For years, New York City has been dutifully pumping more and more money into its giant pension system for retired city workers.

Next year alone, the city will set aside for pensions more than $8 billion, or 11 percent of the budget. That is an increase of more than 12 times from the city’s outlay in 2000, when the payments accounted for less than 2 percent of the budget.

But instead of getting smaller, the city’s pension hole just keeps getting bigger, forcing progressively more significant cutbacks in municipal programs and services every year.

Like pension systems everywhere, New York City’s has been strained by a growing retiree population that is living longer, global market conditions and other factors.

But a close examination of the system’s problems reveals a more glaring issue: Its investment strategy has failed to keep up with its growing costs, hampered by an antiquated and inefficient governing structure that often permits politics to intrude on decisions. The $160 billion system is spread across five separate funds, each with its own board of trustees, all making decisions with further input from consultants and even lawmakers in Albany.

The city’s pension assets have fallen further and further behind its obligations — the amount needed to cover future pension payouts — a troubling trend that could eventually ripple across the entire city budget, but which has so far received little attention under Mayor Bill de Blasio.

Whether he can restore balance to the city’s pension system promises to be one of his biggest challenges, one that will affect not just future generations of workers, but all city residents and taxpayers.

Pension analysts compare the worsening situation in New York to watching someone try to fill a sink when the drain is open. “They’re never going to catch up,” said Sean McShea, president of Ryan Labs, a New York-based asset management firm that works for pension funds and other institutions.

The fallout can be seen in measures of the pension system’s financial health. From 1999 to 2012, for example, the plan for general workers fell to just 63 percent funded from 136 percent.

Last year, Morningstar, the investment research firm, evaluated for the first time the strength of state and local pension systems across the country and rated New York City’s as poor. Only a few major cities’ pension systems garnered such a low rating, said Rachel Barkley, a municipal credit analyst who wrote the report for Morningstar.

Mr. de Blasio, who has appeared less engaged with the city’s pension problems than his predecessor, Mayor Michael R. Bloomberg, is confronting a legacy of costly and questionable decisions going back at least to the years of Mayor Rudolph W. Giuliani, a review by The New York Times found.

Like many public systems, New York has promised irrevocable pension benefits to city workers on the thinking that fund investments would grow enough to cover the cost — but they have not. Its response so far has been to take advantage of a recovering local economy and inject a lot more city money into the pension system quickly — an option not available to declining cities like Detroit, which filed for bankruptcy last year, or a tax-averse state like New Jersey, which has been underfunding its pension system for years.

At the same time, New York has been aggressively chasing higher investment returns, shifting more money into riskier assets, which come with higher fees. Even as the system’s returns have lagged, pension officials have resisted making changes in the oversight structure that many experts believe could lead to improvements.

Complicating matters for Mr. de Blasio, wages and benefits are likely to swell even more in the near future, in line with a new teachers’ union deal that sets a baseline for more than 100 other expired contracts.

All of these factors have made the system acutely dependent on investment income. Yet its investment strategy is subject to the whims of the city’s electoral calendar, changing whenever a new comptroller is elected.

Regulators are now paying closer attention, very aware of the financial crises that have gripped other cities.

Despite state laws calling for regular audits of the city pension system, there has not been one since 2003. Now Benjamin M. Lawsky, the state’s financial services superintendent, appears to be making up for lost time. In November, he subpoenaed about 20 companies that help pension trustees decide how to invest the billions under their control.

Regulators from his office have also been sifting through documents at New York’s pension office, Diane d’Alessandro, executive director of the general workers’ fund, said at a recent meeting of trustees.

Letters accompanying the subpoenas said that “the recent financial difficulties in Detroit serve as a stern wake-up call, demonstrating why strong oversight of New York’s public pension funds is so important.”

Clashing Voices

Many cities have one pension plan, or two, separating general workers and uniformed personnel. But New York City has five, covering general workers, the police, firefighters, teachers and other school personnel.

Each fund has its own trustees. The exact makeup for each fund differs, but the mayor, the comptroller and organized labor each have their representatives, and their interests are frequently diametrically opposed.

The boards are fond of personally vetting investment firms — something experts in model boardrooms say they should not be doing. Politics can often intrude. The teachers’ union, for example, keeps a list of investment firms it sees as unacceptable because of their connections to groups that, say, favor charter schools.

Ranji Nagaswami, who served as Mr. Bloomberg’s first chief investment adviser, said that changes in the governing structure — consolidating, professionalizing and depoliticizing the pension boards — could result in “vastly improving outcomes.”

In the existing environment, important questions about cost and sustainability can be broached only with great diplomacy. In 2010, Blackstone Advisory Partners, a private equity firm, found out what can happen otherwise. On a conference call with investors, a company official answered a fiscal question by saying retirement benefits for public workers across the country were excessive. When New York City’s trustees got wind of the comment, they called for Blackstone’s chairman to apologize in person. A few months later, he did, and when that proved insufficient, Blackstone issued a statement saying it opposed “scapegoating public employees.”

When the dust finally settled, Blackstone survived as one of the system’s biggest investors.

New York’s pension system is also the only major governmental system in the country to outsource virtually all of its investment decisions to outside money managers, pension experts said. That inevitably leads to higher investment fees. In 1997, the city’s biggest fund, the New York City Employees’ Retirement System, known as Nycers, spent $17.3 million in investment fees for a $31.7 billion portfolio. By 2010, it was spending $175 million for a $35.4 billion portfolio.

Some have argued the pension system would perform better if it hired its own professionals to manage the money in-house. Fees would drop, and the overall strategy would be more coherent, they contend.

For years, pension officials saw little reason to alter investment strategies or governing, in part because the stock boom of the 1990s made it seem as if they had a winning strategy. Even after the tech crash beginning in 2000, the city’s pension reports relied on an unusual calculation that made the system appear 99 percent funded. When that calculation was disallowed in 2006, Nycers’s reported funding level tumbled to 64 percent. Even then, some economists said the city was still underestimating its total obligation.

As it turns out, Robert C. North Jr., the system’s actuary, had been preparing his own stark projections, buried in annual reports. They are based on fair-market values and reflect what an insurer would charge for annuities designed exactly like the pensions. He estimated last year that Nycers was only 40 percent funded, a figure normally associated with funds in severe distress.

Expectations and Reality

In the complex world of pension math, one number looms larger than the rest: the expected rate of return on investments over the long term.

The higher the assumed rate, the less money the city will be asked to inject in the pension system each year.

In New York, this all-important number is chosen by the State Legislature, with input from the pension boards’ many trustees and the system’s actuary. The temptation is to be overly optimistic, because that makes the whole pension plan look more affordable and, therefore, more politically palatable. The more money the city needs to contribute, the more it becomes a problem for the city budget and the greater the likelihood the costs breed resentment against public employee unions.

But excessive optimism can lead to financial disaster, because regular shortfalls could ultimately leave the city unable to fulfill its required payouts. For years, the investment return expectation was set at 8 percent. In reality, the system’s returns have often fallen well short of that, earning just 2 percent on average from 1999 to 2009, for instance. (The returns have ticked up as the market has risen.)

Yet the pension boards have been reluctant to ask Albany to lower its investment-return assumption, out of concern that it would incite a backlash toward unions and pensions.


Already, the growing sums consumed by the pension funds have forced officials to scrimp on certain programs or abandon them, said Marc La Vorgna, a press secretary during Mr. Bloomberg’s administration. One casualty was the Advantage program, which helped homeless people move out of shelters and into apartments. It was eliminated in the Bloomberg administration.

Nicole Gelinas, a fellow at the conservative Manhattan Institute, cited infrastructure spending as another priority that has been affected. Pension costs are “suffocating our ability to make long-term investments,” she said.

In 2012, the pension trustees asked the State Legislature to lower the system’s long-term investment expectation to 7 percent, at the prodding of Mr. North. Many experts say 7 percent is still too high. But cutting the assumption to 7 percent from 8, along with some other adjustments, was going to cost the city an additional $2.8 billion in contributions in the first year. Mr. North eventually lowered the contributions total to $600 million by spreading the cost over 22 years.

The additional cash will certainly help the pension system, but it will still take years and luck in the markets for the city to close the gap from the years it should have been contributing more.

It is the pursuit of higher returns that has led the trustees, and lawmakers in Albany, to authorize more aggressive, alternative strategies, mirroring a national trend among public pension systems. The approach carries the possibility of a greater upside but also brings greater risks and costlier fees.

“There’s nothing wrong with taking the risk,” Mr. North said. “The risk, however, should be recognized and understood as it is mostly borne by future generations,” people who were not consulted on these decisions.

In New York, private equities — stocks that do not trade on any exchange or have a published price — have become a favored asset class. Private equity investments are typically done through partnerships with specialized firms, which last for several years. Until they run their course, the returns cannot be calculated accurately. The fees are high, and it is not yet clear that the partnerships are delivering consistently higher returns.

In one example, John Murphy, a former executive director of Nycers, the fund for general workers, said he noticed in 2011 that the Allegra Capital Partners IV fund had just come to an end, making a final accounting possible. After long delays, he received data showing that Allegra had lost 8.24 percent per year, on average.

“Nycers invested $24 million and got back $11.66 million,” Mr. Murphy said. “This is clearly an imprudent strategy for a large pension fund.”

Mr. Murphy said that Nycers had lost money in just five years out of the last 30 — all in the 2000s, after the system adopted its private equities program. Out of curiosity, he calculated what the returns might have been if Nycers had continued its strategy of investing solely in publicly traded stocks and high-rated bonds. The answer was: billions of dollars ahead of where it is today.

Low Priorities

The city’s decades-old structure for its pension system almost changed in 2011. Mr. Bloomberg and the comptroller at the time, John C. Liu, bitter rivals, unveiled an ambitious plan to consolidate the five plans.

The aims included hiring professional in-house investors and breaking the link between the pension system and the political calendar. Most of the ideas died, however. Some labor leaders felt that they had not been consulted, and Mr. Liu became hobbled by a federal investigation into his campaign finances.

Now, of course, there is a new mayor and a new comptroller, both of whom have been staunch labor allies. A new chief investment officer started last month, and Mr. North, the system’s actuary for nearly 25 years, is expected to retire this year.

It is unclear whether pensions will be a top priority.

Mr. de Blasio, notably, did not mention the word “pension” during his hourlong budget presentation in May. Mr. Bloomberg, by contrast, raised the issue often and made his final formal speech a stemwinder on pension costs.

In May, Comptroller Scott M. Stringer announced he would try to commit $1 billion to smaller investment firms led by minorities and women, despite research showing that initiatives geared toward emerging firms make it harder to achieve top investment returns.

Mr. North said that Mr. de Blasio’s recent deal with the teachers’ union — and two subsequent deals with health care workers and nurses — would necessitate bigger pension contributions from the city. But precisely how much bigger remains unknown because the contracts are complex.

After Mr. North leaves, it would be easy for New York to tweak key assumptions and lowball its contributions. That would save the city money, but it could wreak havoc on the future. He has urged the trustees to be mindful of the city’s not-so-distant past.

“It’s less than 40 years since we were near bankruptcy,” he said.

As the world’s biggest pension manager moves closer to putting more money in risky assets, the ruling Liberal Democratic Party’s deputy policy chief says the fund needs to change its governance first.

Japan should submit a bill in the next parliamentary session to overhaul the structure of the 126.6 trillion yen ($1.2 trillion) Government Pension Investment Fund, Yasuhisa Shiozaki said in a speech at Bloomberg’s offices in Tokyo yesterday. With the fund working on a separate investment-strategy review, discussion is needed on whether it’s right to alter asset allocations before the law change, he said.

“We have to fix GPIF’s governance structure in the extraordinary session and then rework its portfolio,” said Shiozaki. “Governance reform is paramount and it’s important to get it done before the weightings get changed this fall.”

Policy makers seeking to add a board of directors and tougher oversight of GPIF’s investment decisions are running out of time to revamp the fund’s legal structure before it announces its asset review, expected in Japan’s autumn. The Topix index rose 12 percent from this year’s low on April 14 through yesterday amid speculation that GPIF will buy more local shares.

“The investment and governance reforms should go hand in hand, with governance coming first,” Shiozaki said.

Prime Minister Shinzo Abe’s growth policies, revised in June, urged GPIF to immediately alter its asset mix as the economy exits deflation, and strengthen the fund’s oversight.

LDP Plans

The LDP is working on a bill to establish a board of six or seven directors to oversee GPIF, Kozo Yamamoto, a party official in charge of preparing the policy, said in May. Changes may also include allowing direct investments in a broader range of assets, as well as the creation of risk and governance committees, Yamamoto said.

The overhaul of GPIF is likely to be successful because Abe’s government has a firm grip on power and can push changes through, Takatoshi Ito, who headed a group that advised lawmakers on public pensions last year, said in a panel discussion at yesterday’s Bloomberg event.

“The premise is the Abe regime will remain in power for the long term,” Ito said. “If it’s an administration that will be around for a long time, it’s harder for people to say no.”

Under the current system, GPIF President Takahiro Mitani and the health ministry have the final say on investment decisions and the fund is barred from buying stocks directly.

GPIF is already making changes that don’t require parliamentary approval, announcing plans this year to invest in infrastructure, adopt Japan’s stewardship code and hire new domestic stock managers. The fund has also won flexibility to pay higher salaries to attract investment staff.

Seven Samurai

“GPIF has less than 100 people, and it’s been said only seven of them are investment professionals, like the seven samurai,” Shiozaki said. “We really need to add experts.”

GPIF has started a serious review of its portfolio, Shigehito Aoki, an official at the fund, said at a briefing last month as it reported an 8.6 percent return in the year through March, buoyed by an equity rally in the first three quarters.

The Topix sank 0.8 percent to 1,254 as of 10:23 a.m. local time, its fifth day of declines. The measure plunged 7.6 percent in the first three months of this year, before rebounding 5 percent the following quarter.

“We want GPIF to diversify its investments,” Shiozaki said in an interview with Bloomberg after his speech. “We aren’t saying they should buy more stocks. They should decide what to buy themselves.”

Reducing Risk

The fund isn’t holding the right assets to reduce its investment risk, especially as Japan’s inflation picks up, according to Shiozaki.

“They have too much domestic debt,” he said. “Their asset allocations have been off when you think of risk management.”

GPIF will pare domestic bonds to 40 percent of holdings and boost local stocks to 20 percent, according to the median estimate from a Bloomberg survey of analysts in May. That would require selling 19.5 trillion yen of debt and buying 4.5 trillion yen of equities, calculations by Bloomberg using the fund’s holdings at the end of March show.

“Is it OK for GPIF’s governance to stay the same when its asset allocations change?” Shiozaki said. “We have to think about that.”

When Ron Mock became president and chief executive of the Ontario Teachers’ Pension Plan in January – one of the world’s largest pension funds – his appointment raised more than a few eyebrows.

Not just because Mr Mock, who is a 13-year veteran of the $140.8bn Canadian pension scheme, has a background in the somewhat controversial area of hedge funds, but because the hedge fund company he once presided over collapsed in 2000 with losses of more than $125m.

A year after that collapse – and in a show of great confidence – Ontario Teachers hired the 61-year-old as director of its alternative investment arm despite an ongoing investigation into why Phoenix Research and Trading, the hedge fund company Mr Mock co-founded, was forced into closure.

The blame for those losses and the company’s eventual demise was later found to lie firmly with Stephen Duthie, a rogue trader who had taken large unapproved positions in US government bonds. However, in 2003 Mr Mock was reprimanded by the Ontario Securities Commission for failing to supervise Mr Duthie properly and he was prohibited from becoming a director or officer of a public company for six years.

At the time of that reprimand Mr Mock was busy rekindling his career at Ontario Teachers. He had already been promoted to the position of vice-president, a title he held until 2008, when he became senior vice-president and assumed responsibility for all fixed income assets as well as alternative investments and hedge funds.


A source close to Ontario Teachers says the pension fund was “well aware of the Phoenix collapse” at the time of Mr Mock’s initial appointment. “Thorough due diligence was done and the board concluded that Ron had behaved honourably, in self-reporting the employee’s unapproved position.”

Mr Mock, who trained as an electrical engineer, says: “My career is the sum of my experiences. That particular situation reinforced in my mind the critical importance of the reality that the burden of responsibility rests with the CEO.”

And it is clear Mr Mock’s ability and confidence have not been frayed by the events. Ontario Teachers – famous for its direct investments in private companies, infrastructure projects and property – has returned an enviable average annual return of 10.2 per cent since its inception in 1990. In its first set of annual results since Mr Mock took charge the fund posted returns of almost 11 per cent.

During Mr Mock’s first few months at the helm he also oversaw the purchase of a 50 per cent stake in Flynn Restaurant Group, a Taco Bell franchisee, and finalised terms for a 20-year licence to operate the Irish National Lottery.

“I’m having fun,” says Mr Mock, who was once responsible for safety at a nuclear plant. “I believe we broke the mould in the pension fund model when we launched. We were one of the first pension plans to employ derivatives. We were one of the first to go into hedge funds. And we were one of the first to buy a real estate operating company in which we actually develop as well as manage property.

“So who do we look to in order to better ourselves? Probably the toughest form of competition of any kind – we look to ourselves,” he says.

The fund’s list of infrastructure assets is long and includes minority stakes in Birmingham Airport, Bristol Airport, Copenhagen Airport and Brussels Airport; the High Speed 1 rail line linking London with the Channel tunnel; and international water and power utilities. It also owns Camelot Group, which holds the exclusive licence to operate the National Lottery in the UK.

“We don’t say at the beginning of the year that we are going to invest $3bn in Europe or $4bn into Asia. We don’t think like that,” says the chief executive. “We have people all over the world and what we say to them is: ‘There is money available to invest. Bring us what you find, but if you don’t find something that fits with our liabilities and our risk-adjusted returns then there is no pressure to push money out the door.’”

Where Mr Mock does feel the pressure, however, is in finding and hiring the right people to make those investments. Once again he believes Ontario Teachers “broke the mould” in the 1990s by paying staff above and beyond what they would expect to earn at other pension funds.

“Our philosophy is pretty simple,” says Mr Mock, who was paid $2.9m last year. “If you want upper-quartile performance, you need upper-quartile people. We don’t make cars and we don’t make rubber tyres, our assets go up and down the elevator every day. Our assets are intellectual capital and we need to make sure that we are attracting the best intellectual capital we can get our hands on.

“So back at a point in time when pension plan CIOs and CEOs were getting paid $125,000 and $150,000 a year we said: we have to start paying market rates, we have got to start paying for performance. And so today our portfolio managers can make $700,000 to $900,000, while many of our vice-presidents can make $2m. That is not normal pension-plan compensation.”

Mr Mock, however, is quick to point out the fund never overpays – a philosophy Ontario Teachers, which invests assets on behalf of 307,000 active and retired primary and secondary school teachers, also takes into its investments.

“We don’t get turned down when it comes to infrastructure deals,” he says. “Seriously, we don’t get turned down. In fact, we will get asked to join deals because of who we are and what we bring to the table. We get asked into deals where we won’t even pay the highest price.

“But we turn ourselves away if there is a bidding war and the price for assets gets silly. When the price for assets gets too high, that becomes a risk and you can end up paying for it three, four or five years down the line, which can take all your senior management to fix.”

Ontario Teachers is not afraid of taking risks but those risks must be calculated, adds Mr Mock – a message that might indeed be applied to his own appointment some 13 years ago.

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Curriculum vitae

Ron Mock

Born 1953

Education

B.A.Sc. in electrical engineering, University of Toronto

MBA, York University, Toronto

Career

Various positions in field work, design, construction and research at Ontario Hydro

Director of sales and trading staff in derivatives products at Nesbitt Burns (now BMO Nesbitt Burns)

Founder and chief executive of Phoenix Research and Trading

2001 Joins Ontario Teachers’ Pension Plan as vice-president of fixed income

2009 Senior vice-president of fixed income and alternative investments, Teachers’

2013 Chief executive, Teachers

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Ontario Teachers’ Pension Plan

Founded 1990

Headquarters Toronto, with an office in New York City

Assets under management $140.8bn at December 31 2013

Employees Fewer than 1,000 employees in Toronto, London and Hong Kong

Ownership Teachers’ is an independent organisation set up by its two sponsors. The Ontario Teachers’ Federation represents all members. The Ministry of Education and Ministry of Finance jointly represent the Ontario government

Several hedge funds have received margin calls in recent days on their holdings of risk-sharing RMBS bonds from Freddie Mac and Fannie Mae, market sources told IFR.

The sources said the margin calls were met, but the event still unnerved the structured finance market, which has again become reliant on cheap leverage to sustain momentum.

One banker said brokers' margin calls required the hedge funds to pony up an extra four to five points of their equity against what they initially borrowed to purchase the bonds - understood to be more than 80% of the purchase price in some cases - to cover any losses.

"Dealers that lead these trades offer attractive financing of two to three times leverage," one mortgage strategist said. "But if the investor is forced to unwind, it can get ugly."

In the first quarter, some hedge funds were locking in 30-day repurchase agreements to buy risk-sharing bonds at a rate of 1.9% to lever 2.14 times, according to SEC filings.

Risk-sharing RMBS are barely a year old, having sprung up as a new asset class after US regulators issued guidelines urging the government to reduce its footprint in the massive US residential mortgage market.

Hedge funds piled aggressively into the riskier (and often unrated) tranches of the deals, looking for yield pick-up at a time when returns had shrunk dramatically just about everywhere else.

But those deals have recently tumbled dramatically. Between July 11 and July 29, the unrated bonds favoured by hedge funds gapped out as much as 50bp to roughly Libor plus 330bp in the secondary market, according to Wells Fargo data.

"Generally the sell-off has all the signs of a levered unwind," the mortgage strategist said.

And at a time when volatility is high - Lipper this week reported the largest one-week outflow from high-yield funds ever, at more than US$7bn - the risk-sharing bonds are continuing to struggle.

On Wednesday Freddie Mac had to price the unrated tranches of its latest Structured Agency Credit Risk (STACR) trade at Libor plus 400bp and 410bp - a whopping 100bp-120bp wide of Fannie Mae's last risk-sharing deal in July.

And while cheap money certainly enticed some players to buy into the risk-sharing sector in the first place, record volumes lately have led players to look for a way to trade out.

Approximately US$135m in risk-sharing bonds was out for bid in each of the past two weeks, the highest levels by far since the programme started in July 2013, according to Adam Murphy, president of market data company Empirasign.

POSITIVE APPROACH

Despite these stumbles, Freddie Mac is counting on being able to attract a broader base of buy-and-hold investors to the asset class - and remains optimistic.

For one thing, each of Freddie's four STACR deals prior to July had printed at successively tighter levels, as did the three prior Fannie trades.

"Maybe spreads tightened too much and are now back to a more sustainable level," Mike Reynolds, a director of portfolio management at Freddie Mac, told IFR.

"We definitely think the investor book should include hedge funds, and it's natural for them to use to get the yields they need," he said. "But we prefer to be a smaller percent of the total distribution."

And that seems to be happening already. For the 2014-DN3 portion of the new STACR trade, 20% went to hedge funds, down from a 30% participation in April for its DN2 deal, Reynolds said.

Meanwhile the 2014-HQ1 deal - the first from Freddie to include mortgages with loan-to-values above 80% - saw just 5% participation from hedge funds.

I still like biotechs (IBB and XBI), small caps (IWM), technology (QQQ) and internet shares (FDN). By the way, I particularly like Twitter (TWTR) and tweeted people to load up on it when it fell below $30 several weeks ago (stay long)...My personal portfolio remains in RISK ON mode, heavily invested in small cap biotechs like Idera Pharmaceutical (IDRA), my top holding at this moment (very volatile and extremely risky).

The Conservative government is developing a funding policy for the pension plans of Canada’s public servants, military and RCMP, a move that baffles experts because the plans have no real funds and own no assets.

A funding policy typically sets the framework for how to cope with risk and manage any gains and losses by adjusting the contributions paid into pension plans.

But the policy, to be crafted by consultants, would cover years of pensionable service in accounts that are nothing more than ledger records with no real assets. Pension benefits are guaranteed by law and paid from government’s main bank account — the consolidated revenue fund.

Pension expert Malcolm Hamilton said he’s puzzled why the government is charging ahead with a funding policy for the “least funded parts” of its unfunded pension plans.

“Funding is about setting money aside to pay benefits and they don’t pay benefits from those accounts, so why do they need a funding policy?” he added.

“What, if anything, does it mean to fund a pension plan that, by the government’s own admission, has no fund in which assets are held and from which benefits are paid? Beats me. This might make sense if the government was proposing to change the way its handles the pension funds but there’s no suggestion that is the case.”

The public service pension plans are like no other. They aren’t governed by the Pension Benefits Standards Act, the assets aren’t in trust or managed by a trustee, and there is no segregated pension fund owned by the plan in which pension assets are held and invested and from which pension benefits are paid to retirees.

Treasury Board is hiring consultants to come up with a “funding policy,” as recommended by Auditor-General Michael Ferguson in his recent report on the sustainability of the three plans. Bidders have until Tuesday to submit proposals for the two-phase project, which must be completed six months.

The policy is being specifically drafted for the public service pension plan but it must be “flexible enough” to be adapted for the other plans. Consultants will provide a research report, followed by a second phase of weekly consultations on proposals developed for the final policy.

A funding policy sets the framework for funding a defined benefit pension plan, including factors such as workforce demographics, stability and affordability of contributions, and the handling of surpluses or deficits. It takes into account the employer’s — in this case the government’s — financial position and risk tolerance.

Without a policy, Ferguson said the Public Sector Pension Investment Board, which manages the plans’ assets, is forced to make assumptions about the government’s tolerance for risk and funding preferences when targeting rates of return in its investment strategy.

The bid documents, however, indicate the funding policy is for the pension assets and liabilities accrued before 2000, which aren’t managed by the investment board. All the pensionable service built up before 2000 is considered unfunded.

Treasury Board officials offered no explanation on why the policy is for the pre-2000 plan other than it would “provide additional guidance” for funding and financing decisions while also “strengthening” its guidance to the investment board on investment strategies and risk management.

Hamilton, the pension expert, said a funding policy also won’t resolve the major problems critics have with the way the government records the cost of the plans on the books.

The C.D. Howe Institute has long argued the plans are not fully funded and the government is grossly understating the size of Canada’s debt and deficit — and how much it pays thousands of bureaucrats, military and RCMP.

It argues the government should adopt “fair-value” accounting like the private sector, which uses current market prices to value assets and liabilities as a means to ensure plans are fully funded in the event they are liquidated or wound down.

The timing of the proposal has also raised eyebrows, particularly among unions locked in a testy round of collective bargaining with the government over its plan to replace the existing sick leave regime with a new short-term disability plan.

Ian Lee, a professor at Carleton University’s Sprott School of Business, said the project, which includes a sweeping report on the latest trends and best practices in the pension industry, will set the stage for Conservatives to make compensation reform, including a pension overhaul, a campaign promise in the 2015 election.

“I think this report is the first step in that journey,” he said. “They will run as the party with the courage, conviction and ability to reform the largest employer in Canada by modernizing its sick leave, pay, benefits and pensions. These are fundamental changes and they will seek a mandate from Canadians to do it.“

• Managing the funds transferred to it by the Government of Canada for the Canadian Forces, the Reserve Force, the Public Service and the Royal Canadian Mounted Policy pension plans (the “Pension Plans”) in the best interests of the contributors and beneficiaries; and
• Investing its assets with a view to achieving a maximum rate of return without undue risk of loss, having regard to the funding, policies and requirements of the Pension Plans and their ability to meet their financial obligations.

PSP Investments was incorporated as a Crown Corporation under the Public Sector Pension Investment Board Act in 1999. Our investments will fund retirement benefits under the Plans for service after April 1, 2000 for the Public Service, Canadian Forces, Royal Canadian Mounted Police, and after March 1, 2007 for the Reserve Force.

The public sector pension fund posted one of its best returns since the economic downturn in 2008 as it sunk its money into European airports and more Manhattan real estate.

A 16.3 per cent return brings the total value of the investment fund, which is fed by pension plans for public servants, the RCMP and military reserves, to $93.7 billion, according to its annual report. That amounted to an increase of $17.6 billion from the almost $80 billion recorded one year earlier.

If it continues to grow as planned, the fund — the fifth largest in the country — expects to more than quadruple in value over the next 20 years and be worth $425 billion by 2035, just when it will see more money flowing out to pay benefits than it receives in contributions and investment income.

The figures should only add to the ongoing battle between the government and public sector unions about the future and sustainability of the pension plans. Ian Lee from Carleton University’s Sprott School of Business suggested the government could use the figure for more leeway in making changes to the pension system, but shouldn’t avoid making changes based on the projections.

“The government should not be saying, ‘Oh, well, they’re projecting a big fat number … so we’re clear sailing,'” Lee said.

“Any statement about the future is a projection. It’s not a statement of fact.”

If things go wrong — such as lower than expected interest rates or bad investments — “the government is on the hook,” Lee said.

“They’re trying to maximize and get bigger and better returns because they know that down the road they’re going to have an awful lot of people claiming (benefits),” he said.

Pension reform has returned to the national agenda earlier this year when the Tories unveiled “target benefit” pension plans for Crown corporations and federally regulated industries. Public service pensions aren’t part of that proposal, but unions have expressed concerns that their plans could be next for such change after the government raised the age of retirement and employee contributions.

The government has a $152-billion pension liability that it must fund. That amount could easily rise if public sector pensioners live longer: In May, auditor general Michael Ferguson said an extra year or three could increase that liability by between $4.2 billion and $11.7 billion.

A spokesman for the investment fund said the $152-billion liability is for pensionable service before 2000. After that time, payments come out of the fund.

To remain afloat, the investment board has to keep real investment return — overall returns minus inflation and expenses — at 4.1 per cent annually. Over the last 10 fiscal years, the real return was about one per cent above that target.

In the last year, the fund bought a high-rise office building on Park Avenue in New York City; spent $1.5 billion for several airports, including ones in Athens, Budapest and Sydney, that combined handle about 95 million passengers a year; and invested in farmland in Latin America.

“Those assets reduce the risk for the portfolio,” said fund spokesman Mark Boutet. There may come a time when the fund will need to unload those assets to pay for pension benefits, “but that time is far out,” he said.

The top five executives, meanwhile, had their compensation reduced. They earned $13.7 million in compensation, a decrease of 16 per cent from the $16.3 million recorded in 2013.

Those declines came after an outcry from opposition critics last year over a 50 per cent increase in executive payouts between 2012 and 2013.

Gordon Fyfe, who left as CEO in June, took home $4.2 million in total compensation in the last fiscal year, a $1.1 million decrease from the $5.3 million the previous year. Like those of other executives, much of Fyfe’s compensation came from bonuses atop of his base salary of $500,000.


The Public Sector Pension Investment Fund, by the numbers

$97.3 billion: Value of the fund at the end of the 2014 fiscal year

$17.6 billion: Increase in value between the 2013 and 2014 fiscal years

35%: Percentage of funds in foreign investments

$13.7 million: Total compensation to the top five executives at the fund

$4.2 million: Total compensation former CEO Gordon Fyfe received in the last fiscal year

4.1%: Average increase, after costs and inflation, in the fund’s value needed to meet future pension obligations

0.9%: Average increase above the 4.1 per cent the fund has achieved over the last decade

$425 billion: Projected value of the fund by 2035

Three of the leading private equity firms on Wall Street have agreed to pay a combined $325 million to settle accusations that they colluded with one another to drive down the prices of corporate takeover targets, according to a court filing on Thursday.

The three firms — Kohlberg Kravis Roberts, the Blackstone Group and TPG — have agreed to settle all claims without admitting wrongdoing, and they will decide among themselves how to split up the payment, the filing said. Of the seven defendants in the case, all but one have now settled.

The latest agreement, if approved by the Federal District Court in Massachusetts, would resolve the role of the private equity firms in a seven-year-old lawsuit filed by former shareholders of companies that the firms acquired during the boom times before the financial crisis. The plaintiffs, which include pension funds and individual investors, had sought billions of dollars in compensation.

While private equity firms have rebounded strongly from the crash — reaping bountiful profits thanks in part to low interest rates and the soaring stock market — the lawsuit has been a lingering cloud over the industry’s biggest players. The firms, accumulating piles of legal bills, have put up a vigorous defense and succeeded last year in convincing a judge to narrow the case’s scope.

But a trial looms in November, and nearly all of the firms have now opted to pay eight- and nine-figure sums to make the lawsuit go away.

Three defendants — Bain Capital, Silver Lake and Goldman, which did private equity deals through its buyout arm — agreed in recent months to settle the claims against them for a combined $150.5 million.

The agreement with K.K.R., Blackstone and TPG was reached on July 28 though not disclosed until Thursday.

The lone holdout is the Carlyle Group, the giant private equity firm based in Washington. A spokesman for Carlyle, Christopher Ullman, wrote in an email statement: “These claims are without merit and we will continue to vigorously contest the allegations.”

Kristi Huller, a spokeswoman for K.K.R., said in an email statement: “Settling acquisition-related litigation is frequently in the best interest of our investors, on whose behalf we pursue those acquisitions.” She added, “While we continue to believe that the plaintiffs’ allegations are spurious, we determined that after seven years it was best for K.K.R. and our limited partners to put an end to the distraction and expense of this litigation.”

Representatives of Blackstone and TPG declined to comment.

The lawsuit, originally filed in late 2007, took aim at some of the biggest leveraged buyouts in history, portraying the private equity firms as unofficial partners in an illegal conspiracy to reduce competition. Those multibillion-dollar acquisitions were struck by groups of firms in partnership, an arrangement known as a “club deal” that has largely fallen out of favor in the years since.

As they collaborated on headline-grabbing deals — including the buyouts of the technology giant Freescale Semiconductor, the hospital operator HCA and the Texas utility TXU — the private equity titans developed a cozy relationship with one another, the lawsuit contended. Citing emails, the lawsuit argued that these firms would agree not to bid on certain deals as part of an informal “quid pro quo” understanding.

In September 2006, for example, when Blackstone and other firms agreed to buy Freescale for $17.6 billion, K.K.R. was circling the company as well. But Hamilton E. James, the president of Blackstone, sent a note to his colleagues about Henry R. Kravis, a co-founder of K.K.R., according to the lawsuit. “Henry Kravis just called to say congratulations and that they were standing down because he had told me before they would not jump a signed deal of ours,” Mr. James wrote.

Days later, according to the lawsuit, Mr. James wrote to George R. Roberts, another K.K.R. co-founder, using an acronym for a “public to private” transaction. “We would much rather work with you guys than against you,” Mr. James said. “Together we can be unstoppable but in opposition we can cost each other a lot of money. I hope to be in a position to call you with a large exclusive P.T.P. in the next week or 10 days.” Mr. Roberts responded, “Agreed.”

Soon after, the lawsuit contends, Blackstone invited K.K.R. into a bidding group for the radio giant Clear Channel Communications, though the group ended up losing that deal.

Running more than 200 pages, the lawsuit contains numerous references to the protocol of club deals. One unidentified Goldman insider, referring to the takeover of Freescale, said that “club etiquette prevails.” In a different situation, James A. Attwood Jr., a managing director at Carlyle, suggested that “these partnering deals should be a two-way street.”

The plaintiffs, in addition to pension funds in Detroit and Omaha, include several individuals who sold shares in the private equity buyouts. They filed the complaint after the Justice Department’s antitrust division began investigating possible collusion related to club deals. The government never brought any charges.

While the plaintiffs have now coaxed $475.5 million from the buyout firms, much depends on a hearing in September, when a judge will consider whether to approve the settlements and — crucially — whether the plaintiffs can be considered a class for legal purposes. A decision that the plaintiffs are not a class would threaten the existing settlements.

Carlyle’s position as the lone holdout creates a risk for the other defendants. The firm, in theory, could object to the settlements.

But pressure will mount on Carlyle if the settlements go forward. Should it lose at trial, Carlyle would be liable for an outsize level of damages. The firm has sought to have the case dismissed, an effort scheduled for a hearing in October.

“We’re gratified that the defendants have decided to settle the case,” said K. Craig Wildfang, a lawyer for the plaintiffs. “We look forward to going to trial against Carlyle.”

It’s pretty much a given that the underlying conduct smells to high heaven when the top legal fixers in America can’t get seriously rich men out of trouble. In this case, the rich men are the private equity alpha players: KKR, Blackstone, and TPG, who have agreed to shell out $325 million among them to settle claims of collusion on bidding for potential acquisitions. Note that this settlement needs to be approved by the judge to become final. Three other funds, Bain, Goldman, and Silver Lake, already settled with the plaintiffs.

This case was even more of a David versus Goliath than the usual suit against private equity general partners, since the lead plaintiff was the lowly Police and Fire Retirement System of the City of Detroit. Mind you, it’s hard to find any law firm of reasonable stature to go against private equity firms, since they throw around so much legal business that pretty much every blue chip law firm either works for them or wants to get on their meal ticket.

The basis of the dispute was that, in the runup to the crisis, the biggest private equity players would team up to submit joint bids on large takeover candidates. In and of itself, that could be defensible conduct, since one could claim that these so-called club deals allowed the firms to buy even large companies than they could easily (or permissibly, given restrictions in their limited partnership agreements on the maximum percentage of the fund permitted for a single investment) digest. But what was obviously not kosher was arm-twisting other big funds to stand aside. The plaintiffs, who owned shares in the companies that were purchased by these consortia, argued that they were damaged by the price-suppressing effects of these strategies. I have no idea what the rules of thumb are now, but back when I was in the M&A business, having an additional bidder in an auction was generally reckoned to increase the price by 10%.

This private equity troika was eager to cut a deal before September 4, when the judge was to make an initial ruling as to whether to give class action certification to the plaintiffs. If they prevailed, that would greatly increase their bargaining leverage.

The fact that these firms managed to drag the case out of seven years suggests they were hoping to win a war of attrition, but the plaintiffs got such good dirt in discovery that that strategy was no longer viable.

A wild card is that one of the defendants, Carlyle Group, has refused to settle. The Grey lady, clearly running PR for the private equity firms, claims the settlement is in jeopardy if the judge rules against the plaintiffs on the class action status. Informed reader input is welcome:

While the plaintiffs have now coaxed $475.5 million from the buyout firms, much depends on a hearing in September, when a judge will consider whether to approve the settlements and — crucially — whether the plaintiffs can be considered a class for legal purposes. A decision that the plaintiffs are not a class would threaten the existing settlements.

Personally, I’d love to see Carlyle executives on the stand, particularly if the stake were high by virtue of refusing to come to terms with the plaintiffs and facing much higher potential damages by virtue of them getting a class action certification. But litigation is a crapshoot, so stay tuned for the September ruling.

Private equity companies have paid a record 32 per cent of US investment banking fees so far this year, in a sign of the growing power big buyout groups wield in their relations with Wall Street.

Buyout companies accounted for $6.5bn of Wall Street’s $20.4bn in US investment banking revenues from deals so far in 2014, according to Dealogic. That puts them on track to exceed their importance to banks at the peak of the buyout frenzy in 2007, when private equity accounted for 24 per cent of the $36bn of US investment banking business.

These fees have become ever more critical to banks as other formerly lucrative operations have come under pressure and return on equity has been driven down by new regulations and capital requirements.

The recovery from a trough in the crisis year of 2008 when private equity accounted for just 12 per cent of fees comes despite the fact that buyout companies have largely sat on the sidelines of a new wave of multibillion-dollar mergers and acquisitions. Private equity transactions have accounted for only 19 per cent of all such deals globally since the beginning of 2012, Dealogic notes.

The latest data show, however, that private equity houses such as Blackstone and KKR do not need to do big acquisitions to be treasured by Wall Street. Banks are still reaping the fruits of deals done at the peak of the buyout market seven years ago as private equity houses take profits on companies they bought then.

Big private equity companies have taken advantage of the Federal Reserve’s easy money policies to refinance the highly leveraged deals they did at that time, paying themselves dividends in the process.

As US equity markets have risen to record levels, they have listed many of their holdings and then sold down their stakes. Investment banks earn fees for such follow-on deals, which is one reason why bankers covet private equity clients.

Blackstone’s initial public offering of Hilton, the hotel chain it bought in 2007, generated $230m in fees, helping make Blackstone last year’s single largest fee payer, handing over $880m. Similarly, in the year to July 25, Carlyle was investment banks’ single most lucrative client, with its $696m total boosted by a large part of the $295m in fees from one of its companies, Numericable. Numericable, which went public late last year and then bought rival French telecoms group SFR, was the largest corporate fee payer for the period, Dealogic found.

“This is an attractive time for [private equity firms] to harvest their gains,” said Craig Siegenthaler, who covers the industry for Credit Suisse. “I expect a high level of monetisations for the next several quarters.”

In the mid-1990s, private equity paid just 2 or 3 per cent of all investment banking fees, according to Dealogic.

The private equity industry's lobbying group met officials from the Office of the Comptroller of the Currency and the Federal Reserve last week to address concerns over a crackdown on junk-rated loans, people familiar with the matter said on Monday.

The private meeting - the first between the Private Equity Growth Capital Council (PEGCC) and the U.S. regulators over the issue - underscores many buyout firms' reliance on leveraged loans for outsized returns in their debt-fueled acquisitions of companies.

It also highlights the willingness of the OCC and the Fed to engage with parties they do not regulate. Private equity firms are typically regulated by the U.S. Securities and Exchange Commission.

The PEGCC sought and received assurances from the OCC and the Fed that regulators have not been targeting the private equity industry in their efforts to prevent excesses in leveraged lending, the sources said.

The OCC and the Fed also told the PEGCC that they were not being inflexible in their application of the lending guidance, which was issued last year, the sources said. The regulators are also working on providing follow-up guidance to banks, the sources added.

Among those attending the meeting were Martin Pfinsgraff, senior deputy comptroller for large-bank supervision at the OCC, and Anna Lee Hewko, a deputy associate director at the Fed's division of banking supervision and regulation, the sources said.

The sources asked not to be identified because the meeting was private. The PEGCC and the Fed declined to comment, while an OCC spokesman did not immediately respond to a request for comment.

The meeting comes as the leveraged finance industry awaits the outcome of an annual review of banks' loan books that took place earlier this summer. Regulators have warned that underwriting standards have deteriorated, though bankers say they expect the review's findings to be in line with last year's.

Lending for U.S. leveraged buyouts totaled $46.9 billion in the first half of 2014. It reached $90.5 billion in 2013, the highest level since 2007, according to Thomson Reuters Loan Pricing Corp.

A small number of PEGCC's members, such as Blackstone Group LP and KKR & Co LP, are alternative asset managers that have direct lending divisions which could benefit from a regulatory crackdown on the leveraged lending businesses of Wall Street banks.

Asked about the impact of the leveraged lending guidance on KKR, Scott Nuttall, head of KKR's global capital and asset management group, told analysts last month the firm stood to benefit on the credit investment side while it would withstand any retrenchment of banks on the private equity side.

"We have direct relationships with a number of institutions around the world, some of which, frankly, are not subject to these potential limitations ... Our private credit business should benefit if the Fed guidelines get adhered to once people figure out what all of the rules actually mean in practice," Nuttall said.

"It's not a question of enough, pal. It's a zero-sum game: somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another."

So said Gordon Gekko, the anti-hero in Oliver Stone's 1987 film Wall Street, as he perfectly described the financial world's attitude to acquiring more and more money. It will probably be worth recalling that approach this week as we sit through two sets of results from firms just floated by Gekko's branch of finance, private equity.

On the real Wall Street, we get second-quarter numbers from King Digital Entertainment, the UK computer games group flogged to American investors earlier this year. The shares have lost 15% since.

On the same day we also get numbers from the takeaway food website Just Eat, sold to pension funds by venture capital in April, but now 17% cheaper.

There are plenty of similar tales about private equity's class of 2014 – all of which seemed to find obedient fund managers to buy the shares, despite all the warnings about being suckered in at the top of the market.

Still, those pension fund managers criticised for sacrificing our hard-earned money can consult Gekko for a decent riposte: the money has not been lost, they can argue, simply transferred to an alternative perception.

A government accounting maneuver to pay for road repairs, subways and buses will allow many U.S. businesses to delay billions of dollars in pension contributions for retirees.

President Barack Obama on Friday signed a $10.8 billion transportation bill that extends a "pension-smoothing" provision for another 10 months. In short: companies can delay making mandatory pension contributions, but because those payments are tax-deductible some businesses will pay slightly higher tax bills, which will help pay for the legislation.

Companies with 100 of the country's largest pensions were expected to contribute $44 billion to their plans this year, but that could be slashed by 30% next year, estimated John Ehrhardt, an actuary at consulting firm Milliman.

International Paper Co., for example, had planned to set aside $1 billion by 2016 to fund its $12.5 billion U.S. defined benefit plan. The paper company says it now expects to funnel that money into other projects, including share buybacks or investments in new plants.

"It means more cash for us," says Chief Financial Officer Carol Roberts.

But the accounting tactic is controversial. The government's moves could undermine its own efforts to shore up the pension system. Some worry about the strain it could put on the government agency tasked with protecting the retirement of 44 million workers.

"To use the federal pension insurance program to pay for wholly unrelated spending initiatives is just bad public policy," said Brad Belt, former executive director of the Pension Benefit Guaranty Corporation, the government's pension insurer. "It has adverse implications for the funding of corporate pension plans."

Companies have struggled to keep up with mounting pension bills since 2008.

The present-day value of those promises increases when interest rates decline. Currently, the largest pensions have a $252 billion funding deficit, which has increased by $66 billion since the beginning of the year, according to Milliman.

The accounting maneuver was introduced in Congress's last highway bill in 2012, and was backed by large business groups, such as the Business Roundtable. The new bill, which expires in May, will extend the method.

The bill essentially allows companies to base their pension liability calculations on the average interest rate over the past 25 years, instead of the past two. The 25-year average is larger, because interest rates were much higher before the financial crisis.

The accounting technique doesn't actually reduce companies' obligations to retirees. Instead, it artificially lowers the present-day value of future liabilities by boosting the interest rate companies use to make that calculation.

The risk is that pension smoothing will ultimately increase corporate pension deficits by encouraging executives to delay payments, says the Congressional Budget Office. For instance, more companies could default on their obligations to retirees.

PBGC executives and labor unions aren't worried about the impact of the new transportation bill. "Even with this smoothing provision, we'll be in a vastly better position," says Marc Hopkins, an agency spokesman.

The financial health of the government's PBGC is improving. The agency has mapped out different scenarios of economic growth and estimated its fund to cover defaults will have an average deficit of $7.6 billion in 2023, down from $27.4 billion late last year.

Pension smoothing measures will only add $2.3 billion to its estimated deficit, the agency says.

The AFL-CIO, the nation's biggest labor union federation, says it supports pension smoothing because it reduces volatility to balance sheets, which makes the prospect of offering pensions less daunting.

"We've been supportive of greater smoothing in pension funding generally," said Shaun O'Brien, assistant policy director for health and retirement at the AFL-CIO. "While we would prefer a longer-term permanent change in the rules, we're supportive of the approach Congress has taken."

Under a 2006 law, companies need to make their plans whole over time. Pension smoothing provisions both artificially and temporarily make funding levels look healthier, so companies can lower their contributions.

Exelis Inc., a defense contractor, now expects to cut its pension contributions by as much as $350 million by 2017. Chief Executive David Melcher told investors earlier this month that Exelis would use the money to fund dividend payments, buybacks and to invest in the company.

Some companies will continue to finance their pension plans. Boeing Co. says it won't change its strategy and still expects to make a discretionary $750 million payment to its $68.6 billion in pension obligations.

"All you're really doing is deferring payments," said Jonathan Waite, chief actuary at SEI Investments Co., an asset manager. "It has to be put in someday."

My father and brother are psychiatrists and tell me that 10% of the population suffers from depression at one point in their life (life prevalence) and 3% of the population at any given time (point prevalence). And these are people from all socioeconomic backgrounds all over the world. The disease doesn't discriminate between rich and poor but it does strike more women than men.

Luckily most people suffering from depression are easily treated but they have to recognize the signs early and do something about it, especially if it's severe. Employers also need to be informed and provide their employees with resources to battle this and other mental illnesses. Don't ask, don't tell simply doesn't cut it anymore.

"I prefer to think that smoothing mitigates the damage done by the artificially low interest rates imposed by PPA'06 and compounded by the Fed's efforts at stimulating the economy." 

A large California pension manager is using complex derivatives to supercharge its bets as it looks to cover a funding shortfall and diversify its holdings.

The new strategy employed by the San Diego County Employees Retirement Association is complicated and potentially risky, but officials close to the system say it is designed to balance out the fund's holdings and protect it against big losses in the event of a stock-market meltdown.

San Diego's approach is one of the most extreme examples yet of a public pension using leverage—including instruments such as derivatives—to boost performance.

The strategy involves buying futures contracts tied to the performance of stocks, bonds and commodities. That approach allows the fund to experience higher gains—and potentially bigger losses—than it would by owning the assets themselves. The strategy would also reduce the pension's overall exposure to equities and hedge funds.

The pension fund manages about $10 billion on behalf of more than 39,000 active or former public employees.

San Diego County's embrace of leverage comes as many pensions across the U.S. wrestle with how much risk to take as they look to fulfill mounting obligations to retirees. Many remain leery of leverage, which helped magnify losses for pensions and many other investors in the financial crisis. But others see it as an effective way to boost returns and better balance their holdings.

"We think we'll see a lot more people look at risk the way we do in the not-too-distant future," said Lee Partridge, chief investment officer of Houston-based Salient Partners LP, the firm hired to manage the county's money. "Yes, we are an outlier, but that is not a bad thing."

Mr. Partridge said one of the main goals is to avoid an overreliance on the stock market for returns.

Like many public plans around the country, San Diego County's fund doesn't currently have enough assets to meet its future obligations. The plan is about 79% funded, it says. It gained 13.4% last year.

As a group, state pension funds across the U.S. have enough assets to cover just 75% of future benefits for their members, according to Wilshire Associates, an investment consultant in Santa Monica, Calif.

San Diego board members haven't yet set a limit on how much leverage would be used, but one estimate floated at an April board meeting is the bet could involve an amount equal to as much as 95% of the fund's assets. Simply put, it could have a market exposure of $20 billion despite only managing half that amount.

Wilshire Associates Managing Director Andrew Junkin said more pension funds are now "examining leverage" as they seek to add balance to their portfolios, meet return targets and reduce their reliance on stocks.

San Diego's new approach is comparatively complex at a time when some big pension plans are moving in the opposite direction. The country's biggest pension, California Public Employees' Retirement System, is weighing a number of changes to its investment strategy designed in part to simplify the portfolio, The Wall Street Journal reported this week.

San Diego's plan was approved by the county in April but didn't receive much attention until this week, when a local newspaper columnist wrote criticizing the strategy. In response, the pension fund posted a letter on its website to answer questions on the issue.

Some local residents said they were wary.

"Larger [pension] systems are moving away from risk, and try to be a little more conservative. We don't need to see our systems move in the opposite direction," said Chris Cate, a taxpayer advocate in San Diego, who is running for city council.

San Diego-area residents are well-acquainted with pension problems. A decade ago, the city's pension, which is separate from the county's, endured a scandal after its accounts were found riddled with errors, though the matter didn't involve sizable investment losses.

Then, in 2006, the collapse of Connecticut hedge fund Amaranth Partners LLC created tens of millions in losses for the county's fund. Amaranth made a series of risky bets on natural-gas futures.

"Leverage is a tool, and it can be used improperly. And if it's used improperly, you could suffer large losses, as shown in Amaranth," said Brian White, chief executive of the retirement system in San Diego County.

The CEO said there is a "huge difference" between Amaranth's approach and the one being employed by Salient. The investments being made by Salient, Mr. White said, are "highly liquid" and diverse, as compared with the illiquid, very concentrated bets made by Amaranth.

Salient is being paid $10 million annually for managing San Diego County's pension fund.

Public funds still have most of their assets in stocks, but many funds that were burned by the tech-stock bust and the 2008 financial crisis have turned to private equity, real estate and hedge funds as alternatives.

Public pensions for years have had indirect exposure to borrowed money through property or buyout funds, but most have steered clear of putting more money at risk than they have in their portfolios.

The State of Wisconsin Investment Board was one of the first to embrace the leveraged approach. Trustees in 2010 approved borrowing an amount equivalent to 20% of assets for purchases of futures contracts and other derivatives tied to bonds.

Wisconsin staff members initially thought putting 100% of assets at risk might protect the fund against a variety of economic scenarios, but they concluded that such an amount "could be considered to be a substantial amount of explicit leverage for a pension fund," according to a December 2009 report.

Wisconsin's fund has remained among the healthiest public pensions in the country and currently has enough assets to meet all future obligations to retirees.

A spokeswoman said the Wisconsin system is moving slowly on its strategy because of concerns about adding leverage at a time when economists expect interest rates to rise as the U.S. economy strengthens. That would cause bond prices to fall, and leverage could magnify the impact of those declines on the fund's assets. The current amount at risk on Wisconsin's strategy is roughly 6% of the fund's $90.8 billion in assets. 

At the core of SDCERA’s operations is its acclaimed investment program. SDCERA is entrusted to prudently manage the multi-billion dollar pension fund that provides retirement benefits to members. An accomplished team of investment professionals and money managers, in conjunction with the Board of Retirement, prudently manages the investment of the pension fund.

SDCERA’s investment program has earned industry accolades and awards as one of the top performing retirement funds in the country. The program’s success is largely due to a well-diversified portfolio and progressive investment strategies that put it in the same league as some of the country’s most sophisticated investors. SDCERA is a long-term investor with a gross 10-year annualized investment return of 7.26% and a gross 25-year annualized investment return of 9.46% as of March 31, 2014.

First 13.4% when the average large Public Plan did 17.4% is hundreds of millions in underperformance.

Partridge makes over $10 million a year. A whistleblower exposed Partridge etc. There are dozens of articles of shady dealings at San Diego County.

The largest U.S. public pension plan is considering a dramatic retreat from some riskier investments, as it tries to simplify its $295 billion in holdings and better protect against losses during the next market downturn, according to people familiar with the matter.

California Public Employees' Retirement System is weighing whether to exit or substantially reduce bets on commodities, actively managed company stocks and hedge funds, the people said.

The pension, which manages investments and benefits for 1.6 million current and retired teachers, firefighters and other public employees, is a bellwether for investment trends at other public plans. Any shift it makes will likely influence others because of its size and history as an early adopter of alternatives to stocks and bonds.

"When Calpers makes a decision, it has a ripple effect through the state and local pension community," said Jean-Pierre Aubry of the Center for Retirement Research at Boston College.

The discussions are taking place between the fund's interim Chief Investment Officer Ted Eliopoulos and Calpers's other top investment executives. The Calpers board hasn't yet been informed about any possible changes and no final decisions have been made, the people said.

The potential moves would constitute a major strategy change for a pioneer of public investments in so-called alternative assets. It isn't clear where Calpers would shift money pulled from these investments.

The retrenchments also could mean a reduction in external managers who are paid millions of dollars to make these bets for Calpers, these people said.

Many state and local pension funds were badly battered during the financial crisis and haven't yet recovered, leaving them struggling to meet obligations to 19 million workers and retirees nationwide. A run-up in the stock market has allowed Calpers to partially recover from the crisis, but it only had enough assets to cover 76% of guaranteed benefits to retirees as of June 30.

Calpers also is putting some new investment ideas on hold. Executives recently shelved internal discussions about whether to make a deeper push into securities backed by risky debt.

The Sacramento-based retirement system is wrestling with how much risk it should take as it follows one of its best performances since the financial crisis. The fund reported investment gains of 18.4% for the fiscal year ended June 30. That exceeded internal goals as domestic and international equities rose nearly 25%, real estate was up 14% and private equity increased 20%.

A top Calpers executive declined to discuss specific areas under review but acknowledged that a number of big questions are up for discussion, including whether the pension's most-complex investments are too small to make an impact on the fund's overall returns. Another issue is whether the fund can rely on individual trading bets to beat the overall market.

"What you have to ask yourself is, can you trade your way to success with $300 billion?" said Eric Baggesen, the fund's senior investment officer for asset allocation and risk management.

Until somewhat recently, pension funds invested almost exclusively in stocks and bonds. Calpers was among the first to invest heavily in real estate in the 1990s and then hedge funds and private equity in the early 2000s.

By October 2007, Calpers's assets hit a precrisis high of $260 billion. During the financial crisis of 2008-2009, they dropped to $165 billion as some of those alternative investments didn't perform as expected, particularly real estate and private equity.

Just one bad year can have serious consequences, since Calpers relies on its returns and contributions from local governments to fund pensions. Calpers has to request more money from municipalities if its investments decline in value, and cash-strapped cities then are forced to cut services or raise taxes to cover the bill.

Calpers hinted at a shift away from complex investments last fall when it released a set of investment principles that included a warning that the fund "will take risk only where we have a strong belief we will be rewarded for it." In February, it approved a new set of investment goals that reduced future exposure to equities and private equity while increasing allocations to bonds and real estate.

One of the more-dramatic moves under consideration is a complete pullback from tradable indexes tied to energy, food, metals and other commodities, according to people familiar with the discussions. Calpers began making such investments in 2007 as a way of diversifying its portfolio and it currently has $2.4 billion in such derivatives, or less than 1% of total holdings.

Executives on Calpers's investment staff also are debating whether it would be better to shift $55 billion it currently invests in individual company stocks and link those investments to broader market targets such as industries or countries, said people familiar with the discussions.

Another topic of discussion is what to do with Calpers's $4.5 billion hedge-fund portfolio, which amounted to 1.5% of the pension plan's total holdings as of June 30. Calpers in 2002 became one of the first public pensions to invest in such funds, which charge higher fees and typically bet on stocks, bonds or other securities using borrowed money. But over the past year, staff members have clashed over whether the investments are too complicated, can truly act as a buffer during a crisis or are large enough to affect Calpers's overall returns. The Wall Street Journal reported last month that Calpers already is reducing its hedge-fund stake and expects to take it as low as $3 billion as compared with $5 billion earlier in the year.

Former chief investment officer Joseph Dear was in favor of increasing Calpers's hedge-fund stake, but he died in February. In March, the board asked Mr. Eliopoulos to review the program, and he gave that task to fixed-income chief Curtis Ishii, said people familiar with the moves. Mr. Ishii's recommendations to the board are due in the fall.

The billionaire investor Leon Cooperman stocked up on Apple while other prominent hedge fund managers were divided on Walgreen. Ally Financial was a favorite for Daniel S. Loeb, John Paulson and Richard Perry.

On Thursday, some of Wall Street’s most prominent investors offered the world a peek at their portfolios.

Four times a year, the secretive world of big hedge funds is briefly thrust into the spotlight when they are required to report changes to their United States stock holdings. These quarterly updates, known as 13-F filings, offer investors a chance to see which stocks and sectors traders were betting on some 45 days ago when the quarter ended.

In perhaps the most fitting illustration of the backward nature of these filings, Carl C. Icahn disclosed a plan to shake up Gannett, one week after the company announced plans to separate its print and broadcast operations. Mr. Icahn’s fund, Icahn Associates, said it had acquired a 6.6 percent activist stake in Gannett and believed “value could be created by splitting the issuer.”

Omega Advisors, Mr. Cooperman ’s $10.5 billion hedge fund, added a new stake in Apple in the second quarter, buying 1.2 million shares. His fund has owned Apple shares in previous quarters.

Robert Citrone’s $13 billion Discovery Capital Management also built a new stake in Apple, buying 6.5 million shares in the quarter.

David Einhorn’s Greenlight Capital, meanwhile, trimmed its position in Apple to 9.3 million shares from 13.78 million after adjusting for a 7-for-1 stock split in June. Apple shares gained 20 percent during the quarter, to close at $92.93 on June 30. Apple has been one of Greenlight’s largest stock holdings for the last several quarters.

Tiger Consumer Management, the hedge fund led by Patrick McCormack, took a big 18 million share stake in the online game maker Zynga Inc. But Mr. McCormack’s timing may have been off.

Shares of Zynga fell 27 percent during the quarter, closing at $3.21 on June 30. The stock has continued to tumble since then and is now trading at about $2.85 a share. The company reported disappointing second-quarter earnings on Aug. 8 and also lowered its revenue forecast for the year.

The position in Zynga is a new one for Mr. McCormack, a protégé of the legendary hedge fund investor Julian Robertson, although his fund has owned shares of Zynga before. The firm’s 13-F filing did not disclose when Tiger Consumer bought the shares nor the average price it paid to acquire them.

Hedge fund managers were divided on another social media group: Facebook. Appaloosa Management, the hedge fund led by David Tepper, increased its stake to 3.5 million shares. Meanwhile, Andreas Halvorsen’s Viking Global Investors halved its stake to about four million shares.

Daniel S. Loeb’s Third Point disclosed the firm’s most recent bold bet: auto lending. It had a 9.5 percent stake in Ally, the former financing unit of General Motors, in the second quarter. While Mr. Loeb informed his investors of the stake in a recent letter, this is the first time it has been disclosed publicly.

Perry Capital, the hedge fund founded by Mr. Perry, also added a position in Ally, buying 14.3 million shares, or a 3 percent stake.

Third Point sold several headline stocks including Valeant Pharmaceuticals, which is locked in a hostile takeover battle for Allergan, the maker of Botox, and Citigroup, which announced a $7 billion settlement with the Justice Department last month. It also sold its stakes in Google and its Chinese equivalent, Baidu, but maintained its position in Sotheby’s, where Mr. Loeb won three seats on the board after a long and bitter fight with management.

Walgreen, the drugstore chain, was the focus of many hedge fund managers. A group of shareholders that included Barry Rosenstein’s Jana Partners pushed the company to consider a tax inversion — effectively renouncing its United States citizenship — through a deal to take full control of the British pharmacy chain Alliance Boots, in which it held a 45 percent stake. Last week, the company agreed to acquire the rest of Alliance Boots but rejected an inversion.

On Thursday, Jana disclosed it had sold one million shares in Walgreen, reducing its stake to 11.1 million. Third Point bought 700,000 shares, building a new position in Walgreen, while Stanley Druckenmiller’s Duquesne Family Office maintained its position.

Traders who bet on Family Dollar were rewarded. Earlier this year, the billionaire activist Mr. Icahn agitated for Family Dollar to sell itself to Dollar General amid a competitive retail landscape. In July, Dollar Tree acquired Family Dollar. In the second quarter, John Paulson’s Paulson & Company placed a bet on Family Dollar, increasing its stake to eight millions shares.

Meanwhile, Third Point and Paulson & Company both raised their stakes in Dollar General to 1.3 percent, while Tiger Consumer and Thomas F. Steyer’s Farallon sold their shares.

Tiger Global Management, the fund founded by Chase Coleman, another protégé of Mr. Robertson, exited from sizeable stock positions it had in Coca-Cola Enterprises and Carter Inc., the children’s clothes manufacturer, in the second quarter. Meanwhile, the firm’s hedge fund added about 2.2 million shares to its existing position in Hertz Global Holdings, the rental car company. Mr. Coleman’s firm also opened a new two million share position in the Exact Sciences Corporation, a company that is developing products for detecting and preventing colorectal cancer.

Top U.S. hedge fund managers did some shopping for shares of discount retailer Dollar General Corp (DG.N) and drug store operator Walgreen Co (WAG.N) in the second quarter.

Daniel Loeb's Third Point added 1 million shares of Dollar General, raising his stake by 33 percent, while Blue Ridge Capital, founded by Tiger Cub John Griffin, nearly doubled its stake in Walgreen when it bought 2.8 million shares. That translated into 4.57 percent of the fund's portfolio.

Other fans of Walgreen included Andreas Halvorsen's Viking Global Investors, which still held more than 20 million shares as of June 30, albeit down from roughly 24 million shares the previous quarter. Aaron Cowen's Suvretta Capital Management had a 312,000 share stake.

Walgreen, which purchased a controlling stake in Britain's Alliance Boots, earlier this month decided not to relocate its corporate headquarters to Europe to save on taxes, a strategy known as inversion. It faced complications in pulling off the transaction, as well as heavy political pressure in the United States not to move.

On Aug. 5, the day before the company said it would not reincorporate in Europe, Walgreen shares traded as high as $72.76. On Thursday, the shares ended regular trading at $62.25.

Billionaire activist investor Carl Icahn, Family Dollar Stores' (FDO.N) largest shareholder with a 9.4 percent stake, wanted the company to sell itself to rival Dollar General in the face of stiff competition from big-box retailers such as Wal-Mart Stores Inc (WMT.N). But in July, Family Dollar agreed to sell itself to Dollar Tree Inc (DLTR.O).

Meanwhile, David Einhorn's Greenlight Capital reduced its Apple Inc (AAPL.O) stake to about 9.3 million shares, down from about 13.78 million shares, after adjusting for a seven-for-one stock split in June.

Apple long has been one of Einhorn's largest holdings and in a recent conference call, Einhorn said Apple was still "cheap on an absolute basis."

Blue Ridge Capital sold its entire stake, getting rid of 2.2 million shares.

But Leon Cooperman's Omega Advisors took a new stake in Apple of 1.3 million shares, while Soros Fund Management held 1.8 million shares at the end of the second quarter, up from 88,670 shares the previous quarter.

The quarterly disclosures of manager stock holdings, in what are known as 13F filings with the U.S. Securities and Exchange Commission, are always intriguing to investors trying to divine a pattern in what savvy traders are selling and buying.

But relying on the filings to develop an investment strategy comes with some peril because the disclosures are backward looking and come out 45 days after the end of each quarter.

Still, the filings offer a glimpse into what hedge fund managers saw as opportunities to make money on the long side.

The filings do not disclose short positions, bets that a stock will fall in price. As a result, the public filings do not always present a complete picture of a manager's stock holdings.

The following are some of the hot stocks and sectors in which hedge fund managers either took new positions or exited existing positions in the second quarter.

ALLY FINANCIAL

John Paulson's Paulson & Co took a new 2 million share stake in Ally Financial (ALLY.N), and Soros Fund Management opened a new position of 1.5 million shares.

COVIDIEN PLC

Covidien (COV.N) is being bought by rival Medtronic Inc (MDT.N) in another inversion deal, in which Medtronic wants to move its headquarters to Ireland to take advantage of lower corporate tax rates.

Farallon opened a new position, buying 2.2 million shares.

DOLLAR GENERAL CORP

While Loeb's Third Point increased its stake in Dollar General, Farallon closed out its position, selling 3.2 million shares, and Omega Advisors sold its entire stake of 1.7 million shares. Tiger Consumer also liquidated its 814,723-share position, which had made up 2 percent of its portfolio.

DOW CHEMICAL CO

Third Point, already a big investor in Dow (DOW.N), increased its bet dramatically by buying 14.7 million shares, to raise his holdings by 204 percent. The company now ranks as Loeb's biggest U.S. stock holding, at nearly 14 percent of the portfolio.

EBAY INC

Barry Rosenstein's Jana Partners cut its stake in eBay (EBAY.O) by 2.9 million shares to 1 million shares.

FACEBOOK INC

Putnam Investments raised its holding in Facebook (FB.O) by 30 percent and bought 1.2 million shares. David Tepper's Appaloosa Management held 3.59 million shares as of the end of June 30, up from 478,500 shares as of March 31.

GENERAL MOTORS CO

Tepper's Appaloosa Management increased its stake in GM by 64.7 percent to 13 million shares as of the end of June 30. Putnam Investments increased its stake in GM (GM.N) by 13 percent when it bought 849,076 shares.

SIRIUS XM HOLDINGS INC

Jana Partners and Eric Mindich's Eton Park Capital Management sold their entire stakes in Sirius (SIRI.O) of 72.3 million shares and 11.2 million shares, respectively.

Omega Advisors cut its stake by 4 million shares to 82 million shares.

SEAWORLD ENTERTAINMENT INC.

Cooperman's Omega Advisors took a new stake of 1.1 million shares in SeaWorld (SEAS.N), but two sources familiar with the matter told Reuters on Thursday that Omega sold all of its SeaWorld shares "three weeks ago."

Jana Partners, meanwhile, took a new stake of 75,000 shares, while Mindich's Eton Park Capital Management took a new stake of 1.5 million shares.

WALGREEN CO

Stanley Druckenmiller's Duquesne Family Office held its stake in Walgreen's steady at 1.2 million shares, ranking it as the portfolio's third-largest position.

Jana Partners cut its stake by 1 million shares to 11.1 million shares. Third Point added a new position, buying 700,000 shares.

ZYNGA INC

Patrick McCormack's Tiger Consumer Management added a new position in Zynga (ZNGA.O), buying 18,062,145 shares.

Legendary investor George Soros nearly doubled his ownership in a U.S. gold mining companies ETF and initiated new stakes in other gold producers, suggesting the big names in hedge funds continued to have confidence in the yellow metal.

Now we're reading about hedge funds (ie. leveraged beta chasers) piling into "risk-sharing RMBS," which is a "new asset class" with an old twist. It's basically betting on unrated paper offered by the once bankrupt Freddie Mac (FMCC) and Fannie Mae (FNMA).

But times have changed. Both these government-controlled mortgage giants posted profits for the April-June period as the housing market continued to recover. Gains in recent years have enabled them to fully repay their government aid after being rescued during the financial crisis. And both entities are boosting their dividend to the U.S. Treasury in a clear sign of wanting to attract investors.

And as you can see below, their share price has soared over the last year (click on images):

And who has been buying shares of these once bankrupt mortgage giants? Who else? Some of the best known hedge funds. In particular, I noticed Bruce Berkowitz's Fairholme Capital Management is the top holder of both Freddie Mac and Fannie Mae shares. This is the same fund that made outsized gains buying AIG early on and they remain a top holder of that company too.

So maybe there is more to this housing/ mortgage recovery story than meets the eye but the structured finance side of it makes me nervous. I'd rather bet with Bruce Berkowitz on their shares recovering than taking leveraged bets on unrated paper in the RMBS market.

At 4.14%, the rate on a 30-year mortgage is down from 4.53% at the start of the year. Rates have fallen even though the Fed has been trimming its monthly bond purchases. The purchases are set to end in October.

As far as the overall market, geopolitical risks, fears of a global Ebola outbreak and low summer volume are making people nervous. Everyone is looking for a chance to cash out during this latest correction but I'm sticking firm with my thoughts which I expressed in my comment on preparing for another crash.

Importantly, there are always plenty of reasons to panic but the market has been steadily climbing the wall of worry each and every time. Do you remember when Greece teetered on the edge of default and everyone was worried that the eurozone was going to collapse? I do and told my readers to ignore the news media and keep buying them dips.

Of course, you can't buy the dips forever and in this market there are some stock specific dips which are worth buying and others that you have to steer clear from. When Twitter (TWTR) fell below $30 a share, I tweeted "top hedge funds are loading up and so should you!".  And what happened? Twitter killed their numbers and the stock is trading near $43 now. And wait, it ain't over, this stock will surge past $100 over the next 12 months because in a knowledge hungry world, Twitter will kill its social media competition, including Facebook (FB), which is all about vanity, not knowledge (rightly or wrongly, I still refuse to open up a Facebook account).

What else do I like? I already told you :

I still like biotechs (IBB and XBI), small caps (IWM), technology (QQQ) and internet shares (FDN). By the way, I particularly like Twitter (TWTR) and tweeted people to load up on it when it fell below $30 several weeks ago (stay long)...My personal portfolio remains in RISK ON mode, heavily invested in small cap biotechs like Idera Pharmaceutical (IDRA), my top holding at this moment (very volatile and extremely risky).

And there are plenty of other biotechs courtesy of the Baker Brothers and others which are on my radar. Companies like ACADIA Pharmaceuticals (ACAD), Pharmacyclics (PCYC), Seattle Genetics (SGEN), Synageva BioPharma Corp. (GEVA), Biocryst Pharmaceuticals (BCRX), Progenics Pharmaceuticals (PGNX), Synergy Pharmaceuticals (SGYP), TG Therapeutics (TGTX),  XOMA Corp (XOMA) and other biotechs that can easily double from here (but they remain very risky so don't bet the farm on them if you're risk averse).

A first-half return of 6.7 per cent for the Caisse de dépôt et placement du Québec in 2014 is “solid right down the line” but may not be matchable in the final six months of the year, chief executive Michael Sabia said Friday.

“I’d like for it to be the case, but I don’t think it will happen,” Sabia told reporters in a conference call unveiling the Caisse’s mid-year report card.

Economic conditions around the world are growing more challenging, there is geopolitical instability in places like Russia and Syria and the five-year boom in stocks already has lasted much longer than the usual bull market, Sabia noted.

As is his custom, he took pains to emphasize that short-term returns are not a priority for Caisse management, which treats long-term results and the relative needs of its depositors as top priority.

In that context, a rate of return on assets over four years of just over 11 per cent, relative to depositors’ needs for a return of 6 to 6.5 per cent, is more than satisfactory, and slightly above the benchmark index, said Sabia, who took the helm at the provincial pension-fund manager in 2009 after it stumbled badly during the economic crisis of 2008-2009.

The Caisse, which oversees more than $214 billion in assets, is continuing to reshape its investment style in a quest for more stable, long-term assets, Sabia said.

Infrastructure investments, for instance, account for $36 billion of its portfolio, double the amount five years ago.

It’s also increasing its presence in emerging markets, the expected growth motors of the future. Next week, the Caisse will announce the chosen candidate to oversee its operations in Asia, and the search is on for a candidate in Latin America.

With interest rates so low and modest returns projected over the next five years for stocks in developed markets, “we’re going to have to try harder, go to places in the world where growth is,” said chief investment officer Roland Lescure.

Russia’s not one of them, though. Sabia said the Caisse’s Russian holdings were “as close to the mathematical concept of zero as you can get, and that’s how we want it to be.”

Mexico and India, however, are on its radar.

Sabia said the Caisse had invested about $830 million this year in Quebec companies, mostly small businesses, and the addition of former Coalition Avenir Québec finance critic Christian Dubé will further boost its expertise in that area.

Asked about specific names that it already has in the portfolio or might be considering, he said it was closely following events at Bombardier, not at all interested in the troubled construction company Hexagone, and very impressed with the turn of events at SNC-Lavalin, which it took some heat for backing during its crisis two years ago.

SNC-Lavalin “is in a hell of a lot better shape than two-and-a-half years ago, when everybody was heading for the exits,” Sabia said. “That company’s moving and moving in a good direction.”

Stocks in general, and Canadian stocks in particular, were a major contributor to the Caisse’s six-month returns, rising 9 per cent. The fixed-income portfolio contributed 4.7 per cent, thanks mainly to a drop in interest rates.

As of June 30, the portfolio allocation was 48 per cent stock, 36 per cent fixed income and 16 per cent “inflation-sensitive” investments.

The head of Quebec’s giant pension fund manager is warning that headwinds are starting to form that will slow investment returns in the global economy in the coming months.

Michael Sabia, chief executive officer of the Caisse de dépôt et placement du Québec, said Friday numerous factors are confronting the markets – including mounting geopolitical risks and lagging global growth outside of the U.S. market – that will make it difficult for investors to earn the same returns they have seen in recent years.

He said he would “like very much” if the Caisse’s returns in the second half of 2014 could duplicate its 6.7-per-cent investment return for the first six months, when total assets grew to $214.7-billion from $200.1-billion.

“But I don’t think that will happen,” Mr. Sabia told reporters on a conference call. “The global investment environment is becoming more demanding.” A key challenge, he said, is that the U.S. economy is virtually the only large engine powering economic growth because of China’s slowing growth rates and persistent concerns that Europe is “extremely fragile.”

“In China and emerging markets, we’re not suggesting there’s a crisis and things are going to become unstuck, but their capacity to motor the global economy forward is not what it used to be a little while ago,” he said.

“And hence with a single motor working in the global economy – that being the United States – we think there is a lot of fragility there.”

Mr. Sabia also said he agrees with a comment in July by former U.S. secretary of state Madeleine Albright about the global geopolitical position when she bluntly concluded “the world is a mess.”

He said upheaval in Ukraine, Iraq, Gaza and Syria add “a further weight and a further headwind for the global economic growth.” He noted the Caisse has no investments in Russia – “as close to the mathematical concept of zero as you can get.”

Mr. Sabia also warned the recent pace of growth in global stock markets cannot continue indefinitely. He said that historically, the average bull market lasts for 45 months, but global markets have now expanded for 66 months.

“There are a lot of reasons why you might expect this one to be longer than the average of 45, but at some point this is going to slow down, and we think we’re seeing signs of that now.”

Public equity market returns are likely to be in the range of 5 per cent to 7 per cent annually over the next four to five years based on current forecasts, Mr. Sabia said, which is “a far cry from where we’ve been.”

It won’t help, he added, that the U.S. Federal Reserve is in “unknown territory” as it tries to plot a strategy to withdraw stimulus from the economy and figure out how to begin raising interest rates.

The result, he predicted, is likely to be either Japan’s experience where interest rates remained extremely low for a prolonged period, or a scenario where interest rates inch up extremely slowly.

“In either case, it’s hard for us to see how that’s something that contributes positively to the investment environment,” he said.

Given low interest rates and volatility in public equity markets, Mr. Sabia said the Caisse is increasing its emphasis on seeking growth in private investments and in emerging markets with potentially higher growth rates.

He said the fund manager is “very focused” on finding investments in Mexico, which he called “a very interesting country at a very interesting time in its history.”

He also said there are good opportunities in certain sectors in India, and said the Caisse is also interested in investing in Australia because it offers a “surrogate” way of gaining exposure to opportunities in Asia.

The pension fund has also invested $25-billion in a portfolio of global equities focused on major companies positioned for growth in emerging markets, including Procter & Gamble Inc., Unilever Group and Nestlé SA, he said.

In the first half of the year, the Caisse reported equities climbed by 8.8 per cent, while fixed-income investments earned 4.7 per cent and inflation-sensitive investments such real estate and infrastructure earned 3.5 per cent.

The Caisse now has 48 per cent of its holdings in public and private equities, while fixed-income holdings are at 36 per cent and inflation-sensitive assets account for 16 per cent of the portfolio.

Also Friday, the Caisse announced it has appointed Christian Dubé as executive vice-president for Quebec, a newly created role dedicated exclusively to overseeing the fund’s Quebec investment holdings. Mr. Dubé, a former forest products industry executive, was elected to Quebec’s legislature in 2012 and served as finance spokesman for the Coalition Avenir Québec party.

It's safe to say many Manitobans aren't familiar with Leo de Bever, the CEO of AIMCo.

For that matter, most people have no idea what AIMCo is.

It's likely equally true many Albertans whose pension and public assets were under management with AIMCo during de Bever's six-year tenure don't know too much about this wealth-management entity, either.

Yet AIMCo -- or the Alberta Investment Management Corporation -- is one of Canada's largest institutional-management organizations. With about $75 billion under management, it's the fifth-largest investment-management company in Canada, and it's responsible for Alberta's largest public pension funds, endowments and government funds and the renowned Heritage Fund that has contributed $36 billion to health care and education in Alberta since its inception in 1976.

All these assets were brought under one umbrella -- AIMCo -- in 2008 with de Bever at the helm, and since then, the fund has added more than $21 billion to its net worth.

Now, de Bever is leaving the firm.

Certainly his career has been illustrious by Canadian investment-industry standards. An economist born and raised in the Netherlands before coming to North America to pursue graduate studies, de Bever has worked at Manulife Financial, the Ontario Teachers' Pension Plan and the Bank of Canada, to name a few.

Recently, he was a guest speaker at the CFA Institute's summer analyst seminars in Chicago, discussing the difficulties of managing public money for the long term in a short-term world.

While geared for investment professionals, much of what he discussed also applies to the average mom-and-pop investors as much as it does to managers of vast amounts of capital.

De Bever took time out from his busy schedule to speak to the Free Press about some of the issues he touched upon in Chicago.

Bonds

Bonds have presented a conundrum for institutional investors as much as they have for retirees looking to make their savings last. Pension funds and insurers, for example, had relied on bonds to generate steady returns to meet their liabilities. But in this ultra-low interest rate environment, bond yields are low -- often not enough to meet financial commitments such as paying the benefits of a growing number of pensioners. Consequently, institutional investors have relied more on stock market returns. They have also sought out alternatives, such as investing in infrastructure and real estate. But like most investors, the big guys still need to invest in bonds.

De Bever said bonds have a major role to play in most investors' portfolios -- even though we are facing an interest-rate hike that would send most bond portfolios' values tumbling.

"So if you're going to be in bonds, be in high-quality bonds that have a short duration of three or four years," said de Bever. "If you're going to get hit as interest rates go up, it won't be that bad, and you still get the incremental yield along the way."

Other low-cost alternatives are exchange-traded funds that invest in floating-rate-style, fixed-income investments such as PowerShares Senior Loan Portfolio ETF, which is traded on the New York Stock Exchange.

"It's in loans that are tied to prime, so that means if rates go up, the interest-rate return goes up with it, but the problem with it is there's been a lot of inflow into these assets, and you start to wonder if there is a bit more risk than there was a year ago," said de Bever. "But at least you can make three or four per cent on something that is tied to short-term interest rates."

Yet investors with a long time horizon, those under age 40, can and likely should be taking on more stock-market risk in their portfolios.

"I would say if you're young and you can withstand the fact that every five or six years you're going to have a stock-market correction, it's still a good idea in my mind to undertake equity risk."

Of course, that comes with one important qualification -- you must have the risk appetite for it.

Stocks don't come cheap

One problem with equity markets is the stock prices of companies are outpacing their revenues. That's led many observers to forecast a correction is coming. So investing in stocks today involves a high probability your capital could fall 10 to 20 per cent a short time down the road, de Bever said. Conditions are such that the markets could keep going upward, he added.

"The only reason you could argue that stock markets aren't overvalued is there is so much productivity that even with slow growth in top lines (revenues), the bottom lines (profits) seem to be holding up really well," he said. "The question is, how much of that is sustainable?"

Needless to say, there's just as much short-term uncertainty with stocks as there is with bonds, but investors with a short time horizon for their money will likely find the stock market too much of a stomach-churning ride for their taste.

"If you have a five- or 10-year horizon or more, though, I would still have a lot of my portfolio in stocks compared to bonds," said de Bever.

Technological panacea

Tech stocks have produced tremendous returns recently, but demand for them is now arguably outpacing their value. Today, newly listed tech stocks -- social-media firms in particular -- are commanding high valuations without any profit. The situation seems quite a bit like the late 1990s and early 2000s, when web-based firms with no profits had skyrocketing values, only to crash by 2002.

Yet de Bever said technology is undoubtedly a driving force going forward, and institutional investors have a major role to play in funding promising firms with innovative technologies that can have a dramatic impact on the world. The problem for retail investors is these companies are not yet listed on stock exchanges, so we average folks can't get much or any exposure to promising new firms (nor would they necessarily want to).

"These are companies that have gone past the lab stage and the initial verification stage, but they still need a lot of money to build a pilot plant and work out the kinks in making a commercially viable proposition," said de Bever. "You need to have that long, patient capital, and a mutual fund structure wouldn't be amenable to that." This is largely because retail investors bail out of these funds when they suffer losses. But even the big dogs with billions to invest are new to this part of the tech sector. De Bever said he even had to convince AIMCo's board this alternative investment area holds tremendous promise. AIMCo is trailblazing with this strategy, and forging new opportunities surprisingly isn't all that common in his industry, he said.

"The typical discussion I have with other pension managers is along the lines of 'You're absolutely right. We should be doing that,' but few of them actually are."

Understanding the J-curve

One of the problems with investing in early-stage technologies with long-term upsides is getting over the initial jitters. This often comes down to understanding the 'J-curve' associated with up-and-coming firms. The term refers to what these firms' growth looks like on a chart over long periods of time. It's shaped like the letter J because, initially, their value usually falls and stays down for some time until their innovative product or service reaches the commercialization stage, when it starts to increase in value. De Bever said the J-curve illustrates the benefits of taking the long view to investing.

"That's often easier said than done because human nature is to say 'Yes, I understand that,' but when times get a little tough, they say 'I didn't know I was buying into that kind of potential outcome.'"

Big investors for the public good

Investing in developing technologies also takes truckloads of investment acumen -- deep knowledge of the sector as well as an ability to read between the lines of hundreds, if not thousands, of pages of reports.

Few investors have the ability or time to do that. But institutional investors often do. That's why de Bever believes they can be a driving force in developing new technologies that will improve health care, education and infrastructure. More importantly, pension funds and other large investors can fund innovation to reduce our impact on the environment, including our footprint in the oilsands. He says companies involved in the industry have a difficult time convincing their shareholders to invest in long-term innovation because there is often no immediate short-term payoff.

That's where institutional investors can step in, he said.

"When we started talking to them (energy companies), a lot of them would say 'This is exactly what we're looking for.'"

Public pensions -- something's got to give

It's no secret public defined-benefit pensions are facing future difficulties as retirees live longer with fewer workers contributing to plans to support their benefits.

"It used to be that you had four workers for every retiree," de Bever said. "Now with most pension plans, it's become one worker for each retiree, so the burden of active members to pensioners is just too high."

This is unsustainable. In fact, many defined-benefit pension plans are now underfunded. "And I can't think of any that are fully funded on an honest discount-rate basis," said de Bever.

Many plans that are fully funded are using a rate of return of about six per cent, he said. But when that expected return falls by two per cent, a once fully funded pension plan could find itself underfunded by 30 per cent. De Bever said what's needed now is action to ensure these plans, which are the best retirement-savings vehicles around, remain solvent. The biggest obstacle is the options often involve some financial hardship for all stakeholders. Still, they're likely necessary.

"I firmly believe you have to tell your clients what they need to know, not just what they want to know, because eventually it will catch up with them," said de Bever. "It's very tough to do because in the current environment, the only way out is to either increase the retirement age, cut pension benefits, which is tough to do, or increase premiums, and premiums are already very high."

AIMCo says the acquisition of 50 high-quality and geographically dispersed Canadian mortgages fits well with its existing holdings secured by institutional quality, income-producing properties.

No other details on the deal were disclosed.

AIMCo, which invests on behalf of 27 pension, endowment and government clients in Alberta, is one of Canada's largest and most globally diversified institutional investment managers with assets under management of more than $80 billion.

With $3-billion in loans, AIMCo is also one of Canada's leading mortgage lenders.

OMERS, with more than $65 billion in net assets, provides pension administration and products and services to almost 440,000 members in Ontario.

The advice to stay short duration in fixed income was pretty much good advice from about a year post credit crisis, more or less til this year. Short and long rates have since been falling, and the yield curve is flattening. Despite all central bank efforts, I tend to see a mild deflation scenario playing out, something you have commented on. With that in mind, I think fixed income holders are best served to be diversified in credit and interest rate duration, and currency, definitely avoid an all in directional bet on rates.

By tradition, a public pension fund is safe and boring.

If you run one of these multibillion-dollar funds, replacing a lost benefit check should be your biggest problem on any given day. Same goes for taxpayers who support the pension system, and retirees who depend on it.

Here’s what you don't want: A front-page article about your fund in The Wall Street Journal.

Yet that’s precisely where San Diego County’s fund landed Thursday morning, as it has on many U-T San Diego covers in recent years.

Here’s how Journal reporter Dan Fitzpatrick described the situation: “A large California pension manager is using complex derivatives to supercharge its bets as it looks to cover a funding shortfall and diversify its holdings.”

That sounds neither safe nor boring.

Until the 1980s, when pension managers began adding stocks to portfolios, most funds were restricted to ultrasafe government bonds. But by the 2000s, many had added hedge funds, commodities, private equity and other alternative investments.

Now fund managers are reconsidering whether the returns have justified the additional risk. On Monday, The Wall Street Journal reported that managers of CalPERS, the nation’s largest fund, are considering a move away from alternatives.

The trend leaves San Diego County increasingly alone at the cutting edge of complexity.

And this story isn't over, because members of the fund’s governing board face important decisions about how their manager will make highly leveraged bets.

In April, the fund’s governing board voted unanimously for a new investment strategy.

Under the previous strategy, the county fund was among the nation’s most aggressive in its use of leverage. The board allowed investment strategist Lee Partridge of Houston to effectively borrow 35 percent of the fund’s assets for bets on Treasury prices.

But now, as of July 1, Partridge has a green light for 100 percent leverage, according to Brian White, the fund’s chief executive.

Put another way, Partridge can leverage the county’s $10 billion retirement fund, using derivatives, to place at least $20 billion at risk in stock, bond and commodities markets.

I use the term “at least” advisedly, because board member Richard Vortmann estimated at a July 17 board meeting that the actual leverage could easily approach 150 percent.

Partridge didn't correct him. Nor did officials with Wurts Associates, the independent consultant hired to monitor the fund’s risk management.

Given the history of spectacular collapses of leveraged investment funds, why does the county use such complex financial tools?

Because it needs money.

Partridge and Wurts have forecast average annual returns of about 6 percent over the next decade, using a traditional investment portfolio of 60 percent stocks and 40 percent bonds.

This would be very bad news for the county’s fund, which assumes it will earn at least 7.75 percent a year to meet retirement obligations.

For perspective, the fund’s actuarial debt to its members increased 4.7 percent last year to $2.45 billion — mostly because its portfolio earned 7.73 percent. Cutting returns to 6 percent could add billions to its liability.

So the fund’s board, in the clearest terms possible, has instructed Partridge to boost those returns. His strategy, stated explicitly in public meetings, is increasing risks to the pension fund — using leverage — to raise returns.

“We’re trying to bring up the risk, not keep the return and dial down the risk,” he said in April.

To be clear, Partridge and Wurts officials say there are plenty of circuit breakers built into the strategy to prevent the entire fund from disappearing.

However, large “downdrafts” are possible, Partridge said. Such losses could very well equal those of a traditional pension fund, which holds 60 percent in stocks and 40 percent in bonds, he said.

At its Sept. 18 meeting, the board could approve an “investment policy statement,” a document following the April decision that is supposed to define the fund’s complex strategy.

The effort has not gone well. In July, the board rejected the 18th draft of this key document.

What’s been missing is much discussion of the fund’s headline-grabbing history with leverage.

In 2001, the San Diego County Board of Supervisors approved a 50 percent increase in lifetime benefits to retirees, instantly creating $1.4 billion in debt for the pension fund, which was worth $3.7 billion at the time. The board then borrowed $900 million.

In 2006, an $87 million county investment collapsed after a young trader at a “multistrategy” hedge fund lost $6 billion in a week. Then, in 2008, the county’s portfolio lost 25 percent of its value, much of it on leveraged equity hedge funds.

Like most funds, the county’s has bounced back, earning an average 9.7 percent a year since 2009.

But the board's fondness for risk is still earning it headlines.

Last year the fund sent three board members to a training session in Hawaii, where one of the sessions was called “Avoiding a Front Page Scandal at Your Pension Fund.”

Perhaps they weren't taking notes.

Recent media coverage of the San Diego County Employees Retirement Association (SDCERA) has suggested its retirement fund’s portfolio managers have recklessly pursued riskier investments in pursuit of higher returns to close the pension funding gap. In fact, nothing could be further from the truth. SDCERA is answering the real concern impacting public pensions by using tried and true principles of asset liability management and diversification, and not relying heavily on more volatile equities to close this gap.

The fund is responsible for paying the retirement benefits for thousands of individuals, and has done so consistently since 1939. SDCERA’s administration of the retirement contributions and the fund’s investment earnings have pre-funded 80 percent of the assets necessary to pay for members’ promised future benefits. SDCERA’s Board of Retirement, which includes county representatives, active employees, and retirees, monitors the risk in the portfolio and periodically adjusts the strategy to account for changing macroeconomic and market conditions.

For the past decade, San Diego County and its employees paid 100 percent or more of their annually required contribution to the SDCERA retirement fund. Consistent employee and employer contributions over the years have laid a foundation for investment gains and asset growth. SDCERA’s investment strategy helps the employer’s budgeting process and stabilizes employer costs by reducing the volatility of returns and steadily achieving the rate of return needed to fund the benefit.

At $10 billion, the SDCERA fund is able to pursue certain investment strategies that larger plans like CalPERS cannot access and smaller plans do not have the resources to deploy. SDCERA’s investment strategy is purposely designed to be no riskier than traditional pension fund asset allocation strategies. Risk-parity and trend strategies, which utilize leverage, are limited to 25 percent of the SDCERA portfolio, not the entire set of portfolio assets. The other 75 percent of the portfolio is managed using traditional asset allocation and rebalancing approaches.

SDCERA focuses on controlling the volatility of the investment portfolio and diversifying across a range of investments suited for a variety of economic environments. The use of leverage is a useful and effective tool that allows us to increase exposure to diversifying assets while reducing exposure to more volatile assets like equities. Different portions of the portfolio have different levels of risk, all of which together contribute to a diversified fund designed to moderate risk over the long term across different economic conditions.

SDCERA utilizes leverage in an attempt to obtain superior risk-adjusted returns and long-term, prudent growth through diversification, not to achieve higher returns or reduce funding shortfalls. This point has been discussed in public at many SDCERA board meetings since before the initial adoption of the strategy in October 2009. At that time, SDCERA adopted an investment strategy with the objectives of diversifying the portfolio across a wide range of economic scenarios; managing exposure levels to various asset classes more dynamically to maintain predetermined risk and diversification targets; and adopting a more conservative approach, as measured both by the variability of returns and by the reduced likelihood and potential magnitude of a significant loss of capital. With this investment strategy in place, SDCERA’s portfolio has performed as expected — preserving capital in difficult markets and generating strong returns in up markets.

Of course, no investment program offers guaranteed success, and as shown throughout history, drawdowns can have an enormously negative impact on the overall financial health of an investment program. With these important considerations in mind, SDCERA’s board adopted an asset allocation designed to serve the dual objectives of maximizing the fund’s likelihood of meeting its return objective while minimizing the risk of significant loss. This is clearly much different from using leverage to increase risk in an ill-conceived pursuit of higher returns. This change was adopted by a unanimous vote of SDCERA’s board after months of public discussion, consideration of a wide range of options, and stress-testing in various economic conditions.

SDCERA’s meticulous risk management is the opposite of “gambling” — it is prudent governance. Managing risk exposure has been a long-standing practice at SDCERA, and one that continues in the fund’s current investment strategy. This context is crucial to fully understanding SDCERA’s approach to portfolio management.

It’s unfortunate that the Wall Street Journal relied on the report of a local business columnist in writing about the SDCERA portfolio, as what that columnist wrote and what the facts are happen to be exactly opposite. For example, the leverage is not across the entire portfolio. I won’t go point by point--- I have attached below the SDCERA response printed today in the local newspaper.

I noted you poked around the SDCERA website. I am proud to say that SDCERA is one of the most transparent pension funds in the country. Since 2010, every meeting is broadcast live over the internet, with all supporting documents the trustees use posted on the broadcasts as well. In addition, those meetings are then archived so that anybody can review the meeting and the documents at a later time. The link is found at the “meetings online” section of the website, where you can scroll through to any meeting you want. The discussions of the trustees and staff, and the documents that we relied on are publicly available—see the “investment meetings” dating back through last year when discussion of the structure of the current portfolio first began, and investment meetings going back to 2010 where the prior portfolio with similar objectives was first constructed.

As far as Chris Tobe goes, let me be blunt----he’s full of crap. The “whistleblower” he refers to is an investment analyst who was fired for repeatedly disclosing confidential documents to the press. That firing was upheld by a Civil Service Commission following a three day hearing, and his federal lawsuit against SDCERA for his firing was dismissed by the judge. There aren’t shady dealings at SDCERA, nor dozens of articles about the shady dealing at SDCERA.

Short term performance is meaningless to draw conclusions about a portfolio, but while we are on the topic—the SDCERA portfolio, designed to minimize volatility and guard against downside risk, returned 6.5% in fiscal year 2012, vs equity heavy peers that were negative or returned 1-2%. As expected, last year SDCERA returns lagged more equity heavy peers, and in every year where equity markets soar, SDCERA will lag but still beat its assumed rate of return.

The advice to stay short duration in fixed income was pretty much good advice from about a year post credit crisis, more or less til this year. Short and long rates have since been falling, and the yield curve is flattening. Despite all central bank efforts, I tend to see a mild deflation scenario playing out, something you have commented on. With that in mind, I think fixed income holders are best served to be diversified in credit and interest rate duration, and currency, definitely avoid an all in directional bet on rates.

A deal's a deal, right? Well, not when it comes to the province of Quebec and the pensions of its municipal employees.

And if Quebec gets away with cutting municipal worker pensions, which have been eaten away through mismanagement by the very people doing the cutting, then watch this phenomenon spread.

Quebec is pulling a Detroit. About a year ago, I pointed out that the shattered dreams of Detroit pensioners should be a warning to the rest of us. But unlike Detroit, Quebec is trying to snatch back promised pension money by fiat through its proposed Bill 3 pension reform legislation, without the inconvenient legal process of bankruptcy.

To read many of the stories about these Quebec pension cuts you would think that it was the pensioners' fault. The same kind of thing happened in Detroit. Outraged taxpayers inveigh against government employees for sucking money out of the public purse for a cushy retirement. It's as if by choosing a job with a pension and keeping to their side of the contract, the workers are taking advantage.

"Right now, municipalities are taking all of the risk on the payouts and employees are taking relatively none of the risk,"said economist and McGill Professor Brett House on CBC's Montreal's radio morning show.

Such comments anger Bernard Dussault, the architect of the Canada Pension Plan and former Chief Actuary for the Government of Canada. The CPP is well known around the world because, unlike many government plans, it is properly funded and can pay out forever (as I've mentioned before, the flaw with the CPP is the actual payout is too small, barely covering rent in many Canadian cities). In fact, this week the chief executive of Hong Kong's social services said he is studying CPP as a model for the reform of the territory's pension system.

As an actuary, Dussault is a sort of super statistician who studies lifespans, average investment yields and the cost of risk. He says that if you do your calculations right, update them frequently and set enough money aside, there is almost no risk involved with pensions.

He says "risk" is not the reason Canadian pension plans are facing problems, and he points out that Quebec is not an exceptional case.

"There are plans with problems all across Canada," says Dussault.

In every case, he says, the problem is a simple failure to set enough money aside.

Many blame the market crash of 2008 for shortfalls in pension plan investment returns. Dussault agrees that was a setback, but adds that it's a weak excuse, because as I write this the Toronto stock exchange has just hit another all-time record high. Yes, it's higher than the peak before the crash. And any pension contributions invested since the crash have seen extraordinary gains.

That assumes, of course, that the pension plans have collected enough money in contributions from both employer and employees, and have actually invested it. And therein lies the flaw.

In Quebec's case, the pension deficit can be traced back, in part, to a previous attempt to balance the province's books. Back in the nineties, Quebec downloaded hundreds of millions in costs to the municipalities. To help them deal with those expenses, since pension plan investment returns were strong at the time, municipalities were permitted to take a pension-contribution holiday.

Brett House agrees that pension holidays were a mistake, and regular contributions should have continued. "By any historical measure, those were exceptional surpluses that should have been saved rather than disbursed."

Actuaries know that even if things look really good one year, that only makes up for other years when things look really bad.

In the dark

And unless they did some serious homework, the workers wouldn't even know the pension pot wasn't full.

Their monthly contributions would come off their paycheques. They would get periodic pension statements showing their accrued benefits based on the promises in their contract, but the accounting in those documents was imaginary. By this year the province, which is ultimately responsible for municipal debts, was in the hole by almost $4 billion for municipal pension deficits.

Just like Detroit, just like the car companies, Quebec and its cities negotiated these pension contracts with their unions with their eyes wide open. Now they are planning to walk away from those deals. Years after you've signed a deal with the bank you can't go and say, "You charged me too much for my mortgage; I'm taking it back." Try it and see what happens. But that is what the province is saying to city workers.

And in their negotiations for improved pensions, the workers traded away other benefits, like better pay. "We’d rather have taken our salary raises,"says the head of the Gatineau police union.

"It is terrible because it is stealing money that has already been accrued," says Dussault.

He adds that Canada has a good financial reputation because it regulates banks, insurance companies and pension funds.

"So now we allow pension plans to renege on their obligations," he says. "We will next allow banks and insurance companies to renege on their obligations?"

Dussault points out that Quebec is not the first to take away pensioners' accrued benefits. New Brunswick did the same thing and pensioners are still not happy about it. And he says if Quebec succeeds, it won't likely be the last.

Perhaps the most underfunded pension plan in the country belongs to the federal government. Federal employees have pension contributions deducted and they go into a "fund," but that fund is based on what Dussault calls "notional bonds." Essentially, the contributions are on the government's books, but they go into general revenue and no outside assets are purchased to cover them — ultimately the payment to the pensioner will come out of future general tax revenue.

"All this accounting is theoretical. It is not real money," says Dussault. "I don't see the federal government reneging on its obligations, but there are more and more pressures. And that frightens me."

Despite the theoretical accounting, Canada's federal government more or less has its financial house in order. But as we saw in Detroit, other governments — and many companies — have shown a willingness to hide disturbing amounts of financial trouble by sweeping it under the carpet of pension deficits.

It may be a painful process, but it appears that Quebec workers will be forced to negotiate a new pension deal. As they do so they should study other arrangements, such as the Ontario municipal pension fund OMERS and the Ontario Teachers Pension Plan. Those pension plans are fully funded and about as well managed as any pensions anywhere.

The difference? It's certainly not risk. They were exposed to the same market crash as everyone else.

What is different is where the money goes and who manages it. Contributions from both the employees and employer go straight into a fund. No notional bonds. No deficits. No promises to pay later.

And the fund is invested and controlled by the employees. The only way the government will get that money back is in the income tax those pensioners pay as they live out a comfortable retirement.

Montreal Mayor Denis Coderre said he would “never give in to thugs” as the province’s political leaders appeared ready to take on restive public-employee unions over Quebec’s controversial pension-reform plans.

Hearings into the Liberal government’s pension legislation opened in Quebec City against a backdrop of heightened security and noisy street protests by municipal workers furious about the bill.

As employees protested outside, Mr. Coderre and the mayor of Quebec City, Régis Labeaume, both outspoken proponents of the pension changes, said taxpayers couldn’t keep sustaining the current pension regime.

“The status quo is no longer an option,” Mr. Coderre said. “We’re now confronted with a financial reality we can no longer ignore.”

Pension costs in Montreal have more than quadrupled since 2002 and now eat up 12 per cent of the municipal budget, the mayor said. Mr. Coderre said he was open to compromise with the unions but wouldn’t countenance the rowdy spectacle that unfurled at City Hall Monday night, when protesting firefighters and other municipal employees surged into the historic building and littered it with papers and other debris.

“The last few weeks have been hectic and even emotional for many people,” Mr. Coderre said. “But now, time has come to work together.”

The pension legislation, Bill 3, seeks to have municipal employees in Quebec assume a larger share of their pensions by requiring workers and cities to split the cost of covering their plans’ $4-billion deficit.

The proposal has morphed into the first major test for Premier Philippe Couillard, who has made belt-tightening a byword of his four-month-old government. He has vowed to stand firm on pension reform.

As expected, unions are up in arms over the proposals. Serge Cadieux, secretary-general of the Fédération des travailleurs du Québec, told the hearings Wednesday the bill was inequitable, set a bad precedent and was probably unconstitutional.

City unions in Montreal have never shied from a forceful fight with their bosses. Blue-collar workers have a track record of militancy: A former, high-profile union leader, Jean Lapierre, appeared at a demonstration in Montreal on Wednesday to announce that protest actions would get more “radical” and this was “only the beginning of hostilities.” Police officers in camouflage pants and fire trucks plastered with stickers have become routine in labor conflicts.

But it’s unclear whether the public will side with the unions this time. Several observers say Monday’s vandalism at City Hall may have cost the unions some public sympathy; police officers were seen on site standing by without reining in the rowdy demonstrators.

The head of Montreal’s police union, Yves Francoeur, defended his members on Wednesday, saying they never got the green light from senior officers to step in and carry out crowd control. Even after the boisterous mob had entered City Hall, police sought the go-ahead from their superiors to do their job, Mr. Francoeur said. But the rank-and-file officers were told no, because city hall had not requested police intervention. Mr. Francoeur referred to the incident as a “comedy of errors.”

Hearings into Bill 3 continue on Thursday.

So-called ‘shared risk’ plans have nothing to do with sharing

Every child grows up learning the importance of sharing. It’s also fundamental to the labour movement. Unions bargain with employers to ensure that workers share in the fruits of their labour. This makes for a stronger, stable economy and a fairer society.

Sharing is also at the heart of workplace pensions. Part of the wages and salaries that unions bargain get deferred until retirement, in the form of pensions. When our negotiated pension plans experience funding shortfalls, as they have in the last six years, unions have stepped up and agreed to pay more into the pension fund, even temporarily cutting back on benefit levels. In return, unions expect that employers will live up to their commitments and pay retirees the pensions they’ve earned over a working lifetime – the essence of the defined-benefit (DB) pension deal.

Even as our pensions return to health, however, employers are looking for ways to rid themselves of the cost and headache of pension plans altogether. And the federal government is lending a hand. In April, the federal government announced that it is proposing target-benefit plans or so-called “shared risk” pension plans in the federal private sector, and for Crown corporations.

In fact, so-called “shared risk” plans have nothing to do with sharing. Let’s look at some of the myths around these plans:

Myth 1: “Shared-risk” plans split the risk and rewards between employers and employees.

These plans don’t “share” risk; they dramatically reduce employers’ risk by shifting it onto plan members and pensioners. Employers would enjoy cost-certainty and strict limits on future risk, while plan members face an open-ended risk of benefit cuts, even when retired. Employers converting their existing DB plans would be able to turn promised pension commitments (once a legal obligation that could not be revoked) into fully reducible “target benefits” that may or may not be delivered.

Myth 2: “Shared-risk” plans strike a balance between worker-friendly DB plans and the defined-contribution (DC) plans that employers prefer.

For employers, switching to a “shared-risk” plan brings significant advantages: Employer contributions are capped, no pension guarantees of any kind are made to employees, and no pension liabilities appear on the employer’s financial statements. Plan members, however, experience a massive loss of security: The legal protection for already-earned benefits is taken away, and everything can be reduced, including pension cheques being mailed to retirees.

Myth 3: If benefits are reduced in a “shared-risk” plan, they will only be temporary reductions.

In fact, there is no requirement in a “shared risk” plan that benefit reductions only be temporary. Permanent benefit reductions are indeed a possibility in this model. This means, absurdly, that temporary shortfalls in the plan could lead to permanent reductions in benefits.

Myth 4: The “shared-risk” plan is a hybrid, in which some benefits are guaranteed and some (like inflation protection) are conditional.

Not true. There are no legal benefit guarantees of any kind in “shared risk” plans. All benefits (whether basic pension benefits, or additional benefits like inflation indexing) can be legally reduced without limit.

Myth 5: Unions have embraced the “shared-risk” model.

The vast majority of unions do not support the conversion of DB plans into “shared-risk” plans. Faced with the distinct possibility that their pension plan would be wound up, a small number of New Brunswick bargaining units supported “shared risk” plan conversions for a few severely-underfunded pension plans. By contrast, “shared risk” conversions are now being proposed for healthy and sustainable pension plans, across the country.

The fact of the matter is that the “shared-risk” approach is about one thing: reducing employers’ risk and cost. But Canadians cannot allow the conversation to be restricted to just employers’ costs. We have to talk about adequacy and security of retirement income, and in that respect, we’re not making progress. Access to pensions at work continues to dwindle as a share of the working population, and a growing number of families face a retirement plagued by financial insecurity.

Over 60% of working Canadians have just one pension plan at work: the Canada Pension Plan or the Quebec Pension Plan. These plans are truly shared, paid for equally by employers and employees. The Canadian Labour Congress calls on the federal government to expand the Canada Pension Plan and Quebec Pension Plan. The government’s misguided shared-risk initiative will only further undermine the retirement security of Canadians.

• although not properly identified and designed in Bill C-11, the proposed increase in PSPP members’ contribution rates and the proposed increase from 60 to 65 in the age at which PSPP members become entitled to a normal (unreduced) retirement pension, respectively, are the only areas of remedies that are relevant to the unfavourable financial findings identified in the April 1, 2012 actuarial report on the PSPP;

• it is too complex, which was publicly acknowledged by the Minister of Finance, as he did himself publicly stated that he does not fully understand it, and as its implementation, management and day to day administration would be an overly expensive and intricate endeavour.

The S&P 500's surge past the 2,000 level this week for the first time ever is just the latest milestone for the great rally that stocks have enjoyed over the past 5½ years. But Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, doesn't think the latest splashy market headlines will do anything to bring in the many retail investors who have long been staying on the sidelines.

Individual investors are "still nervous, they're concerned," Silverblatt said on CNBC's "Futures Now" on Tuesday. "Even though we're into this rally over five years now, and they're getting very little if they're sitting in a bank or some alternatives, they are not moving back into the market." And he said the S&P's crossing of 2,000 won't lure retail investors.

After all, many small investors will not soon forget the market collapses of 2000/2001 and 2008/2009, which robbed them of their confidence in stocks. And in fact, the S&P has taken more than 16 years to get from 1,000 to 2,000—yielding a mere 6.2 percent annualized compound return, including dividends, from then to now.

So if that's the case, what explains the market's drumbeat of new highs? Silverblatt looks to the other key group in the market.

"On the other side you've got institutions, who are sitting in the market. They're reallocating somewhat, but they're not pulling out. These institutions appear to be more concerned with missing out on potential gains than the market declining."

"Both of these groups are just sitting tight," Silverblatt added. "And the market, in between, has taken small steps upward."

So what will shake the confidence of institutions or the reticence of retail investors?

"I'm not sure what kind of event, ... but it's going to be major," Silverblatt said. These two groups are "really difficult to move."

Equity long-short managers cut net exposures on average to 40%-45% from 50%, said Anthony Lawler, who manages portfolios of hedge funds at GAM.

Some managers are also using put options—the right to sell at a predetermined price—to protect against market falls, taking advantage of what some investors say is low pricing in these instruments.

Anne-Sophie d'Andlau, co-founder of Paris-based investment firm CIAM, bought puts at the end of June, citing market nervousness over the timing of a rise in U.S. interest rates and possible "negative surprises" in the European Central Bank's review of euro-zone bank assets, which is set to be completed later this year.

Ms. d'Andlau, whose fund is up 12.3% in the year to the end of July, said she was "not so confident on the direction of the market."

"Our analysis is that the current environment is more unstable on a macroeconomic level," she said. "You're buying puts for almost nothing."

Pedro de Noronha, managing partner at London-based Noster Capital, which runs $100 million in assets, has owned default protection on emerging-market sovereign debt for some time but recently sold some stocks and is holding more cash. He said he wanted "to make sure I have dry powder for a tough September/October. I see the market as offering very little value, and this is one of the times where the opportunity cost of sitting on the sidelines isn't so big."

But while funds have generally reduced their bets on rising prices, few believe that markets are in a speculative bubble such as the dot-com boom of the late 1990s, which preceded tumbles in stock markets.

"This isn't a greedy rally," said Chris Morrison, portfolio manager on Omni Partners LLP's Macro hedge fund, which made 5.8% in July as a call against U.S. small-cap stocks paid off. "I don't see people high-fiving. They're not saying 'get your moon boots, this stock is going to the moon.' It has been driven by a desperate need to earn a return."

As the S&P 500 topped 2,000 for the first time Monday, Chris Hyzy said that the stock market is just five years into a 20-year bull market.

"I know it sounds easy to say," U.S. Trust's chief investment officer said on CNBC's "Halftime Report.""When you really think about this, this is an elongated business cycle. You're going to have fair value through most of it. You're not going to get a lot of overvaluation."

Hyzy identified what he saw as key for the continued bull market.

"You're going to have some very big opportunities inter-sector and themes. M&A is running wild. But the key to all of this is the manufacturing in the next decade," he said. "It's already happening. You've got energy independence on its way. The private sector's piercing through whatever restrictions are being put out there, and you've got technological advancement that we haven't seen since the early 1990s.

"That sets us up for an elongated business cycle, which is about five years into a pretty long secular market."

Hyzy, who expects GDP growth of 3 percent to 3.25 percent for the United States this year, said that he liked the financial sector best of all, with selected technology and oil-service plays.

Europe, he added, resembled Japan at the outset of its 20-year deflationary spiral. With credit growth contracting, weakness in Germany and French bond yields below that of the U.S., European Central Bank President Mario Draghi "has to act at some point, and it's a little too late."

"I would argue that the first movement on QE in Europe is a good thing for low-quality assets," Hyzy said. "You'll get the big rally. And then you'll levitate for a while if growth doesn't get there."

With the market’s major indexes continuing to climb to new all-time highs, investors are getting increasingly jittery about the incorrigible bears’ warnings that the huge correction they have been predicting is on its way. The selloff will signal the market has hit its peak, they assert. What to do?

Ride with the bulls — and face any pullback with enough cash firepower to buy the battered shares of fallen angels with proven track records. The proven antidote to a massive pullback is to embrace it and prepare to buy shares of companies that are fundamentally sound and equipped to thrive after a market pullback. The key is to be prepared – not by selling but to be an opportunistic buyer as prices plummet.

“The bears keep seeing market tops as the bull charges ahead,” notes Ed Yardeni, president and chief investment strategist at Yardeni Research. Even some of the bulls had warned about an imminent correction but instead, after a 3.9% drop from July 24 through Aug. 7, the S&P 5000 made a new record high on Monday, Yardeni points out.

But should perplexed investors really worry about the coming of a Big Correction? Not if you listen to savvy market watchers and analysts who recommend running with the bulls. True, the bull market is over five years old now, but Yardeni looks at it this way: “It seems to be maturing rather than aging. It is certainly less prone to anxiety attacks, and has treated buying dips as buying opportunities.”

Indeed, although the market continues to gain and treks to higher grounds, it appears more persistent in climbing walls of worries in the U.S. and overseas.

“While the bears continue to look for signs that the bull market is about to break up, I don’t see any significantly bearish divergences, or decoupling, between key internal stock indicators and the overall market,” says Yardeni. “It’s a well-adjusted bull,” is how Yardeni describes it.

The market’s technical picture looks particularly healthy, according to some veteran technical analysts. “The trend remains bullish and an extension above 2,000 (in the S&P 500) would favor a strong push higher into 2030, where we would expect some initial profit taking,” says Mark D. Arbeter, chief technical analyst at S&P Capital IQ. He notes that the S&P 500 has been in an uptrend within an ascending trend channel for the last few years.

So where is the index headed from here?

“The long-term outlook is pointed higher, while above support at 1,838 – 76. Only a drop below the lower trend channel boundary and support at 1,738 would substantially damage the structure of the big picture rally,” says the analyst.

And based on the fundamentals, the market’s outlook seem as positive, as well. “Indeed, the market may be feeding off of consensus expectations for a near 11% climb in yearly earnings-per-share growth through the second quarter of 2015, as compiled by Capital IQ,” says Sam Stovall, chief investment strategist at S&P Capital IQ. He sees the S&P 500′s “fair value around 2,100 a year from now, based on earnings per share growth forecasts, the expectation that inflation will remain around 2%, and that we get a meaningful digestion of gains along the way,” says Stovall.

Meanwhile, the bears aren’t getting much confirmation for their bearishness, notes Ed Yardeni – not even from the Dow Theory, which postulates that the Dow industrials and transportation groups should both be moving higher in a sustained bull market. Well, both the Dow Jones Transportation and the S&P 500 Transportation indexes rebounded to record highs in recent days, notes Yardeni.

Now that the S&P 500 is almost at our 2014 yearend forecast of 2014 for the S&P 500, well ahead of schedule, we remain bullish and continue to favor financials, health care, industrials and information technology.

These groups appear to be the stocks of choice for continued strength and stamina in this long-running bull market? As the S&P Investment Policy Committee sees it, the energy, health care, industrials, and information technology are the attractive sectors, which they recommend to clients to overweight in their portfolios. The committee rates the financial sector as “underweight.”

With U.S Federal Reserve policy easing drawing to a close, Societe Generale's uber-bearish strategist Albert Edwards predicts that a bubble in stock markets is on the verge of bursting.

"Is that a hissing I can hear?" Edwards quipped in his latest research note, published on Thursday.

Edwards claimed the "share buyback party"—which some analysts see as the key driver for recent record Wall Street highs—was now over.

"Companies themselves have been the only substantive buyers of equity, but the most recent data suggests that this party is over and as profits also stall out, the equity market is now running on fumes," Edwards said.


Buybacks occur when firms purchase their own shares, reducing the proportion in the hands of investors. Like dividend payments, buybacks offer a way to return cash to shareholders, and usually see a company's stock push higher as shares get scarcer.

According to Societe Generale's research, share buybacks fell by over 20 percent the second quarter versus the first quarter. However, TrimTabs Chief Executive David Santschi said in a research note on Sunday that buyback announcements were "solid" as earnings season wrapped up.

Some firms borrow cash to buy back their shares, taking advantage of ultra-low interest rates in the U.S. and other developed nations. Edwards warned that as companies had issued cheap debt to buy expensive equity, a "gargantuan" funding gap could yet emerge.

"The equity bubble has disguised the mountain of net debt piling up on U.S. corporate balance sheets. This is hitting home now QE has ended. The end of the buyback bonanza may well prove to be decisive for this bubble," Edwards wrote.

Edwards is known for his markedly pessimistic predictions, and regularly touts the idea of an economic "Ice Age" in which equities will collapse because of global deflationary pressures.


Some analysts remain unconvinced. MacNeil Curry, head of global technical strategy at Bank of America Merrill Lynch, sees no imminent hit to equities. He predicts further upside for the S&P 500—currently near all-time highs—over the next few weeks, and sees the benchmark index reaching 2,050-to-2,060 points by late September.

Multistrategy firms, which use a range of tactics to invest across asset classes are the most popular this year after collecting a net $29.5 billion, according to Hedge Fund Research. The funds returned 4.4 percent through July 31, compared with 2.5 percent for hedge funds overall.

“Pension funds see multistrategy hedge funds as a one-size-fits-all investment,” said Brad Balter, head of Boston-based Balter Capital Management LLC. “It’s very difficult right now to identify attractive opportunities, so they are letting the manager make the tactical decisions rather than wait for their own investment committees to re-allocate capital.”

Hutchin Hill, which employs more than 60 investment professionals, uses five main strategies, including equities, credit and one that makes trading decisions based on quantitative models.

Chriss’s goal is to provide better and more consistent returns than he might using just one approach. His background is in computers and math: He taught himself to program at age 11 and sold a video game to a software company when he was a high-school sophomore.

Chicago-based Citadel, run by billionaire Ken Griffin, helped spark a backlash against multistrategy funds after it lost 55 percent in 2008, one of the worst hedge fund declines stemming from the financial crisis. Six years later, its $22 billion in assets have surpassed its previous peak in 2008.

Its main hedge fund, which is up 9.9 percent this year, has pulled in a net $1.2 billion in 2014, even though it’s limiting inflows primarily to sovereign wealth funds, according to an investor. The firm’s Global Fixed Income fund, run by Derek Kaufman, attracted $2.7 billion.

Millennium, founded by Israel “Izzy” Englander, has collected a net $2.6 billion this year, after only taking in enough money to replace client withdrawals in 2013. The New York-based firm, which manages $23.5 billion, decided to raise money again because it’s adding more teams to the 150 that currently work at the firm. The fund has climbed about 4.2 percent this year and has posted an annualized return of 14.6 percent since January 1990, said investors, who asked not to be named because the fund is private.

Investors who don't have money with Pershing Square Capital Management are likely salivating at the hedge fund's industry-leading 26 percent return from January through July.

But investing with Bill Ackman and other top-performing managers after a great run is probably a bad idea, according to a new study of long-term hedge fund industry performance.

A white paper by Commonfund, which manages nearly $25 billion for close to 1,500 endowments, pensions and other institutions, shows that putting money with the hottest hedge fund managers can work in the short term, but that sticking with them for three years or more is worse than picking managers at random. Picking up losing hedge fund strategies can even produce slightly positive performance.

"Not only does positive-return persistence tend not to work as a selection strategy, but it is especially ineffective in the medium-to-long-range horizons that institutional investors may prefer, and indistinguishable from a strategy of selecting losers," authors Kristofer Kwait and John Delano wrote.

Kwait and Delano found that picking winning hedge funds produced returns of 13.29 percent after 18 months, versus an average of 10.62 percent for all funds. But the same group held for 36 months gained the same as the average; over 48 and 60 months, they rose just 9.49 percent and 8.48 percent, respectively.

In theory, hedge fund allocators could invest with the best managers and then quickly cash out within 18 months. But the vetting and subscription process to get in can take months or even years, especially for cautious institutional investors. Plus, hedge funds often require that their investors commit money for at least a year, and then restrict redemptions by spreading them out over several quarters.

Commonfund said its findings were consistent with a point made by Cliff Asness of AQR Capital Management.

The hedge and mutual fund manager has written that investors often try to catch short-term results in various asset classes but use a multiyear time frame, which often means they instead get hit with losing reversals—or miss winning ones—when the trade inevitably reverts to the mean. Asness declined to comment on the Commonfund study.

Ackman, for example, underperformed stock indexes in 2013 with a 9.3 percent gain, hurt by losses on J.C. Penney (JCP) and a short position on Herbalife (HLF). But Pershing Square has rocketed back this year with wins on Allergan, Canadian Pacific, a reversal in fortune for Herbalife and others, according to a recent letter to investors.

Another famous example of a hedge fund reversal is Paulson & Co. John Paulson saw his client base increase dramatically after he scored huge returns with bets against the housing market before it crashed. But heavy losses in 2011 and 2012 from too-early bets on the U.S. economic recovery caused investors to pull their money (Paulson's hedge funds snapped back in 2013).

The study also found that teasing out manager skill, or "alpha," from the general market ups and downs, or "beta," is critical to selecting hedge fund managers who will outperform.

"For an allocator, that this relationship between observed alpha and skill is not necessarily certain may leave a door open for inferring a sort of skill even from beta-driven returns, perhaps on the basis of a hard to define but powerful argument that a manager is 'seeing the ball,'" the paper noted.

The Absolute Return Composite Index, which aggregates hedge fund returns across all strategies, gained 3.79 percent this year through July. By comparison, the S&P 500's total return was 5.66 percent and Barclays Aggregate Bond Index gained 2.35 percent.

The challenge is parsing out what alpha really is; hedge fund managers are quick to attribute their gains to skill rather than market forces.

Large investors—and their teams of advisors—appear convinced they can draw the distinction. No less than 97 percent of 284 institutional investors surveyed recently by Credit Suisse said they plan to be "highly active" in making hedge fund allocations during the second half of 2014. That's even more than the 85 percent who already made allocations in the first half of the year.

According to industry research firm HFR, investors allocated $56.9 billion of new capital to hedge funds in the first half, pushing total global assets to more than $2.8 trillion, surpassing the previous record of $2.7 trillion from the prior quarter.

Should you always add more when a hedge fund or external manager gets clobbered? Of course not. Most of the time you should be pulling the plug way before disaster strikes. You need to look at the portfolio, assets under management, people, process, and risk management and make a quick decision.

This isn't easy but if you don't, you'll end up holding on and listening to a bunch a sorry ass excuses as to why you need to be patient. And no matter who he is, I would never accept any hedge fund manager 'chiding' me for redeeming from their fund. That's beyond insulting, but in an era where hedge fund superstars are glorified, this is what routinely happens.

Been there, done that, it's a bunch of BS. The media loves glorifying hedge fund managers but the bottom line is all these 'superstars' are only as good as their last trade. Institutional investors should stop glorifying these managers too and start grilling them hard.

Neil Chriss is hitting his stride.

The math doctorate turned hedge-fund manager founded Hutchin Hill Capital LP more than six years ago and built it to cater to large investors. After posting annualized returns of 12 percent, about six times the average of his peers, he finds himself in the sweet spot for fundraising. Hutchin Hill’s multistrategy approach is the most popular hedge fund style this year, helping the New York-based firm double assets by attracting $1.2 billion.

Chriss, 47, is one of the prime beneficiaries as investors are on track to hand over the most cash to hedge funds since 2007, driven by a search for steady returns and protection from market declines. The biggest firms, such as Citadel LLC, Och-Ziff (OZM) Capital Management Group LLC and Millennium Management LLC are bringing in the biggest chunks of money, yet a select group of smaller firms like Hutchin Hill have collected more than $1 billion each.

“There are huge sums of money being put to work,” said Adam Blitz, chief executive officer at Evanston Capital Management LLC, an Evanston, Illinois-based firm that farms out $5 billion to hedge funds. “You are getting some big checks coming into a fairly small universe of brand-name managers who want to grow and are on the approved list of hedge-fund consultants.”

Hedge funds attracted a net $57 billion in the first half of this year, compared with $63.7 billion for all of 2013, according to Hedge Fund Research Inc. Ten firms, including Hutchin Hill, gathered about a third of that amount, investors in the funds said.

Assets Swell

Industry assets have swelled to a record $2.8 trillion even though funds, on average, have posted 7 percent annualized returns since the financial crisis, compared with 12 percent over the previous 18 years, according to the Chicago-based research firm.

Inflows are coming from pension plans, sovereign wealth funds and high-net worth investors. Some of the institutions, such as the Hong Kong Jockey Club, are making direct investments in hedge funds for the first time, rather than going through funds of funds. The club, which controls horse-racing in the city, said in April it gave money to Och-Ziff and Millennium.

Multistrategy Popularity

Multistrategy firms, which use a range of tactics to invest across asset classes are the most popular this year after collecting a net $29.5 billion, according to Hedge Fund Research. The funds returned 4.4 percent through July 31, compared with 2.5 percent for hedge funds overall.

“Pension funds see multistrategy hedge funds as a one-size-fits-all investment,” said Brad Balter, head of Boston-based Balter Capital Management LLC. “It’s very difficult right now to identify attractive opportunities, so they are letting the manager make the tactical decisions rather than wait for their own investment committees to re-allocate capital.”

Hutchin Hill, which employs more than 60 investment professionals, uses five main strategies, including equities, credit and one that makes trading decisions based on quantitative models.

Chriss’s goal is to provide better and more consistent returns than he might using just one approach. His background is in computers and math: He taught himself to program at age 11 and sold a video game to a software company when he was a high-school sophomore.

Lured Away

After obtaining his Ph.D. from the University of Chicago, he was lured away from a teaching job at Harvard University in 1997 to go to Wall Street. He set up his firm in 2007 after working for Steve Cohen’s SAC Capital Advisors LP with early backing from Renaissance Technologies LLC founder Jim Simons.

Hutchin Hill has gained 8 percent this year, according to a person with knowledge of the performance, who asked not to be identified because the results are private.

While firms like Hutchin Hill are beginning to climb the ranks of multibillion-dollar managers, the domination of the biggest funds in raising assets hasn’t slowed, even when they report bad news or post mediocre returns.

Och-Ziff, the biggest U.S. publicly traded hedge-fund firm with $45.7 billion under management, pulled in a net $3 billion into its hedge funds this year, even as it warned shareholders that the Securities and Exchange Commission and the U.S. Department of Justice were investigating the firm for investments in a number of companies in Africa. Its main fund returned 2 percent in the first seven months of the year, less than half the average of multistrategy funds tracked by Bloomberg.

Sovereign Wealth

Chicago-based Citadel, run by billionaire Ken Griffin, helped spark a backlash against multistrategy funds after it lost 55 percent in 2008, one of the worst hedge fund declines stemming from the financial crisis. Six years later, its $22 billion in assets have surpassed its previous peak in 2008.

Its main hedge fund, which is up 9.9 percent this year, has pulled in a net $1.2 billion in 2014, even though it’s limiting inflows primarily to sovereign wealth funds, according to an investor. The firm’s Global Fixed Income fund, run by Derek Kaufman, attracted $2.7 billion.

Millennium, founded by Israel “Izzy” Englander, has collected a net $2.6 billion this year, after only taking in enough money to replace client withdrawals in 2013. The New York-based firm, which manages $23.5 billion, decided to raise money again because it’s adding more teams to the 150 that currently work at the firm. The fund has climbed about 4.2 percent this year and has posted an annualized return of 14.6 percent since January 1990, said investors, who asked not to be named because the fund is private.

Balyasny Assets

The popularity of the multimanager, multistrategy approach that Millennium helped pioneer a quarter-century ago has been a boon to some smaller managers. Dmitry Balyasny’s Chicago-based Balyasny Asset Management LP attracted $1.5 billion this year, bringing total assets to $5.9 billion, while Jacob Gottlieb’s New York-based Visium Asset Management LP pulled in $700 million into its multistrategy fund this year, after raising $1 billion in 2013.

Event-driven funds, which include managers who take activist roles at the companies in which they invest, continue to attract investors this year as the strategy gained 6 percent through July.

Loeb, Solus

P. Schoenfeld Asset Management LP climbed to $4.1 billion in assets as clients invested a net $1 billion and Solus Alternative Asset Management LP attracted $1.25 billion. Dan Loeb’s $15 billion Third Point LLC, which is known for taking activist positions, had been closed to new investments since 2011 and returned capital last year. It recently told investors it would open Oct. 1 for a limited amount of capital that clients expect will be about $2 billion, they said.

A few start ups have also received a billion dollars or more this year, in part because they are coming out of firms with strong track records that are closed to new investments. Herb Wagner, who started FinePoint Capital LP this year and raised $2 billion, was a co-portfolio manager at Baupost Group LLC, the Boston-based firm run by Seth Klarman. Matthew Sidman opened Three Bays Capital LP, another Boston firm, in January and is now managing $1.2 billion. He worked at Jonathon Jacobson’s Highfields Capital Management LP for 14 years.

Spokesmen for all the firms declined to comment on inflows and performance.

Big Money Raisers 2014

Firm PM Net AUM
Inflows

Citadel Ken Griffin $3.9 bln $22.0 bln
Och-Ziff Dan Och $3.0 bln $45.7 bln
Millennium Israel Englander $2.6 bln $23.5 bln
FinePoint Herb Wagner $2.0 bln $ 2.0 bln
Balyasny Dmitry Balyasny $1.5 bln $ 5.9 bln
Solus Chris Pucillo $1.25 bln $ 4.6 bln
Hutchin Hill Neil Chriss $1.2 bln $ 2.5 bln
Three Bays Matthew Sidman $1.2 Bln $ 1.2 bln
Passport John Burbank $1.0 bln $ 3.9 bln
P. Schoenfeld Peter Schoenfeld $1.0 bln $ 4.1 bln

In the outcry about the recent merger mania to take advantage of the tax avoidance transactions known as inversions, certain key players have been notably silent: public pension funds.

Many of the nation’s largest public pension funds — managing trillions of dollars on behalf of police and fire departments, teachers and others — have major stakes in American companies that are seeking to renounce their corporate citizenship in order to lower their tax bill.

While politicians have criticized these types of deals — President Obama has called them “wrong” and he is examining ways to end the practice — public pension funds don’t appear to be using their influence as major shareholders to encourage corporations to stay put.

In the past six months, some of the nation’s largest companies have announced plans to move abroad. AbbVie, a pharmaceuticals company based in Illinois, has agreed to acquire a smaller British rival, Shire, so the combined company can relocate to Britain for tax purposes. Another drug company, Mylan, which is based outside Pittsburgh, has proposed buying the international generic drug business of Abbott Laboratories so the company can relocate to the Netherlands. Medtronic, a medical device company based in Minneapolis, has agreed to acquire Covidien of Ireland. Applied Materials has agreed to buy Tokyo Electron so it, too, can move to the Netherlands. And last week, Burger King announced it was buying Tim Hortons, the Canadian chain of coffee-and-doughnut shops, in a deal that would make Burger King a corporate citizen of Canada.

The California Public Employees’ Retirement System, the nation’s largest public pension fund and typically one of the most vocal, has remained silent.

“We don’t have a view on this from an investor standpoint — we’re globally invested, as you know, and appreciate that tax reform is a government role,” Anne Simpson, Calpers’s senior portfolio manager and director of global governance, told me. “We do expect companies to act with integrity, whatever the issue at hand — that goes without saying. We also want to see a focus on the long term.”

When I pressed for more, her spokesman wrote to me, “We’re going to have to take a pass on this one.”

Public pension funds may be so meek on the issue of inversions because they are conflicted. On one side, the funds say they care about the long term and the implications for their state. Calpers’s “Investment Beliefs” policy states that the pension system should “consider the impact of its actions on future generations of members and taxpayers,” yet most pension funds are underfunded and, frankly, desperate to show investment returns. Mergers for tax inversion can prop up share prices of the acquirers and clearly help pension funds, at least in the short term, show improved performance.

Some pension managers say that their job is strictly about generating cash for pensioners and that they shouldn’t take other issues into consideration. Ash Williams, the executive director and chief investment officer of the Florida State Board of Administration, which manages more than $150 billion, explained it to me this way: “If you’re in my seat, you’re thinking about it not only as an investor, but you’re thinking about it as a fiduciary, which sort of walls out a lot of the political considerations that might otherwise be there.” He went on: “You just have to think, ‘O.K., so I’m guarding the economic interest of my beneficiary. That is my duty, and that’s the start, the middle and the end of it.’ ”

When I pressed him about whether he felt he needed to consider the impact of these deals on the American tax base, which would affect pensioners, he said, “I guess I’d have to say what’s best for the company, what therefore maximizes the value of the ownership relationship I have to the company.” He added, “I mean, my gut is, as an American you’d like to keep businesses here.”

Mr. Williams’s approach appears to be the norm among most investors. However, Mark Cuban, the investor and owner of the Dallas Mavericks, took to Twitter with the kind of view you’d expect from a public pension fund, not a free-market evangelist.

“If I own stock in your company and you move offshore for tax reasons, I’m selling your stock,” Mr. Cuban wrote on Twitter in July. “When companies move offshore to save on taxes, you and I make up the tax shortfall elsewhere,” he said, encouraging investors to “sell those stocks and they won’t move.”

Last month, Shirley K. Turner, a Democratic New Jersey state senator, introduced a novel piece of legislation in an effort to make inversion deals less attractive. She proposed that the state’s pension board be forbidden to invest in companies that are involved in inversion deals. She said the state of New Jersey “ranks sixth among public pension funds investing in corporate inverter AbbVie, holding more than 1.5 million shares of the company’s common stock, valued at $81.9 million.”

It is unclear how such legislation would work. For example, would the state immediately be forced to sell its holdings in a company involved an inversion?

Not all officials who oversee pension funds are focused only on the immediate bottom line.

“Our fiduciary duty to our members is to vote our economic interest — and that means making an individualized determination of whether a given transaction is in our best interests as long-term share owners,” said Scott M. Stringer, the New York City comptroller. “As a result, we don’t merely look at the offer price on the day of closing but instead take into consideration everything from potential influence on shareholder rights to whether a merger places short-term gain over long-term growth.” Still, as Pfizer, one of the largest companies in New York, has continued to contemplate a merger with AstraZeneca that would make the combined corporation a British entity, neither Mr. Stringer nor any other investor acting on behalf of pensioners has spoken out. Perhaps not surprisingly, the only people who appear to be concerned are a small but growing group of politicians in Washington.

After Burger King announced its deal with Tim Hortons, Senator Carl Levin, Democrat of Michigan, declared, “If this merger goes through, there could well be a strong public reaction against Burger King that could more than offset any tax benefit it receives from a tax avoidance move,” suggesting customers take up the cause.

Indeed, the Walgreen Company, which had been considering a tax inversion transaction with Alliance Boots of Britain, voted against changing its corporate citizenship because the American pharmacy chain’s board and management worried about an outcry from customers, according to people close to the board, and were concerned that pressure from customers could spill over to the government.

Where are the investors? Happily watching their returns rise. When I asked Mr. Williams, the Florida pension manager, what he would do if he had to vote on a deal involving a Florida company pursuing an inversion that would hurt the state’s tax base, he sighed and said: “This issue is new enough — and fortunately, at this point, it’s small enough — that it hadn’t reached those dimensions. And I would just hope that we can get something done at the policy level to resolve it. That’s the best outcome.”

Of course, nobody really knows where the stock market is heading. A million things can derail this rally and cause jittery investors to pull the plug and sell their stocks. But with pension deficits rising as bond yields fall, pensions will be forced to take on more, not less risk. And where will they be taking that risk? Stocks, corporate bonds and alternative investments like real estate, private equity and hedge funds.

All those headlines about new stock market highs may look sexy, but life for active managers hasn't been quite so much fun.

In fact, running large-cap mutual funds has been a rough business, with about 80 percent underperforming the S&P 500 in 2014, according to S&P Capital IQ Fund Research. That's four out of five managers who've failed to match a simple stock market index fund that usually has lower fees and other advantages.

There are a handful of explanations for why performance has been so weak this year, but at the core seems to be the general and stunningly persistent belief that the market remains ahead of itself, with danger always right around the corner. Fear of a looming correction has kept many investors playing defense.

"We've gone 35 months without a decline of 10 percent or more, and the median since World War II is 12 months," said Sam Stovall, S&P's chief equity strategist. "Everybody seems to be waiting for that all-elusive correction, when everyone will pile in. But if everybody's waiting for it, it won't happen."

Stovall believes the trouble active managers have had actually could feed into the market rally. As the year winds down, managers may begin to chase performance, taking on more risk or actively seeking out poorly performing sectors such as small-cap stocks.

"If they underperform by too much, they don't get their bonus," he said. "With 80 percent underperforming vs. the more normal 73 percent, you have a greater number of fund managers who are going to feel like they've got to really turn in the afterburners to hopefully outpace the market by the end of the year."

There is, however, a bit of a silver lining in the troubles for active managers.

Todd Schoenberger, president of J. Streicher Asset Management, said the underperformance actually is indicative that managers are prudently reducing risk during an aging market rally.

"If you have a portfolio manager who's knocking the ball out of the park and hitting grand slams, doing amazing performance, the investor should always ask what is the amount of risk being taken to achieve that number," he said. "If you have a portfolio manager making 30 percent, there's a solid chance they can lose 30 percent. The portfolio managers, even though they're lagging the averages, they're probably doing the prudent thing in managing risk."

Active management has lagged in the years since the financial crisis—ever since the Federal Reserve employed a historically strong intervention into financial markets and stocks have operated on a risk-on risk-off mode, with correlations high and little place else to go for return but equities.

Investors have flocked from mutual funds since the crisis, though at least in terms of money flows 2013 and 2014 have been better years.

The exchange-traded fund industry, which uses passively managed low-cost index funds, has exploded to $1.81 trillion under management, a 20 percent gain over just the past 12 months, according to the Investment Company Institute. The $15.7 trillion industry has grown 14.8 percent in the 12-month period—respectable, for sure, but behind ETFs.

Doug Roberts at Channel Capital Research believes extreme central bank easing has made it tougher on active managers.

"Once you have everything going up, it's really difficult for an active manager to outperform," he said. "He has to be right on the mark. He has to get into something that not only has good long-term fundamentals but also is at an inflection point. That's no small task."

...remember the wise words of John Maynard Keynes, "markets can stay irrational longer than you can stay solvent." The events I'm describing above won't happen in the next year or even five years. So while the Zero Hedge bears keep posting scary clips, relax and mark my words, the real risk in the stock market is a melt-up, not a meltdown, and institutions betting on another crash will get clobbered.

Andrew Coyne of the National Post wrote an op-ed, Forcing Ontario’s chronic under-savers to contribute to new pension plan won’t save money:

Among the list of arguments advanced for the proposed Ontario Retirement Pension Plan (ORPP), which with the re-election of the Liberal government will now suck up $3.5-billion of Ontarians’ savings every year to invest on their behalf, efficiency was near the top.

Not only are the province’s hapless citizens chronic under-savers, as the recent budget lectured them, but if left to invest unchaperoned they would simply blow it all on things like mutual funds, with their notoriously high management fees. That much is true: people who invest in mutual funds, of the kind that blanket the airwaves with claims of their superior returns at RSP time, are suckers — of which there are, by one estimate, more than 525,000 added to the population every year.

But the premise, that by forcibly merging everyone’s savings into one big, government-sponsored fund, such waste can be avoided, does not necessarily follow. I’ve had a look at several years’ worth of annual reports from the Canada Pension Plan Investment Board (CPPIB), on which the ORPP is to be based (indeed, the government cites the plan as a fallback from its preferred position, of simply expanding the CPP). It was hard slogging: the figures on costs are buried in acres of print near the back. But the picture that emerges is unmistakable, and gives the lie to any claims of savings.

In the last fiscal year (ended March 31), the board incurred costs of about $1.74-billion, or nearly 1% of the $183.3-billion in assets it started the year with. (The fund now stands at $219-billion.) Of this, about $1-billion was in fees paid to external managers, who invest on the board’s behalf. Another $200-million or so was in transaction costs — the cost of executing trades and acquiring assets. The rest, nearly $600-million, was in general operating costs. In the last four years, total costs have more than doubled; since fiscal 2007, they are up roughly seven-fold.

The choice of year is significant: 2007 was the year the board switched from a purely “passive” investing strategy — that is, simply “buying the index,” seeking to replicate the performance of the broad market in each asset class, rather than trying to pick particular stocks or bonds — to “active” management, including a major plunge into private equity and other relatively risky assets, in hopes of earning higher returns than the average. It hasn’t really worked out that way.

In the eight years since it shifted to active management, the CPPIB’s return on investment, net of all costs, has beaten its “reference portfolio” — made up of the indexes for each of the asset classes in which it invests — just four times: 2007, 2008, 2011, and 2012. The other four times it lost. To be sure, in those four good years, it beat the reference portfolio by an average of two percentage points. Add it up, and the board estimates its efforts “added value” to the tune of a cumulative $3-billion, meaning the fund is worth about 1.4% more, eight years later, than it would have been without them. But it spent more than $7.5-billion to do so. And there’s no guarantee even that meagre gain won’t be wiped out next year.

A not inconsiderable part of the bill went in salaries to its senior executives. The seven top managers listed in the annual reports collected an average of $3-million apiece in total compensation last year. (Admittedly that was a good year, but it’s commonly in excess of $2-million.) There’s no need to begrudge them that — they’d probably pull down something comparable in the private sector. But that’s the point: in the private sector, it’s sucker money they’re collecting. Whereas with a compulsory fund like the CPPIB, it’s all of our money.

CPP execs were in the papers boasting of the 16.5% return they earned last year — 16.2% after operating costs. Great: the reference return was 16.4%. That’s the average, meaning it’s the return you could expect to collect, on average, just by picking stocks (and bonds) at random — the proverbial flinging darts at the stock listings, if newspapers still had stock listings. You don’t need to pay people $3-million each to slightly underperform the average. (For example, I would be willing to do it for a third as much.)

That’s not quite fair. Nobody earns the same return as the index: there’s always some costs involved. But the costs the CPP is incurring are vastly higher than they would be had it stuck with the original passive strategy. My own little portfolio of exchange-traded funds (ETFs), all of them strictly index-based, has an average management expense ratio of 0.19% — less than a quarter the CPP’s.

I don’t mean to suggest the CPP is doing anything wrong, or corrupt. As investment funds go, I’d guess it’s better managed than most. Certainly it hasn’t behaved anywhere near as foolishly as Quebec’s Caisse de dépôt, which lost a quarter of its value in 2008 after betting heavily on asset-backed commercial paper, nor does it compare to the continuing mess at the Alberta Heritage Savings Trust Fund. It’s only making the same mistake as all the other actively managed funds — or rather the people who invest in them: thinking they can beat the market.

The evidence on this is overwhelming: in any given year, two-thirds to three-quarters of actively managed funds get taken to the cleaners by their index. Over a 10-year period, it rises to 90%. Their managers aren’t stupid: they just aren’t any smarter than all the other smart managers out there. The only way you can beat the market is if you know something everyone else doesn’t — new information, not previously public — and not just once, but routinely. That’s not just hard to do. It’s damn near impossible. Which is why the smart money buys the index, and leaves the sucker money to do the heavy lifting.

And yet the CPP is spending $1.74-billion a year of your money and mine in the same futile attempt to beat the index. And the Ontario government is about to copy them. Because God forbid they leave it up to you. Suckers.