Friday, December 30, 2011

Did Pensions Get Clobbered in 2011?

William Selway of Bloomberg reports, U.S. State, Local Pensions Drop 8.5%:

U.S. public pension-fund assets fell in the third quarter by the most since 2008 as stocks sank amid concern that Europe’s debt crisis would curb economic growth, Census Bureau data showed.

Assets of the 100 largest public-worker plans decreased $237 billion, or 8.5 percent, from the prior quarter to $2.53 trillion by Sept. 30, the bureau said today in a report. It marks the first decline since the second quarter of 2010 and the biggest since the last three months of 2008, when holdings slid 13 percent during Wall Street’s credit crisis.

The setback may strain state and local governments that have set aside more money to cover retirement benefits. That’s pressured governments already coping with diminished tax collections and has propelled efforts to reduce benefit costs.

The asset decline was driven by losses in stock holdings, which slipped $134.7 billion to $769.6 billion, the Census Bureau said. The value of holdings of corporate bonds, U.S. treasuries, and international securities also fell.

The third-quarter (SPC) rout pushed the pensions’ assets back to where they were during the last three months of 2010, wiping out gains this year.

Markets Swinging

Pension funds typically count on earnings of about 8 percent a year to pay for promised benefits, which means they need more money to pour into their funds or to generate returns that will compensate for years when money is lost.

Fund overseers use accounting techniques to spread gains and losses over time. That prevents required contributions from swinging with changes in financial markets, though losses elevate required contributions over time.

U.S. stock markets have recovered some of the losses suffered during the third quarter as European authorities moved to ease strains on banks and countries in the euro currency zone. The Standard & Poor’s 500 Index has gained 11 percent since the end of September, recovering most of the 14 percent loss from the prior three months.

100 largest public pension plans see first asset declines in 5 quarters:

Total assets of the 100 largest public defined benefit retirement systems declined 8.5% in the third quarter, their first overall quarterly loss in more than a year, according to the Census Bureau.

he top 100 plans had total assets of $2.5 trillion as of Sept. 30, a 1.1% increase over the same quarter in 2010, but investment returns were negative for the first time since the second quarter 2010, with $198.6 billion in losses recorded in the third quarter.

The 100 largest public plans surveyed by the Census Bureau represent 90% of total public plan assets. This year, the summary included 81 state plans and 19 local plans, Erika Becker-Medina, chief of the Census Bureau's employment and benefits statistics branch, said in a telephone interview.

The overall decrease in assets over the previous quarter was largely because of investment losses, with a 14.9% drop in corporate stocks and a 14.2% drop in international securities. Corporate bonds decreased 8.6% and federal government securities decreased 2.4% in the same period.

According to census data, the 100 largest plans have 30.4% of their holdings in corporate stocks, followed by 17.7% in international securities, 15.7% in corporate bonds, 7% in federal securities, 4.1% in cash and short-term investments, 0.4% in mortgages, and 0.1% in local government securities, with the remainder in other securities and alternative investments, including private equity and mutual funds.

“While this is just a snapshot in time, volatility like this is something that pension funds have to worry about,” Kil Huh, research director for Pew Center on the States, said in a telephone interview.

Assets of major public pension funds fell 8.5% in third quarter:

The stock market's summer slide took a toll on public pension funds, with the assets of the 100 largest ones down 8.5% in the third quarter, according to the Census Bureau.

The quarterly decline was the first since early last year and the steepest since the fourth quarter of 2008, when the asset total plummeted 13.5% at the height of the global financial crisis, the bureau said Wednesday.

The latest drop brought the value of investments and cash held by the biggest pension funds — including the California Public Employees' Retirement System, the California State Teachers' Retirement System and the Los Angeles City Employees' Retirement System — to $2.5 trillion at the end of September, down $236.6 billion from the end of June.

Driving the decline was a 14.9% slide in the funds' corporate stock holdings, which at last count represented 30.4% of the funds' assets.

The pension fund numbers reflect the performance of financial markets in the third quarter, when stock prices worldwide tumbled from the intensified European debt crisis.

The Dow Jones industrial average dropped 12% in the three-month period. But stocks have rebounded since the end of September, and pension fund holdings probably have bounced back as well.

Indeed, stocks and corporate bonds have rebounded and pension fund holdings have bounced back. Also, keep in mind that pensions invest in government bonds as well as private markets like real estate and private equity where market values are less volatile.

But not all investments fared well against the major indexes. In particular, it was a tough year for hedge funds, many of which are still on the ropes. The long and short of Long/Short funds and most hedge funds is that they sell beta as alpha. Period. This is why I've been urging pension funds to rethink their hedge fund strategy and consider following the real smart money and seeding some emerging managers in liquid strategies that offer true alpha.

Importantly, all pensions should allocate a minimum of 2% into emerging hedge fund manager platform using a solid managed account platform which provides them with transparency/liquidity and risk controls. Seeding hedge funds isn't as risky as people think, especially if it's done properly.

More worrisome, pensions that are piling into hedge funds, getting raked on fees, still do not understand what they are getting in terms of returns. They blindly accept some monthly NAV as if it's gospel! This last point was underscored by a contact of mine at Phocion Investments, an investment performance consulting firm that services the investment management industry:

"...We got some leads and spoke to a few offices, but what we are realizing is that this industry is clueless and is very slow in accepting change and being accountable. Even the offices who invest with external manager accept what the managers given them without any scrutiny. We found major risk in pension funds that invest in alternative assets, they are very comfortable in reveiving a monthly NAV without asking any questions on what's included in the NAV, who prepared it and so on..."

Most pension funds are absolutely stupid and clueless when it comes to investing in hedge funds. All too often, they are intimidated by charismatic managers who use "sophisticated" lingo to try to impress or intimidate unsuspecting pension fund managers.

I'll never forget my due diligence experience with some of these charlatans. It took me less than 15 minutes to figure out Norshield was a Ponzi scheme. Johnny "X" (John Xanthoudakis) walked into the boardroom sporting a tan, wearing a fancy Italian suit, smiling with his bleached white teeth, flaunting his "incredible risk-adjusted returns," a perfect 45 degree line. When I told him they are "too good to be true," he asked me if there was anything he could do to "facilitate an investment" (code for "how much to bribe you?"). That meeting was over fast. Amazingly, municipal pension plans in Quebec invested hundreds of millions in this joke of an outfit (too many of them are on the take; you better believe it is time to take action on municipal pensions).

I also dealt with my share of arrogant assholes in the hedge fund industry. Guys like "von Muffins" (our pet name for him) who was threatening us that if we do not invest with him, we will "never have access to his fund". Or another condescending jerk who was talking down to me telling me "Soros taught me risk management, you guys don't get it" to which I replied "is that why Soros fired you?" (don't ever get cute with me in a meeting, I'll rip your balls off and shove them down your throat!).

Anyways, back to 2011. It was an extremely tough year because of the macro environment and endless political dithering in Europe. Volatility minced returns and this might be a harbinger of things to come as machine readable news take over markets. Pensions and other institutions will need to adjust to this changing landscape.

Below, I leave you with a clip of NYSE COO Larry Leibowitz discussing new ways to police an automated market (ie. maintain the status quo). I also embed a clip of the best and worst CEOs of 2011 (h/t, Jack Dean). No question about it, John Corzine was definitely the worst, but along with Jeff Bezos, I would have put Steve Jobs as one of the best. In the pension fund industry, I know who I would nominate as the best CEO for 2011 and the last decade. Will close out the year tomorrow.

Thursday, December 29, 2011

Winning the Battle at Princeton?

Michael Lewis, author of my favorite book on Wall Street, wrote an interesting comment for Bloomberg, Princeton Brews Trouble for Us 1 Percenters:

To: The Upper Ones, From: The Strategy Committee, Re: The Alarming Behavior of College Students

The committee has been reconvened in haste to respond to a disturbing new trend: the uprisings by students on elite college campuses.

Across the Ivy League the young people whom our Wall Street division once subjugated with ease are becoming troublesome. Our good friends at Goldman Sachs, to cite one example, have been forced to cancel their recruiting trips to Harvard and Brown. At Princeton, 30 students masquerading as job applicants entered a pair of Wall Street informational sessions, asked many obnoxious questions (“How do I get a job lobbying the U.S. government to protect Wall Street interests?”), rose and chanted a list of charges at bankers from JPMorgan and Goldman Sachs, and, finally, posted videos of their outrageous behavior on YouTube.

The committee views this latter incident as a sure sign of trouble to come. The whole point of going to Princeton for the past several decades has been to get a job at Goldman Sachs or, failing that, JPMorgan. That Princeton students are now identifying their interests with the Lower 99 percenters is, in its way, as ominous as the return of the Jews to Jerusalem.

Having fully investigated the incidents in question, we are now prepared to offer strategic recommendations. Going forward all big Wall Street banks, when visiting college campuses, should adopt the following tactics.

No. 1. Send only women. You may not have fully understood why you hired them in the first place, but now is their moment to shine. For some time now the standard recruiting mission has included at least one woman and one person of color, to “season” the sauce. But typically, in the interests of keeping it “real,” there has been on the scene at least one white male recruiter.

Anyone who studies the Princeton-JPMorgan video will see that we can no longer afford to keep it real. The camera passes forgivingly over the JPMorgan women -- the viewer feels sorry for them, for some reason -- and comes to rest on the lone white Morgan man. The viewer doesn’t feel sorry for him. Get him out of there. Now.

No. 2. Having identified your female employees, gather them together to explain that they have no obligation to justify your behavior, even to themselves. They shouldn’t give college students the satisfaction of thinking that you have devoted so much as a passing thought to the following subjects: Why it is OK for Wall Street banks to create securities designed to fail; why it is OK for them to game the ratings companies; why it is OK to get paid huge sums of money while working for companies rescued, and still implicitly backed, by the U.S. government; why it is OK to subvert attempts by politicians to reform the financial system?

Avoid taking questions from college students. For that matter, avoid engaging them in substantive conversation of any sort. Your women need to shift the conversation from content to form. They must say things like, “I don’t mind what you are saying, I just mind how you are saying it.” And “I don’t understand why you can’t treat other people with respect.”

They must cast themselves not as extensions of a global financial empire but as guests. Everyone at Princeton can agree that it is wrong to be rude to ladies on a visit.

Happily, many Princeton students, hiding behind aliases, have already taken up this cry on campus websites. Encourage those who still want to work for big Wall Street banks to blog and post our new defense. Don’t offer jobs to these students who agree to help, however. They are better suited to being Wall Street customers than Wall Street bankers.

No. 3. Focus on what actually angers these angry young people, rather than what they say angers them. The character of Princeton students didn’t change overnight; what changed is their circumstances. They think they are pissed off at us because of what we did. They are actually pissed off at us because we can no longer afford to hire them all. To that end ...

No. 4. Engage, quietly, with the ringleaders. Of course, all variations of the Occupy movement claim to be leaderless. We on the committee aren’t buying this. With the possible exception of Bank of America, there is no such thing as a leaderless organization, only organizations in which the leaders operate in the shadows.

Sources inside inform us that one of the leaders of the Princeton-JPMorgan protest -- the young man who led the so- called “mic check” -- is a comparative literature major named Derek Gideon. Sources further indicate that for his senior thesis Mr. Gideon is writing -- get this -- a poem.

This poem of his apparently leaves him with a great deal of time and energy to stir up trouble.

“My goal is to change the dominant campus culture,” he has been quoted saying, “the culture that assumes that going to work for Goldman Sachs and JPMorgan is the most prestigious thing you can do, without having any critical sense of their current role in society. We’re very privileged to be here. We’re getting an incredible education. All just for us to be sending 30 percent, 40 percent of our graduates to the finance sector?”

Unsurprisingly, Mr. Gideon doesn’t know precisely what he is going to do with his life after he graduates. This young man strikes the committee as an ideal candidate for a job at Goldman Sachs. Yes, in our experience, even the Gideons of this world can be persuaded. After all, what better way for him to improve our behavior than to become one of us? Put that way, he almost has an obligation to take his natural resting place among us.

As awkward as it is to find ourselves in a war with students inside our own trade schools, we cannot simply cease to deal with them. After all, many are our own children. Disinheritance is messy. And, anyway, what’s the point of winning the estate-tax battle if we have no heirs?

More important, the students at Ivy League schools are our most devastating ammunition in this looming cultural war. They show the Lower 99 that today’s economic inequality isn’t some horrible injustice but a financial expression of the natural order of man. The sort of people who become Upper Ones are inherently different from the sort of people who become Lower 99s. The clearest sign of this inherent difference is that we begin our adult life by getting into places like Princeton.

Win the battle at Princeton and we might still win this war.

When I was studying economics at McGill University, I joined McGill's United Nations Club. We traveled to Princeton, Harvard, Yale, UPenn and Columbia to debate these Ivy Leaguers. It was fun, especially when we kicked ass. We saw firsthand the privileges of being part of the top 1%.

I remember bunking at dorms, sleeping on couches in our sleeping bags. If we were lucky, we got beds. It didn't really matter, it was the experience of traveling to these campuses and meeting and debating with their best and brightest that we loved. I'll never forget how some of the students proudly displayed pictures of them shaking hands with Bill Clinton or Ronald Reagan.

This is what being part of the top 1% means; it gives you access to the top political and financial power brokers. At the time, I was very impressed, but later in life I realized these poor Ivy Leaguers were being indoctrinated into a corrupt system of power and deception. A lot of them probably ended up lobbying Congress, serving their money masters. I can assure you, differential accumulation was never part of their curriculum, and still isn't.

But perhaps a great awakening is finally taking place at these prestigious universities. Maybe students are realizing that there is more to life than wearing pinstripe suits, collecting outrageous bonuses, snorting cocaine, sleeping with prostitutes, drinking themselves into oblivion to ease their emotional distress as they shamelessly scam the system and wreak havoc on the real economy. I am of course, somewhat facetious, but the reality is working on Wall Street isn't all that it's cracked up to be. Take it from my humble father, a psychiatrist with over 40 years experience, when it comes to money and sex, "only too much is enough" (famous quote from John Updike).

The battle at Princeton will be a long and arduous one, but one that will hopefully knock some sense into banksters who take reckless risks, profiting from money for nothing and risk for free. Below, I leave you with the video of Princeton students disrupting a JP Morgan recruiting session (h/t, Embargo Zone). Also embedded trailers from Inside Job, Capitalism: A Love Story and Frontline's Inside the Meltdown. If you've never seen these documentaries, watch them this holiday season.

Wednesday, December 28, 2011

Differential Accumulation and Threat of War?

My good friend Jonathan Nitzan sent me a paper he wrote with Shimshon Bichler on Differential Accumulation:

The Flip-Flops of Oppressive Tolerance

Early in 2011, we received a surprising invitation from the Financial Times Lexicon. A reader had suggested that an entry on differential accumulation be added to the Lexicon, and the online content developer asked us if we would be willing to write it.

Our first thought was that this must have been a mistake. The FT speaks for capital. Like all mainstream financial media, its theoretical-ideological baseline is staunchly neoclassical (plus ‘distortions’ to account for the disobedient facts). Occasionally, it allows the odd piece by a soft-Keynesian, but that tends to be the far-left marker. Rarely if ever would you read in this newspaper a real critique of capitalism, let alone one that goes to the root (unless you include in this category Op-Ed pieces by Wall-Street-warriors-turned-social-activists and other converts specializing in the ‘social justice’ niche). All things considered, it wasn’t the natural outlet for our analysis of dominant capital, modes of power and strategic sabotage. Not by a long shot.

So how did we get invited?

Simple. The content editor received a request for an entry on ‘differential accumulation’. Naturally, he didn’t know what the term meant, so he searched it on Google and found The Bichler & Nitzan Archives. At that point, he should have taken the time to read a bit. Had he done so, he would have realized that this was the wrong subject to pursue. But slaving for the FT, he had already seen it all. He knew all the tricks of self-promotion, all the ways of making banality look like novelty, all the paths to a reinvented wheel. There was nothing Bichler & Nitzan, whoever they were, could possibly teach him. So instead of reading, he passed the buck and asked us to write the entry. It wasn’t too much of a risk. If the piece ended up being a misfit, he could always flip-flop and refuse it.

We knew all about such flip-flops. Over the years, we have received enough invitations-turned-rejections to work out the template. The cycle typically comprises three stages. It begins with our receiving an enthusiastic, flattering letter asking us to make an original contribution. It continues with a steady stream of encouragements and inquiries about delivery time. And it ends with a prolonged silence, after the editor realizes he got more than he had bargained for: a piece too creative for its own good and clearly unfit for print.

Still, the invitation was tempting. This was not some obscure academic journal, or a marginal newspaper. It was the Financial Times Lexicon. Posting a permanent entry there could help us present radical ideas to a very large conservative audience. And the time seemed right. As one FT writer put it, the ongoing crisis has robbed capitalists of their ‘intellectual compass’, and intellectual confusion often opens the door for radical alternatives. Maybe this was our chance?

We decided to test the water. We asked the content developer how long the article could be: ‘as long as you wish’, he replied (virtual bytes cost nothing). We inquired whether we could incorporate figures and charts: ‘yes’, he said (visuals always sell well). We emphasized that our entry would offer a new approach: he had no objection whatsoever (tomorrow it will be flushed down with the rest of yesterday’s news). He did warn us, though, that the FT does not pay for contributions: we never thought of asking for money (suckers). The whole exchange seemed amicable, and the content developer was encouraging, even enthusiastic. And besides, we had nothing to lose but our chains.

We worked on the piece, and the content editor, fulfilling his role in the script, kept sending us encouraging queries. By the end of March, the piece was completed, and we delivered it safely to the FT. The editor replied promptly, promising to examine it ‘as soon as he can’. And then he fell silent. Ten days later, having heard nothing, we wrote to inquire. The editor apologized for not writing. He was ‘busy’ and would reply ‘as soon as he can’. Another two weeks passed, and we sent another email. It was a ‘busy time again’, we learnt, but the editor promised to look at the definition in the ‘next couple of weeks’. Those two weeks came and went, and when the silence persisted, we sent another friendly query. This time, the reply was automatic: the editor was out of the office. We waited patiently for the standard two-week period and wrote again. The editor, forever polite, apologized. He needed more time – but not to worry, he would definitely get back to us ‘within the next two weeks’.

We were getting ready for yet another two-week period, but then we noticed that there was a footnote to the email. The content editor must have realized we weren’t getting the message, so he decided to be a bit blunter: ‘Please note that some of our FT readers do not speak English as a first language, so definitions must be clear’.

And then it dawned on us.

The problem wasn’t our ideas. It was our words: they were simply too complicated. Power, sabotage, dominant capital, and differential accumulation – these are difficult words. They challenge one’s worldview. They rattle the mind. They can even make you think. And that, the content developer insinuated, is not what we need in our Lexicon.

What we need are clear words. Conventional words. Words like ‘free competition’, ‘productive investment’, ‘profit maximization’, ‘deregulation’, ‘efficient markets’ and ‘sound finance’. Words that can help us standardize the FT readership. That is what we need.

And so, we lost our chains and set our article free. You can read it below, with no FT strings attached.

I invite my readers to read their excellent short paper on differential accumulation by clicking here. Jonathan and Shimshon are two of the smartest political economists in academia but they will never win any Nobel prize for their work (not that they care). Intelligent money managers like George Soros will find tremendous value in their work (Jonathan used to be an Associate Editor at BCA Research working on emerging markets; unlike many economists, he knows all about how markets really work).

Let me go over a few key passages below. On the institution of capital, they write:
Capitalization represents the discounting to present value of risk-adjusted expected future earnings, and each of its symbolic components – the expected future earnings, the risk that capitalists associate with these earnings, and the normal rate of return that they use to bring them to present value – is a manifestation of organized power.

The primacy of power, say Bichler and Nitzan, is built into the concept of private ownership. The very concept implies exclusion and deprivation. In this sense, private ownership is a negative, not a positive, entity. It is based not on the ability to produce, but on the capacity to incapacitate. It is wholly and only an institution of exclusion, and institutional exclusion is a matter of organized power. Of course, exclusion does not have to be exercised. What matter here, argue Bichler and Nitzan, are the right to exclude and the ability to exact pecuniary terms for not exercising that right. This right and ability are the foundations of accumulation. They enable capitalists to profit greatly from mismanaging the world’s ecosystem, from making society more unequal and from blocking the development of humane alternatives – and to do all that under the guise of ‘scientific management’ and the ‘efficient allocation’ of resources.

Capital, Bichler and Nitzan claim, is nothing but organized power. This power, they say, has two sides: one qualitative, the other quantitative.
The qualitative side comprises the many institutions, developments and conflicts through which capitalists constantly creorder – or create the order of – their society; that is, the processes through which they shape and restrict the social trajectory in order to extract their tributary income. The quantitative side is the universal algorithm that integrates, reduces and distils these numerous qualitative processes down to the monetary magnitude of capitalization.
In order to understand capitalism, you have to understand how organized power serves the interests of the elite few. And as we all know, absolute power corrupts absolutely. But according to Bichler and Nitzan, power is never absolute; it’s always relative:
For this reason, both the quantitative and qualitative aspects of capital accumulation have to be assessed differentially, relative to other capitals. Contrary to the claims of conventional economics, say Bichler and Nitzan, capitalists are driven not to maximize profit, but to ‘beat the average’ and ‘exceed the normal rate of return’. Their entire existence is conditioned by the need to outperform, by the imperative to achieve not absolute accumulation, but differential accumulation.

And this differential drive is crucial: to beat the average means to accumulate faster than others; and since the relative magnitude of capital represents power, capitalists who accumulate differentially increase their power (to emphasize, for Bichler and Nitzan capitalist power relates not to the narrow neoclassical notion of ‘market power’, but to the broad strategic capacity to inflict sabotage).

The centrality of differential accumulation, claim Bichler and Nitzan, means that the analysis of accumulation should focus not only on capital in general, but also and perhaps more so on dominant capital in particular – that is, on the leading corporate-state alliances whose differential accumulation has gradually placed them at the centre of the political economy.
Bichler and Nitzan plot the differential accumulation of dominant capital in the United States since 1950 but note the following:
This measure, though, significantly underestimates the power of dominant capital. Note that the vast majority of firms are not listed. Since the shares of unlisted firms are not publicly traded, they have no ‘market value’; the fact that they have no market value keeps them out of the statisti-cal picture; and since most of the excluded firms are relatively small, differential measures based only on large listed firms end up understating the relative size of dominant capital.

In order to get around this limitation, Bichler and Nitzan plot another differential measure – one that is based not on capitalization but on net profit – and that measure includes all U.S.-incorporated firms, listed and unlisted.

As expected, the two series have very different orders of magnitude (notice the two log scales). But they are also highly correlated (which isn’t surprising, given that profit is the key driver of capitalization). This correlation, say Bichler and Nitzan, means that we can use the broadly based differential profit indicator as a proxy for the power of dominant capital relative to all corporations. And the result is remarkable. The data show that during the 1950s, a typical dominant capital corporation was 2,586 times larger/more powerful than the average U.S. firm. By the 2000s, this ratio had risen to 22,097 – nearly a ninefold increase.
That last figure is an eye-opener. The paper ends with a discussion on Middle-East energy conflicts, a subject that might be a dominant theme in 2012:
Bichler and Nitzan’s research offers various historical studies of differential accumulation in which they examine the quantities and qualities of capital as power. One of these is their work on the Middle East. Figure 5 (above) shows the differential performance of the world’s six leading privately owned oil companies relative to the Fortune 500 benchmark. Each bar in the chart shows the extent to which the oil companies’ rate of return on equity exceeded or fell short of the Fortune 500 average. The gray bars show positive differential accumulation – i.e. the per cent by which the oil companies exceeded the Fortune 500 average. The black bars show negative differential accumulation; that is, the per cent by which the oil companies trailed the average. Finally, the little explosion signs in the chart show the occurrences of ‘Energy Conflicts’ – that is, regional energy-related wars.

Now, conventional economics, say Bichler and Nitzan, has no interest in the differential profits of the oil companies, and it certainly has nothing to say about the relationship between these differential profits and regional wars. Differential profit is perhaps of some interest to financial analysts, and Middle-East wars are the business of experts in international relations and security analysts. But since each of these phenomena belongs to a completely separate realm of society, no one has ever thought of relating them in the first place. And yet, these phenomena, argue Bichler and Nitzan, are not simply related. In fact, they could be thought of as two sides of the very same process – namely, the global accumulation of capital as power. They point to three remarkable relationships depicted in the chart:
  • First, every energy conflict was preceded by the large oil companies trailing the average. In other words, for an energy conflict to erupt, the oil companies first had to differentially decumulate – a most unusual prerequisite from the viewpoint of any social science.
  • Second, every energy conflict was followed by the oil companies beating the average. In other words, war and conflict in the region, which social scientists customarily blame for ‘distorting’ the aggregate economy, have served the differential interest of certain key firms at the expense of other key firms.
  • Third and finally, with one exception, in 1996-7, the oil companies never managed to beat the average without there first being an energy conflict in the region. In other words, the differential performance of the oil companies depended not on production, but on the most extreme form of sabotage: war.
That last one should make us pause and reflect on the state of the world today and whether or not we are on the verge of another "extreme form of sabotage," ie. war. I thank Jonathan and Shimshon for their thought provoking analysis and hope my readers will take the time to read their excellent paper. Below, Ted Rall on RT discussing how US trajectory on Syria 'a self-generating path to war'.

Tuesday, December 27, 2011

Dangers Of Machine Readable News?

Themis Trading reports on the dangers of machine readable news (h/t, Jack Dean at Pension Tsunami):

The above chart is not the May 6th flash clash. It is an intraday chart of Constellation Energy from yesterday. If you ever wanted an example of how machine readable news and trading bots can wreck a stock in a matter of minutes, then look no further than the above chart. Let’s reconstruct the events as they happened:

11:58 – Headline crosses that “US sues to block Excelon acquisition of Constellation Energy “. CEG is trading at $38.93 at the time of headline.
12:03 – CEG is halted due to a circuit breaker popping when the stock drops 10%. CEG last trade before the halt was $35.03
12:08 – CEG reopens and shoots straight back up to $38 on heavy volume.
12:10- Headline crosses saying “US settles with Excelon”

In the time span of 12 minutes, two distinct headlines ripped a stock up and down 10%. Some may say that the circuit breaker did what it was supposed to do and “allowed cooler heads to prevail”. And they would be partially correct. But the question remains, how does a stock drop that quickly and spring back up that quickly? The news was barely disseminated and the stock had already dropped 10%. Bids disappeared almost instantaneously and no doubt stop-loss orders kicked in. Volume weighted participation algos also no doubt chased the spike down as volume soared in the 5 minutes of trading before the halt.

The way this news was released is also very questionable. To announce a lawsuit and then a settlement 12 minutes later is not fair to investors. The companies involved should have requested a trading halt prior to the news announcement. But the fact remains that the news was disseminated immediately to the trading bots since it is now available in machine readable format. There was no time for a human to intervene to try and make sense of these headlines. The trading bots that subscribe to machine readable news services interpreted the news as bad and pulled out of the market. It is kind of ironic that earlier in the week Nasdaq announced that they bought a machine readable news company named RapiData. The WSJ said that “such machine-readable news is used by sophisticated trading firms that pull in signals from market prices and other sources to inform rapid-fire buying and selling of securities and derivatives contracts.” They described Rapidata as:

RapiData packages and sends out figures from the U.S. Bureau of Labor Statistics and Treasury Department, according to the company. Staff enter data into RapiData’s systems, which check figures for accuracy and disperse them electronically when the government sends out the figures on its own. The firm uses high-speed fiber optic corridors and strategically placed servers that communicate the figures to trading systems in sub-second speeds. Such machine-readable news is used by sophisticated trading firms that pull in signals from market prices and other sources to inform rapid-fire buying and selling of securities and derivatives contracts.”

Not only do we now have a market that can whip stocks up and down 10% at the flicker of a headline, but now we have an exchange that is getting into the business of machine readable news. What ever happened to the real function of an exchange? Aren’t exchanges supposed to treat all investors fairly? Are exchanges that desperate for revenue that they have to get into the shady business of machine readable news so that they make sure that their best customers continue to have an advantage over everybody else? Maybe the demutualization of exchanges was not such a good idea after all. Their constant quest for profit places them in a conflicted position and makes their ability to treat all investors fairly very difficult.

Have to tell you, the above chart is the number one reason why I do not place tight stops or get too cute when I trade. In fact, I hardly ever day trade and have held onto positions that went 30% or 60% against me and eventually made a profit. Why? Because I knew that the stock was being manipulated by high-frequency trading (HFT) platforms and added to my position at the right time (traders will tell you never add to a losing position but that is total bullshit! Sometimes you're better off backing up the truck and going in heavy in one position!).

These markets dominated by HFT platforms can wreak havoc on any portfolio. The only way you can beat computers is by not playing the losing game of over-trading. Sure, some traders are good at it but most of them eventually get slaughtered.

Go back to read Niels Jensen December Absolute Return Letter where he recommends the following:

Prohibit high frequency trading (HFT). HFT uses powerful computers and sophisticated software to take advantage of microscopic inefficiencies in markets around the world. HFT models will often sell a security within a few milliseconds of having bought it. Does that add any economic value to financial markets? I don’t think so. Does it create unwarranted volatility occasionally? I very much believe so. Although I am not in favour of the much discussed financial transaction tax proposed by the Germans and the French, ironically, a modest transaction tax (if it were global) would wipe out all HFT based strategies, and the world would be a better place as a result.
The reality is that many pension funds allocate money to hedge funds that engage in HFT. But pensions should also have internal teams set up to profit off these whacky movements in stocks. It's not hard to pinpoint them.

On any given day, I can spot weird moves in the stock market and if I had deep pockets of a pension fund, I'd jump on these opportunities every time these high-frequency crooks manipulate stock prices.

You might be asking what regulators are doing about this nonsense. Absolutely nothing. There are powerful interests (ie. banksters and hedgies) who want to continue ripping off clients and scamming the system. They claim to be providing more liquidity but the opposite is true. And the SEC is bent on covering up Wall Street crimes. All they need to do to stop these HFT shenanigans is reinstate the uptick rule. Watch clip below from a CNBC interview done earlier this year.

Monday, December 26, 2011

US Economy, a Bubble About to Burst?

Jim Rogers, CEO, Rogers Holdings, feels that the US economy is a bubble which would burst at some stage. He added that his view is bearish on emerging markets, including India. Watch the interview here or just watch it below.

I like Jim Rogers, and agree with him, ignore ratings agencies, they are bad for your financial health. But he is totally wrong on the US economy, it remains and will remain the most important economy for many years and only those who believe in the myth of decoupling think otherwise. And US bonds, the most misunderstood asset class, will do just fine. No bubble there either.

I am increasingly optimistic on the US economy which is clawing back from the devastating effects of the housing meltdown and the ensuing 2008 financial crisis due to credit derivatives based on toxic mortgages. Employment gains are meager but they will pick up in 2012 as confidence creeps back into the economy.

Will there be other bubbles? You bet there will. In a world where banksters get money for nothing and risk for free, there will be a series of bubbles but you will never know about it until it is well underway. The only thing I can guarantee you is that these markets, like all markets, are driven by greed and fear, and that sooner or later one of these collective emotions will win the upper hand.

And what about Jim Rogers' call on agricultural commodities and silver? I don't have an issue with these calls but keep in mind he has vested interests in playing up commodities. Also, commodities are related to bigger emerging markets story, and are vulnerable to the Risk On/ Risk Off trade which dominated markets in 2011.

Bottom line: Listen to Jim Rogers below but keep in mind that Rogers, Soros, Dalio and other well known investors are no match for central banks. When they pump up the jam, stocks will take off in a huge way. The big theme going forward will be to forget euro woes and realize that the stock market rocket has already lifted off. Focus on La Dolce Beta and pay attention to what elite funds are doing, not what some are saying on television or on Zero Hedge!

Sunday, December 25, 2011

Merry Crisis, Happy New Fear?

Celebrating Christmas in Montreal with my humble father who recently turned 80 and close friends, but miss rest of my family in Athens, Greece, especially my three musketeers above. Nothing brings me more joy than spending time with them.

Below, a Christmas message from Athens showing us the true meaning of Christmas. And while Athens is making due with next to nothing, in Montreal we are wasting taxpayers' money clearing imaginary snow (watch clip below, h/t, Jason) Only in Quebec! That would make a fantastic scene to a sequel from my all-time favorite French comedy, Le dîner de cons (watch trailer below). Think I am going to watch it again, need a good laugh this time of year.

Wish all of you a Merry Christmas, Happy Holidays and a Happy, Healthy and Peaceful New Year. Don't worry, 2012 won't be the end of the world, and we will move past eurofatigue. Keep buying the dips and remember, it's all about La Dolce Beta! Enjoy your holidays, don't overeat, drink too much or else you'll regret it. -:)

Saturday, December 24, 2011

Volatility Minces Returns?

Beverly Goodman at Barron's reports, Volatility Minces Returns:

Where have all the stockpickers gone?

Even John Paulson has apologized.

It's no secret that 2011 was a tough year. But investors who sought refuge in hedge funds—especially those thought to excel in choppy markets—were sorely disappointed. Not to mention none the richer.

As of Nov. 30, the 2,000 hedge funds tracked by Hedge Fund Research are down, on average, 4.5%, trailing the Standard & Poor's 500 by almost four points. "This is only the third year since 1990 that the hedge-fund index has ended on a decline," says HFR president Ken Heinz.

The news is a little better on an asset-weighted basis, which weights the bigger funds more, so it is a better measure of how most investors did. On this basis, the HFR index is down 1.84%, which, of course, still trails the S&P. In case you are thinking this means bigger is better when it comes to hedge-fund investing, don't bust out your checkbook yet. Hedge-fund titan Paulson, in an apology to investors that spread like wildfire, called 2011 "the worst in the firm's 17-year history." His Advantage Plus fund was down 44% through the end of October.

Parsing the data doesn't make everything look prettier. Broadly speaking, the worst-performing hedge-fund strategy was long/short equity—a strategy many investors assumed would save them from market volatility. Long/short equity funds were down 7.15% for the year, compared with the S&P's loss of 0.85%. Yet investors poured $2.7 billion into the strategy in the third quarter alone, even as it was suffering $51.3 billion in performance-based losses.

"It's definitely been a challenging year for those funds," Heinz says. "2011 was a year in which the macro overwhelmed the micro. There was so much uncertainty." Over time, Heinz says, long/short equity is the best-performing strategy. But that may not do much to calm whipsawed investors.

"There's been political paralysis in Europe and the U.S., which isn't OK. So every bit of news sends the market rocketing in either direction," says David Sherman, president of Cohanzick Management, which oversees $325 million, including a long/short hedge fund. "That's why we reduced our shorts and moved to cash. It just got too hard." Sherman's tiny $60 million fund is up 3% for the year.

The dispersion between the best and worst performing hedge funds has widened as well. The top 10% of the best-performing funds returned an average of 28.3% in the year ending Sept. 30, while the bottom 10% lost almost as much, 24.17%, in the same period.

The best-performing strategy barely nudged into positive territory. Relative value arbitrage funds eked out a 0.33% gain as of Nov. 30.

Unhappy investors are catching a break on fees, though. That 2-and-20 standard—the 2% of fund assets charged in management fees and the 20% in profits siphoned off as an incentive fee—seems to be shrinking, at least for new funds. Average management fees for funds launched in the past 12 months (ending Sept. 30) declined to 1.58%, a drop of three basis points over the same period in 2010. (A basis point is one-hundredth of a percentage point.) Similarly, average incentive fees for funds launched in the past 12 months declined to 17.04%, more than 100 basis points lower than the average of funds launched in 2010. Lower fees help, but aren't exactly the reason investors give their money to hedge funds.

Alpha falling by the wayside was a big theme in 2011, not just for hedge funds but for the whole money management industry. Hedge funds, however, charge much higher fees, which is why they are singled out when they grossly underperform.

The article above also shows you the discrepancy between the performance of top hedge funds and the average hedge fund. This hardly surprises me as top funds have deep pockets and are able to attract top talent. But keep in mind, emerging managers are also performance driven, which is why I've been urging institutional investors to rethink their hedge funds strategy and start seeding hedge fund managers, especially here in Canada.

Below, Peter Henry, head of senior trader recruiting at Commodity Search Partners, talks about the movement of commodity traders from banks to hedge funds and the impact of financial regulation on compensation and the ability to trade. Henry speaks with Lisa Murphy on Bloomberg Television's "Street Smart."

Friday, December 23, 2011

Supreme Court Grinches Steal Christmas?

The Supreme Court of Canada dropped the ball, once again. Drew Hasselback of the Financial Post reports in the Montreal Gazette, Supreme Court rejects national securities regulator plan:
The federal government's ambitious plan to set up a single national securities regulator has been dealt a severe blow by the Supreme Court of Canada, which ruled Thursday that Ottawa's proposed legislation is unconstitutional.

In a ruling that is bound to disappoint Ottawa, Ontario, and several business groups, the Supreme Court held that oversight for the investment industry fits squarely within the "property and civil rights" powers that are assigned to the provinces by the Constitution Act of 1867.

Ottawa had tried to claim control over the securities business by invoking its regulatory power over trade and commerce, but the Supreme Court ruled that the federal government's plan overstepped the constitutional boundaries that case law has erected over time to prevent Ottawa from overusing that power.

In the unanimous decision, which was released by the court and is therefore not attributed to any specific judge as author, the court says Ottawa's planned approach would dive too deeply into the day-to-day operations of the securities industry, which are contractual in nature and therefore fit squarely within the provincial power over property and civil rights.

Yet the ruling does suggest that it would be possible for both levels of government to seek "common ground" and share oversight of securities, with the provinces able to look after the day-to-day aspects of the industry and the federal government able to keep an eye on systemic risk.

"While the proposed act must be found ultra vires (beyond) Parliament's general trade and commerce power, a co-operative approach that permits a scheme that recognizes the essentially provincial nature of securities regulation while allowing Parliament to deal with genuinely national concerns remains available," the court's written 64-page written ruling states.

Finance Minister Jim Flaherty introduced the Proposed Canada Securities Act in May 2010. The federal government's plan called for the provinces to voluntarily join a scheme that would gradually transfer regulation of securities to a single national regulator from the current patchwork of 13 provincial and territorial securities commissions.

The federal proposal is too heavy handed and upsets the existing constitutional balance that exists in the division of powers, the court said.

"Co-operation is the animating force. The federalism principle upon which Canada's constitutional framework rests demands nothing less."

The court's reasoning strictly adheres to previous court rulings and treats the question before the court as a legal problem, not a policy one. It applied a five-step test from a 1989 decision called General Motors that sets out the boundaries for the federal government's trade and commerce power. The essence of the test is to determine whether the federal government seeks to oversee something that would be beyond the ability of the provinces to regulate on their own.

For generations, previous court rulings have confirmed that securities oversight was a provincial competence under the "property and civil rights" provisions of the Constitution.

Indeed, provincial courts of appeal in Alberta and Quebec have previously concluded that Ottawa's planned legislation is constitutionally out of bounds. Alberta's Court of Appeal last March ruled 5-0 that Ottawa lacked the power to regulate securities, while Quebec's court in early April rejected Ottawa's plan in a 4-1 ruling.

In a decision that reiterates long-held constitutional boundaries, the nine Supreme Court judges unanimously confirmed that Ottawa's legislations fails the constitutional test.

Josh Rubin and Les Whittington of the Toronto Star report, Concerns and praise meet Court’s decision against national securities regulator:

Investors are more vulnerable to corporate fraud, Canadian companies will have a harder time raising money and the financial services industry in Toronto will be less competitive thanks to a Supreme Court of Canada decision nixing the federal government’s plan to create a national securities regulator, critics say.

In a 7-0 ruling, the Supreme Court said Thursday that the government’s proposed legislation was an unconstitutional infringement on provincial jurisdiction, but left the door open for a more cooperative approach.

“While the economic importance and pervasive character of the securities market may, in principle, support federal intervention that is qualitatively different from what the provinces can do, they do not justify a wholesale takeover of the regulation of the securities industry.”

“It is a fundamental principle of federalism that both federal and provincial powers must be respected, and one power may not be used in a manner that effectively eviscerates another. Rather, federalism demands that a balance be struck, a balance that allows both the federal Parliament and the provincial legislatures to act effectively in their respective spheres,” the decision read.

It was a heavy blow for federal Finance Minister Jim Flaherty, who had sought the Court’s opinion on the legislation in 2010.

Flaherty said Ottawa will respect the Court’s opinion, but added in an official statement “it is clear we cannot proceed with this legislation.”

Prior to Thursday’s decision, the federal government had a very gun-ho attitude toward creating a national securities regulator. The court’s word was non-binding and if the justices had delivered a wishy-washy, debatable “no” verdict on the plan, Flaherty had planned to push ahead with the legislation anyway, sources said.

But the court’s unequivocal and unanimous rejection of the national securities regulator as unconstitutional has stopped Flaherty in his tracks.

While business representatives seized on the potential opening the court gave Flaherty to craft a role for Ottawa in national securities regulation in a more cooperative arrangement with the provinces, there was no talk of such a fresh approach in the disappointed halls of the finance department Thursday. “No one’s saying anything about next steps today,” an official said.

The debate over a national regulator is already in danger of being overtaken by the international nature of financial markets, according to Michael E. J. Phelps, who chaired a federally-appointed committee looking at the industry.

“Capital markets are increasingly integrated. It will be a struggle to even keep national regulation, let alone lower level jurisdictions,” said Phelps, whose 2003 “Wise Persons’ Committee” came out strongly in favour of a national regulator.

But opponents of a single regulator welcomed the decision.

“This is a victory of federalism against unilateralism,” said Quebec Finance Minister Raymond Bachand.

“It’s better to regulate from Manitoba than from Bay Street,” said Manitoba Finance Minister Stan Struthers in support of the court’s position.

In Ottawa, the New Democrats and Liberals said the court’s stance was proof the government was readying to trample on provincial rights.

Ontario Finance Minister Dwight Duncan said the Supreme Court decision is “not good” for securities regulation and Ontario will continue working with other provinces to find ways of making the system more efficient without a national securities regulator.

“Now we have to go back to the drawing board,” a disappointed Duncan told the Star, noting Toronto is home to the country’s largest stock exchange and headquarters for investment dealers. “Given we have such a large role in it, I think we’ll take a lead. The Supreme Court said this is up to governments to negotiate.”

While Ontario has supported Flaherty’s idea, six provinces — led by Quebec and Alberta — opposed a national securities watchdog on the grounds that it trampled on provincial rights under the Constitution.

Flaherty had argued that having 13 separate provincial and territorial securities agencies is inefficient, costly for business and fails to adequately protect consumers. That kind of patchwork approach is a problem, agrees Michael King, assistant professor of finance at the University of Western Ontario’s Ivey School of Business.

“Canada is one of very few countries without a national securities regulator. This has created loopholes that have been exploited by white collar criminals,” said King. “It seems absurd that we have national banks and national stock exchanges, but we have regulators that are regional.”

The lack of a single regulator, says King, could make it harder for Canadian companies to attract investment from outside the country, or that they’ll demand a higher return in exchange for the perceived risk.

A single regulator would also make it easier to stop problems that are national in scope, including the asset-backed commercial paper crisis which swept across the country in the wake of the 2008 collapse of Lehman Brothers, said Ian Russell, president of the Investment Industry Association of Canada.

“The asset-backed commercial paper problem was national. … The system we had didn’t do a great job at solving that,” said Russell, who was nonetheless encouraged by the Supreme Court’s suggestion that a collaborative approach by the federal government and the provinces would work.

“It sends a negative message to global investors,” said Janet Ecker, president of the Toronto Financial Services Alliance industry association.

The decision also means the loss of what would have likely been a sizeable Toronto office of the proposed regulator, says Ecker.

“It would have made sense to have had either the headquarters or the biggest office here,” said Ecker.

I am 100% behind Jim Flaherty, Canada needs a national securities regulator. The current arrangement is weak, leaving the entire country exposed and vulnerable to serious contagion risk. Ask David Dodge, the former governor of the Bank of Canada, about the pressure he received from Henri-Paul Rousseau, the former President & CEO at the Caisse, following the ABCP blow-up. A friend of mine saw a red-faced Rousseau at the lobby of Fairmont Royal York hotel in Toronto after tense meeting where the Bank of Canada basically told him to "fuck off" and clean up his own mess.

This country is a joke on so many levels, especially national secuirties regulation and white-collar crime. How do I know? My first job coming out of McGill was consulting the Special Investigations branch at Revenue Canada (now called the Canada Revenue Agency), producing a report on white-collar fraud in Canada. I was mandated to estimate the "size of the underground economy," which was totally stupid because you can't measure what you can't see.

I saw first-hand how they cut sweetheart deals to white-collar tax evaders and crooks. Unlike the US, Canada treats white-collar criminals with kid gloves. We simply are not doing enough to investigate, prosecute and protect our most vulnerable citizens. And while I welcome the new RCMP commissioner's tough stance on white-collar crime, the reality is he first needs to clean up that organization, targeting outrageous conduct. He should also investigate how the RCMP's pensions are managed and serious breaches of confidentiality (like the one I experienced).

One thing I did like about Canada's Revenue Agency is that they had some of the best certified fraud examiners in the country (do not know if that is still the case). These investigators are the best of the best. They've seen it all. I still remember guys like Ron Moore (now retired) who investigated thousands of fraud cases. He knew the legal challenges of prosecuting these crimes and so did Jeanne Flemming, my boss's boss at the time, now FINTRAC's director.

Back to the Supreme Court's decision. It might be legally right, albeit way too rigid, but it fails in so many respects to be the right decision for the collective interests of our country. That's why groups like CARP are not pleased with this decision and rightfully concerned. And unlike Supreme Court judges, most Canadians do not enjoy the benefits of gold-plated defined-benefit pension plans.

Finally, Mr. Bachand, Quebec's finance minister should be more concerned about the bureaucratic red tape imposed by the Autorité des marchés financiers which makes it next to impossible to set up a fund in this province (gross overreaction to Norbourg, Earl Jones and Norshield). That, and the fact that Quebec's financial institutions are not doing enough to seed and support money management funds, is why our investment industry has been steadily contracting over the last decade. Below, Global Montreal reports on this decision.

Thursday, December 22, 2011

2011, The Year of Stasis?

Kip McDaniel of aiCIO wrote an editorial comment, 2011, The Year of Stasis:

It is both cliché and seemingly essential in editorial circles to say that we (whoever ‘we’ are) are currently at an action-packed point in time where everything is changing and nothing is as it was 12 months ago. The reason for this is simple: Stasis does not move magazines off newsstands or entice advertisers to place ads in those magazines.

The people who run magazines, therefore, have a financial incentive to say capital is quickly changing hands (for every time capital changes hands, there is an opportunity for a magazine), regardless of the claim’s necessity or veracity—which makes the argument I’m about to force upon you somewhat at odds with my own self-interest.

The past year was essentially one of stasis in the pension/E&F/asset management industry. Yes, there were pockets of movement and change—Jeff Scott (formerly of the Alaska Permanent Fund) and Chris Ailman (of the California State Teachers’ Retirement System) changing the way their massive funds perceive asset allocation come to mind, as well as shifts towards tactical asset allocation strategies at some smaller pension funds and a slight increase in hedge fund usage industry-wide—but, by and large, 2011 was a year of “I know I should do it, I just can’t do it now.”

This is not the result of current chief investment officer/investment board laziness, lack of education, or poor judgment. This is a result of the remaining flotsam from the crisis of 2008. In November, I used the analogy of the Panama Canal to describe the current state of liability-driven investing (LDI). Here’s how it went:

On the Atlantic side of the Canal lays Colon, a port town known for violence and grit. Its coast is scattered with Panamax tankers waiting to make the Canal traverse. Three locks raise the ships up to the passage level—the Canal, although originally intended to be lock-less, was later created with locks due to the sheer scoop of such an undertaking. From there, the ships take eight hours to traverse the 48-mile stretch of windy waterway, their helm controlled by a special Canal pilot who knows the passage intimately. When it reaches Panama City—a rapidly modernizing town of 1.2 million—the ship descends another series of locks, exiting the Canal into the Pacific.

Applied to LDI, the analogy is simple. The ships bobbing in the Atlantic are those who failed to execute an LDI strategy before interest rates and assets fell in 2008; those in the Canal—and those lucky few who have passed fully into the Pacific—are those that extended duration and partially or fully immunized before the global economy was roiled. Extending the analogy, the ships in the Atlantic are exposed to rougher seas than those in the Canal, although those making the voyage are by no means safe from every danger; ships in the passage never turn around and exit the same locks they entered; and Canal ship captains can be equated to consultants, or specialized asset managers that aid those in passage.

Upon further reflection, this analogy can be applied to many issues beyond LDI. Whether it is pension buyins/buyouts, investment outsourcing, or moves into new strategies such as risk parity, there is a group of funds that made decisions before 2008, and, in this analogy, are either in the canal or have passed into the Pacific. For other funds—wracked by political upheaval (Think: San Diego County, many other public plans) and low funding ratios (across the board)—2011 saw them largely staying in the Pacific. Add in regulatory uncertainty, perhaps the largest contributor to stasis outside of low funding ratios, and you have multiple factors aligning against large, secular—and, I would argue, essential—changes in the institutional asset management space.

I will certainly take flak for claiming that stasis ruled the past year. Change is always happening, yes, but I would argue that right now it is happening only on the margin. We in the financial media have been arguing since the autumn of 2008 that the global financial crisis will fundamentally alter the way institutional assets are managed. We speak of LDI, general de-risking, investment outsourcing, risk parity, hedge-fund saviors, and a variety of other strategies that might amount to a secular alteration in this universe. But, I would argue, we have yet to really see large-scale movement. Funding levels are too low, markets are too flat, investment boards are too scarred by the crisis, and regulatory uncertainty is just too great.

For the sake of the institutional asset management world—and, it must be said, for the financial benefit of aiCIO and other industry publications—let’s hope I’m not writing the same column a year from now.

I agree with Kip, 2011 was mostly more of the same among large institutional investors. Most pension funds will claim they took "drastic actions" to curb risk and bolster asset allocation, but they're just tinkering at the margins.

What does more of the same mean for me? Piling into hedge funds and other alternatives, getting raped on fees, going for broke, claiming they are sophisticated when the opposite is true. Ultimately, these are losing strategies that won't make a difference in their severely underfunded plans. That's why all pension roads invariably lead to Rhode Island.

If pensions are going to seriously tackle their deficits, hard political choices need to be made, but above and beyond that, we need serious pension governance reforms to make pension fund managers and board of directors a lot more accountable for the decisions they take.

And pensions need to start thinking outside the box, rethink alpha and beta strategies. There are tons of opportunities for internal alpha and seeding external managers, especially in hot areas like commodities. Pension funds should fire their consultants and listen to me. I've seen it all, can smell bullshit from a mile away, if you want to keep sinking, stick to your losing strategies.

Finally, please read aiCIO's cover article, Is Ray Dalio the Steve Jobs of Investing? Large financial institutions need more Steve Jobs and Ray Dalios and less political weasels who practice cover-your-ass politics. This is the cancer destroying many institutions from within. I know this better than anyone else, which is why when I look at an organization, I look at the people first and foremost. People who are not afraid to be challenged, embrace and learn from failure, are what make the difference between an ordinary organization and an extraordinary one.

Below, Dyson founder and CEO Sir James Dyson, discusses making mistakes and doing things better. I also embedded a CNBC interview with Ray Dalio done earlier this year. Great entrepreneurs and great money managers know all about fighting stasis and always coming up with something better.

Wednesday, December 21, 2011

Clawing Back Wall Street Pay?

Donal Griffin of Bloomberg BusinessWeek reports, Tougher Wall Street Clawbacks Needed, NYC Comptroller Says:
New York City Comptroller John C. Liu, who oversees $108 billion in pension funds, said Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley should target senior executives’ pay to prevent improper or risky practices.

Liu filed shareholder requests with the three New York- based banks to toughen their so-called clawbacks, which allow the firms to reclaim pay awarded to employees who acted improperly. The lenders, which now limit clawbacks to individual wrongdoers, should target supervisors as well, Liu said in a statement today. The city’s pension funds held $483.3 million in shares of the firms through Dec. 19, according to the statement.

Perverse incentives and bad compensation practices helped cause the financial crisis by encouraging Wall Street employees to disregard risk in the pursuit of profit, according to a study last year by the Council of Institutional Investors. Liu targeted the three firms as they have each paid more than $100 million over the past 18 months to settle charges of improper conduct tied to mortgage-backed securities.

“No one should profit or be rewarded with bonuses when engaged in improper or unethical behavior,” Liu said in the statement. “These tougher clawback provisions will not only recover money that shouldn’t have been paid in the first place, but also set the tone for a stronger standard of conduct for company executives as well as their bosses.”

‘Material’ Losses

JPMorgan, the biggest U.S. bank, and Goldman Sachs, the fifth-biggest, only try to recoup executive compensation after “material” losses, which creates “unrealistically high legal and financial standards,” Liu said. The proposal would delete the word “material” from the requirement, according to the statement. The two firms as well as Morgan Stanley, the sixth- biggest U.S. bank, should make any clawback actions public, according to the proposals.

Goldman Sachs, led by Chief Executive Officer Lloyd Blankfein, agreed to pay $550 million in July 2010 to settle regulators’ claims it misled investors in products tied to subprime mortgages. JPMorgan agreed to pay $153.6 million to settle a similar suit in June. Morgan Stanley agreed to pay $102 million in June 2010 to settle claims by Massachusetts that the firm financed and securitized unfair residential loans.

Jeanmarie McFadden, a Morgan Stanley spokeswoman, declined to comment on the comptroller’s request, as did David Wells at Goldman Sachs and Howard Opinsky at JPMorgan.

Paul Hodgson at Forbes expressed his opinion, Clawing Back Wall Street Pay:

It is comforting that the New York City Comptroller is calling for tougher clawbacks to be applied to Wall Street pay. The Press Release gives a great deal of detail about the resolutions that have been filed at Goldman Sachs, JPMorgan and Morgan Stanley, including the full text of one of the proposals itself. In short, the Comptroller, John Liu, is calling for changes to existing clawback arrangements as follows:

Increase executives’ accountability
Goldman Sachs’ and JPMorgan’s current clawback policies only hold executives responsible for “material” losses, creating unrealistically high legal and financial standards for clawback actions. The proposal asks the word “material” be stricken from the two firms’ clawback policies in order to lower this barrier that protects executives from being held accountable. Morgan Stanley’s existing clawback policy does not include the “material” hurdle so this request is not part of the proposal filed at that firm.

Hold supervisors responsible for bad behavior
Current policies at the three firms limit clawbacks to employees who take excessive risks or engage in improper or unethical conduct. Under the current system, a senior executive can benefit when a subordinate engages in improper conduct that generates profits in the short-term, but that ultimately causes financial or reputational harm to the firm. The proposal seeks to eliminate this perverse incentive.

Disclose clawback actions
The proposal asks that the three firms’ clawback policies be amended to require disclosure of any decision by their boards on whether or not to recoup executive compensation. Currently, they do not have to make clawbacks decisions public.

Global governance research firm GMI has been collecting data on clawback policies at all companies since 2006 when firms began to adopt these policies voluntarily. Since then, of course, they have been mandated by the Dodd-Frank bill, though the SEC has not implemented the rule as yet. In addition, all the banks had to implement clawback arrangements under TARP regulations, though some, like JPMorgan, already had policies in place. For example, according to GMI almost two-thirds of the S&P 500 have some form of clawback policy, though few, if any, will be as strict and wide-ranging as those put forward by Mr. Liu.

As I said, it is comforting to see these proposals being put forward at the banks, and the immediate cause of the proposals – the fact that the three banks have recently paid out more than $100 million in fines to settle charges in connection with their engaging in fraudulent practices surrounding mortgage securities investments.

$100 million between the three banks?

About the size of a decent bonus for any of the CEOs prior to 2008, so hardly much of a dent in each of the banks’ finances.

“No one should profit or be rewarded with bonuses when engaged in improper or unethical behavior,” Comptroller Liu said.

But the fact is, they already have done, and, while laudable, this initiative is – if you’ll forgive the resort to the proverb – closing the barn door after the horse has bolted. Hardly more than a handful of individuals, really, despite the mountains of evidence collected by the feds, has got into any kind of serious trouble and, as far as I know, none have had to pay much of their bonuses back. Yet every single one of the executives at these banks have received stock and cash as incentives that were based, at least in part, on earnings and income that turned out to be illusory.

Never mind clawing back the bonuses, these executives should be trampling over each other to voluntarily return at least a portion, if not all, of the incentives they earned for a fair number of years prior to the debacle in 2008. So should every individual that was involved in packaging and selling CDOs and credit default swaps or who was responsible for anyone that was involved, so, basically, every single executive. If they just got on with it then, apart from the money it would save the authorities not having to prosecute them, the goodwill (my middle name by the way) it would generate would go a long way to restoring trust in the financial system.

Zuccotti Park is not too far from Mr. Liu’s office.

Poor banksters, not only are they being vilified by Main Street, now some pension funds are demanding clawbacks on their bonuses. 2011 has certainly been a tough year. But never to be outdone, banksters are fighting back, joining billionaires to debunk ‘imbecile’ attack on the top 1%. And no matter what happens, they can still profit from money for nothing and risk for free. Yes folks, don't worry, in this world, banksters take it all.

In all seriousness, what banks really need is good old alignment of interests. Buffet and Soros know all about alignment of interests. In fact, all corporations need radical reforms to achieve better alignment of interests at the executive level and so do private and public pension funds. If you want to talk clawing back pension pay, have I got a book for you!

Below, Liam Dalton, chief executive officer at Axiom Capital Management Inc., talks about hedge fund investment strategies. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday." It seems that hedgies are turning more bullish. Maybe they finally woke up and realized that the biggest tail risk in 2012 is a good old fashion melt-up. Just remember who uttered the words "Houston, we have liftoff" first. Unlike banksters, I don't get money for nothing and risk for free, but am beautifully positioned for La Dolce Beta! Ho! Ho! Ho! Merry Christmas!