Wednesday, February 29, 2012

"Gordon Gekko" Geldof Praising Private Equity?

Greg Roumeliotis and Simon Meads of Reuters report, "Gordon Gekko" Geldof praises private equity:

Sporting what he joked was his "Gordon Gekko" shirt, Irish rock star Bob Geldof cut an unlikely private equity figure on Wednesday as he exalted the industry's virtues and urged top financiers in their annual gathering to invest in Africa.

Speaking for an hour without notes at the SuperReturn International conference in Berlin, Geldof made an impassioned address peppered with expletives designed to tug on heartstrings but also appeal to private equity's profit-making instincts.

"You must go and kick the tires. You are the guys who go where capital needs to go. Capital will only go where it is sent," Geldof said, stretching out his arms as if to reach his audience of private equity executives.

"Do we leave this vast continent, with all the resources we will ever need, do we leave it to China? Eight miles from Europe, do we just leave it to them?" he asked, referring to the distance across the Strait of Gibraltar separating Spain and Morocco.

Geldof first became famous as the frontman of Irish punk rock group The Boomtown Rats, but his work on Africa has overshadowed his early rock career, with his name forever tied to the Band Aid single and Live Aid concerts that raised millions of dollars for African aid.

He is now the chairman of an Africa-focused private equity fund which said earlier this month it had raised $200 million from investors, close to half its targeted size of $450 million.

Dubbed 8 Miles, the fund plans to invest in companies that can develop into "African champions" in sectors such as agribusiness, telecoms and consumer goods.

"We put together our little thing - a goldilocks thing, not too small, not too big, just right. And we will make a lot of money, a lot. For me I want to leave behind me firms, farms, factories. Fuck the money, that's me," Geldof said

RATE OF RETURN

The fund is promising investors an internal rate of return of over 25 percent after a year in which the S&P 500 U.S. stock index was flat and investors are hungry for yields they cannot find in listed equities and bonds.

"He is so right, Africa has great potential, and he was really good in his presentation," said Wael O. Bayazid, a managing director with private equity firm Carlyle Group LP, which is raising a sub-Saharan African fund.

Private equity is often criticised for saddling companies with debt only to sell assets, shed jobs and take out profits -- an image which has not helped the U.S. Presidential candidacy of Mitt Romney, a former private equity executive.

"I have learned that private equity, contrary to the Romney-esque debate in the United States at the moment, can be a major vehicle for positive change in this world," Geldof said.

Geldoff referenced the big payday of some of private equity's titans, including Henry Kravis and George Roberts, who got $94 million each in 2011 from buyout firm KKR & Co LP , in also making a wider case for philanthropy.

"You have got the four houses, the three jets, the 10 cars, the 65th fucking Picasso. What's the point? So its stuff, and right now it's the stuff that will get us out of that mess," Geldof said.

Geldof is right about making the wider case for philanthropy. The FT reports that Stephen Schwarzman, the Blackstone chief executive, took home $213.5m in pay and dividends in 2011, a third more than the year before and topping the scale for a select group of the founders of listed private equity companies. He should follow the lead of Blackstone's co-founder, Pete Peterson, and learn the meaning of enough.

As far as praising private equity, more and more are reporting on its critical role for the economy. The Dealbook examined the myths surrounding private equity by revisiting the top 10 leveraged buyout deals. Some deals were good and others, like the $45 billion acquisition of the Texas energy giant TXU — the biggest leveraged buyout in history — has been a painful investment for its private equity owners.

Some industry experts, however, are warning that buyout firms face extinction in fight for funds:

Private equity firms looking for billions of dollars of new capital for deals are facing a fight for survival in the hunt for a diminishing pool of capital - and losers risk a slow death.

Fundraising has been subdued since the credit crisis. In 2011, private equity firms raised just $263 billion for deals, less than half the $600 billion they pulled in every year at the peak of the buyouts boom.

Massive inflows of capital and benevolent financing markets fuelled a spate of mega buyout deals including TXU, Alliance Boots and Hilton Hotels from 2005 through to 2008.

But risk aversion, a lending freeze and economic woes have drastically reduced investors' appetite to fund new deals.

Though worst fears about a wave of defaults have not materialized, the performance of companies bought out during the boom period has been patchy and firms face a long slog to get their money back on many of the largest deals.

"In Europe, probably more so than in the rest of the world, the amount of funds raised will be substantially lower. My guess is probably a third of what was raised in the boom times," Guy Hands, chairman and chief investment officer of Terra Firma, told the SuperReturn private equity conference in Berlin on Wednesday.

BC Partners last week said it had raised 6.5 billion euros for its latest buyout fund, more than originally expected. But the environment is fiercely competitive.

Apax, Permira, Cinven, KKR, Warburg Pincus, and Providence are all looking to raise multi-billion euro pools of capital.

Others including Advent International, PAI, Triton and Guy Hands's Terra Firma are tapping investors, or will do soon, for funds of a couple of billion euros or more.

DARWINIAN SELECTION

At the beginning of 2012, buyout firms were seeking $177.4 billion, a 81 percent increase on the amount they were after at the beginning of 2011, according to Preqin data.

This means the time taken to raise funds is getting longer as investors become pickier and demand more information before taking the plunge. Blackstone Group LP took four years to raise $16.2 billion for its latest buyout fund, BCP VI.

Many had predicted a bloodbath in the private equity industry, with large numbers of firms forced to the wall given the financial crisis, but few have vanished yet because the long life cycles of private equity funds make firms slow to kill.

European buyout firm Candover was a notable exception in vanishing quickly. Those that have had poor performance or prove unable to adapt to a new market may struggle to raise capital, but they will not necessarily vanish overnight, industry insiders say.

"They won't die a spectacular death, but most will just become moribund," said Helen Steers, head of European primary investments at global fund investor Pantheon. "Is that a bad thing? No, it's just Darwinian."

British mid-market firm Duke Street pulled its planned 850 million euro fundraising having secured only a fraction of its target. Instead, it will look to raise money for individual deals as it sells investments and returns cash to investors.

However, investors say that can spell the beginning of the end.

Firms that raise money for individual deals can be less nimble when it comes to pursuing acquisitions as the capital is not instantly at their disposal. And they face the prospect of losing their top talent to rivals, losing investors' trust.

"(Firms) may come back if they keep a team together. General partner continuity is probably the first thing on investor's due diligence list - if the people that did the deals are no longer around it raises warning flags," said David de Weese, partner at Paul Capital, a firm that specializes in buying investors participations in private equity firms.

A lot of attention in the industry has focused on Terra Firma, which battled hard to keep control of music group EMI, but eventually lost it to its creditor Citigroup.

Hands said he was "100 percent confident" that Terra Firma would raise a new fund, but asked about the size of that pool of capital he joked: "That's what I'm less confident on."

"I think a lot of private equity firms will inevitably disappear over time. But it is going to take some time, it is not going to be quick."

"As Darwin said it is not the survival of the strongest, its the survival of the most adaptable," Hands said.

Survival of the most adaptable is indeed the case. Reuters reports that bosses of some of the world's largest private equity groups told the industry's annual get-together that their growth into alternative asset managers, investing in everything from credit to real estate, was necessary for their investors to beat the economic cycle:

Private equity, one of the alternative asset classes offering diversification from stocks and bonds, has traditionally been about leveraged buyouts - where the buyer funds the purchase price through borrowing, using the target company's assets as collateral.

But tighter financing conditions have restrained this kind of financial engineering and investors accustomed to double-digit percent returns in private equity have had to settle for outperforming public markets by only a few hundred basis points.

Financial industry titans, who have amassed vast fortunes by buying and selling companies, said the best opportunities now lay in cherry picking the offerings of major asset managers.

"Buyouts, which is what people normally think of when they think of private equity, are going to be an increasingly small part of a more specialized product base available to the limited partner community," James Coulter, co-founder of TPG Capital LP, told the annual SuperReturn International conference in Berlin on Tuesday.

Many major buyout firms have developed funds for investing in other alternative assets.

These include corporate debt, real estate, infrastructure, hedge funds and venture capital. They have grown to such an extent that in many of the major firms they have collectively overtaken private equity in assets under management.

Where are PE funds looking to invest? Reuters also reports that private equity firms stand to benefit from the misfortunes of Europe's major telecom operators as they snap up mobile assets being sold off by incumbents who need to pay down debt and focus on their core markets.

Where else are PE Funds focusing their attention? Below, Bloomberg's Cristina Alesci reports on private equity firms watching the energy sector for deals. Cheniere Energy Partners LP,operator of the largest U.S. natural gas-import terminal, said Blackstone Group LP agreed to invest $2 billion toward construction of a $10 billion plant to export the fuel. She speaks on Bloomberg Television's "Money Moves."

Hedge Funds Back in the Balance?

Pension Funds Insider reports, Hedge funds back in the balance for pension fund trustees:

A Deutsche Bank survey indicates that pension fund trustees are becoming increasingly sure of the merits of hedge fund investing, despite a disappointing year for the industry's returns.

The firm's annual international survey of hedge fund investors found that only 16% of respondents cited trustees and their boards' views on hedge funds as the biggest impediment to further increasing their hedge fund portfolios, down significantly from 30% in 2011.

The same survey indicated that 38% of investors trustee boards strongly believe in the validity of hedge funds as an investing tool.

That is an increase from 25% fully-fledged hedge fund fans in 2011, which Anita Nemes, Deutsche Bank's global head of capital introduction and report author, explained to Pension Funds Insider was most likely due to experience and the growing institutional offering that hedge funds provide.

The survey reinforced the much noticed institutionalisation of the hedge fund industry. This has been a clear trend since the financial crisis as hedge funds become increasingly appreciative of the advantages of attracting stable long-term investment from pension funds and other institutional investors.

Over one-third of this year's survey respondent were end institutional investors (excluding fund of funds, many of which are also institutional) compared to 11% in 2002.

Nemes told Pension Funds Insider that hedge funds are "an active way of managing risk rather than just another asset class. Anybody with a funding gap will want to invest in dampening volatility and protect from the downside".

The number of investors who said that 30 percent or more of their managers have not reached the high watermark has doubled.

Nemes said that performance and better risk adjusted returns continue to be the main benefit of hedge fund investing, therefore its critical the industry has good performance in 2012.

For many observers performance worries remain a big caveat to the increasing flows of pension money into the industry.

Nemes said "performance will never go out of fashion of course. The only reason anyone invests in a hedge fund is that they are looking for better returns."

Nemes believes that consolidation in the hedge fund industry is likely in the next year. It seems that could be given extra momentum by a wide variation in returns.

She doesn't share concerns about large hedge funds being naturally poorer performers than smaller ones, saying "size can be a problem as it's difficult to be nimble with huge numbers of assets but if you look at the industry on the whole you really can't generalise – some large hedge funds produced fantastic returns last year."

With 80% of institutional investors responding to the survey admitting to have increased their hedge fund investments over the past year, there looks likely to be rich pickings for those hedge funds able to thrive and expand in the current environment.

Strangers no more

A further indication of the increasingly pivotal role played by institutional investors like pension funds in the hedge fund industry is that pension fund trustees now largely see eye-to-eye with star hedge fund managers when it comes to the vital issue of transparency.

70% of respondents to the Deutsche Bank survey say they are satisfied with transparency. Nemes said: "That number used to be much lower and I think that is because hedge funds have become a lot more open, but a lot of pension funds are perhaps also realising what data it is they really need from a hedge fund they invest in."

Nemes said pension fund trustees might have begun to accept that there is no point always asking for full position level disclosure from a hedge fund and are instead focusing on understanding where their returns come from with profit and loss attributions and risk analytics.

Nemes added: "Pension funds are OK in paying two and twenty for alpha but they are not happy with paying two and twenty for beta so they want to be reassured on that."
Not happy paying 2 & 20 for beta? That's exactly what most pension funds are doing at a time when most hedge funds are drowning in high water hell.

As far as position level transparency, most pension funds don't want it because of liability issues. Moreover, even if they had it, they wouldn't know what to do with it. Sophisticated pension funds in Canada and elsewhere are opting for position level transparency, using a managed account platform, exercising full control over the portfolio. But they are the exception to the rule. Most pension funds just write a big check and accept the NAV that hedge funds send them along in their monthly commentary.

All this talk of risk transparency is fluffed up nonsense. Any pension trustee that accepts this garbage deserves to get their hand handed to them.
It's great for lazy pension fund managers who want to appear like they are managing risk of their hedge fund portfolio but it's utter nonsense. Risk transparency means nothing unless you have it real time and can act on it quickly. Remember the flipside of transparency is liquidity. You can have all the transparency in the world but if you can't act on it, it's useless.

As far as large hedge funds, there is a placebo effect. Some of them are performing exceptionally well while others are grossly underperforming. Bloomberg reports, Dalio Earned Clients $13.8 Billion to Lead Hedge Funds as Paulson Slumped:

Ray Dalio’s Pure Alpha hedge fund made $13.8 billion for its investors last year, while John Paulson lost clients almost $10 billion after an unsuccessful wager that the U.S. economy would recover, according to a report by LCH Investments NV.

Pure Alpha, part of Dalio’s Bridgewater Associates LP, has earned $35.8 billion for investors since its inception in 1975, said LCH, a firm overseen by the Edmond de Rothschild Group. Losses for New York-based Paulson & Co. last year cut gains the firm has made for clients since its 1994 founding to $22.6 billion, LCH estimated.

Dalio’s Pure Alpha II ran up a 23.5 percent gain in the first 10 months of the year. The manager, 62, had three of the industry’s 12 best-performing funds, Bloomberg Markets reported in its February issue. The firm charges 2 percent of assets as a management fee and gets 20 percent of profits.

Bridgewater, based in Westport, Connecticut, has about $120 billion of assets and uses a macro strategy to try to profit from economic trends. It placed diversified bets in 2011 after predicting a flight by other investors to safer assets such as U.S. Treasuries and German bonds, standing out in a year when hedge funds lost 5.2 percent on average, according to data compiled by Bloomberg. Paulson posted a record loss of 51 percent in one of his biggest funds.

“Macro investing is notoriously difficult, but the best managers are able to find opportunities, especially in troubled markets,” London-based Rick Sopher, LCH’s chairman, said in the report. Funds lost a net $123 billion, LCH estimated.

Brevan Howard

Macro hedge funds lost 7 percent last year, according to Bloomberg data.

LCH’s research on the 10 most profitable hedge funds ever shows such firms earned clients a net $3.1 billion in 2011. Other money-making hedge funds on the list included Brevan Howard Asset Management LP’s Master Fund with $3.2 billion of gains and Baupost Group LLC with $400 million. Brevan Howard, based in London, was co-founded in 2003 by former Credit Suisse AG trader Alan Howard, 48, and Seth Klarman, 54, founded Boston- based Baupost in 1983.

LCH said its analysis of how much hedge funds made for investors after charging performance and management fees is based on discussions with the funds, audited reports issued by the firms and confidential sources. The total typically includes a manager’s investment in his own firm.

Funds that lost money last year include Paulson with $9.6 billion, George Soros’ Quantum Fund with $3.8 billion, David Tepper’s Appaloosa Management LP with $800 million and Louis Bacon’s Moore Capital Management LLC with $300 million, according to LCH’s estimates.

‘An Aberration’

Paulson, who made billions of dollars betting against the U.S. housing market in 2007, remains the third-most profitable hedge fund manager ever after rivals at Bridgewater and Quantum, according to LCH.

“Our performance in 2011 was clearly unacceptable,” Paulson, 56, wrote in a letter sent this month to clients. “We took too much equity exposure and lacked sufficient hedges to mitigate the market volatility. However, we believe 2011 will be an aberration in our long-term performance.”

Caxton Associates LP and Thomas Steyer and Andrew Spokes’ San Francisco-based Farallon Capital Management LLC didn’t make or lose any client money last year in their main funds, LCH’s data show. Soros, 81, decided last year to return all money to outside investors. Bruce Kovner, 67, Caxton’s CEO and founder, retired in 2011 from the New York-based firm, which is now managed by former Goldman Sachs Group Inc. trader Andrew Law.

SAC Capital

New to LCH’s list of the most profitable hedge funds through 2011 is Steve Cohen’s SAC Capital Advisors, which has made $12.2 billion for clients since inception in 1994, according to LCH. SAC, based in Stamford, Connecticut, replaced Edward Lampert’s ESL Investments Inc. of Greenwich, Connecticut.

Below is a list of how much money clients have made investing in top hedge funds since inception. The data are provided by LCH Investments NV.

Hedge Fund                 Net Gains           Year Founded
Bridgewater Pure Alpha $35.8 Billion 1975
Quantum Endowment Fund $31.2 Billion 1973
Paulson & Co. $22.6 Billion 1994
Baupost $16 Billion 1983
Brevan Howard $15.7 Billion 2003
Appaloosa $13.7 Billion 1993
Caxton Global $13.1 Billion 1983
Moore Capital $12.7 Billion 1990
Farallon $12.2 Billion 1987
SAC $12.2 Billion 1992
Take this list with a grain of salt. I can tell you even though they're great hedge funds, the one large fund I would invest in above all of these at this point of the cycle is Ken Griffin's Citadel Advisors whose main funds have fully recovered after losing roughly 50 percent during the financial crisis, and will again be able to charge performance fees.

When a large hedge fund comes back from a beating like that, it tells me a lot. Despite getting clobbered in 2008 when liquidity dried up, they hunkered down and focused on delivering performance for their clients and recovered quickly by reading these markets carefully and taking intelligent risk (you also have to understand why they lost so much money; if you were patient enough, you made it all back).

Importantly, a great hedge fund manager knows how to come back stronger after posting losses. This is true of Ray Dalio, Ken Griffin, Louis Bacon and others. Even the best of the best have difficult years.

Right now, billions are being shoved into hedge funds. The mania has started all over again. Citing another survey, Reuters reports that hedge fund assets may hit $2.1 trillion in 2012:

Hedge fund assets under management could reach $2.13 trillion at the end of the year, as investors put more cash into the industry and managers report positive returns, a survey conducted by Credit Suisse (CSGN.VX) showed on Monday.

The survey, which covered more than 600 institutional investors representing $1.04 trillion of hedge fund assets, found that investors expect their hedge fund portfolios to return 8.6 percent in 2012, down from 11 percent last year.

This positive performance, together with new investor cash, means the sector will grow by around 12 percent from a year earlier -- adding about $200 billion worth of assets.

"Institutional investors remain positive on hedge funds and on the outlook for further industry growth. They continue to look to hedge funds to generate uncorrelated returns and to reduce overall volatility within their portfolios," Robert Leonard, managing director and global head of capital services at Credit Suisse said.

The survey also asked investors, which include pension funds and family offices, their preferred strategies for 2012.

More than a quarter of respondents said global macro funds, which make calls on global economic events with bets on bonds, currencies, commodities and equities, would be the best performers, while 19 percent selected long-short equities and 18 percent emerging markets, the survey showed.

Global macro, where the likes of industry giants Brevan Howard, Moore Capital and Tudor Investment operate, is also the most sought-after strategy for 2012.

This is ahead of computer-driven funds that bet on futures markets, known as Commodity Trading Advisors, and fixed income arbitrage strategies, which wager that tiny price dislocations in bond markets will correct themselves, and was one of the few sectors to finish last year in the black.

"One of the big bugaboos for investors was the high degree of correlation between long-short (managers) and equity benchmarks," Leonard said.

CTA and macro funds generally provide less correlation with wider equity markets.

Concerns that hedge funds, which generally charge higher fees than long-only managers, are overly correlated with each other is also the biggest risk facing the industry, the polled investors said, ahead of sovereign default risk and counterparty concerns.

Asia and emerging markets are the two most popular areas for hedge fund investments, the survey showed, while investors plan to cut their holdings in European-focused strategies as the region's debt crisis threatens more volatility.

Investors also expect a rise in the number of hedge funds that will merge or liquidate in 2012, although this will largely affect smaller managers that have failed to increase their assets to any significant size.

Despite many hedge funds performing poorly last year -- when the average fund lost close to 5 percent, according to industry tracker Hedge Fund Research -- only 5 percent of those surveyed by Credit Suisse expect funds will end the year in the red.

Global macro has always been popular but even more so now because of what is going on in Europe. It's scalable, liquid, and a handful of managers are exceptional. Having said this, I think investors will end up being disappointed with the returns of macro strategies going forward.

More worrisome, all this money 'chasing alpha' makes me very nervous. Most investors haven't the faintest idea about structuring their hedge fund portfolio and that will come back to haunt them when the next crisis hits.

Below, Ray Dalio's Pure Alpha hedge fund made $13.8 billion for its investors last year, while John Paulson lost clients almost $10 billion, according to a report by LCH Investments NV on the 10 most profitable hedge funds. Olivia Sterns reports on Bloomberg Television's "Last Word" with Andrea Catherwood.

Also, Bloomberg's Betty Liu reports on Citigroup's challenges in the hedge fund business since it bought CEO Vikram Pandit's Old Lane Partners in July 2007. She speaks on Bloomberg Television's "In The Loop." Read more about this story here.

'Mind-Blowing' Kickbacks at Pensions?

Robert Snell and Christine MacDonell of the Detroit News report, 'It just blows my mind,' a pension board trustee says of kickback probe charges:
Former City Treasurer Jeff Beasley was accused in a federal indictment Tuesday of accepting cash, golf clubs, gambling money, tickets to Las Vegas shows, massages, limousine rides and free flights in return for approving more than $200 million in pension fund investments.

Many of those deals fizzled, costing the pension funds more than $84 million, money that could have been used to pay for benefits of thousands of retired Detroit municipal employees.

Beasley, a fraternity brother of ex-mayor Kwame Kilpatrick at Florida A&M University, is portrayed as the gatekeeper to hundreds of millions of dollars controlled by the city's pension funds. Prosecutors allege he wielded power over people and businesses seeking investments from the Police and Fire and the General Retirement pension funds because he sat on both boards and was a fundraiser for the mayor's personal charity, the Kilpatrick Civic Fund.

"I had no idea the kind of money and the kind of things they said he was getting," said George Orzech, a trustee on the city's police and fire pension board. "It just blows my mind. It's sad. That was a dark time in the pension board history."

In several cases, Beasley supported multimillion-dollar loans to businesses that allegedly contributed cash to the mayor's charity, according to an indictment unsealed Tuesday. Beasley also allegedly asked business people to provide private flights for Kilpatrick, his wife Carlita, his father and others to Bermuda, Las Vegas and Florida.

Those who contributed to the Civic Fund reportedly received tens of millions of dollars from the pension funds. One who didn't pay was fired and lost a lucrative contract, according to the indictment.

The 43-year-old Chicago resident is the first person charged in a long-running FBI probe of investments made by the pension funds and pay-to-play allegations.

Twin FBI investigations of City Hall corruption and pension fund wrongdoing have netted at least 18 felony convictions, including former Councilwoman Monica Conyers.

"This is another example of a once trusted public official abusing their power for personal gain," said Andrew Arena, the FBI special agent in charge of the Detroit office. If convicted, Beasley faces up to 20 years in prison. Charges in the six-count indictment include extortion, attempted extortion and conspiracy.

Beasley maintains his innocence, his attorney, Walter Piszczatowski, said.

"I think it's interesting that only one person from 10- and 11-member boards, respectively, got indicted," Piszczatowski said. "I haven't seen their witness list, but you can bet everybody who's testifying is looking for some type of deal."

The police and fire pension fund has fully cooperated with the federal investigation, said Sean Neary, the fund's chairman.

"We look forward to the speedy implementation of justice in these matters so we can move forward in conducting the people's business for all active and retired police and firefighters in this great city," Neary said in a prepared statement.

'Send me a love offering'

The indictment paints a picture of a brazen shakedown of people and companies seeking pension fund loans. Prosecutors allege the extortion happened at the height of the Kilpatrick administration in 2006 and continued into its dying days in September 2008, when Kilpatrick resigned under pressure amid the text-message scandal.

Beasley sat on two city pension funds as treasurer from 2006 until resigning in September 2008.

In August 2007, Beasley allegedly asked a businessman who worked for the police and fire pension fund's real estate consultant for a $15,000 donation to the Kilpatrick Civic Fund charity.

"Send me a love offering," Beasley said in a phone conversation, according to the indictment.

The consultant said no.

Two months later, in October 2007, Beasley and the pension board voted to fire the consultant after 17 years of service, according to the indictment.

In early 2007, Beasley voted in favor of investments totaling $20 million for a private equity firm. That summer, Beasley, his wife and children went on vacation in the Turks and Caicos Islands. The owner of the company reportedly paid for the trip and gave Beasley money for gambling and expenses, according to the indictment.

The indictment also wades into Beasley's personal life.

Several times, a businessman involved in a deal to buy General Motors parts warehouses reportedly paid for rooms at the Atheneum Suite Hotel in downtown Detroit for Beasley and his "paramour," according to the indictment. The businessman also allegedly paid for Beasley and the "paramour" to vacation in Miami Beach in March 2008.

Separately, Beasley is said to have asked a head of the police and fire pension fund's investment management company to hire his "paramour." The businessman complied, according to the indictment.

The Atheneum Hotel is co-owned by Greektown businessman Jim Papas, who has had pension fund dealings.

Invitation requires donation

The indictment includes thinly veiled references to other unindicted pension fund figures.

Ronald Zajac, the top lawyer for the city pension funds, is unnamed in the indictment. But dates listed in the indictment and pension fund meeting minutes indicate Zajac is "Attorney A," who is accused in the indictment of soliciting large cash gifts for Beasley and other pension fund members months before receiving a 33 percent pay hike.

The lawyer helped organize birthday parties at the Atheneum for Beasley in January 2007 and for two police and fire pension board trustees in August 2007, according to the indictment. Many of the guests were people with financial ties to the pension funds.

"In order to attend the party, these people were asked to donate large sums of cash for a birthday present," the indictment alleges. In all, Beasley received $10,000 at the birthday party.

At a second party in August 2007, two pension fund trustees received $5,000 each.

Based on meeting minutes, one trustee was Paul Stewart, the former vice president of the Detroit Police Officers Association.

Months after the party, Stewart and Beasley voted to increase Zajac's annual salary by more than 33 percent.

The pay hike request was surprising at the time, said Orzech, the police and fire fund trustee.

"That came out of the blue," said Orzech, who voted against the hike.

Zajac receives at least $18,445 a month from the police and fire pension fund, according to the fund's meeting minutes.

Zajac's lawyer declined comment. Stewart's lawyer did not return a phone message seeking comment.

"Send me a love offering," got to love that one. This is just another case of many which will surface over the next few years. As the FBI gears up for Operation "Perfect Hedge," they should read one of my classics, The Mother of All Stealth Scams, and start Operation "Pension Pilfer".

Below, the FBI says its probes of corporate criminals led to 241 convictions and $2.4 billion in restitution for financial victims last year as agents went after insider trading and other investment crime that defrauded thousands. If they think that's a lot of moolah, wait till they start probing pensions.

Tuesday, February 28, 2012

Greece Swallows a Bitter Pension Pill?

Elena Becatoros and Nicholas Paphitis of the Associated Press report, Greece approves tough salary, pension cuts:
Greece's Parliament late on Tuesday approved new cuts in public sector pensions and government spending required to secure a second package of international rescue loans.

Lawmakers voted 202-80 in favor of cutbacks worth a total euro3.2 billion ($4.31 billion) and aimed at bringing the 2012 budget back in line with targets. Lawmakers from both parties in Prime Minister Lucas Papademos' coalition, the majority Socialists and the conservatives, backed the legislation.

Earlier, the debt-crippled country's Cabinet decided to apply recent labor reforms, including deep cuts to the minimum wage, retroactively to Feb. 14.

Greece is obliged to adopt a series of austerity measures and reforms before it can receive any funds from its new euro130 billion ($174 billion) package of rescue loans from other eurozone countries and the International Monetary Fund.

The bailout, and accompanying bond swap deal with private creditors, are meant to save the country from a potentially catastrophic default in late March that could drag down other financially vulnerable countries and threaten the European Union's joint currency, the euro.

The rescue package is Greece's second in less than two years. The country has been surviving since May 2010 on funds from a first bailout from the eurozone and IMF, and has received euro73 billion ($98 billion) from the initially approved euro110 billion ($147 billion) package.

But more than two years of harsh austerity implemented to secure the rescue funds have taken a hefty toll on the recession-bound Greek economy, with businesses closing in the tens of thousands and unemployment at a record high 21 percent.

"It is dramatic to cut someone's pensions. ... But why do we have to take these measures? Because our budget is still running at a loss," Finance Minister Evangelos Venizelos said in Parliament. "We are still adding debt to our debt. And if we do not start to generate a primary surplus next year, that will be catastrophic."

The newly approved legislation imposes nearly euro400 million ($538 million) in cuts to already depleted pensions.

Health and education spending will be reduced by more than euro170 million ($229 million), subsidies to the state health care system will be cut by euro500 million ($673 million), and health care spending on medicine will fall by euro570 million ($767 million).

Furthermore, some euro400 million ($538 million) will be lopped off defense spending -- three quarters of which will come from purchases.

The law also revises the 2012 budget, changing the government deficit target to 6.7 percent of gross domestic product from an initial forecast of 5.4 percent.

Measures approved by Papademos' Cabinet earlier Tuesday include a 22 percent cut in the minimum salary, currently at euro751 ($1,010) per month, for private sector workers, and a 32 percent cut for workers under the age of 25, where the rate of unemployment is nearly 50 percent.

Limits also are being imposed on collective wage agreements and the process of labor arbitration, with some measures to remain in effect until overall unemployment falls below 10 percent.

Lawmakers are to vote again on Wednesday on another bill implementing cuts that have previously been announced.

The new wave of austerity measures have sparked widespread anger among a public that has seen its income and living standards drop with no clear end to the crisis in sight.

On Tuesday, about 100 uniformed police, coast guard and fire service unionists protested pay cuts outside Parliament, with a small group burning a wartime military German flag used in the Nazi era in 1935-1945. While Germany is a major contributor to both Greek bailouts, Berlin's insistence on an austerity-based cure for the country's financial woes has angered many Greeks.

Papademos, a technocrat heading Greece's temporary coalition government, is to head to Brussels for a meeting Wednesday with European Commission chief Jose Manuel Barroso.

Greece's European partners have been pressing the country to implement the measures it has already passed, after repeated delays and missed targets over the last two years eroded trust in the ability of Greece's politicians to stick to their pledges.

European Parliament President Martin Schulz was in Athens on Tuesday for a series of meetings, and he gave a speech in Parliament stressing that "Greece must remain in the euro."

"We must do everything we can to prevent the collapse of the euro," he said, adding that more emphasis must be put on measures to promote growth rather than only on cutbacks.

"A policy based solely on austerity spells economic disaster," he told Greek deputies.

"Budgetary prudence is certainly essential (but) ... there is too much focus on financial penalties and austerity packages," Schulz said, adding that economic growth could be stifled in many European countries.

"How are countries whose economies are at a standstill, which are facing a recession, supposed to pay off their debts? Greece has already paid a high price. It cannot go on paying," he said.

On Monday, the Standard & Poor's ratings agency downgraded Greece's credit rating to "selective default" over a debt writedown deal with private creditors that is an integral part of the second bailout.

The downgrade had been widely expected, as ratings agencies had said the bond swap with private creditors, which seeks to cut euro107 billion ($144 billion) off Greece's debt, would constitute a selective default. Once the swap is carried out next month, the agencies are expected to upgrade Greece.

Late Tuesday, the International Swaps and Derivatives Association said it has accepted for consideration a question relating to a potential credit event with respect to Greece. An ISDA statement said a meeting will be held at 1100GMT on Thursday to determine whether a credit event has occurred.

The decision by the New York-based trade association, which represents hundreds of banks and other companies, will ultimately determine whether the bond swap will trigger payment of insurance taken by investors against a Greek default.

I doubt ISDA will declare a credit event. Even if it does, who will make this a binding decision? In my opinion, all this talk of 'credit event' has been blown out of proportion (listen to interview below).

Greece is bankrupt, has been for some time now. It's not just financially bankrupt but morally bankrupt. My uncle reminds me that the crisis is more than just economic, it's social and moral. He's right. For years corrupt politicians, civil servants and business people milked the system for all they could and now all Greeks are paying a heavy price.

Below, Moorad Choudhry, head of treasury the corporate banking division at RBS , tells CNBC, "the markets seem to have subtly moved faintly positive that this latest euro zone bailout is a step in the right direction, so the sentiment has moved slightly from less negative to what it was pre the latest bailout, now looking at the long term Greece will need cash transfers for some time to come but for the time being it is going the way the euro zone politicians would like it to."


David Denison Retiring From CPPIB

Barbara Shecter of the Financial Post reports, David Denison stepping down as head of Canada Pension Plan Investment Board:

David Denison is stepping down as head of the Canada Pension Plan Investment Board on June 30.

He will be replaced by Mark Wiseman, 41, who is currently executive vice-president of investments at CPPIB, the investing arm of the Canada Pension Plan.

Mr. Denison, who turns 60 this year, informed the board of CPPIB in June of 2009 that he intended to retire in 2012. He has been chief executive and president since January of 2005.

Mr. Wiseman joined CPPIB that same year, making the leap from the Ontario Teachers’ Pension Plan. He has been responsible for CPPIB’s overall global investment programs, along with other responsibilities related to the organization’s long term strategy.

Mr. Wiseman earned both an MBA and a law degree from the University of Toronto, as well as a master’s degree in law from Yale University.

“I can think of no one better suited and able to lead this great institution through its next stage of growth and evolution,” Mr. Denison said.

The board of directors unanimously selected Mr. Wiseman to replace Mr. Denison, according to Robert Astley, chair of CPPIB’s board.

Mr. Wiseman praised his predecessor, and said he looks forward to “taking the helm at a time when CPPIB is playing an increasingly important role globally.”

David Denison did an excellent job while at CPPIB. A bit surprised he's retiring so young -- after all, he is only tuning 60 and still jogs 5 miles a day at the crack of dawn! (so I hear)

But the board picked an excellent candidate to replace him. Never met David Denison but have met and spoken with Mark Wiseman on a few occasions and think he's a smart, hard working guy who knows his stuff and knows how to manage a team.

My only concern is that the board of directors "unanimously selected" Mark without opening the process up to external candidates first. This wasn't a smart move on their part and some will rightly criticize the selection process.

Regardless, I like Mark Wiseman on a personal level and think he is more than qualified to assume the responsibilities of President & CEO of CPPIB. He's got his work cut out for him and some big shoes to fill. I wish him all the best as he takes over the helm of this organization and wish David Denison the best with his future plans (will he replace Paul Cantor as chair of PSPIB?).

Below, Bloomberg's Dominic Chu reports on the possible hundreds of billions of dollars the 100 largest U.S. pension plans may have to pay in the next few years. He speaks on Bloomberg Television's "In The Loop." Read the Bloomberg article here.

Europe's 'Demographic Carry Trade'?

Are you suffering from Greek bailout burnout? If so, listen to Lauren Lyster's Capital Account interview with economist Constantin Gurdgiev of the True Economics blog. Gurdgiev discusses the drain of human capital on Europe's struggling economies and thinks the LTRO will lead to stagflation and ultimately a bust in three years.

Check out the chart above on youth unemployment across Europe, courtesy of Marginal Revolution. It's a disaster and it isn't that much better on this side of the Atlantic.

Also love the discussion at the end on the FBI's new public service announcement featuring Michael Douglas asking people to come forth if they know about insider trading (see ad below). Somewhat disconcerting that law enforcement has resorted to these silly ads. My advice, hire experts, set up a special task force looking into predatory trading and put more teeth in the SEC's whistleblower rule. Wall Street's wolves are still getting away with murder.

Governments Robbing Pension Plans?

Institutional Investor reports on how the government is robbing pension plans (h/t, Yves):
Financial repression arrives not with a bang but with a whisper. “It is a very stealthy tax,” says economist Carmen Reinhart of the Peterson Institute for International Economics.

Reinhart is the toast of economic circles these days for speaking out about the newest way Western governments are using financial repression to liquidate their debts, particularly after a financial crisis. They’re doing this on the backs of savers, including pension funds, according to economists.

In practice, financial repression can lead to “the rape and plunder of pension funds,” Reinhart tells Institutional Investor. Financial repression consists of very low nominal interest rates combined with captive lending by large banks or pension funds to a government. The low, stable interest rate facilitates the servicing costs of large public debts. Sometimes modest inflation is added to the mix. This results in zero to negative real interest rates that reduce government debt. Hence, broadly defined, financial repression is a wealth transfer from savers to debtors using negative real interest rates — with the government as one of the key debtors.

“Financial repression is manifesting itself right now,” says Reinhart, who works at the nonpartisan Washington-based research institute chaired by Pete Peterson, co-founder of Blackstone Group.

Low interest rates are a fact of post-crash economic life, designed to kick-start greater borrowing. However, these rates tend to be combined with regulatory measures that give preferential treatment to holders of government debt.

Reinhart outlined examples in her recent paper “Financial Repression Redux,” written with Peterson Institute colleagues Jacob Kirke­gaard and M. Belen Sbrancia. The authors assert that governments — in France, Ireland, Japan, Portugal, Spain and the U.S. — are taking steps to create captive markets for their debt. The subtle, perhaps unnoticed result is a new form of taxation: financial repression.

Interestingly, Reinhart does not denounce this new tax. “Financial repression is an expedient way of reducing debt,” she says. For banks as well as the government, debt overhang is a major economic problem. But every tax has costs, including distortionary effects.

Because financial repression punishes savers, it’s unknown to what degree it inhibits savings. What is clear is that all the elements are in place for more financial repression in the U.S. In the wake of Dodd-Frank, public sentiment is moving against laissez-faire capitalism. Reinhart’s advice for pension funds facing this potential onslaught is simple: “I think awareness is the first step to being able to do something about it.”

I've already written on the hidden burden of ultra-low interests rates. Savers are getting pummeled in this environment, earning nothing in their savings accounts or worse still, forced to speculate in this wolf market dominated by high frequency trading platforms run by large hedge funds and big banks.

And in New York, to top up the pension plan, cities borrow from it first (h/t, Diane):

When New York State officials agreed to allow local governments to use an unusual borrowing plan to put off a portion of their pension obligations, fiscal watchdogs scoffed at the arrangement, calling it irresponsible and unwise.

And now, their fears are being realized: cities throughout the state, wealthy towns such as Southampton and East Hampton, counties like Nassau and Suffolk, and other public employers like the Westchester Medical Center and the New York Public Library are all managing their rising pension bills by borrowing from the very same $140 billion pension fund to which they owe money.

Across New York, state and local governments are borrowing $750 million this year to finance their contributions to the state pension system, and are likely to borrow at least $1 billion more over the next year. The number of municipalities and public institutions using this new borrowing mechanism to pay off their annual pension bills has tripled in a year.

The eagerness to borrow demonstrates that many major municipalities are struggling to meet their pension obligations, which have risen partly because of generous retirement packages for public employees, and partly because turbulence in the stock market has slowed the pension fund’s growth.

The state’s borrowing plan allows public employers to reduce their pension contributions in the short term in exchange for higher payments over the long term. Public pension funds around the country assume a certain rate of return every year and, despite the market gains over the last few years, are still straining to make up for steep investment losses incurred in the 2008 financial crisis, requiring governments to contribute more to keep pension systems afloat.

Supporters argue that the borrowing plan makes it possible for governments in New York to “smooth” their annual pension contributions to get through this prolonged period of market volatility.

Critics say it is a budgetary sleight-of-hand that simply kicks pension costs down the road.

“You’re undermining the long-term solvency of these funds and making the pension fund even more of a gamble than it already is,” said Josh Barro, a senior fellow and pension expert at the Manhattan Institute, a conservative research organization. The state, he said, is betting that the performance of the financial markets will improve over the next decade and bail the system out.

“If performance continues to be weak, then contribution rates will be even higher than the rates we’re trying to avoid now, and you’ll produce even more fiscal pain down the road,” he said.

Nationwide, the cost of public retiree benefits has soared in recent years, and states including California, Connecticut and Illinois have been borrowing to pay, or even deferring, their pension bills. Many states are worse off than New York. New Jersey is still paying off bonds issued in 1997 to close a hole in its pension system.

And governors and lawmakers across the country have been trying to take steps to reduce future pension costs, with limited success.

But New York appears to be unusual in allowing public employers to borrow from the state’s pension system to finance their annual contributions to that system.

The state’s borrowing mechanism, approved in 2010 under Gov. David A. Paterson, was backed by public sector unions and by the state comptroller’s office, which oversees the pension fund and prefers to call the borrowing a form of amortization, or paying a debt gradually, with interest. The public employers that borrow from the pension system essentially contribute less than they owe in a given year, and agree to repay the difference, with interest, over a decade.

Contributions to the pension system, which covers more than one million members, retirees and beneficiaries, are due annually from the state and municipal governments. As they struggle to pay their obligations under the current system, municipalities are borrowing $200 million this year, up from $45 million last year, the first year the borrowing plan was available, according to the state comptroller’s office.

“I don’t think any financial manager likes to see the can kicked down the road, and would prefer to see all costs paid for in the years that they are incurred,” said Tamara Wright, the comptroller of Southampton. Southampton, on the East End of Long Island, recently borrowed a fifth of its pension bill — $1.2 million of $6 million — by decision of the town board.

“I certainly am sensitive to the board’s concerns about the current economic times,” she said.

The state is borrowing too — $575 million in the current fiscal year, and $782 million in the next, under a budget proposed by Gov. Andrew M. Cuomo.

The state’s comptroller, Thomas P. DiNapoli, said in a statement, “While the state’s pension fund is one of the strongest performers in the country, costs have increased due to the Wall Street meltdown.” He added that “amortizing pension costs is an option for some local governments to manage cash flow and to budget for long-term pension costs in good and bad times.”

The comptroller’s office noted that only a part of the overall pension contributions owed by the state and municipalities was being borrowed. And it said the number of borrowers had risen partly because the borrowing plan only recently became available.

“It would not be fair to draw a characterization about statewide municipal finances from these numbers,” said Kevin Murray, an executive deputy in the comptroller’s office.

But it is clear that a number of major public employers are having trouble affording the state’s current pension system.

“Sharp increases in pension costs are unsustainable and are devastating state and local governments,” Robert Megna, Governor Cuomo’s budget director, said in a statement.

Mr. Cuomo, a Democrat, is proposing changes that would require future state employees to share a greater portion of their pension costs, and would allow them to opt into a 401(k)-style retirement plan. The proposal is known as Tier VI because it would be added to five existing pension benefit categories.

The governor’s proposal has been met coldly by labor unions, as well as by many state lawmakers and Mr. DiNapoli, also a Democrat and an ally of the labor movement. The proposal is supported by Mayor Michael R. Bloomberg of New York as well as other municipal leaders, and by business groups.

“It’s the most significant rising cost that we have,” Scott Adair, the chief financial officer of Monroe County, said of pensions.

In Poughkeepsie, which is contributing $3.6 million into the state pension system this year and borrowing nearly $800,000, Mayor John C. Tkazyik, a Republican, said rising pension costs and new federal accounting requirements for retiree health coverage could have dire consequences.

“It could bankrupt the city,” Mr. Tkazyik said, adding that the city had cut its work force, to 367 from 418 employees, in four years as it struggled to compensate.

The New York Public Library is borrowing nearly $2.9 million of a $14.7 million pension bill this year. A library spokeswoman said the decision to borrow came at the urging of the city, which finances a majority of the library’s budget. The city has its own pension system, separate from the state, which has undergone its own fiscal stresses because of sharp contribution increases.

“After a strong recommendation from the city, the library decided to amortize its pension payments because of the cost savings to both the library and the city, which reimburses more than half of our pension costs,” said Angela Montefinise, the library spokeswoman.

But the Bloomberg administration played down its role.

“The library system decides how to manage their finances,” said Marc LaVorgna, a Bloomberg spokesman, adding, “The decision was made by the libraries.”

What is happening in New York is happening across all states where cash-strapped cities are having a tough time honoring their pension obligations. I am afraid that it's only going to get worse from here.

Finally, a buddy of mine who is a portfolio manager sent me this comment:

One of the first things Tony Blaire did when he entered Number 10 was to put a massive windfall tax on UK utilities that effectively stripped pension funds of billions of dividend income.

Below, Michael A. Gayed, the chief investment strategist at Pension Partners LLC, talks about the possible impact of the rise on oil prices on financial markets. He speaks with Matt Miller on Bloomberg Television's "Street Smart."

Monday, February 27, 2012

CalSTRS Looking North to Change Structure?

Follow-up to my earlier comment on OMERS' 2011 results. James Nash of Bloomberg reports, California Pension Looks to Ontario Experience to Reduce Outside Managers:

The California State Teachers’ Retirement System, exploring changes in hiring and pay to reduce its dependence on external managers, is looking to one of Canada’s biggest public retirement funds for advice.

The second-largest U.S. public pension, which manages a third of its $152.7 billion portfolio in-house, is consulting the Ontario Municipal Employees Retirement System (OMERS), which self- manages about 85 percent of its C$55.1 billion ($55.1 billion) portfolio.

The California fund posted a 2.3 percent gain on investments in 2011, reducing its ability to meet long-term obligations to 856,000 members and their families, while the Ontario fund reported a return on assets of about 3.2 percent. Following the Ontario plan’s model, in which investment officers are treated as employees of a corporation, might give Calstrs more flexibility to respond to market conditions, spokesman Ricardo Duran said.

“They act more like a private investment firm,” he said in a telephone interview. “They have the ability to be more flexible with their hiring.”

The Toronto-based fund, known as Omers, oversees benefits for about 420,000 retired and active government workers in Canada’s most-populous province. Rick Miller, chairman of the Omers Administration Corp.’s 14-member board, is scheduled to meet with the California fund’s board March 1 in Glendale.

As of June 30, Calstrs managed 33 percent of its portfolio internally, up from 30 percent a year earlier, according to its annual reports to the state Legislature.

In-House Management

Omers ultimately plans to manage 90 percent of its portfolio in-house, said a spokesman, John Pierce. In 2010, the fund realized $25 in earnings for every dollar spent on its investment staff, compared with $10 for every dollar on outside managers, Pierce said by telephone.

“Omers is independent from government,” Pierce said. “Our investment team has 100 percent skin in the game. They’re not working for anyone else.”

U.S. public pensions operate under a variety of models, said Keith Brainard, research director at the National Association of State Retirement Administrators. Several systems are looking to Canadian-style or non-government structures, he said by telephone.

“One underlying issue is that it’s not unusual for a pension system to have trouble hiring and retaining good people,” Brainard said.

US public pension funds are notorious for underpaying their managers. The governance model at most these funds is weak and it's not just due to poor compensation. They have too much political interference, lack of proper oversight, over-reliance on pension consultants who typically recommend outside managers with little or no regard for alignment of interests.

Is the OMERS model the best model to follow in Canada? No, there are other pension plans like Ontario Teachers that do not have subsidiaries for every investment activity and even though they manage assets internally, they still rely on external managers to manage a good chunk of assets.

Then there is Healthcare of Ontario Pension Plan (HOOPP) which is a private defined-benefit plan and arguably one of the best in North America. They are fully funded and match their assets and liabilities very closely. Jim Keohane who recently became President & CEO told me HOOPP learned a lot from ATP, Denmark's pension plan which posted tremendous results last year.

I think it's good that CalSTRS is looking at the Canadian pension model. I would advise them to talk with as many people as possible, including Neil Petroff and Jim Leech of Ontario Teachers' and Leo de Bever of Alberta Investment Management Corporation (AIMCO). They should also talk with senior managers at HOOPP, ATP and APG, a leading Dutch pension fund managing billions and doing innovative things like seeding hedge funds and managing their beta portfolio more intelligently.

Below, Bloomberg's Kelly Bit reports that newly started hedge funds received $12.4 billion in deposits from 2009 through 2011 from investors that believe many managers perform best during their early years, according to a Citigroup Inc. report. She speaks on Bloomberg Television's "Money Moves."

OMERS Posts 3.2% Return in 2011

Doug Alexander of Bloomberg reports, Omers Posts 3.2% Return in 2011 Led by Private Investment Gains:

Ontario Municipal Employees Retirement System, a pension fund manager in Canada’s most- populous province, posted a 3.2 percent return on investments last year, led by private equity, real estate and infrastructure holdings.

Net investment income was C$1.7 billion ($1.7 billion), the Toronto-based pension fund manager said today in a statement, compared with C$5.5 billion in 2010. Assets climbed 3.4 percent to C$55.1 billion from C$53.3 billion a year earlier, as gains in private investments offset declines in stocks and bonds.

“Our 2011 results are therefore a tale of two halves -- strong positive returns in private markets, and negative returns in the public markets,” Michael Nobrega, the chief executive officer, said at a press conference today in Toronto.

Omers, as the fund is known, beat the 0.5 percent average return of Canadian pension funds, based on a Jan. 23 report by RBC Dexia Investor Services Ltd.

Returns from infrastructure holdings were 8.8 percent in 2011, down from 10 percent in 2010, according to the statement. Real estate returned 8.4 percent, compared with 7.5 percent in 2010. Strategic investments gained 7.2 percent last year after returning 7.7 percent in 2010. Stocks and bonds lost 0.2 percent in 2011, compared with an 11 percent increase in 2010, as markets declined.

Markets Fell

Canada’s benchmark S&P/TSX Composite Index (SPTSX) fell 11 percent and the MSCI World Index declined 7.6 percent in 2011.

Omers said its deficit increased to C$7.3 billion in 2011 from C$4.5 billion a year earlier as a result of the 2008 global economic decline and increasing liabilities as members age. Omers manages pensions for more than 400,000 retired and active municipal employees in Ontario.

Omers is anticipating more opportunities this year in private market investments in Canada, the U.S. and the U.K., according to Michael Latimer, the chief investment officer. The fund is looking to expand in emerging markets, though “it’s not in a rush,” and North America and the U.K. remain its focus, he said.

Omers, which invests in high-quality real estate properties, may consider bidding on Scotia Plaza in Toronto, according to Latimer. Bank of Nova Scotia said last month it plans to sell its Toronto headquarters, drawing attention of firms including Canada Pension Plan Investment Board.

Nobrega also commented on a C$3.73 billion takeover offer by a group of banks and pension funds for Toronto Stock Exchange owner TMX Group Inc., saying the deal might fall apart because of its structure, rejection by regulators or “deal fatigue.”

Status Quo ‘Unacceptable’

Omers isn’t part of Maple Group Acquisition Corp., which in May proposed to buy TMX in an offer challenging a friendly deal between TMX and London Stock Exchange Group Plc. The LSE-TMX deal was scrapped in June after failing to get enough shareholder support. Calling the status quo “unacceptable,” Nobrega said he hoped the London exchange would revisit a TMX takeover if Maple’s bid fails.

Caisse de Depot et Placement du Quebec, Canada’s biggest pension fund manager, said yesterday it generated a 4 percent return last year with net investment income of C$5.7 billion.

Tara Perkins of the Globe and Mail commented on OMERS' swelling deficit reporting, OMERS earns 3.17 per cent as deficit climb:

The Ontario Municipal Employees Retirement System saw its funding deficit climb in 2011, despite positive investment returns, as the crash of 2008 continues to inflict pain on its portfolio.

The plan, which invests on behalf of almost 420,000 members, said Friday that its funding deficit climbed to $7.3-billion last year from $4.5-billion a year earlier.

The increase is the result of the dramatic losses that the plan had in 2008, which it phases in over a five-year period according to actuarial rules, chief executive officer Michael Nobrega told reporters at a press conference. “We had a surplus in 2007,” he noted.

But the losses incurred three years ago continue to sting, at a time when pension plans grapple with headwinds such as an aging population, low interest rates, and an unpredictable investment climate.

Recent surveys have suggested that Canadian pension plans saw their funding fall by almost 15 percentage points throughout 2011, leaving many with large shortfalls.

With the pension sector struggling as the baby boomers enter retirement, governments are considering a number of initiatives to bolster the retirement savings industry, some of which could benefit OMERS, Mr. Nobrega said.

He welcomed recent comments by Ted Menzies, the Conservative Minister of State for Finance, which suggest that pension plans will be allowed to compete with banks and insurers to manage Pooled Registered Pension Plans, a new pension scheme being rolled out by Ottawa.

Mr. Nobrega was also happy to see Ontario’s much-publicized Drummond report recommend that the province look at increasing efficiencies within the pension system, something he hopes will lead to consolidation.

He said that Ontario needs pension “champions” that have world-class headquarters, and “you can’t do it by having six, seven, eight pension funds in the $10-billion range.”

Mr. Nobrega added that the Drummond report could result in OMERS’ members seeing little or no salary increases in the near future, a development that would likely have a positive impact on the plan’s liabilities but a negative impact on its contributions down the line.

In the meantime, OMERS said continued investment returns (which it hopes will be between 7 and 11 per cent annually over the long-term) and temporary contribution increases from members as well as benefit reductions should return the plan to surplus within 10 to 15 years. Mr. Nobrega said he doesn’t think further contribution hikes or benefit cuts will be necessary.

OMERS earned 3.17 per cent on its investments, or $1.7-billion, in 2011, and its assets rose to an all-time high of $55.1-billion.

Canada’s benchmark S&P/TSX composite index fell 11 per cent last year. But a rebound in the final quarter allowed plans, on average, to avoid investment losses, according to RBC Dexia Investor Services.

It was OMERS’ private market portfolio – which includes assets such as infrastructure, real estate and private equity holdings – that kept its returns afloat while stock markets tanked. The private market portfolio generated a return of 8.2 per cent, while the public markets portfolio had a return of negative 0.22 per cent.

At the end of the year OMERS had 42 per cent of its assets in private markets, and 58 per cent in public. It has been shifting away from public holdings in recent years – in 2003, the mix was 18 per cent private and 82 per cent public. Its goal is to have roughly 47 per cent private and 53 per cent public.

Within its portfolio, OMERS also shifted away from stocks toward bonds in the second half of last year in an effort to decrease its risks.

It continues to hold more fixed-income investments, which now make up more than 30 per cent of its total portfolio, chief investment officer Michael Latimer said during a press conference. That’s up about 12 percentage points from the start of 2011.

While OMERS’ executives acknowledged fixed income might be risky these days, Mr. Latimer said it is difficult to keep up returns.

You can go over OMERS' 2011 results by viewing their press release and by going over the breakdown in the fact sheet. First, let's go over their long-term results (click on image to enlarge):

As you can see, OMERS is outperforming its benchmark over the last 10 years. Every plan should publish these long-term results.

Next, we go over the results of the various asset classes (click on image to enlarge):

As you can see, public markets underperformed their benchmark (-0.22% vs. 1.26%) while private markets all outperformed their benchmarks led by private equity (7.23% vs. -5.58%).

Indeed, the strong outperformance of private markets was underscored by Michael Nobrega, OMERS' President and CEO, and used to justify the shift into private markets since 2003.

Here is where I part ways with Mr. Nobrega and the rest of Canada's pension leaders claiming that private markets are the way to go. While there is no denying that 2011 was a volatile year in public equities, there are a few things that people should understand about the risks of private markets:

  • Private markets are not a panacea and they are heavily influenced by trends in public markets
  • Correlations of private to public markets have crept up over the last few years as pension funds shove billions into private equity, real estate and infrastructure.
  • The low interest rate environment adds fuel to the fire in raising these correlations
  • Private markets are illiquid and officially valued on an annual basis when funds get audited. Such stale pricing can lead one to erroneously conclude that private markets are less volatile.
  • Private markets carry other risks like political and regulatory risks that are often underestimated and under-appreciated.
  • And last but not least, benchmark abuse is rampant in private markets, which is why all these large Canadian pension plans have been beating their overall benchmark in the last few years claiming to "add value" in private markets. This has allowed senior pension fund managers to reap huge bonuses in the last few years.

Now, to be fair, there is "added value" in private markets. And unlike most pension funds, OMERS and their Canadian counterparts are investing directly in private markets and this takes specialized skill set.

Unfortunately, none of these large funds post the internal rate of return (IRRs) net of fees and other costs (like currency hedging) of their direct investments versus their fund investments. Moreover, with few exceptions (AIMCo, for example), there is no clear explanation of benchmarks used to evaluate and justify the risk taken in private markets.

One senior pension fund manager shared these comments on why pension funds do not report IRRs of their direct holdings in private markets:

I think it is avoid short-term performance chasing, and bury as much as one can and play to the long-term, that would a reason why to not disclose, some merit to this.

The history of asset allocation also separates asset mix and scale from asset class returns. IRR is a size, dollar and time weighted calculation. AIMR for institutions uses time-weighted. Hence why firms often describe their average annual returns, which mean nothing but does exclude the scale decision.

Of course, they may not disclose because it doesn’t look good, and when people change etc. the history can be hard to climb out from under IRR.

The better question is why are all asset classes, and pension funds as a whole, not using IRR, or at least as a supplement when discussing a specific mandate. Ever increasing size of plans yet size really doesn’t get taken into account in any area.

The ‘way things are done' is powerful but CalPERS, and Caisse at one time, did disclose IRR, I guess when it served a purpose, or when that’s all their early systems could track.

This is why I take all this talk of 'shifting assets into private markets' with a grain of salt. It drives the guys and gals in public markets at pension funds absolutely bananas watching their private market counterparts reaping huge bonuses and justifiably so.

Importantly, it's much harder to beat public market benchmarks in stocks and bonds than beating some bogus benchmark in private markets that does not reflect the risk and beta of the underlying portfolio.

I have been beating that drum for the longest time, writing on bogus benchmarks in alternatives and why when it comes to evaluating and comparing pension funds and asset managers, it's all about the benchmarks stupid!

Is it worth investing in private equity, real estate and infrastructure? Yes, absolutely, especially if you invest directly and co-invest like most of the large Canadian pension plans are doing. They lower fees and control investments to help them realize larger gains. But you have to benchmark these investments appropriately and make sure that you're paying senior pension fund managers accordingly based on the risks they're taking in private markets.

Finally, OMERS and Ontario Teachers are pension plans, which means they manage assets AND liabilities. As seen below, OMERS' deficit swelled last year to $7.2 billion (click on image to enlarge):

OMERS discusses how they will address this deficit in their 2011 Report to Members (annual report will be released later). It includes temporary contribution increases, temporary benefit changes, and as stated above, a shift into private assets to "reduce the Plan’s exposure to stock markets that are expected to be highly volatile in the next several years."

While OMERS has built strong expertise in private markets, it remains to be seen whether this approach will benefit the plan over the long-term. I take a more balanced and skeptical view of shifting a huge portion of pension assets into private markets which carry their own set of risks.

Below, Jane Rowe, senior vice president of Teachers’ Private Capital, the investment arm of the Ontario Teachers’ Pension Plan, talks about the plan's return on investments and the role of private equity in the plan's strategy. Rowe, speaking with Cristina Alesci on Bloomberg Television's "Money Moves," also discusses some of her industry picks and compensation programs that attract top talent.