Pension Pulse

World's Best Hedge Fund Actually a Pension?

2012-02-02T14:30:00.014-05:00

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

“We don’t.”

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

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

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

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

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

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

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

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

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

So what’s next for Rohde and ATP?

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

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

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

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

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

I love it for several reasons. First and foremost, it proves that large, well-run public defined-benefit plans can deliver outstanding results even in the hardest, most punishing years. It also shows you that the world's best fund is not charging 2 & 20, not following the pension herd paying 2 & 20 for hedge funds and private equity funds, and knows how to dynamically allocate risk to add alpha where it ultimately counts -- on overall fund returns! And you'll never see Bloomberg or CNBS interviewing Lars Rohde!

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

CPPIB's David Denison Down Under?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CalSTRS Fully Funded in 52 Years?

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

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

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

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

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

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

Six Projections

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Read AMR’s statement on its pensions here.

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

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

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

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

Hedging Against Disaster?

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

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

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

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

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

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

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

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

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

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

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

Canada’s Subprime Crisis?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Record High Pension Assets Hit by Liabilities?

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

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

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

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

Other highlights from the report include:

Global asset data for the P13 in 2011

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

Asset Allocation for the P7

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

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

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

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

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

Public vs. private sector pensions in 2011

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

Notes to editors

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Greek-German Wrangling Just Pointless Fury?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

So, how about it? Are you game?

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

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

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

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

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

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

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

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

"Eaten Alive" by Hedge Fund Fees?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Future of Pension Profits: Bain or Blessing?

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

The Economist reports, Bain or blessing?:

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

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

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

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

The bigger issue

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

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

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

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

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

Abuzz about fees

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

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

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

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

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

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

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

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

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

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

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

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

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

Davos 2012: Another Monumental Failure?

2012-01-29T10:07:00.010-05:00

As Davos 2012 wraps up, it is my chance to write a critical comment denouncing the world's top 0.00000000001% for another boring summit where they myopically focused on Europe's debt crisis, warning that the eurozone continues to pose a severe threat to the global economy.

Crackling tension among European leaders in Davos is set to spill over into an equally charged EU summit this week. Soros said it all when he took Germany to task. Even if a Greek debt deal is in the works, unless they come up with a lasting long-term solution, this deal won't mean a thing and eurozone will remain vulnerable to more speculative attacks. There is a reason why Soros is so successful, unlike most of his peers, he gets the bigger picture.

But in my opinion, all this talk about "debt crisis" is completely misplaced. The developed world has an unemployment crisis and a retirement crisis, not a debt crisis, two themes that were largely ignored at this World Economic Forum.

What scares me the most about the state of the global economy? Easy, the youth unemployment disaster:

Davos is used to bluster from political leaders. But when usually quietly spoken company bosses from all corners of the earth warn of "not a crisis, but a disaster," when they call something a "cancer in society," you know we have a problem.

The world, they say, is "sitting on a social and economic time bomb". The world is plagued by youth unemployment.

The numbers are stark: In some countries of the Arab world, up to 90% of 16-24 year olds are unemployed. In the United States the youth unemployment rate is 23%. In Spain nearly 50%. In the UK 22%.

Worldwide, some 200 million people are unemployed. 75 million are between 16 and 24 and every year about 40 million young people are entering the workforce.
'Unemployment sucks'
The business leaders at the World Economic Forum (WEF) know why it matters: Young people who were unemployed for a long time will earn less throughout their whole lives.

They will be less employable. They won't have the skills that business needs. They are more likely to have long-term health problems. And it can cause social unrest.

There's a term for it: Lost generation. Or as one business school professor puts it: "Unemployment sucks. Youth unemployment sucks even more."

"The youth has lost a line of sight to the future."

Unless something is done to tackle youth unemployment, the world's 'debt crisis' will only get worse. You'd think the world's power elite would focus all their energy there. Instead, the discussion centered around Europe's debt crisis, which is exactly what the financial oligarchs want us to focus on.

There are many smart economists who attended Davos who would agree with me on this issue, but it's striking how little press coverage this issue got. Sure, they talked about preventing another lost generation, but little was done to take concrete actions to tackle the unemployment crisis that threatens the global economy and the very foundations of capitalism.

Interestingly, Davos founder Klaus Schwab did focus on jobs and morals:

Capitalism is out of whack, the founder of the World Economic Forum says, welcoming critics' ideas of how to fix it — even those camped out in protest igloos near his invitation-only gathering of global VIPs.
This anti-big money mood is surprising for a man who embraces free markets and whose livelihood consists of bringing world CEOs and political leaders together for brainstorming sessions.
Klaus Schwab is also unusually downbeat, his trademark optimism tempered by global economic turmoil and public unrest ahead of this year's forum, which ends Sunday.
"We have unfinished business, and we have to act fast," he told The Associated Press in an interview ahead of the forum's opening on Wednesday.
"I'm a deep believer in free markets, but free markets have to serve society," he said in Davos, the ski resort tucked away deep in the Swiss Alps. He lamented excesses and "lack of inclusiveness in the capitalist system."
"We have sinned," he said, adding that this year's forum would put particular emphasis on ethics and resetting the moral compass of the world's business and political community.
Schwab said the forum invited members of the Occupy protest movement, camped in igloos in Davos, to a session on the sidelines to talk about reforming capitalism.
Thousands of Swiss soldiers and police shoveled snow to erect a "ring of steel" against any demonstrators who hoped to gatecrash the meeting. Some 3,500 soldiers provided security to the VIPs, who included German Chancellor Angela Merkel, British Prime Minister David Cameron and nearly 40 other world leaders.
President Obama didn't attend, but Treasury chief Timothy Geithner was there, as were some members of Congress.
When half a dozen demonstrators appeared briefly Tuesday outside the security perimeter, daubing the snow with anti-capitalist slogans, police checked their IDs but allowed the protest to go ahead.
"Everybody who could make a constructive proposal is very welcome. We need new ideas," Schwab said.
He did note a general aversion to allowing too much anti-capitalist fervor to reach Davos.
"I also emphasize that Davos is a place for dialogue. . . . The participants are usually reluctant to be confronted with people who are not open to dialogue and just want to serve their own sometimes one-sided interests," he said.
He warned that an "intergenerational conflict" could be looming as governments compromise future spending to pay today's debts.
"People feel it's a difficult time. They are irritated. There is, they feel, a lack of future perspective," he said.
Schwab also urged that more attention be paid by leaders and governments alike to jobs — saying Davos participants should focus on "talentism" instead of capitalism — and said leaders must work harder to win public trust.
Schwab has watched the world transform in the 41 years that he's nurtured the forum and turned it into one of the world's leading economic gatherings.
While China, Brazil and other developing economies remain robust, the United States and Europe are still struggling with financial issues that erupted in the credit crunch of 2008, including high unemployment. That contributes to a feeling that the world's economic problems are worse than leaders meeting at Davos in previous years had foreseen.
"We were too optimistic (last year)," Schwab acknowledged.

Indeed, the power elite were too optimistic last year and in my opinion, too pessimistic this year. And once again, they failed to address major issues, including the global disconnect, which will only get worse unless we tackle youth unemployment and the looming retirement crisis.

I suggest the power elite take the time to carefully read Michael Hudson's latest comment, Banking Wasn’t Meant to Be Like This. I quote his conclusion:

Banking has moved so far away from funding industrial growth and economic development that it now benefits primarily at the economy’s expense in a predator and extractive way, not by making productive loans. This is now the great problem confronting our time. Banks now lend mainly to other financial institutions, hedge funds, corporate raiders, insurance companies and real estate, and engage in their own speculation in foreign currency, interest-rate arbitrage, and computer-driven trading programs.
Industrial firms bypass the banking system by financing new capital investment out of their own retained earnings, and meet their liquidity needs by issuing their own commercial paper directly. Yet to keep the bank casino winning, global bankers now want governments not only to bail them out but to enable them to renew their failed business plan – and to keep the present debts in place so that creditors will not have to take a loss.

This wish means that society should lose, and even suffer depression. We are dealing here not only with greed, but with outright antisocial behavior and hostility.

Europe thus has reached a critical point in having to decide whose interest to put first: that of banks, or the “real” economy. History provides a wealth of examples illustrating the dangers of capitulating to bankers, and also for how to restructure banking along more productive lines. The underlying questions are clear enough:

Have banks outlived their historical role, or can they be restructured to finance productive capital investment rather than simply inflate asset prices?
Would a public option provide less costly and better directed credit?
Why not promote economic recovery by writing down debts to reflect the ability to pay, rather than relinquishing more wealth to an increasingly aggressive creditor class?

Solving the Eurozone’s financial problem can be made much easier by the tax reforms that classical economists advocated to complement their financial reforms. To free consumers and employers from taxation, they proposed to levy the burden on the “unearned increment” of land and natural resource rent, monopoly rent and financial privilege. The guiding principle was that property rights in the earth, monopolies and other ownership privileges have no direct cost of production, and hence can be taxed without reducing their supply or raising their price, which is set in the market. Removing the tax deductibility for interest is the other key reform that is needed.

A rent tax holds down housing prices and those of basic infrastructure services, whose untaxed revenue tends to be capitalized into bank loans and paid out in the form of interest charges. Additionally, land and natural resource rents – along with interest – are the easiest to tax, because they are highly visible and their value is easy to assess.

Pressure to narrow existing budget deficits offers a timely opportunity to rationalize the tax systems of Greece and other PIIGS countries in which the wealthy avoid paying their fair share of taxes. The political problem blocking this classical fiscal policy is that it “interferes” with the rent-extracting free lunches that banks seek to lend against. So they act as lobbyists for untaxing real estate and monopolies (and themselves as well). Despite the financial sector’s desire to see governments remain sufficiently solvent to pay bondholders, it has subsidized an enormous public relations apparatus and academic junk economics to oppose the tax policies that can close the fiscal gap in the fairest way.

It is too early to forecast whether banks or governments will emerge victorious from today’s crisis. As economies polarize between debtors and creditors, planning is shifting out of public hands into those of bankers. The easiest way for them to keep this power is to block a true central bank or strong public sector from interfering with their monopoly of credit creation. The counter is for central banks and governments to act as they were intended to, by providing a public option for credit creation.

Michael wrote on Europe but the truth is the world has reached a critical point in having to decide whose interest to put first: that of banks, or the “real” economy.

Jonathan Nitzan, another insightful economist who knows a lot about differential accumulation, doesn't see this as useful dichotomy as he considers the banking and "real" economy as one. But both of them would agree that capitalism is headed down an unpredictable and destabilizing path.

What would I like to see at Davos 2013? I'd like to see Michael Hudson, Jonathan Nitzan and other "radical" economists discuss their views. I'd also like to see some intellectuals like Charles Taylor, Michael Walzer and many others address these global leaders.

Below, Charles Taylor talks at a public debate on the role of religion in the public sphere in Milan on June 8, 2010. Listen carefully to his comments on the basic challenges to solidarity and how we can need to "create mutual respect for different views " to come together and address the challenges that confront our societies.

I also embedded a clip of Michael Walzer discussing free market and morality as well as a BBC piece on positive vs. negative liberty, drawing on the wisdom of the late Isaiah Berlin. Watch all clips below.

Taylor was the greatest genius I ever had the privilege of learning from. Davos desperately needs such great thinkers at their future conferences. Doesn't make for a good interviews on CNBC or Bloomberg but the biggest deficit at Davos is a deeper dialogue on ethics and how we can improve the global economy, making it more inclusive, serving all our citizens, not just the power elite.

Betting on BlackBerry's Revival?

2012-01-28T10:13:00.009-05:00

Hugo Miller of Bloomberg reports, RIM’s Heins ‘Here to Fight’ for BlackBerry Revival:

Research In Motion Ltd. (RIMM)’s Thorsten Heins, five days into his job as chief executive officer, pledged to regain lost ground in the U.S. smartphone market and said he held talks with rivals eager to license its software.

RIM will begin a campaign with U.S. carriers next week to entice consumers to try its latest BlackBerry 7 devices with touch screens and better Web browsers, Heins said yesterday in an interview at Bloomberg headquarters in New York. The promotions won’t be about “just simply money,” they will also involve mobile applications, or apps, he said.

“We have to do something dramatically different in the U.S. to get our market share back,” said Heins, 54. “I’m here to fight. I’m here to win.”

Heins, a 24-year veteran of Siemens AG (SIE), faces the challenge of reversing momentum at RIM after the company lost out in the smartphone market to Apple Inc. (AAPL)’s iPhone and devices that run on Google Inc. (GOOG)’s Android software. RIM’s revenue has slumped for two quarters, driving RIM shares down 75 percent last year.

Heins, who took over from co-Chief Executive Officers Jim Balsillie and Mike Lazaridis, said his immediate priority is to revive BlackBerry sales in the U.S., get a revamped version of Waterloo, Ontario-based RIM’s struggling PlayBook tablet onto the market next month and introduce its new operating system, BlackBerry 10, on time later this year.

“In the first 100 days, that is what you’re going to see me focus on,” Heins said. “My first job is to get BlackBerry 7 into all of your hands.”
U.S. Missteps

The Munich native is getting by on a handful of hours sleep a night so that he can travel by day to meet customers and run the business by night on his BlackBerry. The company needs to improve its marketing and communicate better to build excitement about its products, he said.

U.S. sales fell 45 percent last quarter, dragging revenue lower even as sales in emerging markets like Indonesia and India surged. The BlackBerry’s share of the global smartphone market fell to 11 percent in the third quarter of 2011, from 21 percent two years earlier, according to Gartner Inc. The aging BlackBerry lineup failed to match the features and number of applications available on the iPhone and Android devices.

“When BlackBerry got positioned the way you experienced it, it was on a set of values: battery life, network efficiency, security and best typing experience,” Heins said. “In the U.S. specifically, what we missed is a shift in those paradigms” to more consumer-oriented features like Web-browsing and apps, Heins said.
Licensing Talks

Now, RIM is rebuilding its lineup of BlackBerrys on BB10, an operating system based on software used to run nuclear power plants and unmanned aerial drones. During his interview, Heins repeatedly went back to a video demonstration of PlayBook 2.0, its new tablet software which incorporates many of the features that will come with BB10. He showed how users can flip between e-mail, Web browsing, Facebook and Twitter without ever leaving any of those programs.

RIM’s new software is appealing enough that he’s been approached about licensing it, Heins said. The company has held discussions with interested handset makers and personal-computer makers, he said, declining to name them.

“We’ve had lots of interest about this,” Heins said.

RIM rose 3.3 percent to $16.80 yesterday. The stock was given a lift after Fairfax Financial Holdings Ltd. (FFH) said it doubled its stake in RIM. Prem Watsa, who runs Fairfax, was named as a director at RIM this week as part of RIM’s leadership changes.

The stock has rebounded after falling earlier in the week when comments by Heins on a conference call were interpreted by some investors as a sign that he would run RIM much in the way of his predecessors.

Neither that nor the suggestion that he will be unduly influenced by Lazaridis, who is staying on as vice chairman and leads RIM’s innovation committee, is correct, Heins said.

“I love to work with Mike in his visionary capacities,” he said. ’’But make no mistake, I run the company.’’

One look at RIM's share price over the past two years (click on chart below) will show you the company has been struggling to keep up with rivals like Apple which overtook Samsung in Q4 smartphone sales.

But don't count RIM out just yet. The stock is rebounding and some very successful funds are snapping it up. One of RIM's top institutional holders is Fairfax Financial Holdings, which recently doubled its stake in the Blackberry maker:

Fairfax Financial Holdings Ltd. (FFH), the insurer run by Canadian investor Prem Watsa, doubled its stake in Research In Motion Ltd. (RIM) in a vote of confidence in the BlackBerry maker after Watsa joined the company’s board.
Fairfax owns 26.85 million RIM shares, up from 11.8 million shares in September, according to a regulatory filing today. The company raised its stake to 5.12 percent, worth about $451 million at today’s closing price.

Watsa was named a RIM director on Jan. 22 as part of a management shakeup that included the replacement of co-Chief Executive Officers Jim Balsillie and Mike Lazaridis with former operating chief Thorsten Heins. The company is rebuilding its product line to try to stem recent market share losses to Apple Inc. (AAPL)’s iPhone and devices that run on Google’s Android platform.

“This is a vote of confidence in the current trajectory of the company or he thinks that there’s some value here that can be unearthed,” said Adnaan Ahmad, an analyst at Berenberg Bank in London. “Watsa is extremely well-respected, kind of like the Warren Buffett of Canada, so the bottom line is that the stock today should be up on the back of this.”
Shrinking Market Value

RIM rose 3.3 percent to $16.80 at the close in New York. The stock, which fell 75 percent last year, lost more value this week after Heins told investors there isn’t “drastic change needed.”

RIM’s share of the smartphone market tumbled to 11 percent in the third quarter of 2011, from 21 percent two years earlier, according to Gartner Inc.

The largest shareholder in RIM is Primecap Management Co., with a 5.5 percent stake, according to data compiled by Bloomberg. Lazaridis has a 5.4 percent stake in the company and Balsillie owns 5.1 percent, the data shows.

“This is a huge psychological boost,” said Ian Nakamoto, director of research at MacDougall MacDougall and MacTier Inc. in Toronto, whose firm oversees C$4 billion for clients, including RIM shares.

Fairfax has said RIM is an attractive investment because the company is trading at less than book value with free cash flow, yet still has a growing subscriber base and increases in revenue.
Favors Buffett

The stock purchases were made by Watsa, Fairfax and about a dozen of the Toronto-based company’s subsidiaries, according to the filing.

Toronto-based Fairfax bought 6.5 million shares on Jan. 25 and another 7.6 million shares yesterday, according to the filing. That means the company has spent about $230 million buying RIM shares in the past two days, based on Nasdaq prices for those dates.

Born in Hyderabad, India, Watsa has built Fairfax by investing in the assets of out-of-favor securities, and said this week he may increase his stake in Waterloo, Ontario-based RIM.

Watsa, 61, founded Fairfax in 1985 and has patterned his style of value investing after Warren Buffett, recommending shares of companies such as Wells Fargo & Co., Johnson & Johnson, Kraft Foods Inc. (KFT) and US Bancorp. (USB)

Fairfax benefited from declines in U.S. banks during the financial crisis, purchasing credit-default swaps on lenders. The swaps, instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt, led to investment gains of $2.72 billion in 2008.

Watsa has shifted in recent years to investing in U.S. municipal bonds backed by Buffett’s Berkshire Hathaway Inc. (BRK/A)

I wonder what Watsa thinks of the solar boom in 2012, but he's too conservative to be investing in solar stocks. Although I do not own RIM shares right now, the share price is attractive at these levels and on my radar. If the company is able to boost market share successfully launch Blackberry 10, RIM will rebound and thrive. And although I love my iPad and iPod, I will never give up my BlackBerry (but the Torch disappointed me).

Pension funds should be looking at RIM and many other companies that are at attractive valuations. I can come up with at least 20 'revival stories' off the top of my head but there are literally hundreds. For example, look at the recent selloff at Corning (GLW) as an opportunity to buy an excellent company on the cheap (no rush, share price may fall further, but put it on your radar).

I know it's sexy to focus on private equity but pensions should be focusing a lot more on public equities, opportunistically taking outsized positions to deliver alpha. That's what Neil Petroff and the folks over at Ontario Teachers' are doing on active management and that's what every pension fund should be doing.

Below, Thorsten Heins, Research In Motion Ltd.'s new chief executive officer, says the maker of the BlackBerry needs to "be constantly communicating" with customers about its products. Heins, who replaced co-Chief Executive Officers Jim Balsillie and Mike Lazaridis, spoke in a video posted by the company. Jon Erlichman reports on Bloomberg Television's "Bottom Line."

Bloomberg also spoke with Vic Alboini, chief executive officer of Jaguar Financial Corp., who talked about the outlook for Research In Motion Ltd.'s strategy under CEO Thorsten Heins and the possibility that the BlackBerry maker will be bought or split.

Mr. Alboini is very critical and thinks that the appointment of Heins means RIM is staying the course. He makes some excellent comments in this interview, especially on beefing up the marketing. It's pathetic, they need Peter Economides to rebrand RIM, just like he rebranded Apple. Watch his amazing lecture (in English) below.

Solar Boom in 2012?

2012-01-27T15:12:00.017-05:00

Alex Morales and Jacqueline Simmons of Bloomberg report, Solar CEOs Predict Boom in China Will Ease Glut in 2012:

China may double its installations of solar panels this year, absorbing excess production that depressed prices and margins in 2011, chief executive officers from two of the industry’s top five manufactures said.

Suntech Power Holdings Co. CEO Zhengrong Shi estimated the nation may add 4 gigawatts or more of panels, and Trina Solar Ltd. (TSL) CEO Jifan Gao expects 5 gigawatts. That compares with about 2.2 gigawatts installed in the country in 2011, more than double the capacity of the average nuclear reactor in the U.S.

The cost of solar panels fell 47 percent last year as Chinese manufacturers led by Suntech boosted production, winning market share from Western rivals such as Q-Cells SE and First Solar Inc. With China’s government pushing to consolidate the industry, the remarks from Shi and Gao suggest rising demand may support the biggest panel manufacturers.

“It’s a huge market,” Gao said through an interpreter in an interview at the World Economic Forum’s annual meeting in Davos, Switzerland. “Excellent companies with good technology, balance sheets and also brands will win out. A lot of companies without those advantages will be taken away.”

Those forecasts are more optimistic than the projections of Bloomberg New Energy Finance, which expects Chinese installations of 3 gigawatts this year and world demand from 25.5 gigawatts to 32.8 gigawatts. Trina expects global demand of 30 gigawatts to 35 gigawatts.
Solar Rebound

Solar shares have rebounded in recent weeks, driven in part by politics in Germany, the world’s largest solar market. After adding a record 7.5 gigawatts of panels last year, more than double the government’s target, lawmakers proposed cutting subsidies. A meeting Jan. 25 ended without an agreement and solar stocks climbed.

The Bloomberg Large Solar Energy (BISOLAR) index of 17 companies, which lost more than two-thirds of its value in 2011, gained 1.7 percent yesterday and has increased 20 percent this year. In New York, Suntech rose 2.7 percent and Trina by 5 percent. 30. An index of eight Chineses solar companies rose 5.4 percent, more than five times the pace of the NEX index of clean energy shares.

In Britain, the government estimates that capping subsidies in December would have saved 1.5 billion pounds ($2.4 billion) over 25 years. A court ruled it illegal to end the support then, ahead of schedule, and developers are rushing to complete new solar plants that will earn the old tariff before officials decide when to scale them back.
Chinese Demand

Suntech’s view shows that growing demand in China may also drive a solar recovery this year.

“I’m hearing a lot from on the ground in China about how hopping demand has been,” said Aaron Chew, an analyst with Maxim Group LLC in New York. “China could surpass Germany” as the world’s largest solar market.

Prices of polysilicon, the raw material in most solar panels, rose in four of the past five weeks after falling 65 percent in 2011.

The Chinese government is spurring clean energy to diversify away from coal, which fuels 70 percent of the economy and is blamed for pollution blanketing industrial areas from Hong Kong to Beijing. Renewables currently account for less than 1 percent of supply, which is growing faster in China than anywhere else in the industrial world, according to data from the oil company BP Plc.

Jenny Chase, head of solar analysis at New Energy Finance, said the forecasts assume China will meet and not surpass the government’s target to have 15 gigawatts of solar capacity by 2015. The estimates from Suntech and Trina suggest that China, like Germany, Spain and Italy, may have trouble keeping a lid on installations once developers start understanding how subsidies will apply to their projects.
Supply-Side Push

“Many other governments who have tried to limit their markets have failed,” Chase said in a phone interview from Zurich. “There could be a supply-side push that pushes this equipment out incredibly cheaply without the need for the federal subsidy.”

Solar panel prices have fallen so quickly that the technology is near reaching parity with fossil fuels in terms of the ability to supply power to national electric grids at a competitive price, said Gao of Trina.
‘Grid Parity’

“We have confidence that we will reach grid parity in several years in China -- like in three to four years,” said Gao, adding that Trina had about 10 percent of its sales in China last year. “In places like Australia, this year they will reach grid parity. Next year, it will be Italy and in 2014, regions like California.”

For now, falling prices are hurting companies throughout the industry. Trina cut its forecast for shipments last year along with First Solar, SunPower Corp., Yingli Green Energy Holding Co., Renesola Ltd. and JinkoSolar Holding Co.

Gao also predicted consolidation in the solar industry, and said that while the 10 biggest panel makers now account for just over 55 percent of the market, by 2015, that proportion may reach more than 80 percent.

“Although the industry faced some challenges, if you look at the trend, it’s growing,” Trina’s Gao said. “We expect that by 2015, the new installations that year will be about 50 gigawatts, so it’s constantly growing.”

China, the manufacturing hub for seven of the eight biggest solar panel makers, until 2010 accounted for less than 3 percent of the market for photovoltaics, with 490 megawatts installed. Installations more than quadrupled last year.

Shi of Suntech said China’s market was “exciting” and the market there this year could be “4 gigawatts or more.” Suntech is the biggest supplier of solar photovoltaic panels, and Trina is the fifth largest.

Solar stocks got clobbered in 2011 largely because of euro woes. Germany recently announced it would speed up subsidy cuts and all the solar bears are warning that the solar industry is in trouble.

Rubbish, total rubbish! First, Germany’s solar subsidy program is now the subject of dispute between two ministers in Chancellor Angela Merkel’s Cabinet. But beyond Germany, China is a powerhouse in the solar industry and they are increasing their demand. Moreover, in India, falling costs of solar energy are making it a viable alternative to power generated by fossil fuels.

In fact, Bloomberg reports that India is producing power from solar cells more cheaply than by burning diesel for the first time, spurring billionaire Sunil Mittal and Coca-Cola Co. (KO)’s mango supplier to jettison the fuel in favor of photovoltaic panels.

But solar skeptics abound. Investors prefer listening to bears like Jim Chanos who is shorting China and solars. I prefer looking at what top hedge funds and long-only funds are actually buying. I pay attention to charts, see if the pullbacks are being bought hard and see if fundamentals are gradually improving.

I also love reading articles on the most shorted solar stocks. Why? Just look at Netflix (NFLX), up over 75% this month, and ask those bears on Zero Hedge how their "short Netflix" position is going (LMAO!).

Here is a snapshot of the 10 most shorted solar stocks at the close today (click on image to enlarge):

Bunga Bunga! Keep on shorting those solars, baby, will only make the solar melt-up that much funner for us solar longs! And if the Greek gods are smiling, a debt deal over the weekend will help propel all risk assets, including solar shares, much higher.

Below, Suntech Power Holdings Co. Chief Executive Officer Shi Zhengrong talks about the outlook for solar energy prices. He speaks with Maryam Nemazee and Matt Miller on Bloomberg Television's "Countdown" on the sidelines of the World Economic Forum's annual meeting in Davos, Switzerland.

Hopes Rise For Greek Debt Deal?

2012-01-27T09:43:00.011-05:00

Hui Min Neo of AFP reports, Hopes rise for Greek deal as US praises euro salvage bid:

Europe's economic pointman said Friday he expected Greece to agree a deal with private creditors to write down its debt this weekend as the US praised efforts to combat the eurozone crisis.
Speaking at the Davos forum, EU economic affairs commissioner Olli Rehn said the Greek debt agreement may be hammered out before a gathering of European Union leaders Monday, in what would be a major shot in the arm to the summit.
"We're very close," he told the World Economic Forum in Davos. "They're about to close a deal, if not today maybe over the weekend, preferably in January rather than February."
As he spoke in Switzerland, the Greek government in Athens was in talks with private creditors on a voluntary exchange of bonds that would wipe 100 billion euros ($130 billion) off the country's debt of 350 billion euros.
The deal under discussion would see private creditors take a "haircut" of at least 50 percent on 200 billion euros in debt. Previous talks stalled over the amount of interest to be paid on the remaining debt.
Any failure to strike a deal could trigger a messy default, which would be an economic disaster for Greece itself and a threat to banks holding too much sovereign debt while piling pressure on other eurozone states.
Rehn said Greece would remain a special case and that the private lenders would not be required to take losses on any other eurozone country's debt, thanks to plans for a better eurozone financial safety net.
"While I know more or less how the eurozone will look in the next three years, I know that next three days will be very crucial," he said.
"We need a very sustainable solution for Greece, even if Greece is a special case," he told the audience of business leaders and top politicians. "Private sector involvement will not be applied to any other country of the EU."
Speaking at the same debate, German Finance Minister Wolfgang Schaeuble said he expected Greece to avoid a default but he warned its debt level should not exceed 120 percent of GDP.
"We don't expect a default of Greece," he said. "I know that most participants have for a long time, but I don't expect a default from Greece. I'm sure that everybody is ready to deliver what has been agreed."
The head of Germany's top bank, Deutsche Bank, also said he was confident a solution could be found to Greece's woes.
Josef Ackermann said the "haircut", or losses that banks were being asked to take on their holdings of Greek debt, was "almost 70 percent."
"That is a great, great deal. But everyone has to make their contribution and then we will see where we are. We're going to carry on," he told Germany's NTV.
Speaking the day after the Federal Reserve cited the eurozone crisis as a reason for cutting its growth forecast, US Treasury Secretary Timothy Geithner said there were signs a corner was being turned.
"Europe is making some progress," he told delegates. "Over last two months in part they are laying foundations for more credible framework."
"We have three new governments (Italy, Greece, Spain) doing some very tough things, an ECB doing the things you have got to do."
The annual forum has been marked by gloom about the state of the global economy, and in particular about Europe's struggle to cope with yawning public deficits while at the same time seeking growth and jobs.
The euro has been under pressure -- amid fears that Greece or even eventually a giant like Spain or Italy could default on its debts -- and the 17-nation bloc's economy in on the brink of renewed recession.
Davos has reverberated with calls for eurozone nations to act decisively to restore confidence, with Mexican President Felipe Calderon calling on Europe to "bring out the bazooka immediately" to prevent the problem from sinking Italy and Spain.
Geithner said Europe needs a "stronger and more credible firewall" and hinted that the US and emerging economies could supply the International Monetary Fund with more funding to help the eurozone rescue effort.
"If Europe is able to do that, we believe that the IMF can play a substantive role. It can't be a substitute for a European response," he said.
Further fuelling the mood of optimism, Italy successfully passed another market test by selling 11 billion euros ($14.5 billion) in short term bonds at sharply lower rates.

But opposition to a debt deal is mounting. Abigail Moses of Bloomberg reports, Greek Debt Wrangle May Pull Default Trigger:

Opposition to payouts on Greek credit-default swaps from European Union policy makers is softening as disputes over a voluntary debt exchange threaten to push the nation into default.

Any agreement between the Greek government and the Washington-based Institute of International Finance on debt writedowns will only bind 50 percent of investors in the 206 billion euros ($270 billion) of notes being negotiated, Barclays Capital estimates. Hedge funds may resist a deal, seeking to get paid in full or compensated from insurance contracts.

Greece must repay 14.5 billion euros of bonds in March and an agreement that triggers as much as $3.2 billion of default insurance may be necessary unless all bondholders approve, said Marco Buti, head of the European Commission’s economics division. EU Economic and Monetary Affairs Commissioner Olli Rehn said today in Davos that a deal is “very close.”

“Politicians seem less concerned than before about CDS triggers,” said Michael Hampden-Turner, a credit strategist at Citigroup Inc. in London. “Having a payout on Greek CDS is probably better than the alternative: a loss in market faith of the product’s ability to provide a hedge against sovereign risk.”
Worsen Crisis

Officials, including former European Central Bank President Jean-Claude Trichet, have insisted that a swaps trigger was unacceptable because traders would be encouraged to bet against indebted nations and worsen the crisis.

Analysts at New York-based JPMorgan Chase & Co. and Citigroup say a Greek payout may actually bolster confidence in the $232 billion sovereign insurance market and also help boost the government bond market.

Greek Prime Minister Lucas Papademos resumes talks in Athens today with Charles Dallara, the IIF’s managing director, after “some progress” was made at a meeting last night.

Default swaps insuring $10 million of Greek debt for five years cost $6.3 million in advance and $100,000 annually, according to CMA. That implies an 82 percent chance the government will default in that time, assuming investors recover 22 percent of their holdings.

Greek 10-year bonds fell today, pushing the yield on the securities up 16 basis points to 33.64 percent. The price slipped to 21.05 percent of face value. Two-year notes advanced, with the price climbing to 21.33 and the yield dropping 1,814 basis points to 182 percent.

Greece said it may impose losses on investors who fail to support the debt restructuring by adding a so-called collective action clause, or CAC, into its bond documentation. That would force holdouts to accept the same terms as the majority.
Restructuring Event

Use of CACs would trigger a restructuring credit event and a payout of default swaps, according to rules from the International Swaps & Derivatives Association.

Credit events can be caused by a reduction in principal or interest, postponement or deferral of payments, or a change in the ranking or currency of obligations. Any of these must result from a deterioration in creditworthiness, apply to multiple investors and be binding for all holders. ISDA’s determinations committee rules whether swaps can be triggered.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

“A CAC is looking increasingly like the best option,” Citigroup’s Hampden-Turner said. “That route seems to tick a lot of boxes: they don’t have a bond default, the official sector gets treated differently than the private sector, and everybody has to participate in the exchange without anybody getting paid in full.”
ECB Opposition

While the ECB oppose any involuntary restructuring of Greek debt, policy makers such as Dutch Finance Minister Jan Kees de Jager say they aren’t against a credit event.

The softer stance signals Greece is unlikely to get sufficient participation in a voluntary bond swap to make its debt burden sustainable. Negotiations have focused on the coupon bondholders will accept on new debt with Europe’s finance ministers pressing investors to accept bigger losses after the IIF made what they described as their “maximum” offer.

“It would be welcome if the ECB is no longer blocking the only sensible route for Greece to resurrect itself,” said Georg Grodzki, the London-based head of credit research at Legal & General Plc, which manages $550 billion of assets.

Hedge funds in New York and London are trying to profit from trading Greek government bonds as banks brace for losses from a debt swap.
Greek Bonds

Saba Capital Management LP, founded by former Deutsche Bank AG credit trader Boaz Weinstein, York Capital Management LP, the $14 billion fund started by Jamie Dinan, and London-based CapeView Capital LLP are among managers that now hold Greek bonds, according to people with knowledge of the transactions.

Officials are now more concerned about preventing a disorderly Greek default that might threaten indebted European nations such as Italy, Portugal and Spain. An orderly credit event would be positive for the market, according to Saul Doctor, a London-based credit strategist at JPMorgan.

“There’s less emphasis on the perils of triggering CDS,” said Barnaby Martin, a European credit strategist at Bank of America Merrill Lynch in London. “It’s now about making sure Greece’s debt is sustainable.”
Portuguese Bonds

Portuguese bond yields widened this month on speculation the indebted nation may follow Greece in seeking losses from private investors. The country’s 10-year bonds yield 14.88 percent. Two-year note yields are higher at 16.54 percent.

The upfront cost of insuring Portugal’s debt jumped 5 percentage points since Jan. 13 to a record 38 percent, according to CMA, meaning it costs $3.8 million euros in advance and $100,000 euros annually to insure $10 million of the country’s debt for five years.

Outstanding contracts on Portugal have tumbled to $5 billion from about $8 billion last year, according to data from Depository Trust & Clearing Corp., covering 2 percent of the nation’s debt.

“Contagion has already happened to a large extent and officials are probably not as scared of triggering CDS as they were six months ago,” said Cagdas Aksu, a European rates strategist at Barclays Capital in London. “If there is any way to avoid the CDS trigger, they will of course prefer it, but the chances of this has become low at this stage.”

Not as scared of triggering CDS? Give me a break! There will be no CDS trigger and no big fat Greek payday for hedgies who bought Greek bonds looking to make a killing.

In his latest comment, Andreas Koutras writes, The Restaurant at the end of the World. Bang or Whimper?:

"Are you going to tell me," said Arthur, "that I shouldn't have green salad?"

"Well," said the animal, "I know many vegetables that are very clear on that point. Which is why it was eventually decided to cut through the whole tangled problem and breed an animal that actually wanted to be eaten and was capable of saying so clearly and distinctly. And here I am." …….

"A very wise choice, sir, if I may say so. Very good," it said, "I'll just nip off and shoot myself."

(D.Adams, The restaurant at the end of the Universe)

Douglas Adams the writer of the Hitchhikers Guide to Galaxy, in his science fiction book the “The Restaurant at the End of the Universe”, has a wonderfully surreal scene. Guests at the restaurant are asked to choose which parts from a live animal they wish to eat, while watching the end of the Universe. The animal voluntarily wants to be eaten.

In a strange sort of way this is what Troika is demanding from Private bondholders. Bondholders are asked to voluntarily kill, or at least half-mutilate themselves while the guests (Troika) are watching the end of Greece. The end however could be either a big crunch (default) or a whimper (no default but just slow death).

This I guess is the 14.4billion euro question (Redeeming on 20^th March 2012). Would the end come with a default or would it be just a big whimper? In other words, a slow drift to a cold death with no bangs and no defaults.

My guess is that it all hinges on what the ECB does with its Greek bond holdings. Answering this would in my mind give you almost certainly the answer to the Crunch/Whimper dilemma. Here is why:

Big Crunch(Default)

ECB owns around 20% of the outstanding Greek debt in Bond form. If it is excluded from the PSI then others would free ride on the back of the ECB driving participation down and making the introduction of CAC (Collective Action Clauses) to force it up almost inevitable. There are many problems with this strategy and we have outlined them in previous posts (CAC Warpath, PSI Enigma, ECB and Europe, ECB Accounting).

With or without the ECB, however, there are very few that would gain from a default. Banks holding bonds outright certainly don’t want this. The ECB does not want this as it would mean losses for her and also supporting the Greek banking system. Germany and the EU would have a much bigger problem to solve in an election year. After all, Germany benefits from the lower value of the Euro caused by the Greek crisis.

It would be optimal to stretch the rope to the breaking point but no further. Only a small fraction perhaps less than 5% would stand to gain. The net CDS volume is around 3billion and is insignificant. So, why is it you may ask that they cannot find an agreement to the PSI? To me all this back and forth is just poker playing trying to secure a better deal. Viewed under this light, many actions make more sense. The only problem is that the rope might break earlier and for unforeseen reasons (Greek political turmoil for example).

Big Whimper (Slow cold death)

If on the other hand Europe finds a way to relieve the ECB of its holding or if the ECB decides to take the hit and participates in the PSI, the hold outs would be reduced to a minimum. Namely, to retail bond holders and possibly owners of Greek bonds under English (non-Greek) law. In this scenario, Greece would not need to cause a credit event or introduce CAC’s to force the participation up. It would also respect market practices and give time for reflection and Election (see France, Germany)!

Conclusion

The end game is very hard to call. Rationality and logic point towards a whimper solution. Human failings and unpredictable events point to a big bang. D.Adams motto in the hitchhiker guide to the galaxy is DO NOT PANIC.

Will it all end in a bang or a whimper? I'm not panicking. My take is that the power elite at Davos have enough of the turmoil in financial markets and they will do whatever it takes to put an end to this Greek debt debacle. Stay long risk assets and keep buying the dips hard.

Below, Nobel Prize-winning economist Joseph Stiglitz, talks about income disparity and employment in the U.S., and the European sovereign-debt crisis. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday."

And International Monetary Fund Managing Director Christine Lagarde discusses Greece's progress on structural overhauls and the role of the IMF in avoiding a default. She speaks with Maryam Nemazee and John Fraher on Bloomberg Television's "The Pulse" .

Finally, George Soros talks about the European debt crisis, stating that defenses for Greece are too weak. He speaks with Erik Schatzker on Bloomberg Television's "InsideTrack" from the World Economic Forum in Davos, Switzerland. As I stated earlier this week, Soros gets it, and European leaders would be wise to listen to him carefully.

Anxiety Mounts Over Maturing Real Estate Loans?

2012-01-26T22:09:00.005-05:00

Julie Satow of the NYT reports, Anxiety Mounts Over Maturing Real Estate Loans:

Borrowers and lenders are starting to grapple with the billions of dollars in commercial real estate loans made during the boom year of 2007 that are coming due this year, in a greatly contracted economy.

Experts have warned of a rash of recapitalizations, refinancings and building sales. In New York City alone, nearly $70 billion worth of commercial mortgages that were bundled together and issued as collateral for bonds are maturing this year. Of those, $26 billion, or 37.4 percent, are five-year loans that were originated during the height of the real estate bubble, when underwriting standards were loosest, according to data from the research firm Trepp LLC.
These include loans on prominent properties, including the Manhattan Mall, with $232 million maturing, and the Jumeirah Essex House, with a $180 million loan, according to Trepp.
“These loans are going to have the hardest time being refinanced since they were underwritten when property values and revenues were far higher,” said Thomas A. Fink, a managing director at Trepp. “We are going to see a wave of loans maturing this year, then again in 2014 and 2017, when the 7- and 10-year deals underwritten during the bubble mature.”
Most large commercial mortgage loans are typically not self-amortizing — that is, they require a balloon payment upon maturity.
While the number of loans maturing is expected to spike this year — $40.7 billion worth of securitized commercial mortgage loans matured last year and $49.5 billion worth is expected to mature in 2013 — the universe of lenders has shrunk. European banks, reeling from the debt crisis, have mostly stopped underwriting loans in the United States, while the market for commercial mortgage-backed securities remains relatively small, at roughly $30 billion in new issuance expected this year. And while insurance companies have increased their appetite for commercial mortgage loans, they are very conservative in their lending standards and selective in their deals.
“This means there may not be enough money available to refinance all of the debt that is coming due,” said Lawrence J. Longua, a clinical associate professor at the Schack Institute of Real Estate at New York University.
In a typical situation, a building that was worth $100 million in 2007 was financed with 80 percent debt, or $80 million. Now the loan — which was interest-only, meaning no principal was paid — is maturing. The borrower owes $80 million, but the value of the property has also dropped, to $80 million. This means that the ratio of the loan to the value of the property is 100 percent. Lenders have little appetite in this market environment for highly leveraged loans, so in one increasingly common outcome, the borrower will recapitalize the property by finding an equity partner to inject new capital into the deal, thereby lowering the overall amount of debt on the property.
Other possible resolutions include the lender extending the maturity date of the loan in the hopes that the property’s value will rise, or pursuing a foreclosure. It is also becoming more common for banks and other lenders to sell their loans to third-party investors who may negotiate with the borrower.
One factor that may drive more deal activity this year is that banks, special servicers and other lenders are eager to find solutions to troubled loans now, rather than postpone a resolution in the hope the market will improve down the road, said Scott Rechler, the chief executive and chairman of RXR Realty, which has recapitalized several properties in the last year, including the recent acquisition of 620 Avenue of the Americas.
“The first half of 2011 was very strong, with a lot of deal-making,” Mr. Rechler said, “but then several incidents, including the European debt crisis and the downgrading of the U.S. debt, made the market seem frothy. This was actually somewhat healthy because it put things back into perspective.”
As a result of these market jitters, he said, “lenders who had been waiting in the hopes that the market would improve, realized that things were still unstable and so they are more ready to resolve their loans now than in the past. Maybe not in the first quarter of this year, but by the second and third quarter I see a lot of things in the pipeline.”
Already, the number of recapitalizations has ballooned. There was $13.3 billion worth of recapitalizations nationwide in 2011, according to the research firm Real Capital Analytics, the most since the firm began tracking the number in 2001.
Another factor driving deal flow is the efforts by European banks to offload some of their American loan portfolios. In December, for example, Blackstone bought a $300 million portfolio of commercial loans backed by American properties from Eurohypo, the troubled real estate arm of Commerzbank in Germany. Other sellers include Allied Irish Banks, Bank of Ireland and Anglo Irish. American banks have also been shedding loans: In September, Bank of America sold nearly $1 billion worth of loans to several investors at a discount.
The sale of these loans can help spur deals because investors who buy these loans at a discount have more room to negotiate a payoff with the borrower, said Andrew A. Lance, a partner at the law firm Gibson, Dunn & Crutcher. A loan that has an outstanding balance of $100 million, for example, may sell to an investor for $80 million, enabling the investor to settle the loan with the borrower for any price between $80 million and $100 million, resulting in a profit for the investor and a discount for the borrower. While under this situation the original lender loses out, in the case of several European banks, regulators are ordering them to increase capital and shrink their balance sheets.
Dune Real Estate Partners participated in such a deal last year when it acquired the loan on the Mark Hotel on East 77th Street from Anglo Irish, recently completing a recapitalization of the property. Dan Neidich, the chief executive of Dune Real Estate Partners, said: “There are so many players now who aren’t the natural owners of real estate — like banks and special services — that never intended to own equity and who want to exit those positions. It opens opportunities for people like ourselves, who are in the business of taking equity risk, and bringing capital into the market to restructure deals.”
But not all borrowers will find themselves in trouble. There are many New York landlords who can simply pay down the loans without much struggle, market experts say. Vornado Realty Trust, for example, refinanced a $430 million loan at 350 Park Avenue in January with $300 million in debt and $132 million in cash. It is currently in the market to refinance the $232 million loan maturing on the Manhattan Mall, at Broadway and 33rd Street.
Still, even those borrowers who can pay down the loans themselves will have to contend with the softened market. “The key issue that cuts across all property types and all kinds of loans,” said Dennis W. Russo, a partner and co-chairman of the real estate practice at the law firm Herrick, Feinstein, “is that property values — the value of the collateral that secures the debt — are down. Combine that with the fact that lenders are conservative right now, and the bottom line is that in many scenarios, borrowers are going to have to find additional capital.”

Despite these jitters, commercial real estate sales rose sharply in 2011. Hui-yong Yu of Bloomberg reports, Commercial Property Sales Rose to More Than $220 Billion in U.S. Last Year:

Commercial property sales rose 57 percent to more than $220 billion U.S. last year, led by retail properties and garden apartments, Real Capital Analytics Inc. said in a report today.

More than 14,700 properties, each worth at least $2.5 million, changed hands in 2011, the New York-based real estate research firm said. Retail-property transactions rose 91 percent from a year earlier to $42.4 billion, and sales of low-rise apartments increased 70 percent to $34.5 billion. Manhattan accounted for 12 percent of total deal volume.

Sales rose as investors sought relatively higher yields from income-producing real estate and debt-laden owners unloaded properties acquired during the bubble years. Deals slowed in the second half of 2011 as turmoil in the market for commercial mortgage-backed securities curbed financing. Office and hotel transactions fell in the three months through December after six quarters of “large” year-over-year gains, Real Capital said.

“Buyers have started to broaden their horizons both geographically and by property type,” the firm said.

The biggest declines in capitalization rates were seen in well-leased, high-quality suburban offices and in shopping centers anchored by grocery stores, Real Capital said. Cap rates are calculated by dividing a property’s net operating income by purchase price, with rates dropping as prices rise.

Banker & Tradesman reports that Boston ranked 18^th on a listing of the top 30 cities worldwide that attracted commercial real estate investment in 2010-2011, and are expected to continue leading the way over the next decade according to a recent report from Jones Land LaSalle (JLL). Even Northern Nevada’s embattled real estate and construction industry has hit bottom and is on the road to recovery (buy casino stocks like Las Vegas Sands).

In Canada, commercial real estate transactions in the Calgary region ballooned in 2011 with both dollar volumes and deal velocity significantly higher than the previous year. But you already know my thoughts on the Canadian housing bubble (commercial is less vulnerable because large public plans own most of the prime properties).

In Europe, Property Wire reports on strong demand for German commercial property:

Transaction volumes for Germany's commercial real estate market will exceed €20 billionin 2012 with continued strong demand from both somestic and foreign investors, it is claimed.
According to research by international real estate advisor Savills real estate worth €22.6 billion changed ownership in Germany in 2011, marking a 20% increase on 2010.
‘The final quarter of 2011 recorded the second best investment volume of the year at approximately €5.8 billion, showing little evidence in the investment market of a deteriorating macro economic environment,’ said Lars-Oliver Breuer, head of investment at Savills Germany.
‘Given a number of uncertainties it is difficult to provide an outlook to 2012 but what will be crucial is whether the situation in the financial markets stabilizes and if the eurozone succeeds in convincing investors of its stability,’ he explained.
‘Financing will be the predominant issue this year but if the continuously strong demand for German real estate can be translated into deals the 20 billion mark is realistic for 2012,’ he added.
Savills research shows that as in previous quarters the retail sector dominated German markets in the last quarter of 2011. Overall retail generated an investment volume of over €11 billion, making up almost half, 49%, of total transactions in 2011 and representing an increase of 60% on 2010.
The office sector, which has historically dominated the German investment market, accounted for just below 35% of all transactions in 2011. Overall offices accounted for €6.58 billion of the investment volume in 2011, up from €4.88 billion in 2010.
According to Matthias Pink, head of research at Savills Germany the reason for the increase in retail investment is partly due to the higher rental stability of retail properties. ‘Investors who continue to focus on secure investments appreciate this characteristic. Another reason is the stable and currently very good consumer sentiment in Germany,’ he said.
Overall almost half of Germany’s 2011 total transaction volume was invested in the leading five markets of Frankfurt, Berlin, Hamburg, Düsseldorf and Munich. Due to several large volume deals Frankfurt led the way generating a single asset transaction volume of over €2.3 billion, making up 14% of the total German transaction volume.
Munich also recorded a strong increase almost doubling its volume invested in single assets in 2011 to €1.6 billion. In Berlin volumes were up 11% and in Hamburg they were up 14%. But in Düsseldorf the transaction volume decreased by approximately 40% compared to 2010.

The share of foreign buyers was approximately one third in 2011 with investors of Anglo Saxon origin accounting for over half of all foreign investment. As in the first half of the year open ended and closed ended funds were among the strongest buyer groups and jointly invested €7.6 billion.
The second half of 2011 saw a notable increase in investment activity from insurance companies and pension funds as well as listed property companies and REITs.

Indeed, pension funds have been busy snapping up real estate in Germany and other European cities like London and Paris (click on image below):

As you can see, institutional investors aren't too anxious about maturing real estate loans. Private equity real estate funds like Blackstone and Lone Star will be scooping up distressed loans for a song and making a killing in the process for themselves and their limited partners.

Below, John Levy and FOX Business hosts Connell McShane and Jenna Lee discuss the current commercial real estate market.

'Major' Changes to Canada's Pension System?

2012-01-26T13:25:00.025-05:00

Prime Minister Stephen Harper is in Davos touting 'major' changes to Canada's pension system:

Prime Minister Stephen Harper has signalled his government will bring forward “major transformations” to the country in the coming months — in areas such as the retirement pension system, immigration, science and technology investment and the energy sector.
Of those reforms, Harper said, getting a grip on slowing the rising costs of the country’s pension system is particularly critical.

In the wake of Harper’s speech, it now appears that the Conservative government could be poised to gradually change the Old Age Security system so that the age of eligibility is raised to 67 from 65.
Harper made the revelations in a major keynote speech Thursday at the World Economic Forum, the annual gathering of the world’s political and business elite.

As expected, the prime minister was critical of Europe and the United States for not adequately dealing with the economic problems that have gripped them in recent months and years.

But it was Harper’s assessment of the major changes that lie ahead for Canada that stood out in the speech.

“In the months to come, our government will undertake major transformations to position Canada for growth over the next generation,” said Harper.

The Conservative government will table a budget in the coming weeks that is expected to set the stage for years of deficit-slashing and government reform.

“Under our government, Canada will make the transformations necessary to sustain economic growth, job creation and prosperity now and for the next generation,” said Harper.

He said that means two things: “Making better economic choices now. And preparing ourselves now for the demographic pressures the Canadian economy faces.”

Harper said the country’s aging population has become a backdrop for his concern about how to keep the country strong over the long term.

“If not addressed promptly, this has the capacity to undermine Canada’s economic position and, for that matter, that of all western nations well beyond the current economic crises.”

Indeed, Harper said the country’s demographics — an aging populating and a dwindling workforce — constitute “a threat to the social programs and services that Canadians cherish.”

For that reason, he said his government will “be taking measures in the coming months.”

Harper did not specify what those measures will be, but he said they are necessary — not just to bring the government’s finances back to a balanced budget in the medium term, “but also to ensure the sustainability of our social programs and fiscal position over the next generation.”

“We have already taken steps to limit the growth of our health care spending over that period,” said Harper.

“We must do the same for our retirement income system.”

Harper said the centrepiece of the public pension system — the Canada Pension Plan — is fully funded, actuarially sound and does not need to be changed.

But he added: “For those elements of the system that are not funded, we will make the changes necessary to ensure sustainability for the next generation while not affecting current recipients.”

So far, the government has come forward with a plan to create a private pooled pension system to encourage Canadians to prepare for their retirement.

Still, there are concerns that as baby boomers approach retirement, the cost to government of providing public pensions will skyrocket.

In December, the National Post reported that there was internal debate within the government about increasing the age of eligibility for the other major element of the public pension scheme — Old Age Security — from 65 to 67.

Internal government documents project the cost of the OAS system will climb from $36.5 billion in 2010 to $48 billion in 2015. By 2030 — when the number of seniors is expected to climb to 9.3 million from 4.7 million now — the cost of the program could reach $108 billion.

Among the other priorities where change is coming:

Energy

The Conservative government will make it a “national priority” to ensure the country has the “capacity to export our energy products beyond the United States, and specifically to Asia.”

“In this regard, we will soon take action to ensure that major energy and mining projects are not subject to unnecessary regulatory delays — that is, delay merely for the sake of delay.”

Harper did not explain what he has planned, although he and Natural Resources Minister Joe Oliver have complained that foreign-backed “radical” opponents of the $5.5-billion Northern Gateway project have threatened to slow down hearings by the National Energy Board.

Immigration

The system faces “significant reform,” said Harper.

“We will ensure that, while we respect our humanitarian obligations and family reunification objectives, we make our economic and labour force needs the central goal of our immigration efforts in the future.”

Science

The government will continue to make “key investments in science and technology” that are necessary to sustain a “modern competitive economy.”

“But we believe that Canada’s less-than-optimal results for those investments is a significant problem for our country.”

In future, he said, there will be changes to rectify that problem.

Trade

Harper expects to complete negotiations on a Canada-European Union free-trade agreement this year.

Furthermore, he said, his government is committed to also completing negotiations for a free-trade deal with India by the end of 2013.

And Canada will begin talks to become a member of the Trans-Pacific Partnership while also pursuing opportunities to trade in the emerging market of Asia.

Harper arrived Wednesday at the World Economic Forum determined to tout Canada as a trading nation with a solid economic record and massive oil resources which are ready to be sold and shipped to customers worldwide.

Other members of cabinet who are attending the conference in the exclusive mountainside resort in the Swiss Alps are Finance Minister Jim Flaherty, Foreign Affairs Minister John Baird, International Trade Minister Ed Fast and Bank of Canada governor Mark Carney.

The Canadian delegation used private meetings in the corridors and backrooms at the forum to promote Canada’s hopes for a free-trade deal with Europe, and also break into the emerging marketplace in Asia.

The forum, which dates back to 1971, has drawn 2,600 participants, including 40 political leaders and more than 1,600 senior business leaders.

While the economic uncertainty of Europe gripped the discussions, participants — at the urging of the forum’s founder, Klaus Schwab — also discussed whether capitalism itself needs to be fundamentally reformed to ensure greater social responsibility.

On Thursday morning, British Prime Minister David Cameron told the conference that Europe’s economies had entered a “perilous time” and called for European leaders to avoid “tinkering” with the eurozone debt crisis.

Cameron boasted of his government’s actions to get British debt under control and said the countries in the eurozone (Britain is not a member) must also take “bold and decisive “ action if they want to solve the debt crisis.

Harper issued a scathing criticism of countries in the developed world, which he suggested had forgotten about the importance of creating economic growth.

“Is it the case that, in the developed world, too many of us have in fact become complacent about our prosperity?” Harper asked.

He suggested that developed countries had taken wealth “as a given . . . assuming it is somehow the natural order of things.”

As a result, he said, countries in the western world had become focused primarily “on our services and entitlements.”

As a result, he said, it’s not surprising that, in addition to banks facing debt, countries themselves were also facing sovereign debt crises.

The problem, he suggested, could be “too much general willingness to have standards and benefits beyond our ability, or even willingness, to pay for them.”

Harper warned that the wealth of western economies “is no more inevitable than the poverty of emerging ones.”

He said the problems afflicting Europe and the U.S. threaten to become even more serious in future.

“Each nation has a choice to make. Western nations, in particular, face a choice of whether to create the conditions for growth and prosperity, or to risk long-term economic decline.”

The solution, he said, is for countries to make the sometimes tough, but correct, decisions now.

“Easy choices now mean fewer choices later.”

Easy choices now? Like pandering to banksters and insurance hacks, banking on PRPPs? Thanks but no thanks, that is a recipe for pension poverty, higher debt and less growth down the road.

As a Canadian who blogs on pension issues every single day, I stand against "easy solutions" which will only exacerbate income inequality and reduce retirement security for all Canadians.

If our PM and Finance Minister are serious about solving Canada's pension enigma, they would recognize the need to bolster our public defined-benefit plans, the envy of the world. Some of our smartest pension leaders have made the case for boosting defined-benefit pensions, but they're being completely ignored by our government who panders to banks and insurance companies.

And Canadian banks and insurance companies are being advised by shortsighted fools. If they had any vision and thought about what is best for the country and their long-term profits, they'd be pushing hard to expand CPP and defined-benefit plans for all Canadians. They simply don't get it.

I'm tired of our politicians and corporate leaders telling us that pensions are "too expensive" and that we can't fix pensions and make them better. NDP interim leader Nycole Turmel says MP pension reform should be handled by independent group and that the government should focus on the retirement security of millions of Canadians. Great idea from another MP with her snout in the pensions trough, but who will form this independent group of thinkers?

I know who I would recommend to lead such an independent Royal Commission. Bernard Dussault, the former Chief Actuary of Canada, and John Crocker, the former President and CEO of Healthcare of Ontario Pension Plan (HOOPP), one of the best defined-benefit plans in the world.

Instead our government is going to take the easy route. Canada is facing serious issues, including a major housing bubble about to burst (high end condos are first to go), and all the government can think of is cut everywhere and replace defined-benefit plans by defined-contribution plans.

Don't get me wrong, I'm a fiscal conservative (social liberal) and believe we need serious pension reform, but we are not going about it in an intelligent manner and it's going to end up costing us a lot more in the future.

Every single day I tweet about some company that suffered a pension bomb. Today, it was AT&T who lost a whopping $6.7 billion in the fourth quarter due largely to a change in how it accounts for its employee pension benefits and the breakup fee it was required to pay after scrapping its bid to buy T-Mobile USA.

AT&T is not alone. Many U.S. and Canadian companies are unable to deal with their employee pension benefits. Many have opted out of defined-benefit plan for 'low cost' defined-contribution plans but this is not in the best interest of their employees or in the best interest of their country.

If the leaders at Davos are serious about growth, debt, inequality and other social issues, they have to start thinking hard about retirement security and coming up with a sustainable solution for the long-term.

In a nutshell, here are some of my 'radical' proposals:

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

I wasn't invited to speak at Davos but that's fine, I'm not into schmoozing with billionaires. But some very powerful people do read my blog and they are there, hobnobbing with the world's power elite. Hopefully they will pass on my message.

Below, World Bank President Robert Zoellick talks with Bloomberg's Erik Schatzker about the economic woes facing Italy. And Kenneth Rogoff, an economist at Harvard University, talks about the European debt crisis and the impact of a Greek default on the region.

The Shrinking Private Equity World?

2012-01-26T08:28:00.008-05:00

Maureen Farrell of CNN reports on the shrinking private equity world:

The notoriously private private equity industry can't escape the glare of the spotlight these days, but the more immediate issue facing the industry is a lack of funding.
In 2011, U.S. firms invested just $32.1 billion in private equity, down nearly 79% from the industry's peak year in 2007.
And 2012 is expected to be even worse.
"It's taking a lot longer to raise funds," said Jeffrey Bunder, head of Ernst & Young's global private equity practice. "The process isn't like it used to be. They're having to demonstrate why they deserve the money."
Pensions and endowments, which make up the bulk of private equity investors, have been casting a wary eye on the industry because of the combination of high fees, lackluster returns and generally erratic returns.
Keith Garrison, the director of alternative assets for Texas Christian University's $1.1 billion endowment, said he's been more cautious about investing in buyout funds since the financial crisis.
"The returns have been more drawn out than you would have originally anticipated," said Garrison. "We need to manage liquidity. I'm not the only endowment closely watching its allocation to private equity."
Unlike hedge funds or other assets that offer quarterly returns, private equity funds return cash to investors only when the companies they're invested in are sold, go public or add new debt.
Part of the problem for the industry is that since the financial crisis, private equity firms have had a hard time selling their acquired companies, as mergers and acquisitions and initial public offering activity slowed down.
In fact, current returns are at their worst level since at least 1990, when the California Public Employees' Retirement System first started tracking the data.
Private equity funds raised in 2006 have returned just 4.2% to investors, according to the pension fund's website. Funds raised in prior years generated double digit returns. Similar to hedge funds, managers of private equity firms generally earn 2% fees on all funds they manage and 20% of all profits.
Meanwhile, the same firms are struggling to find companies to take private that could generate returns. The industry is sitting on roughly $400 billion of cash globally. Private equity managers haven't found the right companies to put this so-called dry powder in.
All but the best performing firms are expected to shrink, as investors put a smaller amount of their portfolio into private equity firms.
Firms that have raised between $1 billion and $5 billion with so-so performance will have the most trouble raising new funds.
Most of the largest funds that already have a spot in a public pension such as CALPERs, which manages $219 billion of California employees' retirement funds, will keep some money from these funds. CALPERs and its larger pension peers spend a lot time and a lot of money vetting new investments, so earning that initial spot in a pension portfolio helps keep a private equity firm alive in all but situations of extremely poor performance.
As U.S. investors scale back their private equity investments, the industry is increasingly looking to sovereign wealth funds and wealthy families in Asia and Latin America for new money.
"Funds are spending a lot of time overseas telling their story and thinking there's an appetite there," said Ernst & Young's Bunder. "That money doesn't come in overnight though."
For many private equity funds, that extended fundraising cycle could strike a fatal blow.

So what is going on? Is private equity fundraising really drying up? Not according to Michael Corkery of the WSJ who reports, Public Pensions Increase Private-Equity Investments:

Large public pension plans are pouring more money into private-equity funds, deepening ties between government workers and an industry currently under the harsh glare of U.S. presidential politics.

Big public-employee pensions had about $220 billion invested in private equity in September, or 11% of their assets, according to Wilshire Trust Universe Comparison Service, which tracks the holdings of pensions, foundations and endowments.
That is up about $50 billion from a year earlier, when such investments accounted for 8.6% of large pension funds' assets. A decade ago, pensions with at least $1 billion under management had just 3% of their money with private equity.

Private-equity funds buy companies, restructure them and try to profit by reselling them at a higher price. That approach, particularly with respect to the fate of workers at companies they buy, has become an issue in the Republican campaign because Mitt Romney formerly led private-equity firm Bain Capital.

In Monday's debate in Florida, which holds its primary on Jan. 31, Mr. Romney defended his business track record, which he said involved creating thousands of jobs.

Some of Mr. Romney's critics are labor unions, including those who count public employees as members and have representatives on pension boards that determine how much to invest in private equity. The retirement benefits of thousands of police officers, firefighters and teachers depend in part on the profits of investments in private-equity firms such as Bain.

Earlier this month, the Service Employees International Union, a major public-sector labor group, blasted Bain for what it described as "a long and troubling track record of putting profits above workers." The union said, for example, that Bain had acquired a plant in Indiana where workers were fired and then rehired at a lower wage.
SEIU members have pension money invested in numerous state and county pension plans around the U.S., many of which are invested in private-equity funds. And SEIU members serve on the pension boards that make decisions about where funds are invested.

An SEIU member, for example, serves as a trustee of the Ohio Public Employees Retirement System, which holds billions of dollars in private-equity investments and, in recent years, increased its target private-equity holdings to 7% of assets, from 5%.

Investment officials at the Ohio fund and other public pension plans say their primary duty is to secure the highest returns possible for public workers.

"Our board members are fiduciaries who act in the best interest of the fund, regardless of whatever political leanings they have personally'' or their unions have, said Julie Graham-Price, a spokeswoman for the Ohio pension fund.

An SEIU spokesman declined to comment.

The American Federation of State, County and Municipal Employees, or Afscme, which represents 1.6 million active and retired public employees, is taking a swipe at Mr. Romney for one of Bain's many investments.

"What kind of businessman is Mitt Romney?'' asked a new Afscme-funded television advertisement. The ad said Mr. Romney collected a "fortune" from a company, formerly held by Bain, that was accused of Medicare fraud.

A spokesman for Bain declined to comment.

Afscme's members have billions of dollars of pension money invested in about 150 public pension plans around the nation, many of which are invested in private-equity funds. Afscme's members also serve on pension-fund boards in about a dozen states and cities.

An Afscme member, for example, is one of the trustees overseeing the New York City Employees' Retirement System, which recently increased its targeted allocation for private equity to 7%, from 5%.

The Afscme member on the New York City pension board, Lillian Roberts, said in a statement: "I have a fiduciary duty to protect the investments Afscme members and others have made to the pension fund.''

Ms. Roberts added that she has pushed pension officials to address high fees and other drawbacks of private-equity investments.

A national spokesman for Afscme said it was "ridiculous" to question whether there was a conflict for the union to criticize Mr. Romney's private-equity track record while union members' pensions were invested in private equity generally. "The purpose of the ad was to shine light on Mitt Romney's dubious record in the private sector. …Afscme members have savings in banks that engaged in questionable behavior, too," the spokesman said. "They still know that this kind of behavior needs to be reined in."

Asked about the SEIU and Afscme criticisms, a spokeswoman for the Romney campaign said in a statement: "The last thing President Obama and his cronies want is Mitt Romney as an opponent because they know he is the only candidate that can beat President Obama and put an end to the big labor's power."

Pension-fund officials say they increasingly are turning to private equity in an effort to hit annual return targets of 8%. Over both the past five years and the past 10 years, private-equity returns were more than double those of the S&P 500 stock index and the Dow Jones Industrial Average, according to Cambridge Associates LLC, which tracks over 4,500 private-equity firms.

As of September 2011, median private-equity returns for large public pension funds over the past five years was 6.6%, according to Wilshire Associates. Median stock-market returns for those funds were a negative 0.9% over that same five-year period.

During the private-equity buyout boom of the 1980s, many pension funds steered clear of the sector, fearing the unknown.

Today, pension-fund managers "would say you may be breaching your fiduciary duty if you avoid this asset class," said Bill Kelly, a lawyer at Nixon Peabody who has worked with pensions and private-equity firms for 30 years.

Wilshire said private-equity investments surged last year as a percentage of pension-fund holdings partly because pension funds' existing investments in private equity increased in value while other holdings, such as stocks, were mostly flat.

Pension funds are experimenting with new ways to team up with private-equity firms, such as publishing joint research and investing directly in companies alongside private-equity partners.

In November, the $100 billion Teacher Retirement System of Texas made one of the largest single private-equity investment ever—a $6 billion commitment to new partnerships with Apollo Global Management and KKR & Co. The pension fund and the two New York firms will swap strategies and share resources.

The Texas fund has private-equity portfolio with investments in about 1,500 companies. It doesn't disclose the names of those companies publicly.

"I am confident that our private-equity investments have created more jobs than they have lost,'' said Steve LeBlanc, head of private markets at the Texas fund. "The way you make money is through growth."

Some pension funds enter into side agreements with private-equity firms barring certain investments, such as in tobacco or firearms companies. Since 2004, the largest U.S. public pension plan, California Public Employees Retirement System, or Calpers, restricts private-equity investments in companies that are likely to outsource government jobs to the private sector, such as prison guards and garbage collectors.

In 2010, the Ohio Public Employees Retirement System sent a letter to private equity firm Permira protesting plans by one of its portfolio companies, clothing retailer Hugo Boss, to close a local factory. Permira declined to comment. A spokesman for Hugo Boss said the plan ultimately remained open.

Calpers investment officials had no comment on the criticisms being leveled at private equity in the presidential campaign.

CalPERS' delivered paltry returns in 2011 but their private equity portfolio is up 12% for the first three quarters of 2011.

Increasingly, large public plans are looking to private equity to bolster their returns. Top funds have no problem raising assets. Bloomberg reports that Blackstone secured more than $6 billion of pledged capital for a new real estate fund that will buy mainly distressed-property assets:

The New York-based buyout firm plans to raise at least $10 billion for the fund, known as Blackstone Real Estate Partners VII, said the people, who asked not to be identified because the capital-raising is private. Blackstone expects the vehicle to be fully funded this year, they said.

The company has remained one of the most active investors in commercial real estate at a time when such Wall Street competitors as Goldman Sachs Group Inc. (GS)’s Whitehall funds and Morgan Stanley’s real estate funds retreated after incurring losses in the crash.

“Blackstone is in a bit of a unique position because so many mega-funds have been eliminated or are struggling with ongoing legacy issues,” said James Corl, a managing director at Siguler Guff & Co., a New York-based private-equity firm that raised $630 million for distressed-property investments.

But while the top firms thrive, others lag behind, and private equity is being scrutinized by politicians and investors alike. Some are complaining about private equity's public subsidy while others are calling private equity profits into question:

Private equity has proved better at enriching its own managers than producing investment profits for US pension funds over the past decade, according to a study prepared for the Financial Times by academics at Yale and Maastricht University.

The industry faces mounting political scrutiny as the presidential candidacy of Mitt Romney, a former private equity executive, has drawn attention to its business model and favourable tax treatment. Mr Romney will release his tax returns today after pressure from Republican challengers.
From 2001 to 2010, US pension plans on average made 4.5 per cent a year, after fees, from their investments in private equity. In that period, the pension funds paid an average 4 per cent of invested capital each year in management fees. On top of those, private equity often collects a variety of other fees and a fifth of investment profits.
“Assuming a normal 20 per cent performance fee, this would amount to about 70 per cent of gross investment performance being paid in fees over the past 10 years,” said Professor Martijn Cremers of Yale.

Private equity describes its fees as “two and twenty”, a 2 per cent management fee and 20 per cent share of profits. However, the management fee is usually calculated as a proportion of total capital committed by the investor, which takes time to invest.

So in the early years, the management fee can be a much higher proportion of actual cash invested. For instance, if a $1bn fund invests $100m in its first year, the $20m management fee would be 2 per cent of committed capital, but 20 per cent of invested capital for that year.

From 1991 to 2000, US pension funds paid an average 2 per cent of invested capital each year in management fees, and received 21 per cent returns, after fees, annually from their private equity investments, according to data from the CEM Benchmarking database used for the study. The database covers about a third of US pension fund assets.

The rise in management fees since 2000 may reflect greater fundraising, meaning that more funds are in the early investment phase when fees are high. The increased use of third-party fund of funds to invest in private equity could also have added an extra layer of fees.

The Private Equity Growth Capital Council, a trade body, said that calculating fees on the basis of committed capital was the industry standard, and it was inappropriate to compare fees on the basis of invested capital.

Indeed, Steve Judge, Interim President and Chief Executive, The Private Equity Growth Capital Council, responded to the FT claiming that private equity data isn't rocket science:

Sir, Dan McCrum’s article “Private equity fees called into question” (January 24) describes statistics about private equity performance and fees that we at the Private Equity Growth Capital Council do not recognise. His main finding is that in recent years the pension plans have paid higher fees to private equity funds than in previous decades. In contrast to this assertion, most industry observers believe that management fees have declined in recent years. Preqin, a leading provider of data on alternative assets, finds that management fees for private equity funds are at or below 2 per cent and fees for funds over $1bn in assets have declined to an average of 1.71 per cent.
The reason the nominal amount of fees went up is simple: pension funds and other sophisticated investors have invested substantially more money in private equity over the past 10 years. Since management fees are typically based on the amount of money committed by the investor, it logically follows that the nominal amount of fees to private equity funds will go up as more capital is committed to these funds. This finding is simple mathematics, not news.

Pension plans have found private equity investments to be a superior performing asset class. Just this week Calpers, the pension plan for California’s public employees and the US’s largest public pension, reported that private equity investments returned more than 12.3 per cent during the year while the rest of the portfolio returned only 1.1 per cent.

Mr McCrum’s assertions rely on a study conducted specifically for the Financial Times. Your newspaper should release the study publicly so that the data, methodology and conclusions can be reviewed. Until then, the findings of any unpublished study are inconclusive.

Mr. Judge is talking up his industry. That's his job. The truth is that the bulk of private equity funds are mediocre and if you factor in illiquidity and leverage, they've underperformed the S&P 500 over the last 20 years.

And the fees are high, especially for pensions and endowments investing in private equity funds of funds (totally insane!!!). This is why large Canadian and U.S. public pension funds are increasingly co-investing alongside private equity funds so they can reduce fees.

Of course to do this properly, you need deep pockets and you need to hire talented professionals and pay them properly. For example, Financial News reports that the Ontario Teachers’ Pension Plan has appointed Jo Taylor, a former 3i executive, to be its head of its London office, a new role for the key private equity investor:

The role will involve finding and executing investments, which typically range from between around C$100m (US$98m) and $300m. The London office was set up in 2007 but had until now been run from Toronto by vice-president Andrew Claerhout.

Taylor had spent over 20 years with 3i Group holding a number of senior investment roles before departing in 2008. His last role was as head of venture at 3i, before he then launched an unsuccessful bid to acquire 3i’s venture portfolio in 2009, creating the now-defunct firm Ethean Capital for the bid.

Other large Canadian public pension plans are doing the exact same thing. Will it all pan out? We shall see. None of the Canadian or U.S. funds publish the performance of their direct investments separately from that of their fund investments.

In the end, pensions looking to private equity, real estate and infrastructure to 'save' them might be better off focusing a lot more on public markets. Keep in mind, private equity's landscape is changing and its fortunes are inextricably tied to what's going to happen in public equities.

Below, Jim Bianco thinks the stock market is living on borrowed time. Giving his outlook for the rest of 2012, the president of Bianco research says stocks "might have another 5 to 6% to go and that's on the topside." He has two main reasons for his relative gloom: The end of stimulus and rapidly shrinking earnings.

As much as I respect him, I happen to disagree with Jim. With the Fed committed to keeping rates low until 2014, and other central banks pumping up the jam, I see a massive rally in risks assets once we get over all the Euro gloom and doom. Germany should listen to Soros, he understands what's at risk.

So Much For That Big Fat Greek Payday?

2012-01-25T22:26:00.007-05:00

Stefan Kaiser at Spiegel reports, Hedge Funds Bet on Profits from Greek Debt Talks:

The negotiations over the Greek debt haircut are becoming increasingly suspenseful, with euro-zone finance ministers and the IMF pushing investors to accept greater losses. Hedge funds, more than any others, stand to profit, and are betting that the voluntary debt rescheduling will fail.

Who will bleed for Greece? For weeks, private creditors like banks and insurers have been trying to negotiate a debt rescheduling with the country without success. Even when they seem close to agreement, it remains unclear if all creditors are on board. In particular, hedge funds that own Greek bonds could have a significant interest in ignoring the results of the negotiations, instead preferring to focus on an official national default.

Bank representatives assume in the meantime that many hedge funds are not really interested in an agreement. With a controversial investment strategy they have assured themselves of profiting with either a low level of Greek bad debts, or a complete Greek bankruptcy.
At issue are Greek bonds with a total volume of about €200 billion. How many are owned by hedge funds is unclear, but the amount is estimated to be about €70 billion (including other funds).

The bondholders are expected to voluntarily give up 50 percent of their claims. Another 15 percent is to be compensated with either cash or secure bonds of the European rescue fund EFSF. The remaining 35 percent should come in the form of new Greek bonds, that will likely reach maturity in 30 years.

The amount of money the creditors will actually have to give up depends on the interest rates on the new bonds. The Institute of International Finance (IIF), which is leading the negotiations with Greece, is insisting on an average of at least four percent. The euro-zone finance ministers and the International Monetary Fund (IMF) have instead insisted on rates lower than four percent, in order to make the burden on Greece more bearable. The banks calculate that this means they would actually lose closer to between 70 and 80 percent of their claims, and they are balking.

'Not Worried About Their Public Image'

For some hedge funds, the fight over interest rates has given them more incentive to push for a breakdown of the proposed plan. Officially, they are in the same boat as the banks and insurance companies. But in reality their interests are vastly opposed.
"Hedge funds don't need to worry about their public image," one banker says. Their reputation has already been destroyed. Therefore, they can be relatively cavalier in gambling with the possibility of a Greek bankruptcy.

In an internal analysis of the German Savings Banks Association (DSGV), which represents the public banks, the hedge funds come off fairly badly. With the financial investors "only the performance" is most important. There is "hardly a political or economic corrective factor," such as long-term customer or contractual relations, the analysis says. Therefore, "one can conclude that they are not really interested in an actual Greek rescue."

Unlike the creditors who have long held Greek state bonds and definitely stand to lose in the case of a Greek debt haircut, some investors have only jumped in over the past few weeks. They have stocked up not just on Greek bonds, but also on the related Credit Default Swaps (CDS). These Credit Default Swaps guarantee the buyer protection in the event that the underlying bonds default. "This week alone there will be scores of new CDS transactions," one insider says. "And some of them at exorbitant prices."

Those who in the past few days have bought Greek state bonds worth €1 million euros and wanted to protect them against loss with CDS, would have had to pay more than €400,000 or even €500,000. And they fluctuated wildly -- depending on the news, the price of CDS rose and fell sharply. That indicates that the CDS are being used mainly for gambling.

This example shows how the calculations made by short-term investors work:

One hedge fund stocks up on Greek state bonds. Since the market participants have long expected a haircut of 50 percent, the prices of the bonds are extremely low. They are, for example, at 30 percent of the nominal value at which the bonds were issued. The funds, for example, have bought Greek state loans with a nominal value of €100 million, but paid €30 million for them.
At the same time, the hedge funds are protecting themselves with so-called Credit Default Swaps (CDS) against a Greek payment default. Such Credit Default Swaps are deals between two market participants. The seller agrees to compensate the buyer for losses, should the underlying obligation default, in this case the Greek state bonds.
As long as a debt haircut for Greece has not officially been finalized, the CDS secure the full nominal value of the bond, or 100 percent. Therefore they are also very expensive and cost, for example, 30 percent of the nominal value. In addition to the €30 million for the bonds, the funds have also paid €30 million for the CDS, or a total of €60 million euros.

But there are other ways in which the poker game can play itself out, and the funds can make large profits.

If it comes to a haircut of 50 percent, then two things would happen: The Greek state bonds would gain in value and instead of costing €30 million, run at maybe €45 million. At the same time, the CDS safeguard for the hedge funds would fall significantly in value. Therefore, the funds would only reap a small profit. This variation, therefore, is not attractive for them.
Things look different for the hedge funds if an agreement breaks down. In this case, the threat of insolvency exists. The chance that the bondholders would get their money back would dramatically decrease. The bonds would have less value than before, and would no longer be worth €30 million, but say just €10 million. And the CDS guarantees would be due. The hedge funds would, depending on the arrangement of the CDS, receive up to 100 percent of the bonds' nominal value, or €100 million. Under this scenario, the hedge fund that invested €60 million would get €110 in return - a profit of almost 100 percent.

If the Institute of International Finance (IIF) and Greece agree on a voluntary haircut, it is attractive for the hedge funds holding the CDS to simply not to take part. In this case, there are three possibilities:

Too few of the bondholders take part in the haircut. Should more than 20 percent of the bondholders refuse to accept the negotiated conditions, the debt rescheduling could break down, and with it also likely the second rescue package for Greece. The country would be bankrupt, the CDS would be due, and the hedge funds could cash in.
A lot of bondholders partake. Should, for example, 90 percent of the investors promise to take part, the few holdouts could emerge unscathed, and bet on Greece paying off the bonds as they mature. Hedge funds that hold Greek bonds could in this case become the classic definition of a freeloader.
The Greek government, though, has threatened not to tolerate such freeloaders. If an agreement is reached with 80 percent of the bond holders, they want to force the remaining 20 percent to take part in the haircut. In that case, the existing bonds would later be so-called "Collective Action Clauses." The hedge funds could still cash in because in this case the debt repayment would not be voluntary, and it would be considered a payment default, making the CDS also come due, and the gamblers would profit.

The strategy does have one snag. The hedge funds assume that in the event of a payment default all CDS providers can pay. That is by no means certain, though. The CDS papers are distributed opaquely throughout the financial system. No one knows for sure who holds them at a given time, and who, in the end, will be responsible for them.

The majority of large banks have both issued and bought CDS. The net risks are therefore officially quite small. But should only one of the larger CDS issuers turn out to have difficulty paying, a chain reaction could be possible with unknown consequences. Under that scenario, it would also likely affect the hedge funds.

Some hedge funds are preparing for a legal battle. Sarah White and Tommy Wilkes of Reuters report, Hedge funds prepare legal battle with Greece:

Hedge funds are combing through the small print of Greece's planned rescue deal with private creditors, readying a wave of potential litigation to squeeze a better payout from the country.

Most bondholders face an uphill battle in wringing a payment from Athens through the courts, but shrewd funds picking up specific bond issues with investor-friendly small print have a much better chance of succeeding.
This is so worrying those negotiating Greece's private sector deal that many are trying to keep the final structure of a rescue package under wraps until it is done to prevent the funds from finding a legal edge, sources close to the talks say.
Challenging countries through the courts is a well-worn hedge fund strategy - some are still battling Argentina for payouts more than 10 years after its record-breaking default.
The closer Greece edges to a disorderly default where it imposes losses, rather than a managed one in which it agrees a deal with a majority of bondholders, the more creditors are likely to go down the legal route.
Athens is racing to cut a deal to slash its debt pile by some 100 billion euros (83.5 billion pounds) through a voluntary bond swap that would see private creditors swallow 50 percent losses.
If a deal is not in place by mid-March, when a 14.5 billion euro bond falls due, Greece may not get the funds it needs from the European Union and other lenders to avoid a managed default.
"If the path followed (in Greece) is a non-voluntary one, there will be excessive litigation," said Rodrigo Olivares-Caminal, a banking and finance law specialist at Queen Mary, University of London, and an expert in sovereign debt.
Madrid-based Vega Asset Management threatened it would take legal action when it quit the committee leading private creditors in talks with Athens last year, unhappy about the size of potential losses, sources said at the time.
One lawyer specialising in debt restructuring said on Tuesday he had been contacted by funds looking at legal options relating to Greece, while several funds also told Reuters they were weighing up strategies if they are forced to take losses.
BLOCKING TACTICS
Funds forced into losses as part of the bond swap or default have several avenues to bring a case, including the European Court of Human Rights or the International Centre for Settlement of Investment Disputes, Olivares-Caminal said.
Hedge fund tactics range widely. Many will be keen for a deal to get done and will not sue, especially if they can profit from the difference between the level of losses imposed and the price they paid for the debt in the secondary market.
Others hope to be paid out in full if enough other private creditors -- primarily banks and insurers -- sign up to the bond swap.
If Greece can get the go-ahead from about two-thirds of private creditors, it plans to pass laws to coerce reticent bondholders, like the hedge funds, into taking losses, sources have told Reuters.
To counter this, some hedge funds are going for defensive strategies and buying up some of the 18.3 billion euros of Greek bonds that were drawn up under English or foreign law, industry and legal sources said. These would be immune from any changes to Greek law.
The English law bonds do contain so-called collective action clauses designed to force outliers into a deal -- but they state Greece would have to get 75 percent of creditors to back a deal, most likely higher than the threshold Athens would impose in domestic law bonds in its bid to get a deal done.
They also contain precise clauses that could help hedge funds sue or eke out a settlement if they are forced into an unfavourable bond swap, because they are not being treated equally to other creditors like the European Central Bank.
The English law bonds include pari passu clauses, which mean creditors have to be treated on an equal footing and could give them leverage over the ECB, which owns around 45 billion euros worth of Greek bonds bought in the secondary market.
So far the ECB has shown unwillingness to participate in the bailout, but if Greece can succeed in forcing funds to take losses, the holders of these English law bonds could argue the ECB's immunity is unfair.
One big worry is that hedge funds could buy up enough of the English law bonds to block the clauses from being triggered for specific bond issues, although none of the sources contacted by Reuters had evidence of this happening yet.
That would make an overall agreement with private creditors very hard to reach, and give hedge funds ways of resisting further deals if Greece were to default.
RESTORING REPUTATION
Suing bankrupt governments is still a risky game, however. Funds such as New York-based Elliott Management and its affiliates, which specialise in these types of tactics and have won court cases against Argentina, are still chasing the money they are owed.
That debt restructuring saga was also easier for hedge funds to play as the bulk of the bonds were under U.S. law, limiting Argentina's influence over them.
One hope in the far tougher game that is the Greek negotiations is that Athens, keen to restore its reputation as a reliable debtor, might prefer to settle with reticent creditors than head into years of courtroom battling.
That would echo strategies employed by Ireland to deal with unhappy bondholders when it restructured the debt of its banks.
"The primary strategy is unlikely to be a court judgement after protracted litigation," said Steven Friel, a litigation partner at Brown Rudnick.
"Bondholders are much more likely to work towards settlement, if necessary using the threat of litigation as leverage to negotiate a better deal."

Finally, Landon Thomas Jr. reports, Hedge Funds Scramble to Unload Greek Debt:

So much for that big fat Greek payday.
Hedge funds that loaded up on Greek bonds in the last month — betting on a quick gain — are now scrambling to sell those holdings, fearful that European policy makers will force them to take a deep and binding haircut on the debt.
But walking away from the trade may not be that easy. While the money managers had little problem snapping up the bonds from European banks eager to sell, the pool of potential buyers is drying up.
Hedge funds have few options. Although talks between Greece and its bondholders have stalled, European officials are pressing for a deal by the end of this month. Under the proposed debt restructuring plan, hedge funds and other private sector creditors would have to incur losses of 50 percent or more — whether or not the bondholders agreed.
“I think it’s going to be take it or leave it. And if you do not participate you will get massively beaten up,” said one hedge fund holder of Greek debt, alluding to the unpleasant prospect that if he did not take the deal — and the steep loss in value, or haircut — he would end up with nearly worthless Greek bonds and with virtually no legal protection.
The situation represents a significant shift in how Europe has approached the issue. Last year, when the idea of a Greek debt default seemed a remote possibility, the private sector agreed to a “voluntary” 21 percent loss on its bonds. The fear was that forcing mandatory losses would lead to a disorderly default and scare investors off European debt altogether.
But as Greece’s economic problems have worsened and the need for debt relief has become more acute, Europe, particularly Germany, has come around to the realization that the private sector must take a deeper loss. In a sign of the new direction, the region’s leaders have begun discussions with the European Central Bank on an arcane debt swap that would strip 55 billion euros ($72 billion) of Greek bonds from the central bank’s portfolio, thus removing the possibility that the central bank might share losses with the private sector in a debt restructuring deal.
Now, the smart money isn’t looking so smart. Starting in December, the counterintuitive, go-long Greece bet was one of the more popular pitches made to hedge funds in New York and London. Investment banks — Merrill Lynch was particularly aggressive in recommending the trade, investors say — argued that even though Greece was nearly bankrupt, those who bought the paper maturing in March could double their money when Greece received the next installment of its bailout, due that same month.
The theory was that the bulk of that money would be paid to bondholders to keep Greece solvent, just as was the case with past payments from the European Union and the International Monetary Fund. Greece might well restructure its debt, the bankers said, but added it was likely to happen later and would not affect the March payout.
The pitch worked. In the last month or so, hedge funds purchased an estimated 4 billion euros ($5.2 billion) of beaten-down Greek bonds that mature on March 20.
But the bonds have gone from bad to worse. “There was a lot of volume going in, but not a lot going out,” said one broker, speaking on condition of anonymity. The broker said prices for March 2012 bonds had slipped to about 35 cents on the dollar, from approximately 40 cents to 45 cents.
Brokers estimate that of the 14.5 billion euros worth of these bonds outstanding, the largest holder is the European Central Bank, which bought the securities in 2010 at a price of about 70 cents in an early, ultimately futile, attempt to lift Greece’s failing bond market. The brokers say that 4 billion to 5 billion euros of bonds are owned by hedge funds at an average cost of about 40 cents to 45 cents on the dollar, with some of the larger positions being held by funds in the United States that have large London offices.
“It was a very binary trade,” said one hedge fund executive who listened to the pitch but passed. “If you got paid, you double your money in a month. But you may also look like an idiot.”

As I stated, it's crunch time for Europe, and politicians will ram this deal down hedge funds' throats. Smart hedge funds will take the offer and walk. Those foolish enough to sue Greece will be taught a lesson. There will be no big fat Greek payday for them.

Below, Nobel laureate Michael Spence, a professor of economics at New York University, talks about the European debt crisis. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday" at the World Economic Forum's annual meeting in Davos, Switzerland.

Soros Taking Germany To Task?

2012-01-25T17:00:00.013-05:00

Svenja O'Donnell and Jana Randow of Bloomberg report, Soros Says German Austerity Drive Threatens Breakup of Region:

Billionaire investor George Soros said that German-driven austerity plans in Europe risk creating tensions that could splinter the region as it struggles with a debt crisis entering its third year.
“Germany is acting as a task master, imposing fiscal discipline,” Soros told reporters at the World Economic Forum in Davos, Switzerland today. “But that could create tensions that could destroy the European Union.”

Investors have become less upbeat about the euro region, according to a Bloomberg Global Poll today. For the first time, a majority -- 56 percent -- say one or more nations will leave the single currency in the next 12 months. Meanwhile, Greece is trying to complete a deal with private bondholders on a debt- relief plan before a summit of European leaders on Jan. 30.

“Greece may pose a problem if it in fact defaults,” Soros said. “Defaulting by itself doesn’t necessarily mean they will leave the euro. But the need to at least reach a primary surplus may force Greece out of the euro.”

Soros also said there is a “big difference between Greece and Italy,” with the latter doing “really quite well.”

As Italian Prime Minister Mario Monti has stated, “there needs to be some reward,” Soros said. “There need to be some benefits for Italy and that would strengthen the Monti government.”

Strict Discipline

Monti has pushed through a 30 billion-euro ($39 billion) austerity plan and a package designed to boost growth in the past two months. Italian borrowing costs have fallen since he came to power in November, and he said this week his measures have been “appreciated” by European colleagues.

“You must impose strict fiscal discipline on deficit countries, but then you must find some stimulus to get out of the deflationary spiral,” Soros said. “Structural reforms alone won’t do it.”

He said eurobonds will be needed to provide additional economic support and that while measures by the European Central Bank “relieved the liquidity problems of European banks,” they “didn’t cure the financing disadvantages highly indebted countries suffer.”

“Stimulus has to come from the EU,” Soros said. “This will require eurobonds one way or the other.”

“Half a solution isn’t enough,” he said.

Soros is right, half a solution isn't enough. I completely agree with him that eurozone will require eurobonds if they are to tackle this debt crisis in a meaningful way.

Eric Pfanner of the NYT's DealBook reports, Soros Promotes Crisis Plan for Europe:

The billionaire investor George Soros said on Wednesday that it was possible Greece could be pushed out of the euro zone this year.

“The odds, let’s say, are in that direction,” Mr. Soros said in a speech at the World Economic Forum in Davos. Instead of working to keep the country as a member of the single currency, he added, European policy makers ought to focus on saving the rest of the euro bloc.
Recent action by the European Central Bank, which in December moved to provide large amounts of liquidity to the region’s banks, have calmed the financial markets for now, he acknowledged. But he said these measures would not be enough to solve the festering sovereign debt problems that have driven up the borrowing costs of weaker euro zone countries. Spain and Italy, he said, remain “dangerously exposed.’’
“It leaves the weaker members of the euro zone relegated to the status of third world countries that became highly indebted in a foreign currency,” he said. “Germany is acting as the task master imposing tough fiscal discipline. This will generate both economic and political tensions that could destroy the European Union.”
Mr. Soros used the occasion to promote an alternative plan to deal with the euro crisis, as outlined in his new book, “Financial Turmoil in Europe and the United States.”
Under his proposal, the European Central Bank and others, including the European Financial Stability Fund, would act in concert as “lenders of last resort” to governments, a role that the central bank has steadfastly disavowed. Mr. Soros says this would allow Italy and Spain to issue treasury bills at around 1 percent.
The European economy will also need stimulus to get moving again, Mr. Soros said, adding that the cost would have to be shouldered collectively. As such, it will require the issuance of so-called euro bonds under which the debt of euro zone members would be pooled “in one guise or other.”
If nothing more is done, and if policy makers continue to mostly pursue austerity measures, the euro zone will fall into a debt-deflation spiral, he said. That, in turn, could prompt widespread social disorder, he added.
“What is happening in Hungary today,’’ Mr. Soros said, “is a precursor of what is in store.”

And Soros painted an equally bleak picture for America, predicting riots, police state and class war:

I am not here to cheer you up. The situation is about as serious and difficult as I’ve experienced in my career,” Soros tells Newsweek. “We are facing an extremely difficult time, comparable in many ways to the 1930s, the Great Depression. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system.”
Soros goes on to compare the current state of the western world with what the Soviet Union was facing as communism crumbled. Although he would think that history would have taught the globe a thing or two about noticing trends, Soros says that, despite past events providing a perfect example of what is to come, the end of an empire seems imminent.
“The collapse of the Soviet system was a pretty extraordinary event, and we are currently experiencing something similar in the developed world, without fully realizing what’s happening,” adds Soros.
Soros goes on to say that as the crisis in the Eurozone only worsens, the American financial system will continue to be hit hard. On the way to a full-blown collapse, he cautions, Americans should expect society to alter accordingly. Riots will hit the streets, says Soros, and as a result, “It will be an excuse for cracking down and using strong-arm tactics to maintain law and order, which, carried to an extreme, could bring about a repressive political system, a society where individual liberty is much more constrained, which would be a break with the tradition of the United States.”
The recent adoption of the National Defense Authorization Act for Fiscal Year 2012 and the proposed Enemy Expatriation Act, if approved, have already very well paved the way for such a society. Under the NDAA, the US government is allowed to indefinitely detain and torture American citizens suspected of terror crimes without ever bringing them to trial. Should lawmakers Joe Lieberman (I-CT) and Charles Dent (R-PA) get their Enemy Expatriation Act through Congress, the US will also be able to simply revoke citizenship without trial, essentially removing constitutional rights from anyone deemed a threat.
Others have cautioned that, as inequality becomes more rampant in America, the country’s citizens are becoming increasingly agitated with those on the other side of the extreme. In a recent survey released by the Pew Research Center, 66 percent of the adults studied believe that either “very strong” or “strong” conflicts exist between America’s elite and the impoverished, a statistic that has skyrocketed in recent years. Between 2009 and 20011, the proportion of those that sense conflicts exist as such between the class groups grew by 19 percentage points. While less than half of Americans fearing a fight brewing at the dawn of the Obama administration, today two-out-of-three Americans feel that there is a strong conflict between both extremes of society.
Addressing the issue of inequality, Soros tells Newsweek that the main issue that will make or break a reelection for US President Barack Obama will be whether or not the rich end up being taxed more. Among the current frontrunners in the Republic Party’s race for the GOP nomination, wealth and taxes have been of the biggest concern of party rivals. The top candidates have made millions off of investments, and at a time of immense inequality, represent what 99 percent of Americans don’t. Taxing the rich to a bigger degree might finally bring a chance, and Soros says, “It shouldn’t be a difficult argument for Obama to make.”
Soros adds that if the US manages to make it through the troubled times to come, it come allow the nation to enter another golden era. “In the crisis period, the impossible becomes possible. The European Union could regain its luster. I’m hopeful that the United States, as a political entity, will pass a very severe test and actually strengthen the institution,” he tells Newsweek.
With almost seven percent of Americans living below half of the poverty line, four unemployed Americans for each job, a shrinking middle class and an increasingly overzealous police state, it could very well be a tough road to get there, though.

Perhaps this is why Soros agrees with the President Obama that the richest Americans should pay more in taxes. "I'm a rarity in the hedge fund community," he said.

He is indeed a rarity in the hedge fund community and EU leaders would be wise to listen carefully to what Soros is saying about tackling the debt crisis. Below, Soros addresses the World Economic Forum (h/t, Guardian). I also embedded this CNBC interview.

Caisse on Financial Steroids?

2012-01-25T08:55:00.010-05:00

Nicolas Van Praet of the National Post reports, ‘Leverage is financial steroids’:

It’s become a fact of life in Quebec that if you’re the coach of the Montreal Canadiens or the chief executive of the Caisse de dépôt et placement du Québec, there’s always somebody, somewhere out there screaming for you to resign.

In Michael Sabia’s case, it happened even before he set foot in his 11th-floor corner office suite.

As the first anglophone and non-Quebecer to lead the Caisse, Canada’s largest pension fund manager, Mr. Sabia was the subject of attacks from the moment he was named to the job in March 2009. His employment track record? “Controversial at best,” wrote one columnist. His connection to Jean Charest by way of Brian Mulroney and the Privy Council? Proof of political favouritism, wrote another.

The critics were merciless. He’s an outsider from Ontario, they charged. He could never succeed in steering the Caisse in its historical role fostering a Quebec French-speaking financial class. He’s a crony, they said. Not the right person needed to plant the Caisse back on course and claw back the embarassing $39.8-billion annual loss under his predecessor in 2008 — the biggest in Canadian pension-fund history.

Funny how time can change perceptions. Funny, too, how the bottom line tends to speak for itself.

When Mr. Sabia took over from former CEO Henri-Paul Rousseau, the Caisse had $120.1-billion in net assets as of the end of 2008. Since then, the fund has grown that asset base by $37.8-billion through the end of June 2011, to $157.9-billion. Its two-year annualized return is 14%.

If the pension fund’s private investments sufficiently offset likely stock market losses, it could tally a third straight year of positive returns when it reports 2011 results as scheduled at the end of February. That would put it within striking distance of recouping the money lost under Mr. Rousseau.

Those who know Mr. Sabia will tell you he will not be taking sole credit for the recovery, when it happens. That’s just not his style. He’s not a flashy guy. He doesn’t like fancy restaurants. He doesn’t fuss with expensive suits or watches. Prone to self-deprication, the bilingual 58-year-old is not a fan of hyperbole or dramatic language.

In an interview last week at Caisse headquarters on the edge of Montreal’s old quarter, he wore a casual red wool sweater. No tie. In many ways, he’s Quebec’s Sergio Marchionne, an expert in industrials who talks straight, dresses down when he can, and thinks three steps ahead.

Besides, as Mr. Sabia well knows, the real test is yet to come: How to protect depositors’ money more permanently against the kind of volatility currently lashing the world economy. And how to more definitively restore public confidence in the Caisse, shredded after a spectacular failure of risk-management that showed it simply didn’t understand many of the investments it was making.

“When I got here … the place really felt under siege and there were lots of morale issues,” Mr. Sabia says. “The thing that has mattered a lot is getting people to feel like the organization is moving forward, that is has a direction, that they’re part of something that’s progressing. And I think that’s happening.”

Make no mistake, this is not the same Caisse that saw one quarter of its assets wiped out in 2008. Its 13-member executive committee has been almost completely shaken up. New executive talent has been tapped including Roland Lescure, an investment specialist from France who led one of that country’s largest asset management firms. As well, risk-control practices have been dramatically tightened.

That work done, Mr. Sabia is focussing on the next phase in the Caisse’s development, one that’s arguably a lot tougher.

The former Bell Canada chief executive is now trying to build an organization in which all of its investment professionals have a profound understanding of what the Caisse has bought and why, a knowledge of investments that goes beyond profit and loss statements and digs into the quality of operations. He’s already got real-estate professionals who run shopping malls and office towers. Now he’s begun hiring specialists who know airports and pipelines and mines.

It’s all part of a rethink of the pension fund’s diversification strategy — one that will see it shift away from buying indexed stocks towards fewer but more targetted investments that are much better mastered, and from both public to private markets.

“You’re going to see people moving away from the extent of the reliance that we’ve all had on public markets,” Mr. Sabia says. “There are probably better returns” privately, he added, and they’ll be more stable over time.

Pulling back from public markets will create some accountability challenges for the Caisse because its performance is measured against that of various public benchmarks such as the S&P/TSX composite index and the S&P 500. It will have to figure out different ways to communicate successes and failures and what exactly it is doing. That may be difficult given the trust between the fund and its 25 Quebec depositors remains on the mend.

“The confidence of retirees in the Caisse is still shaky,” says Madelaine Michaud, president of the Association québécoise des retraité(e)s des secteurs public et parapublic, a group representing 27,000 retired workers, most of them civil servants. She says the Caisse has been unresponsive to its demand that it allow a retiree representative on its board.

Underpinning Mr. Sabia’s transformation of the Caisse is the belief that it should use leverage in a much more limited way.

In this, he is certainly not alone. Many companies, notably Magna International Inc. under Frank Stronach, have displayed a nearly religious aversion to carrying debt. The Caisse itself has reduced its liabilities by half during the past five years, to 17% of total assets in 2010 from 30% in 2004.

If the financial crisis of 2007-2008 taught the world one thing, it’s that borrowing big is bad. As the U.S. government commission analyzing the debacle concluded: The crisis was avoidable and was caused in part by widespread failures in financial regulation, dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk, and an explosive mix of excessive borrowing and risk by households and Wall Street.

Where Mr. Sabia differs from others on debt is in his willingness to pass up investments using leverage because of the chance it will come back later and bite. To him, buying an investment that generates small and consistent profits with no debt is better than using debt to buy something that may result in big profit-loss swings.

“Look, leverage is just a financial steroid. That’s all it is,” he says. “[And] in a volatile world, you don’t want to be on steroids.”

Michel Nadeau, a former Caisse vice-president, agrees. “The Caisse abused its use of leverage in the past,” he says. “Way too much.”

There are conflicts in that dogmatic position.

If leverage is so bad, why is the Maple Group, that consortium of 13 institutions including the Caisse, using it in spades to buy the TMX Group? And won’t the steroid actually turn into a straightjacket — immobilizing the Caisse at the very time it is convinced there are massive buying opportunities out there because of depressed asset valuations and desperate governments?

To be sure, the Caisse has plenty of cash to play with. But its appetite for asset purchases sounds bigger than what those cash stores may hold.

Mr. Sabia says there will be a wave of substantial infrastructure privatizations in Europe in the months ahead as governments deal with their fiscal issues. The Caisse is a buyer in that scenario, likely in club deals with other investors. Like the Ontario Teachers Pension Plan and others, it has become a potential saviour for states that can sell instead of slashing social programs and risk undermining economic growth in their bid for budgetary sanity.

“If I were in a European government, I would be way more interested in trying to sell a port, sell a toll road, sell a bridge, sell a whatever than I would be … to constantly cut social expenditures,” he says. “There are limits to the political tolerance for those things.”

Likewise, the Caisse is very bullish on the United States. It is watching for motivated sellers of U.S. assets, particularly Europeans who may want to offload real estate. The Caisse has been bitten in this market recently — a Jan.11 Wall Street Journal report said it sold $111-million worth of debt it held on Manhattan’s Park Central Hotel at a loss. But there are plenty more deals to be had.

“The degree of motivation has been increasing recently,” Mr. Lescure says of the sellers. “We’re not a vulture. But what we’re looking at is good opportunities …. The prices are slowly but surely coming down.”

There are other plans on the table. The Caisse is underinvested in emerging markets and wants to increase that exposure. And it has people working on putting together infrastructure investment proposals to support the resource boom projected as part of Quebec’s $80-billion plan to develop its northern territories.

Companies pulling iron ore out of the ground to fuel production in China’s steel-making factories will need shelter for their employees, roads or railroads to get the resources out, and ports to ship it overseas. Funding for a couple of projects has been announced but the infrastructure needs vastly outweigh current supply.

Stoking economic development in Quebec is one of the Caisse’s mandates, something many observers consider a hindrance to the larger imperative of making profits for its depositors. And yet, there are many influential people who believe the Caisse still isn’t doing enough to fuel growth in the province.

It all amounts to a delicate political balancing act for Mr. Sabia, one made all the more complicated when the Caisse runs afoul of provincial language laws. Still, for all the pension manager’s missteps, it is difficult to imagine another Caisse CEO bearing down as hard to prove the naysayers wrong.

The Caisse is a machine whose overhaul is still in progress. It’s all about deepening the understanding of its investments. And Mr. Sabia has plenty more deepening to do.

“I have a pretty simple view of this, and maybe it is an outsider’s view,” Mr. Sabia concludes. “But the whole problem with the investment world is that it got way too preoccupied, way too convinced that as a sector it was the smartest guy in the room. Well, it didn’t turn out to be.”

The article covers many points so let me tackle them one by one. First, it is true that Sabia's appointment created quite a ruckus in Quebec. When his predecessor, Henri-Paul Rousseau, was appointed, the French media lauded him as some sort of 'financial God'. And when the $40 billion train wreck took place, they turned on him, viciously attacking him (Rousseau wasn't the only one to blame in that debacle).

It's easy to attack leaders, and in some cases they deserve it, but Quebec's media is particularly ruthless and shallow. Witness the recent language fiasco at the Caisse and how the French media totally ignored the real issue, namely, the public sector should reflect Quebec's diversity:

When the issue of linguistic or cultural diversity comes up in Quebec, it's rarely to show how diversity benefits the province's economy or helps its workforce become more open, tolerant and flexible. Too often, diversity in the workplace is seen instead as a threat to the primacy of French as the language of work. For weeks last year, the province was embroiled in the issue of whether the Caisse de dépôt should continue to employ two senior executives who did not speak French. The previous year's big Caisse issue - its largest ever loss of $39.8 billion - didn't seem to upset people nearly as much, or for as long.

I will repeat, the Caisse, PSP Investments, the National Bank, Desjardins, Hydro Quebec and other financial institutions in Quebec need to do a hell of a lot more in improving the diversity of their workforce at all levels. This is especially crucial at a time when Quebec's unemployment rate is spiking up (it's not a 'statistical anomaly', it will get worse).

Back to Sabia. He has made several important changes to the Caisse to bolster governance making operations more transparent and managers more accountable but he and his team have a lot more work ahead of them, which they are well aware of.

The shift to private markets is basically what every other large public pension fund is doing in Canada. Why are they doing this? First, to escape the volatility in public markets but the other reason, one that they won't tell you about, it allows them to beat bogus benchmarks and collect big bonuses claiming they added value in private markets. Let me remind people, when it comes to pension investments, it's all about the benchmarks, stupid! And the third reason is leverage -- it allows them to use external managers who can lever up a lot more than they can do internally.

On the point of leverage, Sabia is right and wrong. For me, using leverage is like using derivatives. In the hands of a fool, it can wreak havoc and lead to huge losses. However, those who know how to use derivatives properly can mitigate risk, index properly and efficiently, and make money. Same for leverage. If you know how to use leverage wisely, you can add value to your operations.

Some pension funds use more leverage than others. It's well known that Ontario Teachers' uses a lot of leverage in their operations. But if they know how to use it properly, they can enhance risk-adjusted returns. Leverage is a double-edge sword. You can enhance returns but if you take foolish risks, you'll get burned.

On this last point, the Caisse needs to do a lot more work on taking risk, especially in public equities where they underperformed over the last few years. In my opinion, the Caisse focuses too much risk management and not enough on taking opportunistic risk. But to do this properly, they need to better leverage off their external managers and create a central research group similar to the one at CPPIB and even better.

In short, the Caisse needs to centralize investment research. I already mentioned that Roland Lescure is the CIO of public markets, not all investments at the Caisse. Some say this doesn't matter but if you ask me, the best pension funds have a dedicated CIO and a dedicated research team that looks at all asset classes, focusing on allocating risk across public and private markets. This way you break down silos and leverage information from all sources to make critical decisions, including asset allocation decisions which determine overall returns.

Finally, the Caisse needs to hire more investment professionals and less administrative and support staff. I'm concerned about the lack of jobs in Montreal's investment community and think the Caisse and others, like PSP Investments, need to do a lot more hiring of investment professionals and a lot more to support and seed investment funds in this city.

And they can start by helping me out, the world's best and most underpaid pension analyst. I'm being facetious but the truth is any pension fund would be lucky to have a guy like me on their team. Nobody can cover pensions and markets the way I do, nobody. When I'm on my game, working with good people (not weasels), I thrive and deliver results. Just ask the president of a major pension fund in this city who once told me: "You're the best investment analyst I've ever worked with". At least he got that right!

Below, James Gorman, chairman and chief executive officer of Morgan Stanley, talks about global market conditions, the European sovereign-debt crisis and financial regulation. Gorman, speaking with Bloomberg's Erik Schatzker at the World Economic Forum's annual meeting in Davos, Switzerland, also discusses Morgan Stanley's compensation measures. Tell them to stop whining, they're lucky to have a job and still grossly overpaid.

CalSTRS Returns 2.3% in 2011

2012-01-24T22:26:00.010-05:00

A follow-up to my earlier comment on paltry returns for pensions in 2011. Marc Lifsher of the Los Angeles Times reports, California teachers' pension fund posts 2.3% gain in 2011:

Battered by a volatile market, the California State Teachers' Retirement System posted a 2.3% return on its investments last year.
The performance, though extremely modest, was more than twice as large as that reported by CalSTRS' bigger sister agency, the California Public Employees' Retirement System.
CalPERS had a return of just 1.1% on its $229.5-billion portfolio last year.

The $144.8-billion CalSTRS fund had a rough year in 2011. It got a return of 0.9% on its U.S. stocks, 7.2% on bonds, 9.9% on private equity and 15% on real estate. It lost 14.1% on non-U.S. stocks.
CalSTRS did better a year earlier, reporting a 12.7% return that boosted the fund's value to its October 2008 level in the midst of the recession that ended in June of 2009.
The fund's portfolio lost about a quarter of its value during the worst downturn since the 1930s.
"We continue to feel the effects of the most precarious markets in decades," said CalSTRS Chief Executive Jack Ehnes.
The lingering financial crisis has had a strong effect on CalSTRS' ability to meet medium- and long-term obligations to its membership, 856,000 public school educators and their families.
It currently faces a $56-billion shortfall. As of June 30, 2010, it had only 71% of the funds it estimates are needed to pay future benefits.
CalSTRS' funding differs in one significant way from CalPERS'. The CalPERS board has the independent authority to ask participating governmental agencies to increase their annual employer contributions.
But CalSTRS' board lacks that power and needs the approval of lawmakers and the governor to raise contributions.
"The funding shortfall can be managed," Ehnes said, "but the governor and the Legislature must develop a specific funding plan, as only they have the authority to do so."

Despite doing twice as well as CalPERS, the truth is these are modest gains for two of the largest public pension funds in North America. Just like CaPERS, private equity and real estate delivered strong results (CalPERS did better in private equity while CalSTRS fared better in real estate). CalSTRS does not allocate to hedge funds but they did recently announce the selection of Lyxor Asset Management as its advisor in the development of a new global macro hedge fund strategy.

One thing that struck me is the 14% loss in non-U.S. stocks. Obviously they were exposed to European stocks which got hammered but were they overly exposed to financials? Do they hedge currency risk? I do not know but those are steep losses for non U.S. stocks which also include emerging markets which got clobbered in 2011.

As for the funding, Ehnes is right, it is manageable but the state has to come up with a funding plan. The last thing California wants is to go the way of Texas where two Republican state senators have proposed overhauling the state pension system by taking such steps as ending pensions for new state employees and instead offering them a 401(k) plan. That is a step in the wrong direction.

In New Jersey, public pension funds may have gotten a much-needed boost from Gov. Chris Christie’s landmark overhaul last year, but reports released today show the funds continue to be hampered by the state’s failure to make full payments into the plans.

And its not just Republicans looking to reform pensions. New York Mayor Michael Bloomberg told state lawmakers he backs Governor Andrew Cuomo’s proposals to increase payments for Medicaid, reduce pension-benefit costs for future workers and impose evaluation standards on teachers.

The squeeze on pensions is on. Paltry returns, exploding liabilities are increasing pension costs, pressuring politicians from all sides of the political spectrum to tackle pension reform. Below, Governor Cuomo speaks to reporters on why he thinks "pension reform is essential".

Paltry Returns For Pensions in 2011?

2012-01-24T11:52:00.010-05:00

Janet McFarland of the Globe and Mail reports, Pension plans eke out positive return in 2011:

Canadian pension plans eked out a positive return in 2011, averaging a 0.5 per cent return for the year.
A survey of major Canadian pension plans by RBC Dexia Investor Services found plans reported they earned 4.2 per cent on their investments in the fourth quarter last year, pushing their full-year returns into barely positive territory.
“It’s been a tumultuous year for global markets,” said Don McDougall, director of advisory services at RBC Dexia.
“We had a natural disaster in Japan, geopolitical tensions in the Middle East, a stubborn U.S. recovery with its ensuring political backlash, sputtering Chinese growth and the ever-lingering European debt crisis. Most pensions will be pleased it’s over.”
The survey compiles results from pension plans across Canada with assets under management totalling $340-billion.
The results are similar to estimates published early this month by pension consulting firms that track investment returns using hypothetical model portfolios with typical asset allocations.
The break-even returns mean pension funds still saw their funded status decline in 2011. Pension liabilities are calculated based on long-term bond yields, which fell in 2011, driving up the amount of money pension plans are required to set aside to provide pensions to plan members.
RBC Dexia said pension funds reported Canadian equities were their hardest-hit asset class, with mining, energy and financial services accounting for the bulk of the market’s decline in Canada in 2011.
Canadian equity portfolios underperformed the S&P/TSX Composite index by 0.9 per cent for the year, RBC Dexia said, although beat the composite index in the fourth quarter by 0.6 per cent.
Foreign equities also dragged down returns last year, losing 4.2 per cent and underperforming global benchmarks by 1 per cent. Mr. McDougall said there was broad weakness in foreign markets, although the U.S. market was up 2 per cent for the year, making it one of a select few to remain positive.
“Canadian plans also benefitted from a weaker Canadian dollar against most major currencies with the exception of the euro,” Mr. McDougall said.
Strong returns from bonds offset stock losses, RBC Dexia reported. Bonds climbed by 9.8 per cent in 2011, with the global DEX Long Term bond index recording its best calendar year since 1997.

Things aren't any better in the United States where Marc Lifsher of the Los Angeles Times reports, CalPERS earns 1.1% on investments in 2011:

The nation's largest public pension fund, the California Public Employees' Retirement System, posted a 1.1% return on its investment portfolio in 2011, Chief Investment Officer Joseph Dear told his board.

The 2011 performance was well below the estimated average annual return of 7.75% that the fund's actuaries say is needed to meet current and future obligations to its members.

The $229.5-billion CalPERS provides retirement and other benefits for 1.6 million state and local government employees and their families.

CalPERS' annual investment results, whose volatility has echoed that of the overall markets, have become the focal point in an ongoing debate about looming pension fund liabilities and the ability of future generations of taxpayers to continue financing them. Gov. Jerry Brown has said he wants to overhaul state and local government pension programs, but whether he and the Legislature have the political wherewithal to do so in an election year remains unclear.

During the 2011 calendar year, CalPERS lost 7.95% on its public equity investments, lost 2.29% on its hedge fund investments, earned 12.38% on bonds and earned 9.92% on real estate.

In the first three quarters of the calendar year, it earned about 12.37% on its private equity investments. (The availability of these results lags a quarter.)

CalPERS' 2011 return was well off the 12.6% return for 2010 and 12.1% for 2009.

Calendar-year results, however, are used only as indicators, a CalPERS spokesman said. The fiscal year returns, posted as of June 30 each year, are the legal basis for annual decisions by the CalPERS board to raise or lower the contributions it gets from 3,100 participating government agencies, including the state of California.

As of June 30, CalPERS had a return on its investments of 20.9%, its best annual showing in 14 years. It had a return of 11.6% for fiscal 2010 and a massive recession-related loss of 23.4% for fiscal 2009.

Last fiscal year's strong showing, combined with the signing of a number of state labor contracts that increased the amount that employees contribute to their own retirements, allowed CalPERS to lower by $170 million the amount it sought from the state government this fiscal year.

This fiscal year, the state is contributing $3.51 billion. Next fiscal year's contribution is to be determined in the late spring.

I use CalPERS' calendar year results as a gauge of what to expect from other large public pension funds and it won't be much. The third quarter was a tough one and even though stocks snapped back, many pension fund managers underperformed in their public equities portfolio.

Hedge funds also underperformed in 2011, and even though CalPERS didn't get clobbered in hedge funds, they still doled out huge fees and lost money. When it comes to hedge funds, always ask where are the customers' yachts, and make sure you get the right alignment of interests. Think CalPERS should reevaluate their hedge fund portfolio (too much beta) and seed more hedge funds, including Canadian hedge funds. They should also manage more internally.

Their private equity team, led by Réal Desrochers, is performing well, delivering outstanding results in a tough environment. But private equity is no panacea, and as I recently discussed, this is a challenging environment for all asset classes, including private equity.

Nonetheless, gains private equity, real estate and infrastructure might save Canadian public pension funds from an otherwise bad year. We shall see, but don't expect much as most pension funds will report paltry returns for 2011.

Below, Janine Guillot, CalPERS Chief Operating Investment Officer, discusses improvements, goals and challenges in the operational aspects of the Investment Office (transcript available here).