on Hedge Funds?

2012-02-07T13:16:00.021-05:00

Christine Williamson of Pensions & Investments reports, Institutional investors set to dump poor hedge fund performers (h/t, Abnormal Returns):

Institutional investors will be sharpening their scalpels in 2012, cutting managers that failed to provide what they promised: absolute return.
Last year was the second-worst year for hedge fund performance in the 22 years that Hedge Fund Research Inc. has been tracking industry returns, and the patience that institutional investors had for subpar hedge fund performance is evaporating fast, said industry sources.
Industry insiders predict 2012 will be characterized by significant manager rotation within hedge fund portfolios.
“The hedge fund investment trend won't reverse, but many institutional investors will be carefully evaluating how individual managers and strategies contributed to their portfolios,” Anita Nemes, London-based managing director and global head of capital introduction in Deutsche Bank's Hedge Fund Capital Group, said in an interview.
“This assessment is precipitated by huge performance dispersion in 2011 in some strategies, like long/ short equity, but investors will be making their assessment over the longer time frame of the past few years,” Ms. Nemes added.
Last year was only the third since the HFRI Fund Weighted Composite index's inception in 1990 in which the index's return was negative, at -5.02%. The 2011 returns of hedge funds of funds were even worse, with the HFRI Fund of Funds Composite index producing a dismal -5.51%.
By comparison, the Standard & Poor's 500 index returned 2.1% in 2011; the Russell 3000 index, 1.03%; the Morgan Stanley Capital International All-Country World index, -6.69%; and the Barclays Capital U.S. Aggregate Total Return index, 7.84%.
“2011 was a good testing ground for hedge fund managers who professed to be able to manage risk. Those hedge funds that were not able to preserve capital are going to be under scrutiny,” alternative investment consultant Stephen L. Nesbitt said in an interview.
“The tide went out last year and you could see who didn't have any pants on. Managers complained that everything was correlated in 2011 and they couldn't be expected to perform. There always is an excuse,” said Mr. Nesbitt, who is CEO of Cliffwater LLC, Santa Monica, Calif.
With chief investment officers weary of excuses, Mr. Nesbitt said he expects “an above-average number of manager searches” in 2012, similar to the first half of 2009, when investors upgraded their manager rosters after the financial crisis in 2008. Mr. Nesbitt said Cliffwater's own clients likely will be among those making changes, but declined to disclose any names.
Deutsche Bank's Ms. Nemes said the biggest change for institutional hedge fund investors since 2008's financial market meltdown has been “so much more emphasis on bottom-up manager selection. And if you were not achieving your performance expectations, how you can effect a change going forward is through manager changes.”
“Fundamentally, institutional investors are not focused on changes to hedge fund portfolio construction as much as they are on assessing which managers will do best in the strategy weightings within their portfolios,” Ms. Nemes said. Part of that evaluation of hedge fund manager skill has to include assessment of the individual manager's ability to find investment opportunities regardless of market conditions, said Michael Rosen. As principal and CIO of Angeles Investment Advisors LLC, Santa Monica, Calif., Mr. Rosen advises institutional clients on hedge fund investments and manages the firm's $160 million hedge funds-of-funds strategy.
“You have to analyze the purpose of each hedge fund in your portfolio and what your expectation of that manager is. If a merger-arbitrage manager is sticking to his investment strategy and the market isn't favoring merger arb, then that manager may be meeting your expectations,” Mr. Rosen said.
Mr. Rosen said that in a manager-by-manager portfolio evaluation, the hedge funds he and his team are most focused on are those in which the manager's investment process has not worked and the manager seems “unsure about where to find opportunity. The question is not really so much about performance as it is about the lack of agility, the inability to see how they can make money.”
The $425 million Louisiana State Police Retirement System, Baton Rouge, is one fund that recently upgraded its hedge fund portfolio to improve performance (Pensions & Investments, Jan. 23). EnTrust Capital Management Inc. was hired in January to run $10 million in a hedge fund-of-funds strategy, replacing GAM, which was terminated for performance reasons in September.
Still, sources were unable to give specific examples of hedge fund and hedge fund-of-funds managers that have seen big redemptions or are among those most likely to be excised from institutional investors' portfolios.
But “drawdowns (negative performance) of a certain size will definitely put a hedge fund in the running” for replacement, said Donald A. Steinbrugge, managing member of third-party hedge fund marketing firm Agecroft Partners LLC, Richmond, Va.
Attention-getter

Paulson & Co. Inc. is a large, institutionally oriented hedge fund manager that got a lot of attention last year for disappointing returns. The hedge fund management company that produced a 159% return in 2007 from stellar subprime mortgage bets in its Paulson Advantage Plus Fund sustained a -35% return in the same fund in 2011. The company's oldest fund, the flagship Paulson Partners Fund, was down 10% in 2011, and Paulson Credit Opportunities Fund dipped 18%.
Net redemptions across all of Paulson & Co.'s hedge funds last year were less than in 2010, which in turn were less than 2009 redemptions, said a source with knowledge of the company, who asked not to be identified. The company's assets totaled $28 billion as of Dec. 31, but dropped to $23 billion on Jan. 1 when redemptions and performance were factored in, the source said.
Armel Leslie, a company spokesman, declined to comment.
But Agecroft's Mr. Steinbrugge predicted that “any drawdown of 30% or more just is not acceptable and will not be tolerated.”
He said as investors upgrade, they will be looking for hedge fund and funds-of-funds managers with strong risk controls that enabled them to produce positive returns last year despite extreme market volatility and high correlations between asset classes.
One institutional hedge fund manager — Bridgewater Associates LP — produced 15.3% in its Pure Alpha II fund in 2011. It had annualized returns of 14.6% for the 20 years ended Dec. 31.
The institutionally focused hedge fund Renaissance Institutional Equities Fund, managed by Renaissance Technologies Corp., also had strong performance — 35% — in 2011, although net inflows were “negligible,” according to a source who asked not to be identified.
Jonathan Gasthalter, a RenTech spokesman, declined to comment.
Institutional CIOs might need to move fast if they want to upgrade to 2011's best performers, Simon Ruddick, managing director and CEO of hedge fund consultant Albourne Partners Ltd., London, wrote in an e-mailed response to questions.
“Capacity is fast disappearing with those better-known funds that performed well in 2011, so opportunities to switch into them may well become limited. After way more talk than action, 2012 might see some shift to smaller funds,” he said.

With all due respect to Simon Ruddick, the last thing institutional investors should be doing is chasing hedge funds. Smart institutional investors realize they're getting eaten alive by hedge fund fees. And don't forget, the world's best hedge fund is actually a pension that doesn't invest in hedge funds, preferring to do it all internally at a fraction of the cost. But institutional investors keep pouring into hedge funds, chasing after them, foolishly believing that hedge funds will save them.

Let me repeat, the bulk of hedge funds are mediocre, hyped-up asset gatherers collecting 2 & 20 for delivering beta or even worse, sub-beta results. They absolutely stink. And most institutional investors that keep chasing after hedge funds don't have a clue of what they're doing. Most of these institutions are wasting time, money, and other resources chasing after a pipe dream.

How do I know? I used to invest in hedge funds, some of the best in the world. I went to those silly hedge fund conferences where I saw morons chasing after hedge fund managers. A bunch of horny imbeciles with hedge fund hard-ons chasing after pretty young sales ladies in short skirts peddling them hedge fund hype. The nonsense I've witnessed in the hedge fund industry is utterly scandalous.

John Authers of the FT is right, hedge funds have grown too big and need pruning:

Is there any such thing in the world of finance as a good idea that does not in time get taken too far, and flogged to destruction? I am beginning to doubt it.

If the financial world had any relative “winner” from the disaster of 2008, it was hedge funds. The long-feared collapse of a big hedge fund never took place. Banks turned out to create far more systemic risk. Some smart hedge fund managers actually saw the crisis coming and made money from it.
Managers like John Paulson, who made a huge bet against subprime mortgages, or David Einhorn, who aggressively sold short the shares of Lehman Brothers in a bet that they would go down, while publishing evidence that the investment bank’s accounts were fatally flawed, emerged from the crisis almost heroic – and very much richer.

Their lightly regulated business model, which allows them to borrow, to sell short, and to limit opportunities for investors retrieve their money, seemed superior to regulated funds.

Indeed, hedge funds soon repaired the damage. By the end of 2011, according to Hedge Fund Research of Chicago, the sector’s assets exceeded $2 trillion, greater than in 2007. In the last two years, a net 500 new hedge funds were created.

But it begins to look as though the sector has overplayed its hand. The release of Mitt Romney’s tax returns in the US illuminated what many did not realise – that wealth created by hedge funds is leniently taxed. Alternative asset managers suddenly face political attack.

Those proved right four years ago are now making mistakes. Mr Paulson took a loss of about $500m in the Chinese forestry group Sino-Forest last year as it fought short-sellers’ charges of fraud. As for Mr Einhorn, he had to pay a huge £7.2m fine to the UK’s Financial Services Authority this week, for market abuse.

The hedge fund industry as a whole is not looking so smart. According to HFR, the average hedge fund lost 5.02 per cent last year, only their third down year since 1990. Since August 2008, the eve of Lehman, hedge funds have almost exactly matched the S&P 500 stock index, and far underperformed bonds. Funds of hedge funds, with an extra layer of fees, have fared far worse, and are still 6.5 per cent below their level of August 2008.

They have some excuses. Correlations between securities and between asset classes are extremely high. That is bad news for hedge funds, many of whose strategies rely on correcting mispricing anomalies, selling short overpriced stocks and buying cheap ones. Such strategies fail if all stocks move together in response to the latest macro news.

But global macro funds collectively failed to exploit the twists and turns of the eurozone crisis. Some did. But most seemed to be flummoxed by the need to gauge political as well as financial risks.

Further, Mary Bartels of Bank of America Merrill Lynch shows that the correlation of several hedge fund strategies with the stock market reached record levels last year. That surely defeats their purpose, which is to provide a “hedge” - and implies that the sector is overcrowded, with too many players overexposed to the stock market.

Richard Bernstein, a New York investment advisor, points out acidly that treasury bonds offered true diversification, moving in the opposite direction to stocks. Hedge funds, despite their name, did not. “Traditional asset allocation has provided diversification, superior returns, liquidity and cheaper fees,” he said. “Alternatives have under-performed, are highly correlated to other asset classes, hinder liquidity, and charge high fees. This seems to be a comparison of a superior, less expensive product to an inferior, more expensive product.”

Many hedge fund strategies have a limit on how much money can be deployed, as there are only so many mispriced assets. When too much money makes the same bet, and copycats pile in, returns look ever more like the stock market itself. This is known in the industry as an “overcrowded trade”. It looks increasingly as though hedge funds owe their great performance in the decade before the crisis to cheap leverage, and cannot repeat the trick now that far more funds are trying to perform it.

Some hedge fund managers continue to use the freedom of their lightly regulated environment to reap fantastic returns each year. But many hedge funds are run by former traders using space on an investment bank trading floor, and using ideas spoon-fed to them by the research departments of investment banks.

For the sector as a whole, the picture is now familiar. Hedge funds have grown too big, they are copying each other, and they are tracking the market, but charging big fees for it. That is exactly what has already occurred in the world of mutual funds and unit trusts.

There are too many hedge funds. Those investors lucky enough to be able to invest in them should ask their fund managers whether they really need to exist.

Of course they need to exist. How else will they buy their Ferraris and yachts? And now that investment banks are scaling back bonuses, you're going to see a bunch of disgruntled prop traders who think they're the next Soros open up their hedge fund trying to get a piece of the action. Few will succeed, most will perish.

But their timing may be right. Reuters reports that stock gains turn hedge fund losers into winners:

Last year's hedge fund losers may be turning into winners again.
Several of the largest hedge funds that ended last year deep in the red, jumped to good starts in January, giving their wealthy investors reason to believe savvy traders are getting back their magic touch.
Lee Ainslie's Maverick Capital staged a dramatic rebound, leaping onto the list of top-20 performing funds in January thanks to a 5.89 percent gain in the first weeks of the year. In 2011, he lost 15 percent.
Even John Paulson shared good news with investors when he announced that his Advantage Plus Fund rose 5 percent last month after having been touted as the industry's biggest loser in 2011 with a 52 percent loss. By comparison, the benchmark S&P 500 index rose 4.4 percent in January.
But most prominently, the relatively small Henderson European Absolute Return fund, with about $116 million in assets, currently claims top honors as the year's most profitable fund with a 14 percent gain through late January, HSBC data show.
Last year that fund, known for its manager's contrarian stock picks, ranked second highest on the list of the year's biggest losers with a 42 percent decline.
Fortress Investment Group, one of a handful of publicly traded asset managers, also started 2012 with solid gains after several of its portfolios struggled in 2011.
Its Fortress Macro Fund rose 3.82 percent through January, while the Fortress Asia Macro Fund gained 2.21 percent, according to an SEC regulatory filing Monday. The firm's commodities fund dipped slightly, down 0.43 percent.
One month clearly does not make a year, but for last year's big losers, the January rebound could be a sign their fortunes are changing because the stock markets are doing better and they have made adjustments to their portfolios, investors said.
In fact, much of the $2 trillion hedge fund industry is looking for a revival this year, after funds, on average, posted a 5 percent decline in 2011.
"January can be characterized as having been generally strong across the board," said Paul Zummo, co-head and chief investment officer at JP Morgan Alternative Asset Management.
Similarly, Dan Loeb's Third Point Ultra fund is on the list of winners with a 5.8 percent gain in January after having dipped 2.3 percent last year, and David Tepper who finished 2011 down in the low single digits, turned the corner with a gain in the low single digits in January, people familiar with their numbers said.
While welcome, January's turnaround does not come as much of a surprise for the hedge fund industry considering the stock market's strong start to the year, investors and managers said.
So-called long-short equity funds turned in some of the industry's best returns, with an increase of 2.62 percent in January, analysts at Bank of America Merrill Lynch found. Last year, these types of funds which invest more than a trillion dollars in the stock market, lost about 19 percent.
Adjusting positions helped. After many hedge funds stumbled last year from too many managers chasing the same opportunities, crowding into big stocks like Bank of America, the appetite has shifted this year to small cap stocks, Merrill Lynch analysts said. But at the same time, Bank of America is up 35 percent amid slightly better economic numbers and hopes that Europe's financial crisis can be sorted out.
"Hedge fund managers tend to do better in environments that are not as driven by macroeconomic and politically driven fundamentals," JP Morgan's Zummo said.
Last year's winners are also benefiting from more favorable conditions. Steven A. Cohen's SAC Capital Advisors gained about 2 percent in January after rising 8 percent last year, and Kenneth Griffin's flagship funds at Citadel, climbed 3 percent in January after a 20 percent increase last year.
Not everyone has called an all-clear on the troubles that wrecked last year's returns.
"It is no time to put on our party hats," said one executive at a mid-sized hedge fund who can not be quoted publicly and worried that Greece's debt problems will still make investing tough because many fund managers are exposed to European banks who are in turn exposed to Greece.

My take on all this? I saw it coming last year when I wrote my comment on hedge funds being on the ropes. It's all about beta, not alpha! They all piled into risk assets early in 2012 and they'll keep piling into them hoping to shoot the lights out this year to save their skin and crank up their marketing machine.

Bottom line: With few exceptions, the hedge fund industry is a joke, bunch of momentum driven beta chasers, but the real joke is on pensioners whose contributions enrich these hyped-up money managers.

In the weeks ahead, I am going to use publicly available 13-F filings to show you exactly where "elite" hedge funds (many of which are closed) have been making their money and where they're placing their bets in the stock market (bulk of money still goes to L/S equity hedge funds).

If pensions had half a brain, they'd pull the plug on hedge funds and use the information I provide them on this blog to beat hedgies at their own game at a fraction of the cost.

I'm also very concerned about the concentration of money going to a few well known hedge funds. This is a recipe for disaster because when the next major shock occurs, these mammoth funds could get whacked hard. This is why some of the smarter institutions are going against the current and carefully seeding new hedge funds.

Below, Tony James, president of Blackstone Group LP, talks about criticism of private-equity firms and impact on the industry. James, speaking with Erik Schatzker and Stephanie Ruhle on Bloomberg Television's "InsideTrack," also discusses investment strategy. Blackstone is one of the best alternatives shops in the world, investing in private equity and hedge funds.

A Bridge to Nowhere?

2012-02-07T09:20:00.015-05:00

As Greece's government and international creditors work on the final rescue draft, Andreas Koutras writes, A Bridge (loan) Too Far?:

In September 1944, the allies had a daring plan. They would try to force an entry into Germany by overrunning the bridges of the Maas and Rhine River with airborne forces. If successful, the end of the war would be sped up, possibly to Christmas 1944. Thus the legend of Para Lt Colonel John Frost and the sacrifice at Arnhem was borne. Operation Market Garden as it was named ultimately was a failure. The Hollywood film was not. Incidentally, the film’s title apparently comes from Gen. Browning comment “I think we might be going a bridge too far”.

Moral Hazard

As the maturity of the March 2012 Greek bond nears, the question is still hanging. Would the EU provide a loan to avoid a disorderly default by a European country or would it be simply a bridge loan too far? The PSI started its life in July 2011 and it was barely three months old before it was scrapped for a newer and more severe version in October 2011. Tons of cookies (ammunition) have been consumed in the meeting rooms and possibly a million air-miles have been awarded (Distinguish Service) to the Troika and Greek officials. And yet it seems that we are not nearer in producing a viable solution.

The latest spat is not between the IIF and Greece with regards to the coupon structure of the new Greek bonds but between the Greek politicians who refuse to implement what they have agreed too and Troika. The logic is simple and it involves the moral hazard of reducing ones debt without removing the causes of producing it the debt. It is not a secret that the unscrupulous Greek politicians are mainly responsible for the mess Greece is in.

For decades, many mismanaged public finances for their personal good or re-election prospects. After all, the money flowed from the equally moronic EU with no strings or safeguards attached. So here is the main problem. If the debt of Greece is halved or becomes a minor nuisance while keeping the same policies and politicians in power then the risk of a repeat crisis in a few months from now is great.

The EU is locked into negotiations with a Greek political establishment that regards ignorance, irresponsibility, corruptness, being incompetent and self-centred as a comparative advantage. To deceive is a quality worth defending. It took the EU a couple of years to figure it out and now they are asking for pre-PSI written commitments and legislation by the Greek political parties.

This is a double whammy for the Greek people who have no means of escaping either their politicians or the wrath of the EU policies. Many see the EU money as effectively sustaining the same politicians in power in an analogous way that buying Libyan oil propelled Gaddafi and his regime.

Escrow Account-Bridge Loan

In that respect the latest idea of having an escrow account controlled by the EU that pays only the maturing bonds could be of use. It is clearly much better than the sick and abortion of an idea of a fiscal commissar. How would it work? Simply, the Troika would provide the money with the debt service as a priority. It resurrects the idea of a bridge loan should the PSI talks fail. As it is not called a bridge-loan but an escrow account it also semantically bypasses the Merkel comment of no-bridge-loan.

Would this idea be enough to avoid a Greek disintegration or would it be a bridge-loan too far? My guess is that unless there is political catharsis in Athens nothing would work. In many ways this is what the EU is trying to do in a clumsy sort of way.

Like in Operation Market garden, the EU badly mismanaged the bailout and the reaction of the opposition. Papademos the modern John Frost parachuted in and managed to partially dislodge PM Papandreou. However, it has few troops. Frost at Arnhem Bridge[1] had 740 when 10,000 were promised. The reinforcement never arrived and after it was held for double the predicted time of 4 days he surrendered.

This could be the fate of Papademos too. The main reason is that the Greek people are lost, disappointed and bewildered. Their political parties and system are incapable of making the transition to civilization but are more than capable at surviving the attack. Hope is dying fast in Greece and desperation is taking its place. Greece like Germany in 1944 may have to wait for another year until the regime collapses amid the total destruction. Until then Europe would be throwing good money after bad, or as in Arnhem good men to their death.

[1] The bridge war renamed to John Frost bridge in 1978. Frost published two autobiographies "A Drop Too Many" and "Nearly There".

Hope is dying in Greece. People there realize that no matter what happens, they are screwed for many years. On Greek television this morning, they discussed the insanity of accepting more austerity like a reduction of minimum wage and now Greeks are taking swipes at Germans who want Greeks out of the Euro.

Worse still, Greeks are claiming that Germany made huge profits off the eurozone crisis. I'm not so sure about these Greek claims as even German workers are demanding a raise as their economy teeters on recession.

One thing is for sure, however, Greeks face a difficult decision and are losing hope. Why? Because troika has been myopically (and foolishly) focusing on austerity as the country sinks deeper into an economic abyss. Greeks are fed up with troika, fed up with Germany and France, and most of all, fed up with their incompetent and corrupt political leaders (which they keep electing into office!).

And as I stated in my last comment, now is not the best time for Greek default, but it increasingly looks like that is where we are heading. If not now, sometime in the future. Germany and France have to take a step back and consider their actions more carefully.

Importantly, Greece may be totally insignificant in terms of its economy, but it remains the heart and soul of Europe. Anyone who thinks that the eurozone can survive without Greece is a fool with no sense of history. Once Greece is gone, others will follow, and eurozone will unravel fast.

Speaking of history, Europe's leaders should read Keynes' great work, The Economic Consequences of the Peace. Austerity could once again sow the seeds of extremism in Europe, and that's something we can all do without.

Below, John Taylor, a professor of economics at Stanford University, talks about the U.S. federal budget deficit and fiscal policy. Taylor also discusses Federal Reserve monetary policy and Greece's debt crisis. He speaks with Trish Regan on Bloomberg Television's "Street Smart." On Greece, he says "A walk away would be a default. Nobody wants to do this at this point."

And Eva Kaili, a Greek member of parliament, talks about efforts to complete terms for a 130 billion-euro ($171 billion) rescue package. She speaks from Athens with Maryam Nemazee on Bloomberg Television's "The Pulse." Do not agree with everything she says but she expresses the views of most Greeks who are quickly losing hope.

Now Best Time for Greek Default?

2012-02-06T13:57:00.008-05:00

Jeff Cox of CNBC thinks now is the best time for a Greek default:

As sovereign debt defaults go, there may be no better time than now for Greece.
Global investors are clearly in risk-on mode, with the US stock market off to its best start in 15 years and equities in many emerging markets faring even better.
Friday's job report helped assuage at least one of the primary fears regarding the U.S. economy, even though the housing market remains a shambles-an improving shambles, but still a long ways from healthy.
Last week in general gave life to the recovery theme, with 15 of 23 indicators beating expectations and causing some economists to raise their growth outlook for the full year.
So, with sentiment running so garishly positive, why not go ahead and get that pesky Greek default and all of the accompanying futile denial out of the way already?
"In the last six months, there's probably been no better time to let Greece strategically default than right now," said Citigroup credit analyst Jason Shoup.
Shoup was quick to point out that a Greek debt default is not Citi's "base case," or most likely outcome, but one that needs to be taken seriously if the markets are ever to absorb the magnitude of Greece's problems and come out intact on the other side.
One key reason is that the window could be small for the present enthusiasm to last.
Some economists consider the startling jobs growth-a 243,000 surge in payrolls and an unemployment rate drop to 8.3 percent-unsustainable and as much a product of statistical anomalies as a jump in hiring. Specifically, a revision that saw the workforce drop by 1.2 million and a consistent drop in the labor force participation served as troubling signs.
If the recent uptick in economic indicators is indeed transitory, policy makers may want to consider attacking the Greece situation now while the market can still bear it.
"Letting Greece default either after a (Private Sector Involvement) haircut or in lieu of may have been unthinkable just a few months ago, but it wouldn't surprise us if resistance to such an idea may be weakening in the halls of Brussels and Frankfurt," Shoup said. "Certainly, buoyant markets seem to be emboldening policymakers to take more of a hard line even while Portuguese bonds oscillate."
Indeed, there's the Portugal problem.
It's hardly a secret that Greece will be only the first of several dominos likely to fall in the Eurozone sovereign structure. Several of its neighbors face burgeoning obligations that they cannot meet, and Greece's importance as much as anything is that it will serve as a signpost for how future crises will be handled.
An orderly Greek default in which panic is limited and bondholder haircuts are contained means future defaults may not capsize the markets either. But let the crisis spread and the fallout could be catastrophic.
Bob McKeee, chief economist at Independent Strategy, a London-based research firm, told CNBC that Portugal will be next on the agenda. The nation is far more stable than Greece, which is why the eurozone needs to address its problem children first and then work on more manageable problems.
Concerns over Portuguese debt have come since the nation's 10-year bond rates hit their highest level since the creation of the European Monetary Union. That came after a debt downgrade from Standard & Poor's. In a supposedly solid country with a new government, investor confidence remains a problem.
"We believe this is a sign that, despite the tentative progress made by eurozone leaders on a 'fiscal compact' and increased liquidity support from the (European Central Bank), the eurozone remains in crisis," London-based Capital Economics said in a research note.
News over the weekend that no agreement has been reached in Greece mildly spooked the markets in Monday trading.
The developments show that despite liquidity assurances through the ECB's Long-Term Refinancing Operations, the market wants some closure on how the European crisis will be handled.
Making a decisive move at a time when global markets have stabilized and appear ready to handle shocks, and before other debt obligations in nations such as Italy come to the fore, likely will be just the right medicine.
"While a sovereign debt default in Greece or Portugal might not trigger the end of the euro," Capital wrote in its note, "such an outcome in Italy could very well do just that."

The article is wrong in many respects. First of all, it is true that risk appetite has grown since Q3 2011, mainly because things are improving in the United States and will continue improving for the remainder of the year. Investors better get used to positive economic news coming out of the United States.

Second, and more importantly, even if risk appetite has grown, the global economy remains fragile and vulnerable to any shock. Letting Greece default would be the stupidest thing eurozone leaders can do at this point.

I say this because as I watch Greeks delay bailout talks as Merkel demands action and Merkozy setting up a firewall on Greek debt, I fear that both Greek and eurozone leaders simply do not understand what's at stake if Greece defaults. Time is running out for Greece which is why they have accepted demands by creditors to cut 15,000 jobs in the public sector this year.

But Germany and troika need a reality check too. It's time they recognize there are limits to austerity. Some of the measures they are demanding make no economic sense whatsoever. One professor on Greek television said it best: "They're threatening to light the house on fire so they're asking us to jump out of the window one by one".

Reducing the minimum wage is one measure that makes no sense. And Greek politicians have stop playing the charade with troika on trying to save private sector wages:

Within minutes of PASOK’s George Papandreou, New Democracy’s Antonis Samaras and Popular Orthodox Rally’s (LAOS) Giorgos Karatzaferis completing their make-or-break talks with Prime Minister Lucas Papademos on Sunday night, statements about battles being fought and rights being salvaged were launched into the Athens night.
Samaras and Karatzaferis led the charge of the white knights who claimed to have ridden to the rescue of the embattled Greek citizen. Their argument was that through “tough negotiations” they had saved, or were on the way to saving, the 13th and 14th monthly salaries in the private sector. Papandreou, whose credibility has already been shot to pieces, maintained a lower profile, while Papademos – to his credit – refrained altogether from engaging in this poppycock.
In the more sobering light of a wintry Athens morning and if reports are accurate, claims that red lines were drawn and wages ringfenced are worth no more than claims by card dealers on Adrianou that their games are not rigged.
While the leaders of Greece’s three coalition parties did not agree to the scrapping of 13th and 14th monthly salaries in the private sector, it seems they did accept a substantial reduction to the minimum wage. According to reports, the minimum wage – which currently stands at 751 euros per month (gross) – is to be slashed by 20 to 22 percent.
The first thing to note is that this will lead to the minimum wage dropping to between 585 and 600 euros per month before tax, meaning that someone in work could be earning as little as 470 euros per month after tax. In cities like Athens and Thessaloniki, unless there is a shift in the cost of living, it’s highly questionable whether these will even be subsistence wages.
Beyond that, the reduction would mean that the minimum wage will drop close to the level of the monthly unemployment benefit of 461 euros that Greeks receive for the first year they are out of work. This means unemployment pay will also have to be reduced; otherwise there will be no incentive for those out of work to take jobs on or just above minimum pay. Some reports have suggested it will fall to 369 euros.
Then, there’s the issue of pensions. A downward shift in salary levels means that social security contributions will also decline and there’s little doubt that pension payments will also have to be adjusted to sustainable levels.
However, perhaps we could excuse all this for the sake of snatching those 13th and 14th monthly salaries from the jaws of the troika. The fact they are paid in Easter, summer and Christmas does not make them holiday bonuses: these are about 15 percent of regular private sector salaries. So, surely safeguarding this chunk of Greeks’ wages and therefore preventing further damage to aggregate demand and exacerbating the recession is a true victory?
Here’s the problem, though. Private sector wages are regulated by the national collective contract agreed by labor unions and employers, or by sector-specific deals negotiated in the same way. Apart from the fact that the minimum wage provides the basis for the pay structure in these contracts (if the base drops by 20 percent, it stands to reason that everything else will drop by 20 percent as well), the deals remain in force even after they expire (metenergeia (continued effect) in Greek). So, if employers and unions fail to agree a new contract within six months of the previous one running out, the terms of the expired deal continue to apply.
What the party leaders are about to sign up to – again, if reports are correct – is the substantial reduction of the minimum wage and the abolition of the principle of metenergeia, or nachwirkung as its known in German law. In other words, if employers and unions manage to agree on new collective contracts, the baseline will be 20 percent lower than before, thereby affecting all the wage brackets above it. If the two sides don’t agree on new deals, employers will be free to negotiate individual deals with their employees. The basis for these agreements? The new, 20-percent-reduced, minimum wage.
While some of the political leaders will proclaim their role as saviors of Greeks’ hard-earned crusts by protecting the 13th and 14th salaries, it seems that all they have managed to achieve is swap a 15 percent reduction, which would have occurred if those monthly wages were lost, with a 20 percent one that will come with the slashing of the minimum wage and the terms under which collective contracts apply. Rather than two monthly salaries, Greek private sector workers are set to lose three.
The fact that some people are portraying this as a victory for their negotiating technique means that either they are woefully misinformed or, as is more likely, they are being intentionally duplicitous.
It’s too late for Greeks to do anything about this now. They are bound to pay for quite some time for the mistakes that they and the politicians they elected have made. The only thing they can do is make a mental record of the deception and recall that moment from the memory banks when they walk into voting booths at the next elections.
It was interesting, therefore, that Papandreou and Karatzaferis should both suggest that the term of Papademos’s administration, scheduled to end in April, might be extended even until 2013. After all, who out of the current crop of politicians would want to put themselves before the Greek public in the wake of such a cheap case of misdirection? Denying the public the chance to express its opinion on recent events would really complete the confidence trick.

Having vacationed in Greece numerous times, let me tell you, 400 euros or less a month is poverty, especially in Athens. Some of the austerity measures are stupid and counterproductive.

As Greece nears its latest bailout, markets are yawning, for now. I agree with Aaron below, markets should be very nervous about what's going to happen in Greece and the repercussions. We'll find out soon enough if the market has "completely discounted" a major Greek default. No matter what they announce in Athens, be prepared for a major risk ON or OFF reaction.

Why Are Canadians Whining Over Pensions?

2012-02-06T09:40:00.007-05:00

Bill Curry of the Globe and Mail reports, Ottawa looks abroad for OAS pension solutions:

The Conservative government is looking abroad to find the best way to phase in a higher qualifying age for Old Age Security.
Human Resources Minister Diane Finley argued Sunday that Canada is one of the only countries in the 34-member Organization for Economic Co-operation and Development that isn’t already raising their retirement age.
Ms. Finley was asked directly on CTV’s Question Period whether the government’s plans would see Canadians having to wait until age 67 – rather than the current 65 – in order to qualify for Old Age Security.
“That’s one option. But let’s look at it. It used to be people were expected to have a life expectancy [of] between 68 and 71. Now it’s 81, and they’re still expecting to retire at the same age,” Ms. Finley said. “Almost all of the other countries in the OECD have already moved in this direction. The U.S. started doing this a little close to 20 years ago.”
Ms. Finley, 54, continued the government’s practice of offering hints at the government’s pension reform plans without specifically spelling out when the change would take effect or what it will involve.
“What I’m saying is that in terms of implementing it, we’re not going to tell people that they have to adapt within two years to a dramatically different model. … We’re going to make sure that people my age and younger have time to adjust their retirement plans,” she said.
Alice Wong, the Minister of State for Seniors, told the House of Commons last week that more information on the changes will be in the 2012 budget. The date of the budget has not been announced.
The federal government paid for a research report that summarized what other countries are doing in terms of raising the eligibility age of retirement programs. The October, 2010, report described Canada as an outlier.
“Canada stands out among the OECD countries in not having in place explicit plans to increase the age of eligibility for public pension plan benefits,” states the report, titled Age of Pension Eligibility, Gains in Life Expectancy, and Social Policy, prepared by researchers at McMaster University.
The report includes examples of what other countries are doing:
The U.S. passed legislation in 1983, gradually raising the eligibility age for social benefits by two months each year for five years. The age reached 66 in 2008 and will hit 67 in 2025.
Germany will increase its normal pension age from 65 to 67 between 2012 and 2029
The United Kingdom will raise the age for full pension benefits for women from 60 to 65 by 2020, and the age for both men and women will increase from 65 to 68 over a 22 year period starting in 2024.
Denmark, Finland, Portugal and Sweden have all linked benefits to gains in life expectancy.
The report concludes by recommending that Canada also bring in gradual and modest increases to the eligibility age, predicting it would moderate the inevitable decline in the size of the labour force relative to the size of the retired population. The authors say it would also make it possible to reduce the amount of taxes levied by the government to fund the public retirement income system.
The report’s recommendations are in contrast to another report to Ottawa that found “there is no pressing financial or fiscal need to increase pension ages in the foreseeable future.” That report, by OECD pension expert Edward Whitehouse, noted that a higher pension age could however be used to augment the value of benefits.
If Canada is also planning changes that won’t take effect for years, that may ease some of the heat the government is currently feeling over the issue. However a longer timeline also means the issue could play out during the next federal election campaign, which is expected in 2015.
The opposition NDP and Liberals have been highly critical of the Conservative plans to change OAS since they were first hinted at by Prime Minister Stephen Harper in Davos, Switzerland, during a Jan. 26 speech to the World Economic Forum.

One heavyweight that stepped into this debate is the Bank of Canada's former governor, David Dodge, who hopes Harper steps up on pension reform:

When it comes to pension reform, David Dodge has seen this movie before – twice – but he hopes it ends differently this time.
Prime Minister Stephen Harper has refused to answer repeated questions in the House as to whether he is planning to raise the eligibility age for Old Age Security to 67 from 65, leading opposition parties to howl that he is refusing to come clean.
However, Mr. Dodge – the former governor of the Bank of Canada who was deputy minister at the Finance Department during the deficit-slashing mid-1990s – hopes the government does just that. Moreover, in an interview Friday, Mr. Dodge suggested Mr. Harper should take advantage of his majority government and even raise the age for the Canada Pension Plan, something other governments have shied away from, and which the current Conservatives say is not on the table and not necessary.
“At least since the mid-1980s we’ve known we were going to have to do something,” he said. “We knew that back in ‘97 when we did the revisions of the CPP. At the time the decision was we were doing so much to fix that adding one more layer – i.e. the gradual increasing of the age – was probably too much to bear. So, we didn’t do it, although we certainly talked about it, and the finance minister and officials at the time talked about it and realized we really should do it. But we didn’t because we were doing so much else.”
“So, quite frankly,” he continued, “we’re at least 15 years late in getting started in raising that age of entitlement for CPP, OAS and the normal expectation as to how long people would work in the private sector with private-sector pension plans. That’s absolutely clear, and because labour participation rates will start to fall later this decade, we’re up against the wall. It would have been a lot better if we’d done things in 97, it would have been even better if we had done things in 85 when we first looked at this under the Mulroney government, because you need a long phase-in.”
Leaving the CPP aside, the cost of the OAS program is poised to soar as the baby boom generation retires, which is starting now. Other governments saw this coming, but ultimately backed down from plans to tackle the problem. In particular, when Tory Prime Minister Brian Mulroney partially de-indexed the program from inflation in his 1985 budget, he was famously accosted by then-63-year-old protestor Solange Denis, who fumed “You lied to us.” A week later, Mr. Mulroney reversed the decision, which he called “a mistake.”
Twelve years later, then-Liberal Finance Minister Paul Martin won over Ms. Denis – even to the point of dancing together for the cameras – for his proposed revamp of the OAS in 1996. Mr. Martin planned to replace the OAS and the Guaranteed Income Supplement for low-income seniors with a Seniors Benefit based on family, rather than individual, income. The fury came from others however, and Mr. Martin also backtracked.
Mr. Dodge is warning the Harper government against wasting another opportunity to start the clock on addressing a fiscal problem that everyone has known about for decades.
“There’s nothing, absolutely nothing new here, other than the fact the prime minister spouted off when he was standing among the great and the good over in Davos,” Mr. Dodge said, referring to Mr. Harper’s speech at the World Economic Forum in Switzerland last week, when he indicated he intends to tackle some of these issues.
“This has been in the literature, it’s been well understood for a long period of time. This one is in my mind (a) overdue, and (b) there’s a lot of noise that is pretty stupid, quite frankly – and maybe even politically stupid – coming out and saying, you know, ‘We can’t ever contemplate raising that age.’ All you have to do is remind people that originally it was age 70, and that was when people had a lot shorter life expectancy than they have today.”
Of course, for elected officials there is a big difference between recognizing the gravity of a problem and having the political will to take the actions that top bureaucrats recommend. Mr. Dodge has the battle scars to prove it, having served as Mr. Martin’s deputy. So, does he think the Harper government will break the mould?
“Generally, things that are not necessarily popular are done under majority governments,” Mr. Dodge said. “So I would hope they get on with it and do it.”
And what of the inevitable criticism from opposition parties, which could stalk the government all the way into the next election campaign?
“I would just hope that not everybody on the opposition side of the House is crazy,” he said. “There’s lots of people there that understand full well that there’s a big problem here.”

David Dodge is right, time to get on with pension reform. But it's more pressing than just raising the retirement age. We need a 'radical rethink' of our pension system which I already alluded to when I went over Prime Minister Harper's speech at Davos:

Increase the retirement age to 67 (people are living longer; some economists think we need to raise the retirement age to 70)
Review cost-of-living adjustments (COLAs) and cut when necessary
Scrap all private companies' defined-benefit plans and consolidate them into a few large public defined-benefit (DB) pension funds. Companies should focus on producing goods and services, not managing pensions.
Consolidate all municipal and city pension plans into large public DB plans
Consolidate all Crown corporations DB plans into one large DB plan
Expand CPP to all Canadians and get the funding right
Cap CPPIB and all large public DB plans at a certain size and create new ones as needs arise
Make pensions portable so no matter where people work, their pensions are safe, secure, well managed and will follow them
Last but not least, get the governance right and improve it continuously.

Canadians whining over an increase in retirement age are wrong but so are others who think that this is the only adjustment needed to bolster pensions.

Let me be more blunt: we need to get our collective heads out of our asses, stop fear mongering, stop peddling to interests groups, and start getting on with some serious pension reform which introduces common sense measures and builds on the success of our large defined benefit plans.

I'm tired of watching interests groups from all sides of the political spectrum cry, scream, bitch and whine about pension reform. Wake up already, look what's going on in Europe, especially in Greece where partisan politics has destroyed the country. Having escaped the carnage that has rocked other nations, we've been lucky in Canada, but our good fortune could change at any time and we better be prepared.

Finally, don't be scared of working past 65. Work is good for you, it's healthy. It keeps your mind young and sharp. I see my 80 year old father working 10 hour days as a psychiatrist and he never complains. Admittedly, he's lucky, he's healthy, loves his job, his colleagues, and feels good helping mentally ill patients. Wish more Canadians had his attitude when it comes to work. Below, Canadian politicians doing what they do best, screaming at each other. Absolutely pathetic.

Time Running Out For Greece?

2012-02-05T22:16:00.010-05:00

Congratulations Giants, that was an excellent Super Bowl. Still can't get over that catch! But now my attention is quickly shifting over to Greece where Prime Minister Lucas Papademos announced on Sunday night that agreement had been reached on certain “basic issues” but the talks will spill over to Monday to finalize a deal:

After a five-hour meeting with the leaders of the three parties in his fragile coalition government, Prime Minister Lucas Papademos announced on Sunday night that agreement had been reached on certain “basic issues” -- though the heads of the two smaller parties indicated that they remained opposed to excessive austerity -- and that fresh talks would be held Monday to finalize the details of a second bailout package for Greece.
A written statement issued after the meeting by the premier’s office said that Papademos and the party leaders had agreed to implement measures within 2012 to curb public spending by 1.5 percent of gross domestic product, to secure the viability of auxiliary pensions, to tackle a competitiveness deficit by taking measures which include the reduction of ”wage costs and non-wage costs,” and to recapitalize banks “using a combination of methods that secure the promotion of public interest with the banks’ corporate independence.” The statement, which omitted key details about controversial issues such as proposed cuts to wages in the private sector, concluded that the premier and party leaders would meet again Monday “to finish discussions on the content of the program.”
Earlier, comments by conservative New Democracy leader Antonis Samaras suggested that major sticking points remained. “They are asking for more recession than the country can take,’’ he said, referring to the country’s foreign creditors. “I am fighting against this.’’
The leader of the right-wing Popular Orthodox Rally (LAOS), Giorgos Karatzaferis, also struck an indignant tone, telling reporters that he “will not contribute to the explosion of a revolution due to a wretchedness that will then spread across Europe.’’
In a letter to Papademos, Socialist PASOK party leader and former Premier George Papandreou reiterated his position on the recapitalization of Greek banks, insisting that the new state shares should include voting rights. He also called for the extension of Papademos’s mandate through October 2013 to allow for the implementation of all decisions.
Meanwhile, in central Athens, a few hundred self-styled anarchists and members of left-wing organizations who had gathered in central Syntagma Square Sunday evening for an anti-austerity protest were involved in minor scuffles with police who tried to disperse them. There were no reports of injuries however.
In comments made late on Saturday after talks with foreign envoys, who also met with Papademos earlier Sunday, Finance Minister Evangelos Venizelos gave an indication of just how tough the negotiations had been. “The gap between the successful completion of procedures and a deadlock, which could be accidental or due to a misunderstanding, is very small. We are on the razor’s edge,” he said.
Speaking after a teleconference call with his eurozone peers, Venizelos said the conversation had been “difficult” and that there had been “great concern and great pressure” from creditor states.

Indeed, creditors are fed up with Greeks, stepping up the pressure for austerity:

The pressure from creditor states for Greece to back austerity measures mounted over the weekend, with Jean-Claude Juncker, chairman of Eurogroup of eurozone finance ministers, using some of his harshest language yet, saying that a Greek default could not be ruled out if a deal on the terms of a second bailout is not reached.
“If we should determine that everything is going wrong in Greece, then there would not be a new program, then that would mean that in March a declaration of bankruptcy would occur,” Juncker told German news magazine Der Spiegel. The possibility of bankruptcy should spur Greek politicians into implementing reforms, he added.
In Germany meanwhile, patience with Greece was clearly running out. According to the results of a poll published in mass-selling newspaper Bild am Sonntag, the majority of Germans feel the euro bloc would be better off without debt-wracked Greece. More than half (53 percent) of Germans polled said they thought it would be better for the euro if Greece returned to the drachma. Only 34 percent opposed a Greek eurozone exit. An overwhelming 80 percent said they were against releasing additional rescue funding if measures are not implemented by Greece.
Meanwhile, Jorgos Chatzimarkakis, a German MEP of Greek descent, told Bild that Greece is in need of a new image. Chatzimarkakis proposed that Greece change its name to Hellas and rewrite its constitution as a way of starting afresh. “For many in Europe, the name ‘Greece’ stands for a broken political system, nepotism,” he said, calling for a new political system.
The MEP also argued that the funding Europe is pumping into Greece is going to debt repayment but not tackling the country’s problems. “Greece needs economic growth,” he said. In comments over the weekend Peter Altmaier, the chief whip for German Chancellor Angela Merkel’s Christian Democrats, expressed a different view. The concept of buying growth with government money was adopted in the 2008 and fueled the global debt crisis, Tagesspiegel quoted Altmaier as saying. Such a stimulus plan is no longer feasible as there is no money left to spend, Altmaier is reported to have said.

I don't blame Germans. I'm also fed up of Greek politicians looking to secure loans without implementing reforms and only thinking about how they can win the next elections. I would throw all these leaders in jail for treason. They're a national disgrace.

With time running out, Greece better deliver on reforms or risk sending the country back to the Dark Ages. The party is over, creditors are fed up and so are many Greeks within and outside Greece watching these political leaders trying to score political points. It's time to face the music and accept that Greece is in no position to keep delaying implementing reforms.

Finally, Dimitris Kontogiannis of ekathimerini argues that no matter what happens, official creditors will sooner or later have to proceed with a fresh haircut for Greece:

The likely agreement between Greece and the troika on the terms of the new economic program and the level of private sector involvement (PSI) will significantly raise the cost of a Greek exit from the euro. However, it is likely not to be enough for Greece to avoid another major public debt restructuring down the road.
When this article was being written it was not clear whether Prime Minister Lucas Papademos and the three political leaders would reach an agreement with the representatives of the European Commission, the International Monetary Fund and the European Central Bank -- collectively known as the troika -- on the second economic program.
We have always assumed, however, that the stakes are too high for both sides to fail to reach a fair compromise, and therefore we will proceed on the assumption that there will be an agreement on the terms of the second bailout package and the PSI plan will be implemented.
In this light, we argue that the agreement acts as a barrier against a potential Greek exit from the eurozone because it shifts to a large extent the cost from the private sector to eurozone countries. Therefore, it should put to rest for quite some time talk of Greece’s euro exit in official circles, which was not the case before former Premier George Papandreou came up with the idea of a referendum on the agreement reached at the European Union summit last October.
It is noted that Greek government bonds in private hands accounted for more than 90 percent of total public debt in 2009. At the end of 2011, the percentage is estimated to have fallen to about 56-57 percent as official loans by eurozone countries and the IMF replaced expiring bonds and the ECB amassed some 40 to 60 billion euros of Greek bonds.
Assuming the PSI plan is implemented and participation in it is very high (exceeding 92 percent), the share of Greek bonds in the country’s total public debt is estimated to fall further to below 24 percent. Greek entities such as banks, pension funds and others will end up holding between 6 and 8 percent, with non-residents accounting for less than 16 percent. In other words, the official sector will become the biggest holder of Greek debt.
Readers are reminded that the second bailout package calls for 130 billion euros -- which may be revised higher -- in new loans, of which 89 billion euros should be disbursed in the first quarter of this year. This is in addition to the first financial package equal to 110 billion euros from the EU and the IMF, of which more than 72 billion euros has been disbursed so far.
The cost of letting Greece go down is even bigger if one takes into account the eurozone’s exposure to the country via the ECB’s liquidity operations and emergency assistance, put at more than 100 billion euros.
Moreover, the ECB and eurozone national central banks, which comprise the Eurosystem, are exposed to Greece in another way. This is the case because many eurozone countries have not adopted legislation on sovereign immunity, including protection from pre-judgment attachment of foreign central bank assets, unlike in the US and the UK.
So, central bank assets would not be fully protected and instead would be exposed to litigation risk if Greece were allowed to default. This is an argument in favor of the ECB’s contribution to the reduction of the Greek public debt and a reminder of the legal issues which would arise should Greece and its official creditors not reach an agreement.
Even though the costs of a euro-area exit for Greece will rise significantly following an agreement and subsequently a high participation rate in the PSI, the chances of the country avoiding another major public debt restructuring down the road are real.
By all accounts, the troika is aiming at a Greek public debt to GDP ratio of 120 percent by 2020 to make it sustainable. The IMF appears to have called for additional debt reduction or/and official loans to attain this objective after revising its assumptions to take into account the worsening macroeconomic conditions and more realistic proceeds from privatizations.
Although the new calculations appear to be more pragmatic, we think there is a real risk of Greece falling deeper into the debt trap, despite the expected significant debt relief of some 100 billion euros from the PSI. This is so because the Greek economy appears to have entered a new low-growth phase which the new economic program may protract further by including more austerity measures in the form of higher taxes and few initiatives to boost economic growth.
According to Deputy Finance Minister Professor Yiannis Mourmouras, a member of the conservative New Democracy party, the country implemented austerity measures worth more than 43 billion euros in 2010-11 to have the budget deficit shrink by some 16 billion euros. In reality, the deficit reduction was smaller by some 1-2 billion euros due to one-off expenditures recorded in the budget of 2009, an election year.
All in all, the expected new agreement acts as a barrier against a Greek exit from the euro area but may not be enough to exclude another major restructuring of the Greek public debt down the road.
This time, though, it will involve the holders of Greek debt, namely the country’s official creditors and is likely to take the form of 30-year loan extensions a la Paris Club and Iceland.

Below, Gabriel Stein, a director at Lombard Street Research Ltd., discusses the Chinese economy and the prospect of Greece, Portugal and Italy leaving Europe's monetary union. He speaks with Linzie Janis, Owen Thomas and David Tweed on Bloomberg Television's "Countdown." I too am starting to believe that it's game over for Greece. Its leaders have fumbled the ball once too many times.

Heal The World?

2012-02-05T10:25:00.015-05:00

Millions of people will be watching the Super Bowl today. I'm a die-hard Cowboys fan but will be rooting for the Patriots along with my godson (his favorite team). Madonna has guaranteed no wardrobe malfunction during the halftime show, but the real show will be in Athens where Greece is on a 'razor's edge'.

Market participants will be nervously watching developments out of Athens as the countdown to PSI's paradox has commenced. These days, it seems like the entire world is on a 'razor's edge'. A senior pension fund manager told that the mood at Davos was "decisively somber" and that the Chinese boycotted this year's World Economic Forum because it fell on Chinese New Year.

How stupid! As I wrote last Sunday, Davos was another monumental failure. The word's "power elite" failed to address the most pressing socio-economic problems of our time, namely, youth unemployment, inequality and the retirement crisis looming across the developed world.

I happen to think that most billionaires are completely out of touch. As they jet-set all around the world, working on their next deal, they fail to realize what is going on in the world. There is a cancer in modern day financial capitalism that has yet to be addressed.

Vivek Dehejia, an economics professor at Carleton University in Ottawa, wrote an excellent op-ed column for Hindustan Times, Can capitalism and morality be friends?:

‘Does the free market corrode moral character?’ This is the provocative title of a recent online conversation hosted by the John Templeton Foundation. The lead essay was penned by the economist Jagdish Bhagwati, an ardent advocate in favour of globalisation and free trade.

Bhagwati essentially restates the case made by Adam Smith more than 200 years ago: The free market, far from corroding moral character, enriches it. Smith’s original thesis was that the uncoordinated action of selfish individuals, when given play in the market system, would ultimately lead to the best outcome for society even though each individual is only pursuing his own interest. This occurs by itself as though the actions of individuals are guided by, in Smith’s famous phrase, an ‘invisible hand’.

But Bhagwati doesn’t merely restate Smith’s case; he adds to it. He writes approvingly of the Protestants of Europe and the Jains of Gujarat, who turned profit-making into a virtue by funneling their wealth to good causes such as charity, rather than to ‘conspicuous consumption’. This example, paradoxically, would seem to undermine the thrust of the original Smithian case since it concedes, implicitly, that self-interest must be embedded within a framework of morality for it to have its desired effect.
In a recent blog post for the Financial Times, this wedge in the door is thrust open by American economist and social activist Jeffrey Sachs, who is, ironically, Bhagwati’s colleague at Columbia University. The title of the essay tells us immediately where Sachs is coming from: ‘Self-interest, without morals, leads to capitalism’s self-destruction’. Taking a leaf from John Kenneth Galbraith, American capitalism’s sternest critic from within its fold, Sachs invokes the prospect that self-interest, unalloyed by redeeming moral virtues, will lead to “gluttony”.

Yet Sachs’s case, or Galbraith’s, harks back at its core to the thinking of Karl Marx, who presents a view of the world diametrically opposed to Max Weber. If, for Weber, it is values that create an economic system, Marx turns this argument on its head. In the Marxist vision, it is, rather the economic system that generates the values that support it, with individuals who have imbibed those values often not even conscious of this process, or “falsely conscious” of its opposite. Thus, the Protestant ethic exists to legitimise the process of capitalist accumulation, rather than creating it in any causal sense.

The conflation of these two conflicting ideas has allowed great wealth and great poverty to co-exist in the heartland of Anglo-American capitalism. Even today, some latter-day Christian evangelists will tell their flock that great wealth is a sign that god has looked favourably upon them, and, by implication, poverty is a signal that one must have sinned pretty badly along the way. At its psychological core, it’s not that different from the doctrine of karma, which allows those who believe in it to rationalise one’s success and another’s suffering.

So who is right? Weber or Marx? Bhagwati or Sachs? The truth, as often it does, probably lies somewhere in between. It’s true that markets, when left to themselves, tend to produce greater wealth than any other economic system humans have ever known, and that this wealth may be deployed for the social good. But it’s also true that markets are prone to failure, to capture, and to be preyed upon, and that the very individualistic ethos of capitalism, its Darwinian, winner-take-all mentality, will churn up great inequalities of wealth and income. Income and wealth inequalities in America are more uneven today than at any time since the Great Depression.

And here in India, our embrace of economic liberalisation, however partial it may be for its acolytes, has produced billionaires and fueled an emerging middle class, while it has left many others, who lack the tools to succeed in the cut-throat capitalist world, out in the cold. Just how moral it is for the richest man in India to tower above a shanty dwelling at his feet is, as with so much in this country, in the eye of the beholder.

My biggest fear is that great inequality will lead to desperation and social unrest throughout the world. So, as Madonnna sings and dances during today's Super Bowl halftime show, promising the "greatest show on earth", I think she needs to go back to 1993, and sing Michael Jackson's classic, Heal the World. At a time of great economic uncertainty, the world needs lots of healing. It also needs a prayer and a ray of light. :)

Countdown to PSI’s Paradox?

2012-02-04T10:15:00.029-05:00

Ekathimerini reports that a crucial meeting between Prime Minister Lucas Papademos and the leaders of the three parties supporting his government has been postponed until Sunday:

Finance Minister Evangelos Venizelos, meanwhile, is locked in feverish talks with Greece’s creditors and his eurozone peers.
Papademos is set to meet at 1 p.m. on Sunday, rather than on Saturday, with the presidents of PASOK, George Papandreou, of New Democracy, Antonis Samaras and of Popular Orthodox Rally (LAOS), Giorgos Karatzeferis in an effort to reach a deal on painful reforms that the new bailout contract with the eurozone and the International Monetary Fund will depend on.
The reason for the postponement of the meeting was not immediately clear. A small group of Communist Party (KKE) supporters had been protesting outside Papademos's office in central Athens on Saturday morning but it's not clear whether this affected with the timing of the meeting.
Negotiations with representatives of the IMF, the European Commission and the European Central Bank – known as the troika – are continuing in Athens on Saturday after a lengthy session on Friday with Venizelos having new meetings with key government ministers and the troika throughout Saturday while participating in a decisive Eurogroup teleconference meeting at 2.30 p.m.
The heads of the Institute of International Finance, representing the majority of Greece’s private creditors have also arrived in Athens to conclude a long-delayed agreement on the private sector involvement (PSI) in the Greek debt haircut.

Greek finance minister, Evangelos Venizelos, says crucial issues remain in talks with lenders:

Greece needs to resolve «crucial» issues in talks with foreign lenders to secure a 130-billion-euro bailout, with a long-delayed bond swap now the easier part of the negotiations, the near-bankrupt country's finance minister said.

"After 12 hours of tough negotiations, we have solved many issues but other crucial issues are still open,» Finance Minister Evangelos Venizelos told reporters. «I would say that the PSI (bond swap) is the easier part of the process now."

He said euro zone finance ministers would hold a conference call on Saturday afternoon to discuss Greece ahead of a meeting in person on Wednesday.

Late Saturday evening, after the Eurogroup meeting, Venizos said he sees a thin line between success and deadlock:

“We are on the razor’s edge, the distance separating a successful completion of the negotiations to a deadlock is very small,” said Venizelos referring to talks with the representatives of the European Commission, the European Central Bank and the International Monetary Fund, referred to as the troika.
He added that the government and the troika have agreed on the way that banks will be recapitalized, the course of privatizations and many institutional reforms such as the creation of an effective mechanism that will monitor and eventually suppress the prices that concern the commodities an average household would buy.
What is still on the negotiating table is the labor relations in the private sector and the fiscal measures that need to be taken within 2012.
Venizelos then stressed it is high time all political forces made some binding decisions.

Mr. Venizelos is feeling the heat from his European counterparts, losing patience with Greece:

"There was a very clear message that was conveyed from all participants of the teleconference ... to the Greeks that enough is enough," one euro zone official said. "There is a great sense of frustration that they are dragging their feet.
"They should get their act together and start talking honestly, decisively and speedily with the Troika on the aspects of the programme that remain to be finalised - on fiscal and labour market reforms," the official said.

For its part, Troika is turning up the heat on party leaders:

Greece’s lenders are also asking for a supplementary 2012 budget to be drawn up and passed through Parliament, given that Greece’s economy performed worse than expected last year.
The new budget will have to include about 4 billion euros’ worth of extra measures that were not in the fiscal plan voted through the House in December. Sources said that the troika has made it clear that if this step is not taken, Greece will not receive in March a loan of 89 billion euros, which will be made up of the remainder of its first bailout and the first installment of the new deal.
The troika has already said that it wants the government to focus less on tax hikes and more on spending cuts, so the 4 billion euros in savings is likely to come from a reduction in expenditure on defense, municipalities and drugs. Health Minister Andreas Loverdos said this week that a ceiling of 2.9 billion euros would be set for public spending on medicines.
The EC, ECB and IMF have also asked for savings on public sector wages by introducing a new salary structure for doctors, military personnel and judges from this year.
All of these issues, as well as the controversial topic of lowering the minimum wage and cutting private sector salaries, will be tabled at Papademos’s meeting with the party leaders.
Sources said the prime minister is determined to reach some kind of conclusion at the end of the meeting. If the party leaders fail to agree, Papademos will ask them to allow him to negotiate with the troika or to include Papandreou, Samaras and Karatzaferis in such talks. Government spokesman Pantelis Kapsis ruled out the possibility of Papademos resigning.

The most contentious issue remains cuts in private sector wages. Troika is insisting on changing private labor terms:

Greece’s official creditors remain will not give in on their demand for changes and wage cuts to the labor status in the private sector, Skai radio said on Saturday afternoon citing an unnamed government official, as talks about the new loan contract continue in Athens.

For those of you who do not understand, let me explain. Unlike the rest of the world where wage contracts are based on 12 months of the year, Greek workers have a 13th and 14th salary typically given at Christmas and Easter. Why in God's name did they ever introduce this? Probably because some Greek politicians wanted to buy more votes.

Regardless, Greeks working in the private sector are in no mood to give up an inch of their wages and understandably so. With the economy going through the wringer, unemployment skyrocketing, food and energy prices soaring, they have already experienced cuts in their wages and pension benefits.

Worse still, they're being taxed more to support an over-bloated public sector. Many Greeks working in the private sector are frustrated at the slow pace of cuts in public sector.

Things are bad in Greece. In a scene reminiscent of the Irish potato famine, farmers in Thessaloniki distributed more than 10 tons of potatoes which were snapped up quickly from people falling on hard times.

Moreover, you know things are bad when the Greek government insists that the issue of war reparations remains unresolved:

The government on Friday insisted that the issue of German World War II reparations to Greece remained unresolved despite the International Court of Justice in The Hague rebuffing a Greek reparation claim for atrocities committed by Nazi troops in the village of Distomo, central Greece.
“The issue of German reparations remains open,” the Foreign Ministry said in a statement. The Hague’s decision on Friday, the ministry said, does not prevent Greece from seeking reparations from Germany.
In November 2008, a court in Florence ruled that the families of the 218 men and women killed by Nazi troops in the village of Distomo should be awarded a villa in Menaggio, near Lake Como, which is owned by a German state nonprofit organization, by way of restitution.
Germany successfully appealed against the Italian ruling.
The 15-judge court said in its 12-3 ruling on Friday that the Italian case violated Germany’s longstanding immunity from being sued in national courts.
The ministry noted that the decision does not influence “the international responsibility and resulting obligation of a country to provide compensation where it is due.” The ruling also clarified that such issues could be resolved at the bilateral level, the ministry added. “In this way the court confirmed that these issues have not been resolved,” the ministry said, adding that the government would study the decision carefully.
A spokesman for conservative New Democracy, Yiannis Michelakis, was more outspoken in his assessment of the ruling, which, he said, “does not affect the issue of war reparations,” adding however that “it is not aligned with European values nor with the sense of justice of the Greek people and the people of Europe in general.”
Earlier this week a group of 28 MPs from ND, socialist PASOK and the Coalition of the Radical Left (SYRIZA) called for the issue of war reparations to be debated in Parliament.

Although it sounds like they're grasping at straws, Greece has a legitimate case for war reparations, but that remains a long process which could take years to resolve.

Right now Greece and its creditors have to focus their attention on finalizing debt talks. On this, Andreas Koutras reports on the countdown to PSI's paradox:

The Greek FM Mr Venizelos announced that the PSI talks are close to completion.

This is not the first time. On numerous occasions a PSI deal was announced as imminent. This reminds me of Zeno’s Paradox. Every day we run half the distance to the PSI completion, but we never get there. There is however a deadline that many see as immovable, the 20^th March 2012. This is the date that the GGB4.3% needs to be repaid, all 14.4billion of it.

Working backwards from that date, we have the following tentative schedule:

· Around one week may be needed to administer and settle the new Greek PSI Bonds. Even this may be optimistic. Also the funds need to be disbursed by the EZ.

· Once the PSI is finalised, there should be at least two weeks for the offer and to gather up any interest.

So, assuming everything goes to plan and participation is very high, the PSI would need to be in place by the end of February (Friday 24^th of February).

If on the other hand, it does not go according to plan and participation is low, then a decision needs to be taken on whether to introduce and activate CAC’s. Greece could in principle pass the law any time in the next 7 days or by the 10^th of February (Friday).

But activating the CAC also requires a meeting of the bondholders with the necessary majority. This may actually take another week. So, if there is a need for coercive restructuring the PSI must at least be done before the 17^th February.

In the case of a coercive restructuring followed by a credit event, the EZ must have in place contingency plans for possible contagion. The next 3Y LTRO is on the 29^th February (Leap year) and it may fall right in the middle of the PSI messy offer.

Timing wise, this is a rather restrictive schedule as it leaves very little room for errors or unforeseen events. Markets should be prepared for a rough ride in the next few weeks.

I believe markets should be prepared for a negative or positive surprise. Anything can happen between now and March 20th. Longer term, Greece has to reform itself, and Germany and Europe can and should help.

Greece should also be looking to build on its alliance with Israel and learn from its success in boosting productivity. In fact, Canada may copy some of Israel's policies on funding high-tech startups and turning research ideas into businesses as it seeks to revive the country's weak performance in business innovation and productivity.

Let me end by stating that I'm optimistic that we will get passed this Greek and European 'debt crisis' and start focusing on the real crisis threatening our global economy -- lack of jobs and growth.

Policymakers are deluding themselves if they think austerity alone will free us from another debt crisis. Quite the opposite, austerity is padding the banksters pockets, ensuring debt slavery and a "generation of depression". Below, euronews reports on the latest events. Also embedded a recent Michael Hudson interviews with Lauren Lyster and Max Keiser and the latest Farage 'barrage', railing against EU policies in Greece (another classic).

All is Changing, All is Frightening?

2012-02-03T14:48:00.010-05:00

Nikos Konstandaras of ekathimerini reports, All is changing, all is frightening:

One of the reasons for the impasse in Greece is the clash between two opposite, irreconcilable forces: On one side are those who insist on administering dangerous medicine to Greece’s weakened body, on the other are those who will accept no treatment. Even as both conspire toward the worst possible result, they accuse each other of the crime and persist with their methods. Caught in the middle of this “ideological” battle, the citizens have no convictions, they have no hope.
Uncertainty is worsened by our politicians’ either being terrified of what they must do or excited by the prospect of elections. They know that all is changing, that hitherto dominant forces will be swept away while others -- mainly leftist parties -- which were marginal, will pick up a heavy burden in a difficult climate. Citizens are continually exposed to conflicting arguments. Neither international organizations, nor our partners’ governments, nor our own politicians have persuaded them that we are following the right policy.
There is no synthesis of ideas, no vision, an idea that will unite and inspire the nation. Lucas Papademos’s government gave our politicians a way out, allowing them to share responsibility for difficult decisions, but the continued prospect of elections, the infighting by government members and the left’s unmitigated hostility do not permit any sense of security.
The consequences of strategic mistakes and political paralysis are worsened by the sloppiness of our state -- a sloppiness that betrays the great indifference that our politicians and state officials showed the citizens over many years. Before the crisis, this indifference was papered over by excessive spending, by the “generosity” of a disorganized country. Today we see all the weaknesses in their full glory: Back taxes and pay cuts result in empty pay packets, electricity production is uncertain, prisons are overflowing, the health and pension systems are depriving citizens at precisely the time that they need them most, the country’s finances depend not on our partners’ solidarity but on their fear of our collapse, the recession is deepening, and state and individual incomes are down while expenses are rocketing.
The next few days will be decisive with regard to our debt reduction, the new loan agreement with its difficult terms, with the continued “internal devaluation.” All is changing, all is frightening. Because we do not believe that the war is about victory, but about limiting our defeat.

The next few days are critical. Prime Minister Lucas Papademos is preparing for a make or break meeting with Greek political leaders amid unconfirmed reports that he is considering resigning if the three parties in his coalition government cannot agree on the set of reforms Greece should adopt so it can qualify for more loans.

It saddens me watching this beautiful country I love so dearly going through economic hardship. Greece's bankrupt politicians make me sick but the truth is you can't impose more austerity on Greeks to pay off the bankers and bondholders. Nobody in Greece wants to go back to the drachma, but they don't want to become debt slaves for the rest of their lives either.

I was listening to a panel on Greek television this morning lament "forced wage cuts in the private sector" and demanding "war reparations from Germany." Unfortunately for them, they were rebuffed by the Hague Court of Justice.

Some Greeks are openly voicing their concerns that they're being targeted so politicians elsewhere can use them to instill fear among their citizens, showing them what happens when you don't bow to IMF/ troika demands. As one lady on television rightfully noted: "How are cuts in wages going to stimulate growth which we desperately need?"

It's all distressing and hopeless, wearing down Greeks who are sick and tired of EU summits and Greek political drama. And amid all this, 'Anonymous' hacked into the Greek Justice Ministry site:

The Greek Justice Ministry's website was out of order on Friday morning after being attacked by a group of international hackers sending an anti-austerity message to the Greek government. Known as 'Anonymous,' the group has in the past hit the American Justice Department and the FBI, among other state agencies.
The video sent by the group featured a person whose face was covered by a mask similar to the one featured in the «V for Vendetta» comic book series and film, in which the mysterious protagonist works to destroy a totalitarian regime.
"What is going on in your country is unacceptable,» the masked figure read from a piece of paper. «You were chosen by your people to act on behalf of them and express their wishes. But you have derogatorily failed. You have killed the most sacred element your country had, and that is democracy."
The group also warned that by signing the controversial Anti-Counterfeiting Trade Agreement (ACTA) on intellectual property rights, the government was pushing the Greek people «one step further toward oppression,» adding, «We are anonymous. We are legion. We do not forgive. We do not forget."

Below, watch the message Anonymous posted on the Greek Justice Ministry site. Kind of eery but their message resonates with many Greeks who are sick and tired of being bullied by the IMF and troika into accepting more austerity.

Stay tuned, while millions will be watching the Super Bowl this Sunday, the real war will be fought in Athens -- the war for the heart and soul of Greece and her proud citizens.

Hidden Burden of Ultra-Low Interest Rates?

2012-02-03T09:47:00.005-05:00

Matthew Philips and Dakin Campbell of Bloomberg report, Banks Join Pensions in Squeeze as Federal Reserve’s Low Rates Erode Profit:

The Federal Reserve, which cut its target for the federal funds rate to a zero-to-0.25 percent range on Dec. 16, 2008, said last month that rates would remain “exceptionally low” at least through late 2014. While the unprecedented period of near-zero rates is meant to aid an ailing economy, it poses challenges for banks, insurers, pension funds, and savers.

The hope is that by making mortgages and other loans cheaper, ultra-low rates eventually may revive economic growth, Bloomberg Businessweek reports in its Feb. 6 issue. For now they’re squeezing profits at banks and disrupting investment strategies at insurance companies and pension funds. They’ve reduced payouts on savings accounts and bonds, and may lead to higher bank fees and insurance premiums.

“For most people, there’s been more downside to these low rates than upside,” says Barry Ritholtz, chief executive officer of FusionIQ, a New York-based investment research firm. “They’ve punished savers and people living on fixed income, and made insurance more expensive.”

For banks, low rates provided a boost at first because they could borrow money cheaply and reduce rates paid to depositors while still collecting interest on existing loans made at higher rates.

As old loans matured, banks had to make new loans at lower rates, cutting into profit. At JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup Inc. (C) and Wells Fargo & Co. (WFC), the four largest U.S. banks by assets, net interest margins -- the difference between what they pay to borrow and what they earn on loans -- dropped to 2.99 percent in the fourth quarter from 3.17 percent a year earlier.
‘Margin Compression’

“There’s no best way to counteract net interest margin compression,” says Betsy Graseck, a Morgan Stanley (MS) analyst. “You need to have several different strategies.”

Many banks have announced cost-cutting plans, including layoffs and lower compensation. Jason Goldberg, a Barclays Capital analyst, says larger banks are increasing fees on deposit accounts and slashing debit-card rewards programs.

“There are certainly a lot of levers they are pulling,” Goldberg says. “That said, it’s a big challenge. For a lot of these banks the majority of their profits comes from net interest income.”

Low rates also present a special challenge to insurers, which need safe, predictable investment returns to pay claims. About 64 percent of the property and casualty insurance industry’s portfolio is in high-grade corporate bonds. The average yield on investment-grade corporate bonds has fallen to 4.3 percent, from 6.2 percent in July 2007, according to data compiled by Bloomberg.
Insurance Losses

Insurers suffered $32.6 billion in losses from January through September 2011 in the wake of natural disasters including Hurricane Irene and tornadoes in the Midwest. To make sure they have cash available, insurers have begun moving some of their money into shorter-term bonds, says Steven N. Weisbart, chief economist at the Insurance Information Institute. Since shorter-term bonds have lower yields, that shift leads to a further squeeze on investment income.

Data through the third quarter indicates that industry profits were down 60 percent from the same period in 2010. Weisbart says that to make up for lost investment revenue some insurers may begin tightening underwriting standards and raising premiums.

Like insurers, pension funds have long counted on bonds to help them meet future obligations. After four years of low rates, and a decade of flat performance in the stock market, corporate pension funds face record shortfalls. A January report by Credit Suisse Group AG estimated that 97 percent of companies in the Standard & Poor’s 500 have underfunded pension plans.
‘Dispiriting Year’

The combined deficit at the 100 largest defined-benefit plans increased by $236.4 billion last year, according to an annual pension study by Milliman Inc., a Seattle-based actuarial and consulting firm.

“This was an unusually dispiriting year,” wrote John W. Ehrhardt, a co-author of the report. Depressed interest rates were responsible for 90 percent of the funding shortfall accrued since the middle of 2011, Ehrhardt says. “It’s all about having to cope with low rates right now.”

To address the shortfalls, companies have been making record levels of cash contributions to their pension funds over the past year. Boeing Co. (BA) recently announced that it would contribute $1.5 billion to its pension plan in 2012.

Traditionally, pension funds followed a simple allocation rule of thumb, investing 60 percent of their money in stocks and 40 percent in bonds, according to Ehrhardt.
‘More Sophisticated’

“That was the answer for many years,’” he says. “Things have gotten much more sophisticated.”

The biggest change over the past decade has been the position pension funds have begun taking in alternative investments. Between 2006 and 2010 they doubled their exposure to riskier investments -- including real estate, private equity, and hedge funds -- to 20 percent, according to Milliman.

Lately, pension funds have been trying to boost yields by buying bonds with longer maturities. By lengthening the average maturity of their bond portfolios by about six to eight years, funds have been able to get about two percentage points of extra yield, says Ari Jacobs, a pension specialist at consulting firm Aon Hewitt. That strategy carries its own dangers: When interest rates rise, the value of existing bonds falls--and longer- maturity bonds drop more than shorter-maturity ones.

“The traditional tools to manage a portfolio, like time horizon and diversification, have been thrown out the window,” says Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago. “All the lessons my generation has learned over our lifetime have been seriously called into question these last few years.”

Indeed, the 'traditional tools' to manage a portfolio, like time horizon and diversification, are not working as well as the past precisely because in an ultra-low interest rate environment, all asset classes are highly correlated.

The only real refuge from a shock in such an environment is government bonds. The article above blames the Fed for ultra-low rates but the reality is that the bond market still fears debt deflation, which is why rates remain at historic low levels. It's not just 'QE', there remains a deep fear that the world is slipping into a debt-deflationary spiral.

How should pensions adapt in such an environment? Go back to read my comment on ATP, the world's best pension/ hedge fund. I added insights from Jim Keohane, President and CEO of the Healthcare of Ontario Pension Plan (HOOPP), the best pension plan in North America. Read his comments carefully. The folks at HOOPP and ATP get it.

What else will help pensions? The macro environment. This morning's strong jobs report out of the U.S. crushed expectations. Stocks rallied and bond yields jumped on the news. While this is good for pensions, it won't make enough of a difference to shore up severely underfunded pension plans.

Importantly, you need a significant jump in real yields and a huge boost in stocks and other risk assets to help close the huge deficits pensions have experienced in the last few years. But even that won't be enough. We still need serious pension reform and a better approach to managing assets and liabilities at pension plans.

And don't cry for banks, they always find ways to profit off money for nothing and risk for free. In an ultra-low interest rate environment, the name of the game remains trading, and the big banks are going to continue pushing hard on trading revenue from their capital markets operations. Fees from underwriting, IPOs and merger arb will also add to banks' bottom line.

But what about savers, workers and many others trying to survive these volatile markets? They're getting crushed because most of them do not enjoy the benefits of a defined-benefit pension plan. That is the real tragedy of our time, one that needs to be addressed by courageous politicians willing to make the case for boosting DB plans.

Finally, Fed Chairman Ben Bernanke says he won’t tolerate inflation to boost jobs, but I can assure you he's doing everything in his power to counteract restrictive fiscal policy, reflate risk assets and stoke inflationary expectations. When it comes to deflation or inflation, the Fed prefers to err on the side of the latter, and so do pensions and financial institutions.

Below, Bloomberg excerpts from Bernanke's testimony before the House Budget Committee on the U.S. economy, budget deficit and Fed monetary policy. Bernanke says the economy has shown signs of improvement while remaining vulnerable to shocks. Barring a collapse in Europe, the U.S. economy will continue to surprise to the upside for the remainder of the year.

World's Best Hedge Fund Actually a Pension?

2012-02-02T14:30:00.022-05:00

Mark Cobley of Financial News reports, Danish pension fund makes record 26% return:

ATP, the €78bn Danish national pension fund, recorded its best ever financial return in 2011, despite the markets stalling in the second half of the year.
It made an overall return on assets of 26% - that amounts to Dkr125bn, or €16.8bn, it said this morning.

This impressive looking result was mostly due to a hedging strategy, which enabled it to keep ahead of substantial growth in its financial liabilities resulting from low interest rates. But ATP also took further risk-reducing steps in the middle of 2011, selling off assets such as equities, credit and commodities, which helped protect the fund against falling markets.

Lars Rohde, ATP's chief investment officer, told Financial News today: "We are currently using only a small fraction of our available 'risk budget', so we may increase our allocations to these return-seeking assets this year. But we still think we are in for a rollercoaster ride in the markets, so we will be very cautious."

Pension funds' liabilities, or the total value of all the pensions they have promised to pay, are calculated using expectations of what interest rates will be in the coming decades. These expectations are indicated through the real-time market for long-dated bonds, or prices in the related swap markets.

These markets have been dramatically affected by the ongoing eurozone crisis. Central banks have set rates low in an attempt to stimulate growth through policies such as quantitative easing - bond-buying - and investors have flocked to government bonds considered low-risk, such as UK gilts, German bunds or indeed Danish government bonds.

As a result of all these factors, ATP said its liabilities increased by €16bn during 2011 - almost as much as its assets grew. Around €14bn of this was due to falling interest rates while another €2bn was the result of a tax bill.

ATP's hedging strategy, which aims to insulate the fund's exposure to Danish interest rates, mostly through swaps, did what it was intended to last year - though not 100% perfectly. It covered the fund against most of the liability increase, but recorded a small €1.5bn loss.

This was mainly down to a technical issue, explained Rohde: "Basically, there aren't enough Danish swaps for us to buy. The vast majority of our hedging activity is therefore done with Danish government bonds, German bonds and euro swaps. This means we are at risk from any differential between Danish interest rates and German rates."

This is what happened last year when Danish rates fell below German rates, he said.

However, this hedging loss was more than offset by income from other areas. ATP's bond portfolio has been overhauled as a result of the eurozone crisis, and now consists almost exclusively of Danish and German government bonds.

The fund's equity investments made a loss, but bonds, property and commodties were all positive, and overall the fund made a "profit" over its liabilities of about €500m during the year.

Last year, ATP also set up its first international subsidiary, Now Pensions, to offer savings and investment services to UK employers. From October, all UK companies will be obliged by law to offer workers a pension over the next few years, and ATP hopes many of them will chose its service.

In December, it set up a new FSA-registered investment company in London, NOW Pensions Investment A/S, which will tap expertise from ATP's fund managers and investment officers in Denmark.

ATP's stellar results prompted aiCIO to ask an excellent question, Was 2011's Most Successful Hedge Fund Actually a Pension?:

Where would you find one of the largest and most sophisticated hedge funds on the planet? One that made an investment return of over 20% in the tumultuous markets of 2011. New York? London? Hong Kong?
Hillerød, a small city of 30,000 people some 30 minutes north of Copenhagen, would not spring instantly to most people’s mind.

Most people, however, have not heard of ATP, the Danish fund manager that looks after the assets of the country’s public pension system.
Over the last, chaotic 12 months, through a complex system of hedges, levers and ‘risk buckets’, Chief Executive Lars Rohde and his team have steered some DKK778 billion – around €104 billion - through the headwinds of the Eurozone crisis and beyond.

Rohde has been at the helm of ATP since 1998 and has overseen much of its transformation into an alpha-seeking, risk managing, public sector quasi-hedge fund.

Good humoured, happy to chat with typical Scandinavian perfect English, Rodhe is not afraid to speak his mind.

In 2008 he told me that the European pensions industry needed something like the potential game-changing regulation Solvency II, which was initially formulated for insurance companies, to get them thinking about funding and liability matching.

At the time, he was a lone voice. This does not seem to have changed.

Fast forward four years or so, and Rohde still stands out from the crowd. The strategy ATP runs is more like that of a hedge fund than a pension plan. The portfolio is divided between return-seeking assets and a collection of hedges designed to protect the scheme in all economic weathers.

Last year the investment portfolio made a 20% return. The aggregate hedge fund return over 2011 was a negative 4.9%, according to hedgefund.net.

When I spoke to him about these results published this week, Rohde, in typically understated tones said: “Yes, I suppose we had quite a good year.”

ATP’s results bear out the long-term success of its risk-aware approach. In 2005, it made an investment return of just over 6%, in 2006 around 4.2%, and in 2007, 2%. A 6% loss in 2008 was followed up by a return of 4.3% in 2009 and 6.8% in 2010.

All this time the hedging portfolio has managed to maintain, if not improve, the already 100%+ coverage ratio of its liabilities.

Out of habit, I ask him about what asset classes worked well in 2011? He laughs and says: “Liz, you know it’s not about the asset classes, but the risk allocation…”

The investment portfolio has five ‘buckets’ which are invested according to a risk budget, rather than a propensity for a certain asset class.

I ask him why so few others take this ‘risk allocation’ approach, at least in pension investing.

“I’ve been wondering that too for many years,” he says, laughing.

“Maybe it’s a case of bad habits, maybe peer pressure. As John Maynard Keynes said: ‘It’s better to fail conventionally than to succeed unconventionally’. As long as people are being seen as doing what they are meant to be doing, for some of them that’s the correct behaviour.

“As they used to say: ‘no one gets fired for hiring IBM’.”

Over the past decade Rohde and his team of experts have built up what he calls a ‘unique business model’.

“We have not kept it a secret – we have been very clear that half of it is like liability-driven investment (this is a concept most people understand) and the other is based on absolute return-seeking assets to build up better pensions.”

And longevity, the risk that terrifies most pension scheme investors, how does ATP hedge it?

“We don’t.”

I should have known it was too conventional an idea. Instead, ATP keeps a portfolio of DKK18 billion which it manages to keep up with the increasing longevity of the OECD countries.

“Maybe the ATP model is too complex for the rest of us to understand?” I venture. I speak from experience, having spoken with Rohde at least annually for the past five years on ATP’s structure and visited Hillerød for a private tutorial - I am still less than 100% sure how his ‘risk buckets’ work, but would not mind being a Danish citizen in my old age.

Again, he laughs and says that I will soon be able to benefit from this expertise in the UK.

ATP announced last year that it would be going head-to-head with the UK government-backed National Employment Savings Trust, the pension scheme set up for workers without occupational pension provision.

“With the concept of auto-enrolment, it is an outstanding opportunity for outsiders to get a share of the UK market,” he says.

“We are bringing a proven concept of pension provision that is transparent, forward-looking and is a lifelong product.”

ATP had bid to work with NEST as administrator to the scheme, but pulled out before the winner was decided citing too many uncertainties over the timing of implementation and the size of the scheme.

Now, as auto-enrolment continues to be pushed back by the government, does that make the UK market less attractive?

“Not knowing what the timeframe is does add some risk going forward, but we are sure we will stay and go for it. Britain needs auto-enrolment – companies can no longer afford defined benefit schemes and people need to build up pensions.”

So what’s next for Rohde and ATP?

“All the time we are trying to enhance our understanding of investment models, adding new asset classes and improving our risk management – our core business model is based on risk.”

So more of the same for Denmark’s largest hedge fund – I wonder if the UK is ready for it.

Tell you one thing, while the media is praising Canadian public pensions funds, the best pension fund in the world is being run out of a small city just north of Copenhagen. ATP is obviously doing something right. Wish they came to offer their services in Canada and the United States.

I don't see them getting eaten alive by hedge fund fees. In fact, they can teach hedge funds a thing or two about hedging, dynamic asset allocation and risk budgeting. And unlike hedge funds, ATP is not charging 2 & 20 to manage assets, which means they won't be competing with hedge fund managers outspending bankers on London homes (meanwhile where are the customers' yachts?)

Interestingly, while North America's largest pension funds are delivering paltry returns, waiting 52 years to achieve fully funded status, following endowment funds still betting on hedge funds and struggling to recover from the 2008 crisis, this Danish super fund is humming along nicely, delivering outstanding results and remaining fully solvent.

I love it for several reasons. First and foremost, it proves that large, well-run public defined-benefit plans can deliver outstanding results even in the hardest, most punishing years. It also shows you that the world's best fund is not charging 2 & 20, not following the pension herd paying 2 & 20 for hedge funds, and knows how to dynamically allocate risk to add alpha where it ultimately counts -- on overall fund returns!

Jim Keohane, President and CEO of the Healthcare of Ontario Pension Plan (HOOPP), the closest thing to ATP this side of the Atlantic, shared these comments with me:

I would agree with you that ATP is one of the best run pension organizations in the world. We have spent a lot of time studying how they run their fund and have learned a lot from them. ATP is very open about how they manage their money and have been quite willing to share information with us.
Our liability stream is quite different from theirs so our investment portfolio is not exactly like ATP, but we have adopted many of the ideas that they originated. We have divided our portfolio into a liability hedging portfolio, and a return seeking portfolio following ATP’s approach and we have moved to a risk based approach to asset allocation which is again an idea that we can trace back to meetings with ATP.
Many funds talk about using a liability driven approach but very few have implemented it as successfully as ATP. Their excellent results in 2011 are largely driven by their LDI approach and when you see more funds report their 2011 results it will be quite evident which funds are liability hedged and which ones aren’t!

Jim added:

I watched the CNBC interview with Lars that you posted which points out another similarity between our funds is that if you look at our return seeking portfolio it looks like a multi-strategy hedge fund managed internally. Our rational for this approach is exactly the same as the reasons Lars cited in the interview.
I would echo his comments on the cost structure and the poor risk distribution between hedge fund manager and client and I would agree that we can control the risk much more effectively when these strategies are managed internally. I would also point out that we have structural advantages (such as a large balance sheet, we are highly credit worthy and we are not taxable) that allow us to pursue a number of low risk strategies that hedge funds could not undertake.

Our results won’t be released until April and they won’t match the spectacular results of ATP but they will be solid positive results. When gauging the success of a pension organization it is important to focus in on the correct metric which is surplus. Our objective is to make sure that our assets grow faster than our liabilities (which is ATP’s objective as well).
On this metric we were successful in 2011 in that our surplus remained constant. Because of the significant decline in long term interest the present value of liabilities grew significantly in 2011. Most funds will post a small positive result in 2011, but will have lost significant ground in their funded status due to the large growth in liabilities.

The best returns in 2011 were in long bonds, real return bonds, real estate and private equity. These are all asset classes which are employed heavily in an LDI portfolio. That is why I believe that funds employing LDI will differentiate themselves in 2011.

Below, a February 2010 CNBC interview where Lars Rohde, CEO of ATP, discusses why he decided to invest $1 billion into a series of in-house hedge funds instead of investing in existing ones. Listen carefully to his comments on why he took this decision and how they use swap overlays to hedge their portfolio.

Finally, on risk, it seems that not all hedge funds are bracing for disaster. Below, Michael Novogratz, principal and director of Fortress Investment Group LLC, talks about investment strategy and Facebook Inc.'s initial public offering. Novogratz, speaks with Erik Schatzker and Stephanie Ruhle on Bloomberg Television’s “InsideTrack," also talks about global market performance, central bank monetary policy and hedge funds taking on more risk. Guess some hedgies have been diligently reading Pension Pulse! -:)

CPPIB's David Denison Down Under?

2012-02-02T08:18:00.016-05:00

Nichola Saminather of Bloomberg reports, Canada Pension to Grow Australia Investments for Higher Returns:

The Canada Pension Plan Investment Board, which manages about C$155 billion ($155 billion), plans to increase its longer-dated investments in Australia to boost returns, Chief Executive Officer David Denison said.

“We would like to grow CPPIB’s presence here,” Denison told the Canadian Australian Chamber of Commerce in Sydney today, according to an e-mailed copy of his speech. “Long duration infrastructure assets are highly attractive investments for us because we manage a portfolio that spans multiple generations.”

The pension fund is no stranger to Australia, with more than half of its C$10 billion allocated to Asia-Pacific region invested in the country, he said. It has partnered with the Australian Future Fund and with real estate companies including Westfield Group, Goodman Group and Dexus Property Group, and has been a shareholder of some of the nation’s biggest companies including BHP Billiton Ltd., Commonwealth Bank of Australia and Newcrest Mining Ltd.

The fund, forecast to double to more than C$300 billion within the next decade and to more than CS$500 billion by 2031, is looking oversees as it seeks to ensure future cash flows, Denison said. Australia’s commodities and connections to fast- growing Asian markets, tax policies and promotion of private ownership of infrastructure make it an attractive destination, he added.

The fund remains concerned about the openness of Australia and other countries to foreign ownership of their assets, Denison said, citing the government’s rejection of a proposed merger between the Australian stock exchange and its Singaporean counterpart.

He also expressed concern that more investors, particularly pension plans and life insurance companies, are shortening their investment horizons, doing away with their ability to provide more sustainable funding for longer-term projects.

Indeed, the Globe and Mail reports that Denison sees protectionism as a rising threat:

Protectionism is increasingly standing in the way of investors, warns CPP Investment Board chief executive officer David Denison, who also suggests Ottawa clarify Canada’s takeover rules.

The comments by Mr. Denison, who oversees the management of $152-billion that will be used to pay retirement benefits to 18 million Canadians, were made in the text remarks to a business audience in Sydney, Australia, Thursday. He said that many governments are blocking deals “at a time when the world arguably most needs to accelerate trade, capital flows and economic activity to stimulate growth.”
European antitrust officials blocked a proposed merger between the Deutsche Boerse and the NYSE Wednesday, and Mr. Denison cited Canada’s decision to reject BHP Billiton’s bid for Potash Corp. and Australia’s rejection of a merger between Australia and Singapore’s stock exchanges, as recent examples of the growing influence of protectionism. He urged policy makers “to create transparent processes and decision criteria so that there is more predictability of outcomes for investors and corporations.

“I can certainly say that the presence of opaque policy criteria and decision-making processes absolutely influences where we at CPPIB – and we believe other investors and companies as well – direct their efforts,” he added.

Those comments suggest that Ottawa’s decision not to clarify the Investment Canada Act could cause foreign investors to back away from deals here.

The Globe and Mail recently reported that the Harper government appears to have dropped plans to clarify the rules for foreign takeovers, a source of frustration for Bay Street advisors and potential investors who are unsure how Ottawa would react if an acquirer were to bid for a major Canadian company.

When the government blocked BHP Billiton’s bid in late 2010, the industry minister at the time, Tony Clement, vowed to spell out some principles about takeovers of Canadian companies. He also said he would ask the House of Commons industry committee to review the Investment Canada Act, which governs such deals, and suggest improvements. But neither of those things has happened and the new Industry Minister, Christian Paradis, has said little on the topic.

Mr. Denison also outlined another worry of his these days: that new regulations are pushing many investors, from European pension plans to Canadian insurers, to invest for the short term rather than the long term.

When it comes to pension plans, “the strict solvency rules being proposed within the European Union and contemplated elsewhere, if enacted, will likely materially hinder their ability to make long-term investments,” Mr. Denison said. At the same time, mark-to-market accounting rules and other new regulations are having the same impact on insurers.

This, Mr. Denison believes, is a danger to the financial system as a whole.

“Long-term investors can play an important role in helping to stabilize markets in times of stress – they can act as liquidity providers and counter-cyclical investors in such times to counter-balance the actions of other investors,” he said. “They can be the providers of capital for important long-term projects such as infrastructure or the development of new energy capabilities for example.”

Mr. Denison urged policy makers to think about the implications of their decisions.
“We encourage them to make choices that will maintain more open investment regimes and foster long-term investing,” he said.

The Australian picked up on that last point, reporting the following:

Mr Denison is also concerned about “signs of a shrinking universe of long horizon investors and corresponding availability of true long-term capital”.

“The impact of mark to market accounting requirements on insurance company investment portfolios and other regulatory pressures on them is also reducing their capacity to act as long horizon investors,'' he will say.

He believes CPPIB is less focused on interim changes in asset prices and instead on long-term income growth and/or long-term capital appreciation both in their initial evaluation and continued interaction with their investments.

“Our view is that there aren’t many entities that fit this definition and worryingly some proposed regulatory and other changes would reduce the existing number,” he will say, noting that long-term investors can play an important role in helping to stabilise markets in times of stress.

The value of CPPIB's funds under management is now around $155 billion and that is forecast to grow to more than $300 billion within the next decade and then to more than half a trillion dollars by 2031.

More than $10 billion is invested in the Asia Pacific region and half of that is in Australia.

In 2010 CPPIB acquired Intoll, the owner of the Westlink M7 in Sydney and about a third of Toronto's 407 ETR for $3.44 billion.

It also has a half share of the Northland Shopping Centre in Melbourne, supported Goodman Group's recapitalisation in 2009 and acquired 100 per cent of the Macquarie Communications Infrastructure Group for $1.64 billion.

The Canadian group also committed $375 million in 2010 to the Colonial First State Global Asset Management Property Retail Partnership, alongside the Future Fund and two large superannuation funds.

Denison is right, unlike mutual funds or hedge funds, pension funds can use their deep pockets to buy private and public assets on the cheap, especially after a market dislocation, and wait for them to recover, making excellent returns in the process.

I also like his comments on pensions as a cyclical stabilizer. Think about it, in severe market dislocations like 2008-09, who is the buyer of last resort? Pensions, sovereign wealth funds, endowment funds, and central banks.

Importantly, when everyone is scared to death, someone has to come in to buy cheap assets, providing much needed liquidity to markets.

This also reminds me of something Leo de Bever, President and CEO at AIMco, told me over breakfast. He said that a lot of funds got caught in the credit crisis because the banks and brokers tightened margin requirements, forcing them to deleverage. "If pensions provided these funds with liquidity and their line of credit during the crisis, it would have mitigated the excesses of forced deleveraging."

As far as Denison's comments on protectionism, he's right about that too. It never fails to amaze me how stupid policy makers are during economic downturns. Austerity and protectionism are sheer insanity during a debt deflationary/ deleveraging cycle.

On a more critical note, I do take issue with a major Canadian pension plan investing more in Australia. Why? Because essentially both countries have a very similar profile (commodity exporters) and are vulnerable to the exact same shock, namely, a major shock in China. Also, both countries face their own domestic issues, like high consumer debt and a bubble in their housing market.

It's true that Australia offers nice investment opportunities, especially in private markets where the legal system and government regulations are crucial factors, but CPPIB needs to consider how such exposure will impact their overall fund on many levels. They need to talk to their external managers, including Bridgewater which is betting against the Australian dollar and several emerging-market currencies.

Importantly, just because you're a long-term investor, doesn't mean you can't get caught in a severe downturn which may take several years to resolve.

Pension funds allocate risk across public and private markets. It's critically important to understand the dynamics and correlations between public and private markets, especially for more mature plans which do not have CPPIB's or PSPIB's generous cash inflows (liquidity).

What else? I'd like to see CPPIB and other large public pension funds focus more on opportunities in Europe. Admittedly, it is a bureaucratic nightmare, especially in countries like Greece, but if you ask me, that's where the big juice lies.

Pension funds that want to invest in European infrastructure should hire the right people, not investment bankers, but people with extensive operational experience, solid contacts at top European infrastructure firms, and extensive knowledge of the legal and government bureaucracies in Europe.

Amazingly, I know one excellent candidate which the Caisse, CPPIB and PSPIB foolishly passed over, much to their detriment (ridiculous, this guy can dance circles around their heads of infrastructure and he is a smart, solid and ethical manager with extensive infrastructure experience).

Anyways, you can read David Denison's entire speech here. Everyone should read this speech, including Prime Minister Harper who has been feeling the heat over pensions lately. Although David Denison can't express his opinions on the ongoing debate, I know he too is a staunch supporter of defined-benefit pensions plans.

Below, Australian Trade Minister Craig Emerson talks about the outlook for the nation's economy and trade within the Asia-Pacific region. Australia’s trade surplus unexpectedly widened in December as stronger exports of gold and coal outpaced increases in imports of fuel and lubricants. Emerson also discusses Europe's debt crisis. He speaks with Rishaad Salamat on Bloomberg Television's "On the Move Asia."

CalSTRS Fully Funded in 52 Years?

2012-02-01T18:11:00.006-05:00

James Nash of Bloomberg reports, California Teacher Pension Fully Funded in 52 Years:

The California State Teachers’ Retirement System, with higher contributions from teachers, school districts and the state, may have all the money needed to pay its obligations, 52 years from now, according to a new report.
Calstrs, whose $144.8 billion in assets make it the second- largest U.S. public pension, had only 71 percent of what it needs to cover forecast benefits as of June 30, 2010, down from 78 percent a year earlier, according to a statement. The shortfall amounts to $56 billion.

The fund would be at 100 percent by 2064 if new teachers were required to put 12.2 percent of their salaries toward retirement, from 8 percent now, phased in beginning in 2016, according to one projection in a report to the board. Current teachers would contribute 10 percent; school districts, 14.5 percent of payroll, from 8.25 percent; and the state, 3.1 percent of its budget for teacher payroll, now about 2 percent.

“This is really the governor and the Legislature’s decision,” Ed Derman, the fund’s deputy chief executive officer, said on a conference call with reporters yesterday. “We’re here to help you do this, but you’ve got to solve the problem.”

Full funding by 2064 would also require Calstrs’ investments to earn an average annual return of 7.75 percent. Actuaries have recommended lowering the rate to 7.5 percent.

Six Projections

The report to the Calstrs board, scheduled for discussion tomorrow, outlines six scenarios that would spread the added costs among school districts, educators and the state. Each would require instructors to pay more. Only one would impose additional cost on new teachers. All six would squeeze more from school districts to varying degrees. Four would require additional state money.

Governor Jerry Brown didn’t include additional funds for Calstrs in a series of measures he outlined in October to narrow pension funding gaps.

Derman said Brown’s proposals, which include raising the retirement age and creating a 401(k)-style hybrid retirement plan for new employees, would only partially deal with the funding gap, which was estimated at $56 billion in June 2010.

“You still have the unfunded liability for all of the existing members,” he said. “The governor’s proposal doesn’t change that.”

As far as investments, Dale Kasler of the Sacramento Bee reports, CalSTRS may cut forecast again:

CalSTRS is thinking of cutting its investment forecast for the second time in barely a year, a move that acknowledges the increased financial strain on the pension fund.
The teachers' retirement board on Thursday will consider a recommendation from its actuarial consultant to cut the forecast by a quarter point, to 7.5 percent.
The consultant, Milliman Inc., told the board the current forecast "exceeds the expected long-term return."

Pension funds are reluctant to adjust their investment forecasts. After months of hand-wringing, the California State Teachers' Retirement System cut its forecast by a quarter point in December 2010 – the first adjustment in 15 years.
Now it might do so again, just a week after CalSTRS revealed that its earnings for calendar 2011 came to just 2.3 percent.
The timing is coincidental, pension officials said. The latest recommendation is part of a typical review that takes place every four years, said Ed Derman, CalSTRS' deputy chief executive.
What happened in 2010 was unusual, and was a reaction to the extraordinary losses suffered in the 2008 market crash, he said.
In any event, lowering the forecast could intensify the pressure on the Legislature and Gov. Jerry Brown to come up with a funding solution for CalSTRS. The retirement system is already underfunded by tens of billions of dollars.
CalSTRS gets more than $5.5 billion a year in contributions from the state, school districts and teachers. It says it needs at least $4 billion a year more to eventually get healthy. With the lowered investment forecast, that requirement would grow by an additional $500 million a year, Derman said.
Toward that end, CalSTRS' staff plans to present the Legislature with six different scenarios for raising contributions. The increases wouldn't begin until 2016, which Derman said is partly a bow to political reality as the Legislature deals with a huge deficit.
At the same time, a lowered forecast could bolster arguments by many Republican lawmakers that public pensions are unsustainable. In their view, the solution is reining in costs, not raising annual contributions. One conservative group is pushing a ballot initiative to force newly hired public employees to accept a 401(k)-style program.
Brown, a Democrat, is pushing a proposal to give newly hired workers a retirement plan that blends a traditional pension with a 401(k).

Read more here: http://www.sacbee.com/2012/02/01/4229555/calstrs-may-cut-forecast-again.html#storylink=cpy

I hate anything with "401 (k)" in it. It just means higher fees and more pension poverty down the road. At least CalSTRS is discussing options, putting it all on the table so their members can understand what is needed to shore up their pension plan.

Most pension plans stick their head in the sand until it's too late. The WSJ reports that AMR told its employees with a plan to dump their pensions:

American Airlines parent AMR Corp. is planning to cut 13,000 jobs and terminate its four employee pension plans covering its workers and retirees.

In a memo to employees, the company said it’s necessary to dump its pension obligations for 130,000 workers and retirees in order to successfully restructure its business under bankruptcy protection.

The company has yet to ask the bankruptcy court for approval to walk away from it pensions.

“Pensions have not been discussed with the unions,” said AMR spokesman Scott Sayres in an email to Bankruptcy Beat. “When they have, it will be on the site.” The company is set to speak with its unions Wednesday.

The government’s pension insurer, which would assume responsibility for American’s obligations if the carrier obtains approval from a bankruptcy judge, says the plans have assets of $8.3 billion to cover $18.5 billion in benefits.

Read AMR’s statement on its pensions here.

Read AMR Chief Executive’s Thomas Horton’s letter to employees here.

What a disaster! As I stated before, with few exceptions, most companies shouldn't be managing pension plans. Pensions should be public defined-benefit plans accessible to public and private sector employees. This way when a company goes under, which often happens, employees' retirement funds are secure and well managed.

Don't get me started on the pension crisis, it's a frigging mess and politicians are the ones who are sticking their heads in the sand or taking stupid decisions that will come back to haunt us all. The dynamics at CalSTRS will be interesting to watch because if they succeed in achieving fully funded status by implementing these changes, many others will follow. Stay tuned and mark your calendar for 2064.

Below, Tom Frank of USA TODAY discusses his findings that pensions for state legislators across the country can be highly lucrative. Tell that to American Airlines employees and many others in the private sector that have lost or are at risk of losing their pensions. Think it's time we started treating our workers more like state legislators, offering them a safe and secure retirement.

Hedging Against Disaster?

2012-02-01T09:08:00.006-05:00

Laurence Fletcher of Reuters reports, Hedge funds brace for euro zone break-up:

Nervous hedge funds managers are stress-testing their portfolios and searching for ways of protecting themselves against their worst nightmare -- a potential break-up of the euro zone.

With talks on restructuring Greece's debt mountain still deadlocked, and the exit of one of more countries from the euro seen as a small but definite possibility, funds are modelling scenarios ranging from a 50 percent slump in European stocks or a 45 percent fall in the oil price to a 30 percent rise in gold.
Managers are also trying to dig out old computer programmes they once used to model the behaviour of currencies such as the drachma or the deutschmark as they prepare for an event for which -- even after the 2008 collapse of Lehman Brothers -- they effectively have no precedent.
Many, having already trimmed risk, are piling into credit default swaps or deeply out-of-the-money options, hoping they pick a counterparty that can withstand the shock of a break-up.
"You can't conceive what this event will be like, but it doesn't absolve you of looking at it," said the chief risk officer at one hedge fund firm who asked not to be named.
"People are asking the questions, 'do I have the historical records on how things worked when there was a deutschmark?' and 'did I throw away those computer programmes (modelling the deutschmark)?'."
Funds are also trying to figure out how they might be affected if different asset classes that normally have a low correlation start to fall sharply at the same time.
"Anyone who's a chief risk officer is running these scenarios -- say if the euro falls 15 percent, stocks fall 25 percent, if the possibility of default increases, what if recovery rates falls, which prime brokers, administrators get hit?" said Mark Wightman, head of strategy for Asia-Pacific at specialist technology group SunGard.
"The scenarios are getting quite complicated and people are starting looking at correlations between things to understand the likely impact."
PROTECTION
While hedge funds, which can put on short positions, have more tools at their disposal than long-only funds to cope with market falls, their performance has been patchy.
Last year they lost just over 5 percent on average, according to Hedge Fund Research, while the S&P 500 delivered a total return of 2.1 percent. That was their second calendar year of losses in just four years after heavy losses during the credit crisis in 2008.
Many hedge funds have already cut exposure to assets seen as directly in the firing line such as the euro or European stocks, insiders say, but are finding their options limited.
"We're all still trying to run our businesses right now. I'd like to say I'll put everything in U.S. dollars, but you can't," the hedge fund chief risk officer said.
"Part of it is contingency planning -- what you need to get out of first -- and part is proactive -- 'I don't need so much emphasis in a certain area right now', such as European stocks or the euro," he said.
"Certainly we are taking smaller positions in some of these markets."
Some funds also rejigged their equity short positions after major differences between stronger, core economies such as Germany and weaker peripheral economies became more apparent, said one investor who spoke on condition of anonymity.
For instance, a manager who owned shares in a German bank whilst shorting a Greek bank has switched to hedging the German bank with a short position on another German bank, after the Greek bank's shares "started to take on a life of their own" as a result of the country's debt crisis, the investor said.
However, with uncertainty over which currencies would exist after a break-up and how they would behave, funds are still unsure how far their hedges would protect them.
"A hedge fund may have a hedging programme that is very highly attuned to dealing with its positions. But the day after something happens there's no programme to deal with this and their hedge may be denominated in a new currency," the risk officer said.
AVOIDING CONTAGION
Part of the dilemma is a mistrust of value at risk (VaR), a standard measure used by banks to show estimated potential loss, expressed with a certain percentage level of confidence.
"A traditional measure of risk like VaR has nothing to say on this," said Lance Smith, CEO at U.S.-based Imagine Software, which has been working with hedge funds to assess the impact of a euro zone break-up on their portfolios.
"A euro break-up could be a 7 standard deviation event. A 6.5 standard deviation event occurs once every 34 million years, while a 50 percent fall in the Eurostoxx would be a 21 standard deviation event. This just highlights the flaws in a standard statistical approach."
Credit default swaps, which are meant to pay out in the event of default, currency options or deeply out-of-the-money options, are among the favoured hedges, industry executives say, which has driven up option prices.
However, even here there is a concern over whether the counterparty can pay up.
"You watch the counterpart if (it's) OTC (over-the-counter) to avoid contagion," said Sungard's Wightman. "Thus you do your euro trades with say Japanese, U.S., Asian or Australian institutions."
Meanwhile, one hedge fund manager has structured a trade to buy German bunds whilst offsetting this with credit default swaps, one fund selector told Reuters.
"His base case is that if someone comes out of the euro, the German bund will be the place to be."

All these nervous hedge funds are wasting their time! If Greece defaults, no need to "stress-test" your portfolios, all bets are off, correlations move to 1, there will be nowhere to hide. They can buy all the insurance in the world (CDS), it won't make a difference.

Interestingly, Reuters also ran a piece a few days ago, Hedging against disaster even as markets grow calm:

Don't be deceived by the U.S. stock market's rousing start this year or the new-found stability of the euro.

After months of seizing on every incremental development in Europe as a reason to buy or sell, markets have started 2012 on a firm footing. The S&P stock index is up 4.8 percent so far this year and the euro has rebounded from recent declines on hopes the euro zone will survive a likely default by Greece.
But fund managers betting on economic armageddon say the worst is far from over as they eye the negotiations to restructure Greece's debt warily.
While well-worn measures of volatility such as the CBOE Volatility Index show relative calm, indexes that track bets on extreme outcomes are rising.
It's why "tail risk" investing - pursued by funds that bet on steep, unexpected drops in asset values - is still attracting investors eager to protect against unlikely outcomes such as a market crash. The recent decline in volatility has made these hedges cheaper.
"Tail-risk hedging has been growing quite substantially, especially in this environment where volatility is low and the price of tail risk hedges is cheaper," said Vineer Bhansali, PIMCO's managing director who runs the bond fund's tail risk strategy. "That's when we have the most interest." Newport Beach, California-based PIMCO's tail risk accounts are insuring $45 billion in assets.
These strategies first garnered attention in the wake of the unexpected collapse of Lehman Brothers in 2008, when numerous global markets slumped by more than 50 percent.
Assets invested in doomsday scenarios are hard to quantify since there is no index that tracks such "Black Swan" strategies. JP Morgan Chase's global asset allocation group estimates assets in "tail risk" hedge funds have ballooned to about $38 billion in April last year from less than $500 million prior to the Lehman collapse.
London-based portfolio manager Bob Noyen thinks the market has become too sanguine about Europe's debt and banking woes. The chief investment officer at the $25.4-billion Record Currency Management expects the euro zone to collapse, and started the Record Euro Stress Fund in June to capitalize on euro zone problems.
He said the firm's models have priced in a 10 to 15 percent chance that the "euro zone will enter into a chaotic process of dissolution, and that percentage is steadily increasing."
Record Management's Euro Stress Fund was the first of its kind being solely focused on euro zone stress, Noyen said. He added, however, that Record's fund is not exactly a "Black Swan" fund because the euro zone crisis is already a known and well-telegraphed risk.
It invests in a variety of options, which amount to shorting the euro against the dollar and yen, Noyen said.
That includes bets against European currencies such as the Norwegian and Swedish crowns and the Swiss franc, which could get sucked into a European maelstrom should the euro zone break up.
Noyen's Euro Fund is down 2.26 percent so far this year, hurt by the euro's surprising strength.
WATCHING YOUR TAIL
The $50 billion London-based asset management firm GAM has bought protection on European banks in the credit-default swap market as a hedge against a euro zone collapse even though it has a more optimistic take on the region's crisis.
"If you really think about it, what would drive a crisis again will most likely involve European banks in some form of bank run," said Jack Flaherty, investment manager at GAM who helps run the firm's Absolute Return Bond Strategy.
He added that GAM has decided to use the still reasonably priced CDS as a hedge instead of out-of-the-money S&P 500 puts.
Hedge funds wishing to protect against risks in the euro zone or stock market typically purchase lower-priced, long-dated put options - contracts that give them the right to sell an underlying stock or security on expectations of a fall in price.
They usually buy these options when they are deeply "out-of-the-money" - in which the price at which they can exercise that right to sell is well below the current market level - and hope that over time market conditions change in their favor.
For example, an investor expecting a stock currently trading at $100 to fall could buy a put option at a $60 strike price. Once the stock falls through that level the option would then be "in the money."
But the "out of the money S&P puts have become very expensive, have been all year, and for quite a while because everybody is buying S&P puts especially after the financial crisis of 2008," Flaherty said.
This can be seen by looking at the CBOE Tail Hedge Index, a relatively new index that acts as a benchmark for "tail risk" hedging strategies. This index measures the price of options used for portfolio insurance, and it has been steadily rising of late, a sign of concern.
STOCK MARKET STRESS
Many investors believe the U.S. stock market is undervalued as earnings have steadily increased and the S&P 500 has remained in a range. The forward price-to-earnings ratio on the S&P is currently 14.55, below the historic average of 15.
Mark Spitznagel in Santa Monica, California, sees it differently. He specializes in protecting against extreme outcomes at hedge fund Universa Investments, which he founded with scientific advisor Nassim Taleb, who wrote the book "The Black Swan," a detailed theory on the unpredictability of very rare events.
Spitznagel says the expectation for bailouts and cheap money means U.S. stocks still trade at lofty levels when compared to the replacement cost of companies' assets. This week the U.S. Federal Reserve committed to keeping benchmark U.S. interest rates low through late 2014, and that implicit underpinning makes people overconfident.
He said expectations right now are clearly for "exceedingly high aggregate returns on tangible capital, something that is unsustainable in a competitive economy."
Spitznagel is known for his bearish value- and derivatives-based stock market investing. One of his most profitable trades was his billion-dollar bet on the stock market crash of 2008.
The Universa chief, however, would not disclose his strategy.
JP Morgan estimated Universa's returns for the year to September 2011 at between 20 and 25 percent. Universa won't confirm JP Morgan's figures but market participants say 2011 was a profitable year for most tail-risk funds.
CALM BEFORE THE STORM
Fears about the euro zone have eased temporarily given recent successful debt auctions in Spain and Italy. Greece is trying to broker a deal with creditors to reduce its massive debt pile but that story changes daily.
Noyen is undeterred. He has advised clients that investing in a worst-case euro scenario is often a long-term proposition that can pay off when many other investments are losing money.
"The funds are spent on buying out-of-the money put options. So in the event that the euro goes to parity against the dollar or to $1.10 versus the dollar, we plan to add value to the portfolio by as much as 50 to 100 percent," Noyen said.
PIMCO's Bhansali said that with the decline in implied volatility in equities, currencies and interest rates, the cost of hedging has fallen to roughly 1 to 1.5 percent from about 2 percent of the portfolio in November and provides the perfect opportunity to add more hedges.
"I don't think the market has really priced in a euro zone break-up," Bhansali said. "There are a whole bunch of technical issues that people have not figured out."

The market hasn't "priced in" a eurozone break-up for the simple reason that it won't happen. All these hedgies waiting for a "Lehman-style event" so they can score big are collecting 2 & 20, selling fear to their institutional clients.

The biggest and most powerful hedge funds in the world stand ready to pump up the jam. The black swan of 2012 remains a mild eurozone recession. When fears of a eurozone break-up dissipate, greed and massive liquidity will drive all risk assets much, much higher. That remains my prediction, and if I am wrong, God help us all!!

Below, Bob Parker, senior adviser at Credit Suisse Asset Management, talks about plans for a Greek private-sector involvement accord, the euro area firewall and the U.S. economy. He speaks with Mark Barton on Bloomberg Television's "The Pulse."

Canada’s Subprime Crisis?

2012-01-31T19:06:00.008-05:00

Andrew Mayeda of Bloomberg reports, Canada’s Subprime Crisis Seen With U.S.-Styled Loans:

Canadian lenders are loosening standards, offering mortgages similar to U.S. subprime loans that pose an “emerging risk” to financial institutions, according to the country’s banking regulator.

Banks and other lenders are becoming “increasingly liberal” with mortgages and home-equity credit lines that don’t require individuals to prove their income, according to 152 pages of documents obtained by Bloomberg News under freedom of information law from the Office of the Superintendent of Financial Institutions. The mortgages, typically granted to the self-employed and recent immigrants, “have some similarities to non-prime loans in the U.S. retail lending market,” the documents show.

“It just speaks to the general easing in lending standards, which has contributed to a booming housing market,” said David Madani, an economist in Toronto with Capital Economics, which estimates that Canadian housing prices may fall 25 percent over the next few years. “The problem is sort of baked in now, so I’m not sure there’s a way to prevent a weakening of the housing market.”

Canada’s housing market has surged since the 2009 recession as near-record low mortgage rates fueled prices and home purchases, unlike the U.S., where sales and values have fallen since 2007. Bank of Canada Governor Mark Carney has said record consumer debts are the greatest domestic threat to the country’s financial institutions, even as the central bank has held the benchmark rate at 1 percent since September 2010.
Most Vulnerable

While there are differences with U.S. mortgage practices, the Canadian housing market is displaying classic signs of a bubble, with a run-up in prices, high ownership rates and overbuilding, said Madani of Capital Economics.

“The biggest concern is taking extreme levels of debt for those who are most vulnerable,” Carney told reporters Jan. 18. The bank estimates the proportion of Canadian households “highly vulnerable” to an economic shock - those with a debt service ratio of 40 percent or more - remains above the average of the past decade. Canadians’ debt reached a record 153 percent of disposable income in the third quarter, according to Statistics Canada data.

Most mortgages in Canada are funded through deposits, followed by mortgage-backed securities and bonds guaranteed by Canada Mortgage and Housing Corp., a federal agency known as CMHC.

CMHC had an outstanding balance as of Sept. 30 of C$132 billion ($132 billion) in mortgage-backed securities and C$202 billion in Canada Mortgage Bonds. The agency’s financing arm issued C$41.3 billion in debt last year, up from C$6.5 billion in 2001.
Covered Bond Sales

Banks are also cutting their funding costs by selling covered bonds, a form of corporate bond backed by assets such as home loans. Bank of Montreal and Bank of Nova Scotia (BNS) sold $4.5 billion of the securities this month, according to data compiled by Bloomberg, after a record $25 billion of sales in 2011.

Relative yields for Canadian covered bonds average 91 basis points, or 0.91 percentage point, more than government benchmarks compared with 102 at the end of last year, according to Bank of America Merrill Lynch index data. That compares with a premium of 306 basis points for covered bonds issued by euro- region lenders.

Canada’s banking system has been rated the soundest in the world for four straight years by the World Economic Forum, and none of the country’s lenders needed a bailout, unlike U.S. banks, which suffered losses on securities backed by sub-prime mortgages.
No Documentation

U.S. nonprime mortgages - which include both subprime and “alt-A mortgages” - accounted for slightly more than a third of originations at the peak of the market in 2006, according to Inside Mortgage Finance, a Bethesda, Maryland-based company that tracks residential mortgages. Loans that required little or no documentation of income accounted for 46 percent of all U.S. subprime mortgages that year, according to a Credit Suisse Group AG report at the time.

While there is no common definition of subprime mortgages in Canada, the proportion of such loans has probably fallen from about 5 percent of the market since the financial crisis, said Benjamin Tal, deputy chief economist at CIBC World Markets in Toronto.

“If you look at the overall story and marginal borrowers, it’s a very small segment of the market,” said Tal.

Mortgage terms are also typically shorter in Canada than the U.S., and lenders can pursue defaulting borrowers for full reimbursement even after foreclosure. As well, mortgage interest isn’t tax deductible in Canada, unlike the U.S.
Stress Testing

OSFI head Julie Dickson said in a Sept. 26 speech the agency is “very focused” on mortgages and home-equity lines of credit, which allow individuals to borrow against the equity in their homes.

In a Nov. 2 letter to Canadian financial institutions, the agency encouraged them to follow mortgage underwriting principles recommended by the Financial Stability Board, including limits on the ratio of loans to property values and regular stress testing of mortgage portfolios. OSFI regulates Canada’s biggest banks, as well as smaller loan providers and credit unions.

Home buyers usually qualify for “non-income-qualified” mortgages because they make a large down payment, according to the August 2011 analysis by OSFI. Lenders typically waive the requirement that buyers prove their income, OSFI says, which identified such loans on a list of issues to be considered by its “emerging-risk committee.”
Slackening Standards

Home-equity credit lines without income verification have become “an increasingly popular option,” OSFI says in the analysis, adding that they “pose greater risk” than mortgages because the credit lines are offered at floating interest rates.

Slackening lending standards were one of the early warning signs of the subprime crisis in the U.S., said Joshua Rosner, managing director at research firm Graham Fisher & Co. in New York. “U.S. history should be a guide to the irrationality of that practice,” he said by phone, referring to granting mortgages to borrowers without verifying their income.

By definition, such mortgages should be considered “nonprime,” added Rosner, who warned of the risks of a U.S. housing crash as early as 2001.

“As part of OSFI’s regular supervisory process, OSFI identifies areas that may require an increased level of monitoring,” OSFI spokesman Brock Kruger said in an e-mail, adding that regulators in many other countries have stepped up monitoring and oversight of residential mortgages and home- equity lines of credit.
Credit Standards

OSFI hasn’t imposed new requirements on banks in this area, Kruger added. “When OSFI identifies areas for heightened supervision, we work to ensure that we understand the issues and pressures driving that area before making decisions.”

OSFI officials assessed Canadian banks’ potential losses from defaults on home-equity lines of credit last year, the documents show. The results were blacked out under legal provisions that allow the government to withhold commercially sensitive information.

Bank of Montreal, the country’s fourth-biggest lender, has “prudent credit criteria, and we regularly review our credit qualifications,” spokesman Paul Gammal said in an e-mail. Other banks declined to comment on their mortgage lending standards, referring questions to the Canadian Bankers Association, an industry group.
Managing Risks

Canadian banks “carefully manage risk in their mortgage portfolios,” said Rachel Swiednicki, a spokeswoman for the Canadian Bankers Association. Mortgages in arrears were 0.39 percent of the total outstanding home loans in September, she said, calling the figure “extremely low.” In the U.S., the rate was 3.5 percent in the third quarter, down from 5.02 percent in the first quarter of 2010, according to the Mortgage Bankers Association. In the first quarter of 2007, the U.S. arrears rate stood at 0.98 percent.

Bank of Montreal (BMO) recently cut its interest rate on five- year fixed-rate mortgages to a record low of 2.99 percent, prompting other banks to reduce their rates.

Falling borrowing costs are driving home sales, which increased 9.5 percent to C$166 billion ($166 billion) last year, the Canadian Real Estate Association said this month. Home prices rose 7.2 percent. Toronto-Dominion Bank (TD) estimated in a Dec. 22 report the average Canadian home is overvalued by about 10 percent, and the heads of Bank of Montreal and Royal Bank of Canada warned that condominium markets in Toronto and Vancouver are at risk of correction. By contrast, the median price of previously owned homes in the U.S. plunged about 30 percent from a 2006 peak.
Arrears Rates

Non-income-qualified mortgages aren’t necessarily riskier than conventional loans, said Jim Murphy, head of the Canadian Association of Accredited Mortgage Professionals, which represents mortgage brokers, lenders and insurers.

“There’s no data out there that I’m aware of that says these sorts of mortgage products have a higher arrears rate or a higher default rate,” Murphy said by telephone.

Finance Minister Jim Flaherty has tightened mortgage lending rules three times since October 2008, most recently last January, when he limited the period over which mortgages can be amortized to 30 years, capped the amount people can borrow by refinancing their mortgages, and eliminated government insurance on home-equity lines of credit that are not amortized. Flaherty said Jan. 17 he’s prepared to intervene again if necessary, though the government has no plans to take immediate action.
Mortgage Insurance

Mortgage insurance plays a role in protecting Canadian banks from losses. Federal regulated lenders must insure mortgages to borrowers who make a downpayment of less than 20 percent of the loan, a requirement that doesn’t exist in the U.S. Most mortgage insurance in Canada is underwritten by the CMHC. The OSFI documents refer to both insured and uninsured mortgages.

While CMHC validates the income of all borrowers whose mortgages it insures, the agency “may accept non-traditional means of income validation” from newly self-employed borrowers with an “acceptable” credit history, spokesman Charles Sauriol said by e-mail

CMHC’s policies “help ensure that newcomers and others without a Canadian credit history have access to CMHC mortgage loan insurance products through the utilization of alternatives to validate a borrower’s credit history,” he added.

Reuters just ran an insight piece on how the growth of household debt in Canada to levels approaching those seen in the United States before the 2008-2009 crash seems to be keeping a lot of people awake - from central bankers to economists, lenders, real estate agents and the indebted consumers.

All this confirms my worst fears, namely, Canada's housing market is a disaster waiting to happen. When the great Canadian housing bubble bursts, watch out below, it will take years to repair. And that's when we'll find out just how solid Canada's mortgage monster really is.

When you see BMO's Sherry Cooper coming out telling us that the housing bubble is really a balloon, you know the top is in. "Stick a fork in it Jerry, it's cooked!" (any Seinfeld fans out there?) Just like CMHC's risk models are cooked and grossly underestimate the real risks that lurk if this so-called 'balloon' pops, leaving many people stuck paying off mortgages that are worth more than the actual value of their houses (underwater mortgages).

It's going to get ugly folks, just remember the few of us have who have been warning you all along. Whenever you hear some economist telling you that "Canada's fundamentals are strong" and that "we can never suffer the same fate as the U.S.", start running for cover.

Below, Bank of Canada Governor Mark Carney talks about the potential impact of the so-called Volcker rule on the trading of government bonds, the European Central Bank's efforts to ease the region's debt crisis and bank capital regulations. He speaks with Bloomberg's Erik Schatzker on the sidelines of the World Economic Forum's annual meeting in Davos, Switzerland.

Record High Pension Assets Hit by Liabilities?

2012-01-31T08:30:00.007-05:00

Towers Watson just came out with a report, Global pension fund assets hit record high in 2011:

Global institutional pension fund assets in the 13 major markets grew by 4% during 2011 to reach a new high of US$28 trillion, up from US$26 trillion in 2010 according to Towers Watson’s Global Pension Assets Study released today. The growth is the continuation of a trend which started in 2009 when assets grew 17%, and in sharp contrast to a 21% fall during 2008 which took assets back to 2006 levels. Global pension fund assets have now grown at over 6% on average per annum (in USD) since 2001, when they were valued at US$15 trillion.
The study reveals that, despite the growth in assets, pension fund balance sheets¹ weakened globally during 2011, with the ratio of global assets to liabilities well down from its peak achieved in 1999. According to the study, pension assets now amount to 72% of global GDP, which while lower than in 2010 (76%) is substantially higher than the 61% recorded in 2008.

Carl Hess, global head of investment at Towers Watson, said: “In case investors needed any reminding, the last six months of 2011 have driven home the need to have investment strategies that are flexible and adaptable and which contain a broader view of risk. This approach makes greater allowance for extreme events, which are occurring more frequently, while accommodating the softer elements of risk, such as credit and liquidity. The past few years have focused attention on the multi-faceted nature of risk within our increasingly precarious financial systems. At the same time risk management processes have evolved somewhat to factor in more qualitative measures. However, there is still some way to go before the appropriate measurement and management of risk is firmly embedded in the governance structures of most pension funds.”

Other highlights from the report include:

Global asset data for the P13 in 2011

The ten-year average growth rate of global pension assets (in local currency) is over 6%.
The US, Japan and the UK remain the largest pension markets in the world, accounting for 59%, 12% and 9% respectively of total pension fund assets globally.
All markets, except Japan, saw growth in pension assets in 2011 (measured in local currency), and all markets in the study, except Japan, have positive ten-year compound annual growth rate (CAGR) figures.
In terms of ten-year CAGR figures (in local currency terms), Brazil has the highest growth of 14% followed by South Africa (13%), Hong Kong (10%) and Australia (9%). The lowest are Japan
(-1%), France (1%), Switzerland (4%) and Ireland (4%).
Ten-year figures show the UK has grown its pension assets the most as a proportion of GDP (by 30% to be 101% of GDP ), followed by the Netherlands (up 23% to 133% of GDP), Australia (up 17% to 89% of GDP), Hong Kong (up 15% to 34% of GDP) and the US (by 12% to 107% of GDP). During this time Japan's ratio of pension assets to GDP has fallen by 1% to 55% of GDP.

Asset Allocation for the P7

Bond allocations for the P7 markets have decreased by 3% in aggregate during the past 16 years (40% to 37%). Allocations to equities have fallen by 8% (to 41%) during the same period, although much of this fall (7%) occurred in 2011.
Equity allocations in the UK have fallen from 67% in 2001 to 45% in 2011 (falling 10% in 2011 alone); similarly in the US allocations have fallen from 65% to 44% during the same period. Australia maintains the highest allocation to equities at 50%, while Japan has the highest allocation to bonds of 59%.
Allocations to other (alternative) assets, especially real estate and to a lesser extent hedge funds, private equity and commodities, for the P7 markets have grown from 5% to 20% since 1995.
In the past decade most countries have increased their exposure to alternative assets with the US increasing them the most (from 5% to 25%), followed by Switzerland (9% to 28%), Netherlands (1% to 14%), Australia (14% to 24%) and Canada (10% to 20%).

Carl Hess said: “The volatility in markets and the heightened risk awareness associated with possible sovereign defaults continues to make asset allocation incredibly challenging as companies and trustees balance such priorities as long-term de-risking, short-term market opportunities, rebalancing or maintaining a strategic asset allocation mix. These are already complex decisions - which are increasingly being delegated to specialists such as fiduciary managers - without adding numerous competing considerations, such as contributions from already stretched sponsors, contingent funding arrangements, hedging strategies and pension insurance buy-ins and buy-outs, not to mention changes to benefits structures including fund closures.”

Defined Benefit (DB) and Defined Contribution (DC) for the P7

During the ten-year period from 2001 to 2011, the CAGR of DC assets was 8% against a rate of 5% for DB assets.
DC assets now comprise 43% of global pension assets compared with 41% in 2005 and 38% in 2001.
Australia has the highest proportion of DC to DB pension assets, 81% : 19%.
The markets that have a larger proportion of DC assets than DB assets are the US, Australia and Switzerland while Japan and Canada are close to 100% DB. The Netherlands, historically only DB, is now showing signs of a shift towards DC, having grown these assets by 6% in the past five years to reach 7% of total assets.

Carl Hess said: “If institutions are finding it tough to invest, the growing number of individuals making their own investment through DC vehicles are facing a real challenge to preserve wealth, let alone augmenting their contributions via net-of-fee returns. Getting the default investment option right continues to be a priority for companies and trustees, while various governments battle the rising demographic tide by auto-enrolling or otherwise encouraging their citizens into sustainable vehicles for cost-effective retirement saving . At the same time companies and trustees are trying to balance the affordability of their plans with employee demands for suitable alternatives to retail savings vehicles.”

Public vs. private sector pensions in 2011

65% of pension assets of the P7 group are held by the private sector and 35% by the public sector.
In the UK and Australia the private sector holds more than 80% of pension assets with 88% and 85% of total assets respectively.
Canada and Japan are the only two countries where the public sector hold more pension assets that the private sector, holding 61% and 71% of total assets respectively.

Notes to editors

The P13 refers to the 13 largest pension markets included in the study which are Australia, Canada, Brazil, France, Germany, Hong Kong, Ireland, Japan, Netherlands, South Africa, Switzerland, the UK and the US. The P13 accounts for more than 85% of global pension assets.
The P7 refers to the 7 largest pension markets (over 95% of total assets in the study) and excludes Brazil, Germany, France, Ireland, Hong Kong and South Africa.
All figures are rounded and 2011 figures are estimates.
All dates refer to the calendar end of that year.

¹Measured by asset values over liability values using sovereign bond yields to discount liabilities.

aiCIO also reports, Record High Pension Assets Hit by Rising Liabilities:

Global pension assets hit a record high at the end of last year, but burgeoning liabilities meant funding ratios were in a worse state than 12 months earlier, a survey has shown.
Assets held in defined benefit and contribution schemes at the end of 2011 hit $27.5 trillion, according to investment consulting firm Towers Watson.

This figure showed a 3.9% increase in the asset level over the 12 months, but this was much lower than the 10.9% rise over 2010. All figures were stated in US dollar terms.
However, lower interest rates and changes to other accounting measures around the world’s major economies meant liabilities also hit record highs compared to a benchmark date at the end of 1998, Towers Watson said.

Using this measure, liabilities were 107.3% of their 1998 totals, whereas assets had only grown 54% from this point.

This shift meant global pension fund balance sheets worsened in 2011, losing 4.3% in the asset-liability indicator, despite the growth in assets.

Chris Ford, Head of Investment in Europe, Middle East and Africa at Towers Watson, said: "In case investors needed any reminding, the last six months of 2011 have driven home the need to have investment strategies that are flexible and adaptable and which contain a broader view of risk. This approach makes greater allowance for extreme events, which are occurring more frequently, while accommodating the softer elements of risk, such as credit and liquidity.”

Across the 13 countries counted in the survey, which have the largest pension fund assets worldwide, the allocation to fixed-income investments rose, and the percentage held in equities fell over the year, indicating investors were moving away from risky assets.

The largest shift towards bonds was seen in the United Kingdom, where 15 percentage points worth of assets were moved into fixed-income investments since 2006. A seven percentage point shift to alternative assets made up the rest of a 19 percentage point reduction of equity holdings.

Japan and the Netherlands - both relatively risk-averse investing nations – moved the next largest amount of assets into fixed income. They moved 13 and 14 percentage points of assets into bonds and other related securities over the five years to the end of 2011, cutting equity exposure by over 10 percentage points.

Investors in the United States, which holds 80% of pension assets within its borders, withdrew 16 percentage points from equities over the last five years, preferring split these assets between alternatives and fixed-income securities.

Ford said: "The volatility in markets and the heightened risk awareness associated with possible sovereign defaults continues to make asset allocation incredibly challenging as companies and trustees balance such priorities as long-term de-risking, short-term market opportunities, rebalancing or maintaining a strategic asset allocation mix.”

The largest surge in assets came from some developing economies, Towers Watson said. Brazil and South Africa saw pension assets climb by over 16% in 2011. Australia, which offers mainly defined contribution schemes, saw assets rise by 17% over the same period, in US dollar terms.

Over the past decade, however, Brazil has seen the largest asset growth with an upsurge of 14.3%. South Africa and Hong Kong followed slightly behind with 12.5% and 10.3% respectively.

You can read the Towers Watson Global Pension Assets Study 2012 by clicking here. When it comes to pensions, its all about matching assets to liabilities. And with the growth rate of liabilities outpacing that of assets, it's not surprising that global pension plans are in the hole. But keep in mind that underfunded pensions can get back to healthier status if they take the necessary measures to restore funding.

Unfortunately, here is where things get tricky. If we are heading toward a long-term debt deflationary cycle, then pensions are better off de-risking and shifting more assets into bonds, even at historic low interest rates, and focus more on generating alpha internally or through external managers.

However, if we are on the precipice of major inflation, then pensions should reduce their allocation to bonds, pile into risk assets, including inflation-sensitive assets, and allow the rise in bond yields to 'fix' their funded status gradually over time.

I can make the case for both deflation and stagflation. I am more worried about deflation because we just entered a period of massive deleveraging/austerity which will mute growth in the developed world. Having said this, bankers and policymakers will do whatever it takes to fight debt deflation, injecting trillions into the global financial system. All that liquidity will find its way somewhere and will eventually stoke inflationary expectations, but in a low growth environment (stagflation).

Add to this all the trillions invested in hedge funds and you get a great environment for traders to keep trading and profiting from the volatility in markets. This, in a nutshell, is what I foresee for the decade ahead. This will prove to be an extremely challenging environment for pensions and all long-term investors.

Below, Fredrik Nerbrand, global head of asset allocation at HSBC Holdings Plc, talks about investment strategy, adding risk, and the potential impact of higher oil prices on the global economy. He speaks with Owen Thomas on Bloomberg Television's "On the Move."

Greek-German Wrangling Just Pointless Fury?

2012-01-30T22:28:00.015-05:00

James G. Neuger and Jonathan Stearns of Bloomberg report, EU Nears Confrontation Over Greek Rescue:

European governments moved toward a confrontation over a second rescue package for Greece, just as a dimming fiscal outlook in Portugal opened a new front in the debt crisis.

Euro leaders left a Brussels summit late yesterday with no accord over how to plug Greece’s widening budget hole and German Chancellor Angela Merkel voicing frustration with the Athens government’s failure to carry out an economic makeover.

“Greece’s debt sustainability is especially bad,” Merkel told reporters. “You have to find a way through more action by the Greek government, more contributions by private creditors, for example, in order to close this gap.”

Bargaining with Greece over a debt writedown and its economic management overshadowed efforts to point the way out of the financial crisis. EU chiefs agreed to speed the setup of a full-time 500 billion-euro ($654 billion) rescue fund and signed off on a German-inspired deficit-control treaty.

The summit was the 16th in the two years since the Greek debt emergency provoked a Europe-wide drama, leading to unprecedented aid packages for Greece, Ireland and Portugal and shattering European faith that the common currency was indestructible.

After the gathering of European leaders, EU President Herman Van Rompuy convened a smaller group, including Greek Prime Minister Lucas Papademos and European Central Bank Executive Board member Joerg Asmussen, to weigh the next steps on Greece.
‘On Track’

Van Rompuy spoke of the need “to put the current program back on track” and said finance ministers will try to hammer out the follow-up plan -- in the works since July -- by the end of the week. Greece is counting on aid to meet a 14.5 billion- euro bond payment on March 20 to escape default.

Merkel’s comments indicated that governments are loath to boost an October offer of 130 billion euros of loans in a second package, forcing investors to absorb net-present-value losses on Greek bonds that go beyond the 69 percent now on the table.

Speaking to reporters at 1:30 a.m. today, Papademos said “some difficulties” beset the debt-swap talks and hinted that donor governments may have to put up more money.

“The timeline is tight, but we are absolutely focused on the target of bringing the negotiations to a successful conclusion by the end of the week,” Papademos said.
Greek Feuds

In turn, Greece’s feuding political parties face pressure to deliver more savings and to verify in writing that the austerity program will be carried out, no matter who wins elections to replace Papademos’s interim Cabinet.

Germany’s proposal for an EU-appointed overseer of Greece’s budget prompted consternation in Athens and led to a rejection by other European governments that warned against stigmatizing Greece.

“Greece is a sovereign nation and must enact the promises it’s made,” said French President Nicolas Sarkozy. “Surveillance of Greece’s progress is normal, but there was never any question of putting Greece under guardianship.”

Investors were seized by fresh doubts about the economic health of Portugal. Concern that the EU would break a promise not to restructure Portugal’s debt pushed 10-year yields up by 2.17 percentage points to 17.39 percent yesterday as two-year yields surged to 21 percent, both euro-era records.
‘Sustainable’ Portugal

Portugal’s debt has been judged “perfectly sustainable” by the EU and International Monetary Fund, Prime Minister Pedro Passos Coelho said. Asked if there is a risk of writedowns on Portuguese bonds, he said: “No, there is not.”

The Greek standoff and Portugal’s tottering market punctured the start-of-year crisis respite that had been nourished by 489 billion euros in three-year loans infused by the ECB into the banking system.

ECB loans enabled most bond markets to withstand the impact of credit rating downgrades by Standard & Poor’s. Ten-year yields in Italy, with debt estimated at 120.5 percent of gross domestic product in 2011, last week dipped below 6 percent for the first time since Dec. 6.

While Italian yields went back up to 6.09 percent yesterday, the government stockpiled cash for the year’s biggest bond redemption by selling 7.5 billion euros of debt, close to its maximum target.

Leaders completed the fiscal-discipline treaty, which speeds sanctions on high-deficit states and requires euro countries to anchor balanced-budget rules in national law. Eight countries outside the euro backed the pact, which was shunned by Britain and the Czech Republic.
French Elections

One potential hiccup emerged when Sarkozy said that ratification in France will likely be delayed until after elections in April and May that polls show he will lose.

The front-runner, Socialist Francois Hollande, has vowed to renegotiate the treaty, saying it is biased toward austerity and would put an additional squeeze on the economy.

With an eye toward Ireland, Germany pushed through provisions that only countries ratifying the fiscal compact will be eligible for aid from the permanent bailout fund, the European Stability Mechanism, now set to go into operation on July 1, a year ahead of schedule.

The permanent fund requires governments to put collective action clauses into new bond issues as of January 2013, five months later than previously planned. The clauses are common in U.S. and U.K. law, enabling a debt restructuring to go ahead by a vote of a supermajority of bondholders, denying a veto right to solitary investors.
Bond Clauses

“Collective action clauses shall be included, as of 1 January 2013, in all new euro area government securities, with maturity above one year, in a way which ensures that their legal impact is identical,” according to a final text of the statutes obtained by Bloomberg News.

While the clauses would leave the door open for future restructurings, the fund’s statutes deem write-offs “exceptional” and subject to IMF standards, the text says. It tones down language on “private sector involvement” -- code for forcing bondholders to take losses on governments that fall too deeply into debt.

Leaders sidestepped mounting pressure to raise the ceiling on rescue lending from 500 billion euros once the permanent fund goes on line, sticking with plans to handle that question at the next summit on March 1-2.

Luxembourg Prime Minister Jean-Claude Juncker, Europe’s longest-serving leader and the head of the panel of euro finance ministers, summed up two years of crisis-fighting: “If I wasn’t optimistic you could have reported about my suicide months ago.”

I know exactly how Juncker feels and while I understand Germany's frustration with Greece, and the response from Athens, I agree with what Yannis Varoufakis wrote in his latest comment, it's all pointless fury:

So, some German politicians put on paper that which they have been thinking of a while: Greece has become an unbearable burden and, if they are to resign themselves to continue putting their money in that particular black hole, they might as well have a say in the way it is managed on the ground. Predictably, the leaking of this document gave Greek politicians, and the hapless Finance Minister in particular, a great opportunity to flex muscles, to recite their fury regarding Germany’s trampling on Greece’s national sovereignty, etc.
Poppycock, I say! On both sides. On the Greek side, what on earth did we expect? Once a country accepts the logic of massive loans on condition of austerity that deepen the country’s insolvency, thus demanding more loans, the moment will come when the international lenders will insist upon direct executive powers. In corporate language, this is known as receivership. Greek politicians that put their signatures on the dotted line of the various ‘bailout’ agreements are stretching credulity when protesting the loss of national sovereignty. The horses bolted months ago.

As for the German politicians, I am afraid that the judgment of history will not be kinder. They willfully piled gigantic new loans on an insolvent nation, on condition of austerity that shrinks the national income from which these loans (plus the preexisting ones) would have to be paid. And then, when Greece’s social economy shrivelled and died, they became incensed that the ‘reforms’ did not work, that the tax revenues shrank, that there are no buyers for the Greek state’s assets. My message to them is: you imposed an erroneous policy on Greece, and the rest of Europe’s periphery, and now you must bear the consequences.

For months now, through the pages of this blog (and elsewhere), I have been arguing that the tragedy of the Greek ‘bailouts’, indeed of the overall strategy for dealing with the euro crisis, has been a comedy of errors. Is it not time that our politicians (Greek and German) owned up to their serial idiocy? Has the time not come to stop the blaming game and the posturing?

On a final note, I have a message for Germany’s politicians: As a private Greek citizen, I understand your fatigue with all things Greek. But if you are so sure that your blueprint for stabilising Greece is so good (and that the problem is its implementation by the Greek authorities), I would welcome you to come to Athens to take over its implementation. But on one condition:

If you succeed in making austerity work in the middle of a debt-deflationary cycle, I am happy for you to name your price. E.g. if within a year or so Greek GDP starts growing again and unemployment diminishes to below 10%, you can have our electricity grid (that Siemens has always coveted), our water companies, any assets that you name in advance. But, if you fail, then you must pay a price: e.g. pay in full Greece’s outstanding loans to the troika.

So, how about it? Are you game?

As a Greek-Canadian who knows Greece and Greeks all too well, I think Germany needs to take a step back here. Importantly, Germany cannot change 60 years of corruption, public sector bureaucracy and huge tax evasion in 60 days by ramming more austerity down the throats of Greeks, most of whom had nothing to do with this crisis. It will backfire in a spectacular fashion.

Yes, we all know Greece hasn't done enough in terms of structural reforms. They have way too many public sector workers with way too much power, all threatening the government that if they go though with troika's demands, it will cost them the elections. That's the reality in Greece.

What else? Tax evasion is endemic and happens at all levels of Greek society. Business people, doctors, lawyers, accountants, pharmacists, and tax collectors -- the worst offenders -- are among the people found guilty of tax evasion. These tax evaders are getting away with murder. So are many others that are not part of this official list.

Publishing a list of shame is stupid! Go after these people and throw them in jail! And don't forget to go after ex-ministers -- many of whom 'discovered' new fortunes after serving in government.

I can write books on what is ailing the Greek economy but one thing is for sure, hard working Greeks are tired of being made to look like lazy asses by Germany and other Northern European countries who are frustrated by the slow progress of Greek structural reforms.

At the end of the day, you cannot reconcile austerity with growth. Germany has to listen to Soros and get on with a more permanent solution to the European debt crisis. We can have 100 EU summits, but it all boils down to what Soros is advocating, which is why he took Germany to task at the World Economic Forum.

I know many Germans will fight tooth and nail against fiscal union and eurobonds, but such reactions will only ensure a prolonged and nasty debt-deflationary spiral in Europe and likely bring the rest of the global economy down with it. This is something we can ill-afford, especially after the 2008 financial crisis.

Below, Max Keiser debates with another panelist on Press TV on what he thinks about the Greek debacle and who is to blame. Don't agree with everything Max says, but he is colorful, animated, and knows how to cut to the chase to expose the fraud and corruption in our global financial system. [Note to Max: Jamie Dimon is an American of Greek descent.]

"Eaten Alive" by Hedge Fund Fees?

2012-01-30T13:38:00.019-05:00

A follow-up to my earlier comment on Bain or blessing discussing private equity. This time I'll focus on hedge funds. David Mildenberg of Bloomberg reports, Texas School Fund Weighs In-House Managers to Curb Fees:

Texas's Permanent School Fund may hire in-house money managers to oversee its $25 billion in assets because returns are being “eaten alive” by hedge-fund fees, according to Chief Investment Officer Holland Timmins.
Returns were less than 1 percent for the 44 months through November on assets managed by the five companies that bundle multiple hedge funds into single investment vehicles, Timmins said Jan. 25 at a State Education Board meeting. After fees, the return was negative, he said.

“The sector that should have enhanced our funding for schools actually detracted from it,” Timmins said. “We had a positive return in the asset class, modestly, but it got eaten alive by the fees.”

Hedge-fund expenses have reached about $72.7 million since 2008, according to a document Timmins distributed among board members. The reserve backs school-district debt and distributes $1 billion annually to support public education in the second- biggest U.S. state by population. The board voted 13-0 today to draw up a detailed plan for making the change, said Tom Ratliff, a member of the board’s investment committee.
Driven by Competition

“Big-brand hedge funds have been able to maintain their fee levels, but other funds have had to react to the marketplace and make adjustments,” said Brian Bruce, a former finance instructor at Southern Methodist University who previously worked for PanAgora Asset Management Inc. in Boston. “But that’s been more driven by competition rather than people saying these fees are too high.”

The Standard & Poor’s 500 Index of equities gained 2.3 percent including reinvested dividends from March 31, 2008, through November 30, 2011. The reserve’s hedge funds had a gain of 0.75 percent through that month, according to Timmins.

Timmins proposed hiring one of the current investment managers to advise on allocating assets to hedge funds, while one or more of the poorly performing companies would be dropped. The adviser would be picked from among the five firms, according to Patricia Hardy, the head of the board’s finance committee.

Picking the adviser from among the current providers would save time, as they are familiar to the board and know the reserve’s investment goals, board members said.
Fee Estimate

About 68 percent of the reserve’s costs, or about $34 million a year, is tied to absolute-return and private-equity investments that hold just 16 percent of its assets, Timmins said at a July meeting. Absolute-return fees are projected to be $114.7 million from 2012 to 2016 under the current system, excluding private-equity investment costs, he said.

The fund had $2.42 billion in hedge-fund assets as of Aug. 31, 2010, according to its annual report.

The proposed arrangement would deliver the same strategic advice provided by outside companies at a lower cost, said Ratliff. “They will still be making plenty of money,” he said of the hedge fund companies.

The Legislature last year added $18 million annually to the fund for new employees to manage assets and cut costs, Ratliff said. The board hasn’t acted in deference to Texas Education Agency Commissioner Robert Scott, who is hiring a deputy commissioner to focus on the fund, he said.
Five Companies

The five companies that oversee the reserve’s hedge-fund investments are K2 Advisors LLC, Grosvenor Capital Management Holdings LLP, Mesirow Advanced Strategies Inc., Blackstone Alternative Asset Management and GAM Holding AG (GAM), according to documents distributed in July. The fund dismissed Goldman Sachs Group Inc. (GS) last year, citing performance issues.

Timmins didn’t say how many new employees would be hired if his proposal is set in motion. In July, he estimated about 30 would be added.

Christine Anderson, a Blackstone Group LP (BX) spokeswoman, and William Douglass III, a K2 co-founder, didn’t immediately respond to telephone calls seeking comment on the proposal. Bill Blase, a spokesman for GAM, declined to comment. Officials of Mesirow and Grosvenor didn’t immediately respond to telephone calls or e-mails.

I think this fund and a lot of other pension funds are waking up to the reality that they're getting "eaten alive" by hedge fund and private equity fees. They're also probably asking themselves where are the customers' yachts?

Does it make sense to hire in-house managers? HELL YES!!! Why pay $72 million in fees for mediocre results from funds that can't even deliver beta? At a fraction of the cost, you can hire some excellent portfolio managers who know how deliver alpha. Just make sure you pay these people properly, especially US pension funds which are notoriously cheap on compensation.

I have an even better idea for Mr. Timmins, contact me (LKolivakis@gmail.com) and I will give you all sorts of ideas on rethinking your hedge fund strategy, including seeding some excellent Canadian hedge fund managers in commodity relative value strategies, global macro, CTA and L/S Equity. All liquid, all alpha, no egos, no bullshit, just the way I like it. And these are all great managers who deliver results and can be used as an extension of your investment team.

I am tired of seeing pension funds waste millions in fees to under-performing hedge funds or worse still, fund of funds. For Pete's sake, stop wasting your money on hedge fund hype. The entire industry has grown way out of proportion and just like private equity, most hedge fund managers are mediocre. In fact, as a group, hedge fund performance is ‘shockingly bad':

We often hear that hedge funds are run by the best and the brightest. Their strategies tend to give them ultimate flexibility and of course the highest fees. And most marketing materials claim they can offer investors absolute returns, with lower levels of risk than the market.
Unfortunately for many investors this is simply not the case. I don't want to overgeneralise because there are many excellent hedge funds with great records but as a group they really have not delivered the goods. In fact their performance has been shockingly bad. Here are the findings of some of my research:
1) In Simon Lack's recently released book titled The Hedge Fund Mirage: Illusion of Big Money and Why It's Too Good to Be True, Lack mentions that hedge funds lost enough money in 2008 to cancel out the entirety of the profits they made in the prior ten years. Many will point out that mutual funds have underperformed as well but I would suggest many people are less upset paying 0.75 percent to 1.75 percent in fees than paying two percent plus 20 percent of returns to have the privilege of losing money.
According to Lack, “If all the money that's ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good.” In analysing funds from 1998 through 2010, Lack adjusted the HFRX Index (an index that tracks hedge funds) by factors such as the “survivor bias” (only surviving hedge funds report returns), and found that fees were $324 billion while real investor's profits equate to a loss of $308 billion.
2) In another study published by the Journal of Financial Economics in 2011 titled “Higher risks, lower returns: What hedge fund investors really earn” researchers compared actual investor returns in hedge funds versus buy-and-hold strategies using dollar-weighted returns (which is just a fancy way of estimating how the actual money people had invested in the strategy performed).
Their “main finding is that annualised dollar-weighted returns are on the magnitude of 3 percent to 7 percent lower than corresponding buy-and-hold fund returns.”
In fact they suggest “the real alpha of hedge fund investors is close to zero” and that in absolute terms the “dollar-weighted returns are reliably lower than the returns on the S&P 500 index, and are only marginally higher than risk-free rates as of the end of 2008.”
3) On the whole Funds of Hedge Funds (FoHFs) have also not been very effective in adding much value according to the 2011 study titled “Assessing the Performance of Funds of Hedge Funds”. The authors suggest that “the vast majority of FoHFs do not exhibit alpha.
Furthermore, “only a small fraction of FoHFs deliver alpha per se, i.e. above the one already delivered by the universe of single-manager hedge funds. This means that the additional layer of fees that FoHFs charge eats away any manager added value”. The key here is fees. Jack Bogle, the founder of Vanguard, once said: “Performance comes and goes, but costs roll on forever”.
4) Speaking of Vanguard, a white paper written in 2010 called “Alternative Investments Versus Indexing: An Evaluation of Hedge Fund Performance” concluded that they were unable to “find merit in the argument that hedge funds provide diversification as an alternative asset class. The average returns for hedge funds have been highly correlated with those of long-only indexes. While it is true that hedge funds have been capable of insulating their investors from the worst declines in the broad stocks market, they missed the upturn in the broad market as well.” They also addressed why they felt investors have flocked to this segment and suggest it's simply “irrational exuberance”, the hope while others might have failed, they could consistently pick winners.
5) A Global Asset Allocation note by the research firm BCA titled “Do Hedge Funds Diversify Risk?” on November 30, 2011 suggests that diversification benefits of hedge funds are overstated. Their increasing correlation with the market and each other shows no sign of abating. Style selection is becoming less important.
They also conclude that “As an industry, hedge funds have not met their original objective. Positive returns have not been generated in both bull and bear markets.”
It may be that 2012 is the year hedge funds return to strong performance and outperform. If not, it's likely we will see widespread redemptions from the industry when the opportunity arises. In my opinion the comparison between alternatives and traditional asset allocation is very simple.
Traditional balanced asset allocation has provided diversification, superior performance, liquidity and much cheaper fees, yet investors continue to shun the traditional approach. (See Chart 1/Source: Bloomberg/Anchor Investment).
In 2000 the hedge fund industry was quite small with some $200 billion in assets. It subsequently climbed to around $2 trillion under management by early 2008. In the last two years portfolio allocations to alternatives has jumped from 7 to 17 percent (BCA Research/Scorpio Partnership).
Alternatives have underperformed, tend to be much more correlated to other asset classes than advertised, have limited liquidity, and charge much higher fees, so why do investors continue to pile into such investment vehicles? It is concerning to see an increasing allocation to what one many consider to be an inferior and more expensive product compared to a superior less expensive product.

This is all stuff I know because I invested in hedge funds and can tell you from experience, most hedge funds and funds of funds are full of shit, all hype to gather assets. They couldn't pay me to invest in them (some have tried).

And yes there are excellent hedge funds. In a punishing year, the biggest one thrived. But be careful, don't get too impressed by press coverage on Bridgewater's excellent returns and keep asking them very tough questions (like what is up with cameras following your employees' every move?!? Radical transparency? Sounds more like a paranoid police state!).

I get nervous when I see hedge funds all over the media. I prefer the guys who keep their heads down and deliver alpha. I am very impressed with Ken Griffin and Citadel whose flagships recently cleared their high-water marks, allowing them to start collecting performance fees after getting clobbered in 2008. Coming back strongly from a significant loss tells me a lot about a hedge fund.

Bottom line: If you're forking over huge fees, make sure you're paying for true alpha which you can't replicate internally and don't be a sucker, falling prey to hedge fund hype. I can rip apart any hedge fund and private equity fund (have done it plenty of times). And above and beyond doling out fees, make sure you get knowledge transfer and use your external managers as an extension of your investment staff. Never underestimate the importance of knowledge transfer.

Below, Troy Gayeski, senior portfolio manager at SkyBridge Capital LLC, discusses liquidity conditions for hedge funds and high-yield bonds, and efforts by the U.S. government to boost the housing market. He speaks with Scarlet Fu and Stephanie Ruhle on Bloomberg Television's "InsideTrack."

Future of Pension Profits: Bain or Blessing?

2012-01-30T09:00:00.015-05:00

The Economist reports, Bain or blessing?:

If Steve Scharzman thought it was valid in 2010 to compare Barack Obama’s “war” against business to Hitler’s invasion of Poland, what can he be thinking now? Private-equity executives must be hoping the boss of Blackstone will keep his opinions to himself. More bad publicity is the last thing the industry needs. Other Republican presidential candidates are competing to see who can say the most damning thing about Mitt Romney’s career at Bain Capital. Newt Gingrich’s supporters have even made a sort of horror movie about what happens when private-equity firms like Bain Capital get their hands on otherwise healthy companies.

The buy-out bit of the industry, which buys mature companies, fixes them up and sells them on, is the one on trial (few have a bad word for venture capital, which invests in start-ups). It is charged with destroying the jobs of ordinary people while enriching the likes of Mr Romney.
But private equity isn’t employment’s grim reaper. Buy-out firms usually set their sights on companies that they can improve, which means they may buy weaker or more bloated ones in the first place. A recent NBER working paper looked at employment after 3,200 leveraged buy-outs in America. It found that private-equity ownership resulted in both more rapid job destruction and faster job creation than other forms of ownership. Two years after a buy-out, employment declines by 3% on average; if acquisitions, divestitures and new sites are included the losses are only 1% of initial employment. Other research has found that wages do not rise as quickly at private-equity-owned firms, probably because buy-out firms try to control costs after a takeover. But wages also don’t plummet, which may be why unions that used to oppose buy-outs have moderated their criticisms.

In any case, it is not the mission of buy-out firms to create jobs. Their mandate is to produce higher risk-adjusted returns, and this is where private-equity firms should be judged more harshly. The industry has long boasted about its earth-shattering performance. Investors, and public-pension funds in particular, have piled into the asset class. But the bulk of investors’ capital has gone into funds that were raised when asset prices were at peak levels (see chart 1). Although fears of a bloodbath among bubble-era buy-outs have not yet been realised, returns for most of these funds are going to be middling at best.

Nor is there conclusive evidence that private equity consistently outperforms public companies, although certain high-performing firms undoubtedly do. A recent attempt to analyse private-equity performance, by Robert Harris of the University of Virginia’s Darden School, Tim Jenkinson of Oxford University’s Saïd Business School and Steven Kaplan of the University of Chicago’s Booth School of Business, concludes that it is “very likely” that private equity outperforms the S&P 500 (after fees). But the outcome looks different depending on which database is used. These vary wildly (see chart 2), and none has returns for all funds. The study emphasises a new data set, which could make things look rosier because the worst-performing funds may not be sufficiently represented.

The bigger issue

There is also a question about how private-equity firms calculate their returns. The internal rate of return (IRR) is the usual measure. But according to a 2010 study by Peter Morris, a former banker, entitled “Private Equity, Public Loss?”, it is rare for two firms to calculate IRR in the same way. This can complicate any attempt to compare funds. IRRs can also overstate the actual returns investors realised, according to Ludovic Phalippou at Amsterdam Business School, since the measure implies that the return was achieved on all the investor’s cash, even if some of it was given back early and reinvested at a lower rate.

The S&P 500 may not even be a fair benchmark for private-equity firms, says Mr Phalippou, since most buy-out firms purchase midsized companies, which have performed better than the big firms included in the S&P 500. An index of mid-cap stocks could offer a more accurate comparison, but also a higher hurdle for private-equity firms to jump.

Why would investors put money with private-equity managers who aren’t that good? It could be that investors herd mindlessly into asset classes. But some of it may also reflect the way the industry manipulates data. “Every private-equity firm you talk to is first-quartile,” quips Gordon Fyfe, the boss of PSP Investments, a C$58 billion ($58 billion) Canadian pension fund.

Oliver Gottschalg of HEC School of Management in Paris looked at 500 funds, and 66% of them could claim to be in the top quartile depending on what “vintage year” they said their fund was. The vintage year is supposed to be when the fund has its final “close” and stops fund-raising. But some firms may decide to use the year they started raising the fund or had their first “soft” close (when a fund is no longer officially open to new money), if it allows them a more favourable benchmark.

If investors can work out a way to place their money with funds that are actually in the top quartile, it is probably worth the fees and the extra risk of investing in this illiquid, leveraged asset class. But that is a big if. David Swensen, the man who runs Yale’s $19.4 billion endowment and a noted proponent of alternative investments, has written that “in the absence of truly superior fund-selection skills (or extraordinary luck), investors should stay far, far away from private-equity investments.”

Abuzz about fees

Buy-out executives have always claimed their interests are perfectly aligned with those of their investors, since they can only eat if their investors do. But that has changed as private-equity firms have morphed from small outfits into behemoths managing billions of dollars. Private-equity firms usually charge a 2% annual fee to manage investors’ capital and then take 20% of the profits. Big firms can now support themselves just from management fees. A study by Andrew Metrick at Yale School of Management and Ayako Yasuda at the University of California, Davis finds that private-equity firms now get around two-thirds of their revenues from fixed fees, regardless of performance.

If all that wasn’t bad enough for investors, the prospects for future returns look dim. Higher debt has accounted for as much as 50% of private equity’s returns in the past, according to a 2011 study co-written by Viral Acharya of New York University’s Stern School of Business. But banks are not lending as much as they did five years ago, increasing the amount of equity that firms are having to stump up (see chart 3). That will cap returns. “Employees are going to make less money, and firms are going to make less money. Returns are going to be much more mundane,” is the gloomy prediction of the boss of one of the largest private-equity firms.

Prices have also remained painfully high. Last year the average purchase-price multiple for firms bought by private equity was 8.4 times earnings before interest, tax, depreciation and amortisation, higher than it was in 2006. That’s because the industry is sitting on $370 billion in unused funds, or “dry powder”, that firms need to spend soon or risk giving back to investors, which means there is fierce competition for deals. Many transactions are between private-equity firms, which does little good to investors who have placed money with both the seller and the buyer.

With the option of financial engineering basically gone, private-equity firms have no choice but to improve the businesses they buy. Every private-equity firm boasts about its “operational” skills but sceptics question whether private-equity executives are that good at running companies. A senior adviser at a big buy-out firm and former boss of a company that was bought by private equity says he disagrees that buy-out executives are good managers of businesses: “They’re even less in touch with the real world than public-company managers. They’re a group of very clever, very analytical people paid lots of money whose general feel for the businesses is pretty poor.” Their edge, he says, comes from having a fixed investment term, which helps focus managers’ minds.

With the landscape bleaker than it was, many private-equity firms are reinventing themselves. Most buy-out firms now prefer the fluffy title of “alternative asset manager”. They have started to do more “growth equity” deals, taking minority stakes in companies and using less debt. This has been their strategy in emerging markets like China, where control and highly leveraged deals are not as welcome, but now the approach is also increasingly being used in the West. Big American firms like KKR, Carlyle and Blackstone have all expanded or started other units focused on things like property, hedge funds and distressed debt.

Many private-equity firms will quietly fade away, although Boston Consulting Group’s infamous prediction in 2008 that 20-40% of the 100 largest buy-out firms would go extinct has not yet come true. That is probably because private-equity firms take a long time to die. There are 827 buy-out firms globally, according to Preqin, a research firm. They will not all be able to raise another fund. European private-equity firms are particularly vulnerable because they have not diversified as much as their American competitors.

But Mr Romney’s candidacy will ensure that American firms feel more political heat. Executives’ special tax treatment, under which their profits are taxed as capital gains rather than income, will almost certainly go. The limelight has not yet scared off the 236 buy-out funds that are in the market trying to raise another $172 billion. But it is not as much fun as it was. “Back in 2005 fund-raising was like having a velvet carpet with a rope,” says one buy-out boss. “You had a bouncer and only let the prettiest people in. Now it’s buy one, get one free, and free entrance before 11.”

I've already commented on private equity's public subsidy, as well as its changing landscape, but the article above is excellent and should be read by every single institutional investor.

And Gordon Fyfe, President and CEO of PSP Investments, is right when he says all private equity funds claim to be top quartile but the reality is very few funds consistently deliver top quartile performance. Moreover, even the best funds have flopped in the past (TPG), so each fund and follow-on fund must be evaluated carefully. David Swensen isn't kidding when he says most investors should stay away from private equity.

But institutional investors are piling into private equity and hedge funds, getting raked on fees. Smart pension funds prefer going direct in private equity. Below, listen to Jim Leech, President and CEO at the Ontario Teachers' Pension Plan discuss private equity with CNBC's David Faber and Andrew Ross Sorkin.

Good interviews except I caution investors, take things Jim Leech says with a grain of salt. First, Teachers' has been successful in private equity because Claude Lamoureux, the former CEO, got in that asset class early, way before everyone else. Second, past performance in private equity is not indicative of future performance. Third, while Teachers' does do a lot of direct investments, it's mostly co-investments, not "head-to-head" competition with PE funds which Jim claims. Fourth, just like other pension funds, Teachers' does not report the returns of the fund investments separately from those of their direct investments, so we can't really gauge how good their direct team is relative to PE funds.

If they really are "just as good as PE funds", they too would be charging 2 & 20, becoming stinking rich. Not that Teachers' doesn't pay them well. Their senior managers were the first to profit from bogus benchmarks in private equity and made a killing in the process, a point which irritated Claude Lamoureux when I pointed it out to parliamentarians at pension hearings in Ottawa (truth always stings, especially when it comes to pension compensation).

Having said this, I like what Jim Leech says about staying put in terms of private equity allocation, stating they are "comfortable where they are" (roughly 11%). And he's right, if you can hire the right people and pay them properly, direct investing and co-investing are the way to go because you cut outrageous fees and develop talent internally. Also, listen carefully to his comments on using a realistic discount rate in valuating liabilities and on compensation at Wall Street "creeping up".