Some say that when the average “mom-and-pop” retail investors get back into the stock market, it could be time to get out. But what about when even teenagers start buying?

China has entered a new stock frenzy, like something out of America in the Roaring 20s or the dottiest days of the dot-com bubble, with trading volumes continuing to push to new record highs.

On Wednesday, combined trading on the Shanghai and Shenzhen markets hit 1.24 trillion yuan ($198 billion), the seventh straight session in which turnover surpassed the 1 trillion yuan mark. By comparison, the New York Stock Exchange typically saw $40 billion-$50 billion a day in trading during the first two months of this year.

The Shanghai Composite Index is hovering near its seven-year closing high of 3,691, hit on Tuesday when the index completed a 10-session winning streak.

For the year so far, the benchmark is up 13.8%, making it the best-performing major East Asian stock index of 2015 to date, though it still has a way to go to match 2014’s 53% surge.

The lure of flush times on the Shanghai market is sweeping in unlikely investors by the hundreds of thousands. This week, both the China Securities Daily and the Beijing Morning Post had dueling reports about recent college graduates and, yes, teenagers buying shares.

Typically these young investors speculate with money given to them by their parents, according to a Great Wall Securities broker quoted in the Beijing Morning Post story.

Yet another report, this time by the Beijing News newspaper, relates that at the Beijing trading halls of China Securities Co., “even the cleaning lady” has opened an account to play the market.

The data appear to agree with the anecdotes: Within the last week alone, 1.14 million stock accounts were opened in China, the biggest such surge since June 2007, according to China Securities Depository & Clearing Corp.

What does it all mean?

In a note this week entitled “The Worrying Sense of Calm in China,” analysts at Bank of America Merrill Lynch got right to the point: “Risk-Love (equity sentiment) in China’s equity market is in euphoria territory. It is time to book some profits.”

After holding an overweight rating on Chinese shares since August of last year, Merrill Lynch is now cutting the market to neutral, making it clear that economic problems — especially looming deflation — suggest the current environment doesn’t justify buying into stocks.

“China’s real interest rates remain too high, the currency is too expensive, fiscal policy is tight, and debt deflation is taking hold,” the analysts said.

“We are now concerned that the scale of monetary/fiscal easing required in China is so large, and so radically different from where policy makers’ assessments are, that an overweight [rating] is no longer tenable,” they said.

But of course, there are some bulls in the analyst community as well. Erwin Sanft, a China strategist with Australian investment bank Macquarie, says that despite the recent upsurge, valuations for Shanghai’s yuan-denominated stocks are still “normal ... [and] not at a bubble level.”

Speaking at a panel with financial journalists Wednesday in Hong Kong, Sanft said the climb in Chinese stocks is partly due to the fact that the Shanghai market has been moving off of an extremely low base over the past 10 to 20 years.

According to FactSet data, the Shanghai Composite’s milestones tell a story of Octobers: The benchmark turned 1,000 in October 1996, then peaked at just above 6,000 in October 2007, before crashing to a post-crisis low of 1,665 in October 2008. On Thursday, the index closed at 3,682.

Macquarie China economist Larry Hu, speaking at the same event, said Chinese stocks still have room to grow, if only because the country is in the process of reforming and developing its equity markets as a channel for companies to raise funds directly. Currently, Chinese companies mainly source funds through indirect means, such as commercial-bank loans.

Hu also said Chinese shares are benefiting from trouble in other asset classes. Trust products have turned risky amid the weakening economy, and the real-estate market is in decline, so stocks now look more attractive to Chinese households, he said.

China's house prices are sinking at the fastest pace on record, but you wouldn't know it by looking at the country's massive property companies.

Prices tumbled 5.7% in the year to February, falling across 66 of China's 70 biggest cities.

China's booming economy has driven a colossal supply of houses, including the ghost cities for which the country is now infamous.

But the country's growth is slowing considerably, falling to the lowest level in 24 years in 2014, and falling house prices raise the risk of a debt overhang — when households and businesses have more property debt than the buildings they own are worth. Rabobank's analysts suggest the crash "likely still has years to play out given the level of oversupply."

And you would think that would be bad for China's big property and real-estate companies. After all, residential and commercial buildings are what they sell to make their living, so falling prices certainly seem like a bad thing.

But shares of China Vanke, the country's largest property developer, rose by 4.04% on Wednesday.

It's a similar story for Poly Real Estate Group, another massive developer. Shares rose 5.05% overnight and are up by more than half in the past year. In fact, both companies easily outstripped the 2.13% rise in Shanghai stocks overall on Wednesday. But why?

The answer lies in the perverse incentives on offer — and the fact China's Evergrande Real Estate Group just got a $16 billion (£10.85 billion) lifeline from China's state-run banks.

Here's how The New York Times reported the effective bailout for the developer:

The Chinese leadership is concerned about the health of the country's property market because it is so deeply interconnected with other parts of the economy. Real estate is an important driver of steel consumption, loan growth and jobs for sales agents and migrant construction workers. A drop in home prices hurts ordinary Chinese because they tend to invest a disproportionate amount of their savings in real estate.

It's a more extreme version of the "good news is bad news" phenomenon that a lot of investors closer to home have complained about in recent years — that positive economic news is bad news for stocks because it's a sign that government or central-bank support could be pulled away more quickly. Property prices falling in China means more bailout money.

In fact, Kaisa Group, another property developer that defaulted on offshore bonds in January saw share prices surge Wednesday, up 9.52%. China's house price crash may well be bad news for China, but perversely, it's good news if you're a struggling property developer.

One of Europe’s biggest hedge fund investors, Unigestion, is pushing hedge funds to scrap management fees in place of a bigger slice of profits as investors attempt to crack down on high charges.

Nicolas Rousselet, head of hedge funds at the $16.7 billion investor, which has $1.9 billion invested in hedge funds, said that a zero management fee in exchange for a higher performance fee of 25% was “a great fee structure”. Hedge funds typically charge a 2% management fee and a 20% performance fee although better performing, more established managers can charge much higher fees. These top managers tend to attract investors easily, often having to turn away new ones, and can dictate terms to investors.

Mr. Rousselet said Swiss-based Unigestion had been pushing for a “transformation of fees”, that his team had successfully negotiated lower management fees with some hedge fund managers last year, and in two instances secured rates of lower than 1%.

Among those were both newer managers and more established ones that wanted to work with Unigestion on a new share class or fund.

Mr. Rousselet said: “If [a hedge fund manager] truly believes in his ability to perform, he should take my deal.” However, he acknowledged that low fees could pose a business issue for the hedge fund manager and conceded that the main challenge for investors was that the best-performing funds were oversubscribed.

He said that this transformed fee structure encouraged hedge fund managers to take on more risk, but that hedge fund investors like Unigestion needed to ensure that funds were prepared to take some risks. The aggressive stance is the latest development in a long-running fee debate between hedge funds and investors.

Data released earlier this month by Deutsche Bank Global Prime Finance showed that the success rate of fee negotiations was only gradually improving: some 37% of investors that negotiated fees were successful in one out of every two negotiations. This rate has increased from 35% a year ago, and 29% the year before that.

Investors are usually able to negotiate fees if they can commit a larger investment, and agree to invest for the longer term.

Deutsche Bank said that the most successful negotiators interviewed for its survey, which spanned 435 investors who have $1.8 trillion worth of investments in hedge funds, had an average of $5.6 billion invested in hedge funds. They agreed to invest on average $70 million for at least one year.

Sir, Sir John Ritblat makes a good point regarding hedge fund fees (Letters, March 2). Hedge fund managers should only be rewarded with an incentive fee for delivering performance that exceeds a “normal” hurdle.

For internal benchmarking purposes, many investors use an absolute return measure such as the return on short-dated Treasury bills plus 4 per cent. We should like to see a hurdle at a similar level adopted by the hedge fund industry generally, which by so doing would accept that it expected to deliver a “super return” in exchange for its incentive fee, as its highly talented managers no doubt consider themselves capable of producing. Otherwise investors can find themselves in the depressing position of paying an incentive fee on any positive performance however small.

If one assumes the “standard” — but by no means ubiquitous — 2 per cent plus 20 per cent fee structure, then a 5 per cent gross return to the fund is whittled down to a 2.4 per cent net return to the investor. A hurdle rate — typically of 8 per cent — is standard in the private equity fund sphere and only when the manager has delivered this return to the investor can he help himself to a share of the surplus. Why should the hedge fund industry not follow suit?

We would like to propose a question to you: Is it possible for an investment management firm to operate with the same level of precision and reliability found in industries where failure is simply not an option?

To answer this question, we looked at operational practices in industries such as nuclear power, space travel, aviation and healthcare, which face the prospect of catastrophic failure on a daily basis and have the highest standards for reliability and quality – after all, failure in these industries is a matter of life or death. While the consequences of success or failure in the investment management industry may not be quite as extreme, we do believe that investment managers must treat their investors’ dollars with the same level of respect and thus operate to the same standards.

In this post, we explore what investment management would look if we applied the same level of operational excellence found in these industries. Investment management is a business of precision, yet far too often you hear rumours of ‘fat-finger’ execution errors, or other more serious issues due to operational failures. And these are only the failures that you hear about – what about the failures that go unreported to clients, or even worse, failures that the investment manager itself is not aware of? What it all comes down to is that errors in investment management, no matter how small, are a sign of a lack of quality, and with a lack of quality there is a potential for loss and deviation from strategy.

Are Current Best Practices Sufficient?

Most major operational deficiencies (lack of proper oversight and separation of duties, for example) can often be uncovered by traditional manager due diligence activities. However, many approaches to manager due diligence are conducted through the use of questionnaires which are often built around a series of “check boxes” to ensure that nothing large falls through the cracks. This process places little attention to the quality and repeatability of investment operations. Third party due diligence firms conduct more detailed reviews, but can only see so far into the manager’s processes.

Most practitioners would agree that the intricacies of processes are a potential source of operational risk. For example, frequent small errors could be a reason why a fund might deviate from its benchmark or intended strategy. These errors may also reflect a general lack of attention to detail in the manager’s organization. But most importantly, they conspire to provide the investor with something other than what they are paying for – quality service and predictability of returns.

The Next Level: Systematic and Detailed Examination

Passing a due-diligence audit is a good first step, but managers have the ability to hold themselves to a higher standard. When we at Northwater think about operational deficiencies, we look at all potential failures that can occur throughout the investment process, e.g., inside the details of reconciliation processes, trade execution and model updates. It is only at the finest level of granularity that one can assess errors that may go unnoticed. A systematic method is needed in order to investigate, prioritize and the resolve potential failures.

Failure Mode and Effects Analysis (FMEA) is one technique that we have implemented to assess quality and to reduce the probability of smaller errors, not just to prevent large, obvious ones. FMEA was originally developed by reliability engineers and is widely used today in many non-financial industries. To implement FMEA concepts, we have taken an in-depth look at our own processes to identify areas that can be improved, examine the potential results of errors that can occur, develop highly-documented processes to ensure accuracy and consistency, and continually review and improve these processes.

Nuclear power plants, airlines and hospitals have all adopted strict and well-documented quality control processes that prevent not just large errors, but the potential for a small error to propagate through a system with the potential to push a system beyond its tipping point.

Acknowledge the Human Element

Other industries explicitly acknowledge and manage the human factor and acknowledge that human error rates are not zero even for the simplest task.  Consider a study conducted by NASA to understand human error rates when performing relatively simple tasks; cognitive scientists have found that humans have base error rates in performing even the simplest tasks such as the classification of even vs. odd numbers or identification of triangles.

Despite the best intentions of employees, an underlying issue in investment management is that firms are made up of people and people make mistakes– it is inevitable. Even if the average employee isn’t Homer Simpson, the pilots from “Airplane!”, or the cast from TV’s “Scrubs”, the staff at these organizations face legitimate challenges such as time availability, stress levels, distractions, and even ergonomics and office culture. As such, a lot can be assessed from a review of the processes in place to manage the ‘human factor.’

At Northwater, we have explicitly acknowledged the human element within our processes as well as the performance shaping factors that can impact human performance. Automating processes is a standard method for minimizing the probability of an operational error. It is also possible to redesign processes to reduce complexity. This reduction in complexity helps to minimize the probability of error when a human is involved with a process. We believe that this is an important aspect of our approach to the minimization of operational risk.

By looking to other industries, investment managers can achieve a higher operational standard. If you are interested in learning more about our novel approach to understanding and minimizing operational risk, please contact us.

As discussed, we probably didn't go into sufficient detail in the post. We did quite a few things in our opinion to reduce operational risk.

One, as mentioned, was the implementation of the FMEA methodology. Requires all the people involved in daily trading (PM's, ops people, model people) to systematically map all processes and then brainstorm on how processes can fail. Then rank how failures can cause problems by severity and ultimately prioritize and implement changes to processes to eliminate or significantly reduce the probability of those failures.

FMEA is a standard practice in many other industries to assess operations but you don't seem to hear about it in finance.

We believe that standard op risk practices are important and useful for finding issues associated with investment management firms. They play an important role in helping investors. This topic is more about assessing quality and repeatability of operations. And achieving the highest possible quality, resulting in minimizing the probability of an operational issue associated with day to day portfolio management.

We believe that the third party operational risk firms can't ever go into as much detail as the management firm itself. It is only the people involved in the actual processes that can really understand how processes could fail. Benchmarking and big picture best practices are done well by the third party people but I don't believe they can do a good job at assessing the real quality of the processes.

Financial firms typically strive to implement industry best systems. However, at times, these systems require workarounds and spreadsheets. As well, many of these workaround can be operated by junior people and we believe they are accidents waiting to happen. It is just assumed that these people won't make mistakes or it is up to these people to show sufficient "attention to detail" to never make a mistake. But to us, that is an unrealistic assumption.

Humans make mistakes.

The next aspect that helped us was acknowledgement of the human side. Once you read some of the literature on how humans screw up simple things, you realize it is just a matter of time until someone makes a mistake while operating a process. Humans have small, but non zero error rates for even the simplest tasks. As task complexity increases, the error rate increases.

If a diligent person does 20 simple tasks per day and they do that every day for a year, then you should consider the potential error rate of those tasks. A 1 in 1,000 error rate will cause errors to become a reality for the case of 20 tasks per day for an entire year. If the potential consequences of one of those errors is severe then you have a real problem.

When humans are involved in a process, make their tasks as simple as possible. This accounts for increasing error rates that occur as task complexity increases.

Obviously automation is a well-known solution. Some tasks can’t be automated or at times, systems require some human intervention, and at times a human must intervene in the instance of an exception. These are the instances when the human element should be considered.

We have implemented many more checklists and improved existing checklists for clarity. Implemented many more double checks for tasks involving humans and have also strived to make the independent double checks truly independent. i.e., two people sitting beside each other looking at the same information at the same time is not an independent test since they will potentially influence one another and reduce effectiveness of what is supposed to be an independent check.

We have also implemented a daily pre-trading huddle with people involved with trading, model updates, operations in order to understand the portfolio management tasks for the day. This mirrors the huddles that are more frequently used in operation rooms before a procedure starts (see “Checklist Manifesto”, book by Gawande below).

Again other industries recognize some of these human elements and try mitigate. Finance doesn't seem to do that, most just assume that humans involved in processes perform their tasks perfectly.

We intentionally also modified our working environment. During portfolio management model updates and trading times we do not permit any interruptions of the portfolio management team. We place an indicator in the office that says tells other people in the office that the portfolio management process is taking place and to stay away and do not interrupt the portfolio management team (operations, model updates, reconciliation, trading). An open office (most trading rooms) is great for communication, sharing ideas, etc. but a disaster waiting to happen if you consider how humans perform when they are interrupted or bothered while performing tasks. Again, other industries are aware of these issues.

The FMEA process changes need to be considered within that context. Obviously automation is key, but humans are involved in most processes at some point along the line. Making the human involvements as simple as possible and having safety modes that can catch failures is also key. FMEA is a manner for understanding all of that.

Implementing FMEA and also reading all about how humans make errors changes our way of thinking. We believe we have improved operational efficiency and minimization of operational risk.

Private equity is done. Stick a fork in it. With Kraft singles and Heinz ketchup as toppings, there are many signs that private equity has peaked as an asset class.

Sure, private equity is pervasive, which is one of its problems. According to Dow Jones LP Source, 765 funds raised $266 billion in 2014, up 11.7% over 2013. Ever since David Swensen, the investment manager of the Yale University endowment, almost 30 years ago began successfully allocating outsize portions of the portfolio to “alternate” assets, especially private equity, the so-called Swensen model has been widely duplicated. Last week the Stanford endowment named Swensen-disciple Robert Wallace as CEO. There is a lot of capital chasing similar deals.

When it comes down to it, private equity is pretty simple. You buy a company, putting up some cash and borrowing the rest, sometimes from banks but often via exotic instruments that Wall Street is happy to sell. Then you manage the company for cash flow, making sure you can make interest payments with enough left over for fees and investor dividends. With enough cash flow, you either take the company public or sell it to someone else. And how do you generate cash flow? You can expand the company, but more likely you slash costs, close divisions, cut staff, curtail marketing, eliminate research and development and more. In other words, cutting to the bone.

The Swenson model has worked for the past three decades. But it’s a bull-market investment vehicle whose time is done. Here are the main reasons private equity has peaked—the first four are reasonably obvious, but the last one is the killer.

First, interest rates are going up. As they say on “Game of Thrones,” winter is coming. The Federal Reserve will no longer be “patient” on raising rates. This year? Next year? It doesn’t matter. Rising interest rates mean private equity will see higher costs of capital, wreaking havoc on Excel spreadsheets justifying future returns.

Second, as The Wall Street Journal pointed out last week, banks are slowing lending for leveraged deals. Since 2013, regulators have been discouraging leverage above six times earnings before interest, taxes, depreciation and amortization, or Ebitda, a measure of cash flow. Leveraged loans are the lifeblood of private equity; limits are already crimping the ability to do deals.

Third, tax reform is in the air, and interest-rate deductions are on the chopping block. The Lee-Rubio tax reform plan introduced in March “eliminates the deductibility of new debt.” We all pay taxes on interest income, yet companies get tax deductions on interest payments, which only encourages debt. These tax writeoffs are the air that has filled the private-equity balloon for decades. Lee-Rubio may not get anywhere, but the interest-tax symmetry is long overdue and makes enough sense that it could end up in future tax reform. As an aside, this won’t be pretty for debt-laden cable and telecom companies.

Fourth, private equity has been holding back the economy.When you buy out a drugstore chain or car-rental company and load it with debt, you aren’t investing in the productivity of the economy. More often, by cutting back on new products and services, you are removing productivity from the economy. While generating wealth for endowments and pension funds, private equity can destroy wealth in the economy—my guess is 0.5%-1% lower gross domestic product in an already subpar recovery.

And, by the way, of that $266 billion raised last year by private equity, only $33 billion was for venture capital. Venture investments rarely involve debt—they are productivity creators on steroids. With so many billion-dollar-valued startups, it is hard to argue for more venture capital, but instead expect capital allocated to debt-backed investment to peak and decline.

The final reason private equity is done: It is fresh out of fat targets. In October 2007, KKR and TPG and Goldman Sachs bought the utility TXU Corp. for $48 billion. Bowing to the green gods and regulators, who put so many restrictions on electric generation, the deal now known as Energy Future Holdings Corp. has been a bust, filing for bankruptcy last year. So no more utilities.

Earlier this month, Dutch semiconductor firm NXP bought Freescale for $11.8 billion. Freescale, the old semiconductor arm of Motorola, was bought by Blackstone, Carlyle, TPG and Permira in 2006 for $17.6 billion. Firms that are R&D-intensive aren’t great candidates for buyouts, as interest payments squeeze the research needed for innovation. Dell’s buyout two years ago notwithstanding (Dell is more of a packager and distributor), don’t expect many technology buyouts down the road.

So what’s left? Mattress companies seem to change hands regularly. There are a few more food companies beyond Kraft. General Electric is selling off international-lending divisions. But these are too small to soak up hundreds of billions in private-equity capital that the Swenson model now demands.

The reality is that the best companies with high-enough cash flow to pay down interest can’t be bought. No one is buying Apple or Google. But this is also true of cash machines Uber and Airbnb or high-growth companies like Snapchat and Pinterest. Private equity can’t afford them. And with the Dow bobbing around 18,000, public companies are increasingly off the table. Maybe the oil patch? Good luck with that.

Capital will still chase increasingly expensive deals. That won’t end well. So it’s back to basics—creating companies rather than squeezing the last life out of old ones. Just like Wall Street shrinking and curtailing once-profitable businesses, private equity will begin a slow decline. Yes, we’ll see more deals and even a few successes. But the returns from private equity won’t match those of the past 30 years. And capital will flow elsewhere—let’s hope to productive and wealth-creating segments of the economy.

Private equity may have Buffett envy, but it isn’t rushing to copy him.

There is a burgeoning narrative about how private equity is reconsidering its traditional model, with eyes toward raising long-dated funds that would allow them to hold portfolio companies for 20 years or more. Basically moving closer toward a Berkshire Hathaway structure, albeit not always with publicly-traded shares.

Some of this talk is based on reported experimentation with such funds by large private equity incumbents like The Blackstone Group (BX) and CVC Capital Partners. Some was prompted by a February speech by TPG Capital co-founder James Coulter, in which he talked about the private equity industry experiencing “titanic shifts.”

In general, however, this “evolution” is overblown.

The reason for interest in long-dated private equity funds is that certain institutional investors believe that private equity fees are too high relative to performance. This is largely because private equity charges fees up-front on uncommitted capital, slowly ratcheting down the fees (in terms of hard dollars) as capital is called down (and then often paying them back once investment returns are generated). Or, as Coulter put it in his speech: “That fee drag in the early years of a fund actually becomes difficult.”

But if you create a long-dated fund, you can charge lower annual fees. Not only because fees would be charged for more years, but also because overhead can be reduced. After all, it should be cheaper to run a fund that has 20 years to invest its money than one that only has five years to invest. And the same goes for hold periods (i.e., longer to turn companies around).

The only problem, of course, is that private equity firms already have begun to lower fund fees. Not only “sticker prices,” but many firms are abandoning old rules that said any cost break enjoyed by one limited partner would be enjoyed by all. Today, larger investors can get added discounts for buying “in bulk” — plus are being encouraged to participate in co-investment vehicles that often do not include any management fees on uncalled capital.

And the reductions have proved success, with U.S. private equity fundraising having rebounded from its 2009-2012 lull (average of $95 billion raised annually) to average nearly $180 billion over the past two calendar years. I can think of only a couple of long-dated funds being raised in that more recent crop, and those were for firms that implemented such models long before they became rhetorically trendy.

Even Coulter’s TPG is in the midst of raising a new flagship fund that has… you guessed it, a traditional time structure.

To be sure, private equity firms will try to innovate in their quest for better performance. But when it comes to fundamental structure, few firms will deviate sharply from what has worked for them for decades. If there is movement, it will be glacial.

The average life span of a private equity fund has reached “an unprecedented” 13 years amid concerns about the high fees charged on tail-end funds.

Palico SAS, which operates an online marketplace, said in a report this week that the median life span of a private equity fund—across all regions and sectors—had hit 13.2 years. The figure, which is based on 200 funds dissolved last year, has increased from an average life span of 11.5 years in 2008.

Private equity funds typically aim to return capital to investors within 10 years. About 12% of funds liquidated last year had wound up by their tenth year. A further 29% had liquidated within 12 years, 33% by the 14th year, 14% by year 16, 7% by year 18 and 5% by year 19.

Palico said it meant investors faced lower-than-expected annual returns and potentially serious liquidity problems.

It attributed the longer life spans to drops in asset valuations in the wake of the dot-com bubble of 2000 and the financial crisis in 2008.

“Typical fund life would be even longer without the good exit environment of the past couple of years,” Palico said. “High asset prices, driven by exceptionally low interest rates and widely available credit, have allowed private equity funds to realize a large volume of investments, but they’ve also made it more expensive to acquire companies.”

Jos van Gisbergen, a senior portfolio manager at investment manager Syntrus Achmea, said private equity firms which continued to charge high fees on tail-end funds had caused concern but that longer life spans in general did not necessarily pose significant problems.

“Since funds have common 10-year life spans and up to a three-year extension it is nothing to worry about,” he said. “From experience, I do know the average for [venture capital funds] runs from 15 to 20 years. Also funds of funds as standard run above 15 years.”

Mark Nicolson, a partner at fund-of-funds firm SL Capital Partners, said while strong performing funds that make decent investments early on in the life of the fund will have good internal rates of return regardless of how long the tail continues, the number of funds with one, two or three zombie investments at the end of the life does appear to be increasing.

“It is our job as investors to encourage the managers to realize these,” said Mr. Nicolson. “Certainly we push for them to be realized and for the managers to charge no fees [beyond the agreed extension period] so there is no increased drag in fees.”

For Hamilton Lane, performing advisory work for funds like LACERS is a nice, reputation-burnishing side activity to their big money marker, running various private fund of funds.

Consider what Hamilton Lane’s incentives are. Pursuing their fiduciary duty vigorously would put Hamilton Lane in conflict with their general partners. Since pension fund consultants are typically paid a flat fee to review all prospective investments for funds like LACAERS, playing collegial with the general partners minimizes hassle and effort.

But it’s even worse than that. If pension fund consultants became more rigorous on the advisory side of their business and did real due diligence, those same firms acting on the advisory side of the business would wind up asking managers like Hamilton Lane on the fund of fund side of their business much tougher questions.

Moreover, remember that until recently, the Holy Grail of private equity investing was to get into top quartile funds. Never mind that nearly 80% of the industry could cut its results in a way to claim to be top quartile, and that top quartile performance no longer persists. The reason for hiring a firm like Hamilton Lane is supposedly to make better fund selection. Peculiarly, these same investors understand that trying to outcompete other investors is a fool’s errand as far as stock and bond investing is concerned. As a result, the overwhelming majority are index investors. But rather than save money and hassle and try to act like an index investor in private equity, limited partners work hard at fund-picking.

Given that Hamilton Lane has a large number of pension fund clients it advises, as well as running its own fund of funds, which compete on results, where do you think Hamilton Lane ought to deploy its investment expertise, on the charitable assumption it has any? Pension consultants who are also running funds would be much better served to use it in their fund management activities. Thus it should hardly be surprising that low-information-content reports are the norm. It’s what you’d expect to see from an industry that wanted to keep its best cooking for itself.

Hamilton Lane is an Investor in a Widely-Used Program That Allows Private Equity Firms to Cook the Books of Portfolio Companies. One of the worst ways in which private equity is a non-transparent, “trust me” business is that the limited partner do not have any right to see the financial statements of the companies the private equity fund has bought on their behalf. That is also, as Andrew Bowden pointed out in his speech last year describing widespread misconduct, why so much chicanery is possible: they can have the portfolio companies pay all sorts of fees and costs that may not have been authorized by the governing agreements and the limited partners have no will clue.

Hamilton Lane, as both a fiduciary through operating fund of funds of its own, and as an advisor to major investors like LACERS, should be particularly cognizant of financial reporting risks at the portfolio company level and should strive to reduce exposure to them. Instead, Hamilton Lane is a shareholder in iLevel Solutions, a venture that allows general partners to tamper with portfolio company financials. Since Hamilton Lane clear does know, or could easily know, which general partners use this system, one would imagine that its responsibility to the investors would require it to avoid committing client funds to any general partner that used iLevel Solutions. If you think that’s what Hamilton Lane actually does, I have a bridge I’d like to sell you.

The Ontario Teachers’ Pension Plan is looking abroad for investment opportunities after posting strong returns in 2014.

The pension plan, which invests on behalf of 311,000 teachers and retirees in Ontario, earned an 11.8-per-cent return on its investments last year and saw its assets grow to $154.5-billion, up from $140.8-billion a year earlier.

This is the second year that Teachers has posted a surplus after a decade of recording annual deficits, with funding levels at 104 per cent at the end of 2014. The plan has $6.8-billion of surplus assets above the estimated liability for providing pensions to members.

Teachers has posted an annualized 10.2-per-cent rate of return since its founding as an independent organization 25 years ago.

The pension plan achieved the results despite turbulent market conditions including the drop in oil prices, a competitive private investment environment and economic uncertainty in Europe, said Ron Mock, chief executive of Teachers, in a press conference announcing the results. And in the past four to five months, Teachers has been re-evaluating its investment strategy with an eye on the coming decade, he said.

“The global environment, the investing environment and quite frankly the sovereign wealth [and] pension environment has changed substantially in the last five to seven years,” Mr. Mock said. “So having a strategy that’s global … and in our case long, long-term investing, is critically important.”

The 2014 financial results included a 13.4-per-cent return on equities and a 22-per-cent return on private capital investments. The fund’s fixed income portfolio, including bonds, had a one-year return of 12 per cent, while the real estate group earned 11.1 per cent, and infrastructure earned 10.1 per cent.

Teachers plans to “adapt and modify” its strategy to include looking for more investment opportunities around the world and building up assets in its target regions. “Teachers will need to have global capabilities in the coming years,” Mr. Mock said.

“In 2014, we also spent time growing our global footprint,” said Neil Petroff, chief investment officer at Teachers. After opening a new Hong Kong office in 2013, Teachers spent the past year hiring more local staff and will look to do more deals in the region.

Late last year, Teachers said it would build out its London office, which opened in 2007 and now has a portfolio of assets worth $22-billion. Major investments in 2014 include buying the half of Bristol Airport it didn’t already own in September, and increasing its stake in Birmingham Airport.

“As we look at our global expansion, we’re a little different than the average fund. We don’t open an office and say let’s go find assets,” said Mr. Petroff, who plans to retire in June of this year. Instead, Teachers would look to establish offices in regions where it has holdings. The next logical move for an office might be South America, said Mr. Petroff, where Teachers has a “critical mass of assets” in several countries.

Still, Teachers plans to keep its bottom-up investment strategy, which eschews thematic investing in favour of analyzing individual stocks.

These evolving investment goals come as the average age of plan members has been steadily increasing since the 1970s, from an average expected mortality rate of 79 to 90 years of age for women. The majority of Teachers members are women, who tend to live longer than men.

Right now, Teachers has 182,000 active members and 129,000 pensioners, but the pensioner population is catching up quickly to working teachers, said Tracy Abel, senior vice-president of member services, noting that 135 of the plan’s pensioners are over the age of 100.

The Ontario Teachers’ Pension Plan posted an 11.8 per cent return for 2014, even as falling oil prices took a bite out of its investment portfolio.

Investment earnings for the year were $16.3 billion, up from $13.7 billion in 2013, the pension fund said on Tuesday.

The strong performance puts the defined benefit pension plan in a surplus position for the second year in a row – it’s currently 104 per cent funded – with its net assets under administration reaching a record $154.5 billion.

“Navigating ourselves through these waters is not an easy task,” president and chief executive officer Ron Mock told reporters at a media conference at Teachers’ head office in North York.

“With continuing low interest rates, intense competition pushing up asset prices, the slide in oil prices and resulting stock market-volatility, 2014 was not an easy year for investment success.”

The pension fund said its managers outperformed the consolidated investment benchmark of 10.1 per cent, adding $2.4 billion in returns to the plan last year.

The pension fund invests on behalf of 311,000 active and retired teachers in Ontario. It has an annualized rate of return of 10.2 per cent since its inception 25 years ago.

The value of the plan’s public and private equity investments reached $68.9 billion as of year-end, up 13.4 per cent from the prior year.

Investments by Teachers’ private capital arm rose 22 per cent last year and the plan’s fixed income holdings rose by 12 per cent.

Investments in natural resources were down 19.4 per cent for the year, executives said.

“The silver lining of this natural resource performance is that commodities are a very small allocation. It hurt our returns, but not very much,” chief investment officer Neil Petroff told reporters.

Energy accounts for six per cent of the plan’s public equity portfolio, and four per cent of its private capital holdings, according to the annual report.

The plan’s expense rate is a miniscule 0.28 per cent. The average Canadian mutual fund has a management expense ratio of about 2 per cent.

Investment returns account for more than three-quarters, about 78 per cent, of the pension payouts that teachers receive in retirement. Member contributions account for 10 per cent and the Ontario government, as their employer, contributes 12 per cent.

The Ontario Teachers’ Pension Plan is a defined benefit plan, meaning that the payouts that members receive in retirement are a set or “defined” amount, based on their salary and length of service. Investment decisions, and risks, are assumed by the plan.

Teachers’ has recently invested in GE Aviation, XPO Logistics, and PODS, a company that provides portable, on-demand moving and storage containers. It has also made investments in airports in Birmingham and Bristol, and Premier Lotteries in Ireland.

The plan opened an office in London in 2007 and another in Hong Kong in 2013. It expects to open a new one in South America, where it has investments in logistics firms, and water treatment plants, in the coming months, executives said.

The average age of a retiree who is collecting a pension from Teachers’ is 70. The average age of its active members is 42. The plan has 182,000 active members and 129,000 pensioners.

“Our pensioner population is catching up quickly to the working teacher population,” Mock said.

The pension plan currently has about 130 pensioners over the age of 100. On average, retirees are expected to collect their pension for 31 years.

Petroff told reporters that his 82-year-old mother, who is a retired teacher, receives a pension from the plan. “Every year she calls me and says, ‘You’re doing a wonderful job, Neil. Keep it up.’”

Petroff is retiring from the Ontario Teachers’ Pension Plan on June 1, the pension fund manager announced this week. There will be an internal and external search for a successor.

•  We began by talking about liabilities which are at the heart of every investment decision Teachers undertakes. Ron told me the board sets the discount rate which is mostly determined on mark-to-market basis (keep in mind, the Oracle of Ontario has one of the lowest discount rates in the world and unlike U.S. public pensions, their discount rate isn't marked-to-fantasy). Once the board sets the discount rate and determines the plan's liabilities, the sponsors (the government of Ontario and the Ontario Teachers' Federation) then set the contribution rate and adjust benefits according to he plan's funded status.
• In 2010, the plan removed full inflation protection and introduced 60% inflation protection to return it to fully funded status. As Jim Leech, the former president and CEO, noted back then, the liabilities were due to the maturation of the plan. The main driver of liabilities back then was the drop in interest rates, which significantly reduced bond yields and increased liabilities. In the early 1990s, real-return government bonds (RRBs), the backbone of the plan, generated a fixed 4.5% return plus inflation. These rates of return fell down to 1.6% four years ago - closer to historic averages - which meant the plan needed more money then to pay out future liabilities. They have since fallen to near zero percent, adding even more pressure on the plan to find suitable alternatives to match their long duration liabilities. Every decrease of one percentage point in interest rates increased the cost of a pension plan by 20% in 2010 and it hasn't gotten any better since then. Ron told me the liabilities now swing by $30 billion every time rates go down by 100 basis points (1 percent) and their duration is 22.
• Adding to OTPP’s challenges is the fact that there are now only 1.4 working teachers for every retiree, and higher life expectancies for their members (ie. more longevity risk). As Ron explained to me, "this means there are fewer active members to absorb a substantial loss" and since members are living longer and the average age of their members is rising, they need to make sure their risk-adjusted returns remain extremely high and that they mitigate against any potentially devastating loss, like 2008 which rattled the plan.
• Ron explained how critical "path dependence" is to their plan: "When you have 10 active members for every one retiree, you can absorb a $100 loss much easier by increasing the contribution rate and spreading that loss among the active members. But when you have almost as many retirees as active members, you simply can't afford to sustain a huge loss and because it will significantly impact the cost of the plan and endanger benefits to members."
• Ron also said that the base case for the contribution rate is 11%, meaning the sponsors don't want to see huge volatility in returns which will potentially mean a substantial increase in the plans' liabilities and the contribution rate. "Our job is to minimize the volatility of that contribution rate and keep it stable for as long as possible and the sponsors can use inflation protection as a relief valve to moderate the plan according to its funded status. For a plan to be sustainable, it needs to be flexible and the sponsors need to share the risk of the plan." He added: "Now that the plan is fully funded, the sponsors have the option to restore full inflation protection to the plan's members."
• Because of the long duration (22) of the plan's liabilities and the fact that they simply can't find enough real returns bonds (RRBs) to match these liabilities, it forces them to swap into Treasury Inflation Protection Securities (TIPS) to make up for this scarcity. But even that's not enough because there is a duration mismatch and lack of available product so they're increasingly looking at better matching all their public and public assets with their liabilities to deal with the plan's sensitivity to rates, especially on the downside.
• This is where our conversation shifted to asset allocation and how it relates to liabilities. Ron said that bonds serve three functions: 1) they provide a negative correlation to stocks; 2) they provide return and 3) they move opposite to their liabilities. "If rates go up, our liabilities decline by a lot more than the value of our bond portfolio, which is exactly what we want to maintain the plan fully funded."
• As far as illiquid assets, Ron said that in real estate Teachers looks for class A malls and office buildings and doesn't invest in hotels, strip malls, pure condo buildings, or box stores. "The lease of a hotel is one day. We prefer long term leases of ten years with stellar clients such as well known retailers or office tenants like top law and accounting firms." He added: "Because our liabilities are in Canadian dollars, we have a substantial exposure to Canadian commercial real estate but are also looking in the United States for similar class A real estate because there aren't enough opportunities up here." Teachers isn't alone, many other large Canadian pensions have been busy snapping up U.S. real estate and given my outlook for Canada, I think is is a wise move.
• In infrastructure, he told me that Teachers and OMERS own high speed trains in Europe and there too, they are looking for quality assets that can provide steady returns for a very long time to match their long dated liabilities. Interestingly, Ron said that many pension and sovereign wealth funds are jumping into infrastructure paying top prices and they don't have people with operational experience to manage these assets (a buddy of mine in infrastructure totally agrees and says a day of reckoning awaits all these large funds with investment banking types looking to strike their next infrastructure deal). Ron told me that "Teachers' infrastructure team sticks closely to its pricing discipline even if that often means walking away from an asset they'd really like to own. We also make sure we have board members with operational experience in each of our infrastructure investments."
• In private equity too, Teachers is looking for long term deals that can yield nice returns over a very long period. Ron cited the example of the Irish lottery and other deals that they entered looking for solid returns over a long period.
• In fact, across, public, private and hedge fund assets, Teachers is looking for "the highest Sharpe ratio" in order to match their assets and liabilities as closely as possible. Even in public equities, they moved more into utilities last year to better match assets with liabilities.
• One area where Teachers got whacked again in 2014 was in natural resources, down 19% mostly due to the poor performance of their passive commodities exposure. I will discuss this below but Ron explained to me that they've implemented a Bridgewater type "all-weather portfolio to deal with four economic cycles, including an inflationary environment where commodities outperform" (Teachers has a substantial investment in Bridgewater's Pure Alpa fund).
• Our discussion inevitably shifted to benchmarks and compensation. Ron told me their benchmarks are constructed with liabilities in mind and the risks they take in each investment portfolio are closely monitored by the board to make sure they're in line with the accepted risk parameters. "You won't see us take opportunistic real estate bets to beat our real estate benchmark." Maybe not, but whenever I see any Canadian pension fund trouncing its benchmark in any asset class (like Teachers did in real estate and infrastructure in 2014), my antennas immediately go up and I start wondering whether those benchmarks accurately reflect the risks of the underlying investments (admittedly, over the last four years, which is what compensation is based on, the outperformance isn't as stark in either asset class).

Teachers' uses absolute return strategies to generate positive returns that are constructed to be uncorrelated to the returns of the plan’s other assets. These strategies are executed primarily by the Tactical Asset Allocation and Fixed Income & Alternative Investments teams. Internally managed absolute return strategies generally look to capitalize on market inefficiencies. The plan also uses external hedge fund managers to earn uncorrelated returns, to access unique strategies that augment returns and to diversify risk. Assets employed in absolute return strategies totalled $15.8 billion at 2014 year end compared to $12.2 billion the previous year.

Ron started the meeting by stating: "Beta is cheap but true alpha is worth paying for." What he meant was you can swap into any index for a few basis points and use the money for overlay alpha strategies (portable alpha strategies). His job back then was to find the very best hedge fund managers who can consistently deliver T-bills + 500 basis points in any market environment. "If we can consistently add 50 basis points of added value to overall results every year, we're doing our job."

He explained to me how he constructed the portfolio to generate the highest possible portfolio Sharpe ratio. Back then, his focus was mainly on market neutral funds and multi-strategy funds but they also invested in all sorts of other strategies that most pension funds were too scared to invest in (strategies that fall between private equity and public markets; that changed after the 2008 crisis). He wanted to find managers that consistently add alpha - not leveraged beta - using strategies that are unique and hard to replicate in-house.

Based in Ripon, Wisconsin, Alliance Laundry says it’s the world’s largest designer and manufacturer of commercial laundry equipment with brands including Speed Queen and UniMac. Ontario Teachers’ bought the company from Bain Capital Partners in 2005 for $450 million.

Alliance expanded its reach across Europe, the Middle East, and Asia through the 2014 acquisition of Gullegem, Belgium-based Primus Laundry Equipment Group. Alliance reported revenue of $726 million in 2014, up 32% from the previous year, company filings show. It had net income of $29 million for the year.

Ontario Teachers’ also owns a 30% stake in coin-operated laundry machine provider CSC ServiceWorks Inc.

The federal government is changing the way it accounts for its employees’ pension plans — a change that would indicate the plans have a nearly $100-billion deficit.

The government says the move will have no impact on Canada’s finances or the viability of the plans.

But that doesn’t stop Canada’s 17 federal unions from worrying that this accounting change could spark a political blowback.

They fear that those who believe public sector pensions are too rich will exploit this deficit — even though it is only on paper — to lobby for further reductions or reforms to the pension plans of Canada’s public servants, military and RCMP.

Ron Cochrane, co-chair of the joint union/management National Joint Council, said the unions were briefed on the change and accept that it is an “accounting matter.”

But he said they can’t help but question why the government is making the change now — months before an election — after handling the accounting in the same way since the 1920s.

“The unions’ big concern is optics and whether this will become a feeding frenzy for the Conservative base and those institutes that favour changing public servants’ pension plans,” said Cochrane.

“It has no impact on anyone and everything stays the same, but that doesn’t mean it might not be used to give more fodder for Conservative supporters to make hay and push for changes.”

The change will have no impact on the government’s finances because the employee pension obligations have been accurately recorded in the federal budget and the Public Accounts, which is the government’s overall financial statement.

Treasury Board President Tony Clement wouldn’t comment until the reports have been tabled. The annual report and financial statement for the public service pension plan is expected to released Tuesday.

Stephanie Rea, a spokeswoman for Clement, confirmed the change will have no “financial implications” for the government. It will not affect the deficit or government plans to balance the budget in 2015.

She said the change is one of “presentation” only, and was done to bring the plan’s financial statements in line with public sector accounting standards as urged by Auditor General Michael Ferguson and the federal comptroller general.

The unions were also assured the change would have no impact on the plan, its viability, the contributions employees make or the benefits paid to more than 700,000 public servants and pensioners.

So, just what is the government doing?

The federal pension plan has two accounts, one for pension contributions that employees made before 2000, and another for ones made after 2000.

The pre-2000 account, known as the superannuation account, was created in the 1920s as an internal account to keep track of employees’ contributions, interest and benefit payments. It had no cash.

By the 1990s, this account began racking up a massive surplus that became the centre of a long court battle to decide if the surplus was real or not and who owned it, ending up in the Supreme Court of Canada.

Meanwhile, in 2000, the government passed legislation to create a new pension plan that was invested in the market and managed by the Public Service Investment Board.

The government began publishing financial statements for the combined plans in 2004. They included the superannuation accounts as “assets” along with the investments managed by the Public Service Investment Board. This was an interim step until the Supreme Court issued its decision.

By 2012, the Supreme Court decided federal employees were not entitled to the surplus and the accounts were nothing more than “ledger accounts” with no real cash or assets.

With the lawsuit resolved, Treasury Board decided that removing the superannuation account’s notional “assets” from the financial statements would more accurately reflect the fact the account was only a ledger account. It would also bring them in the line with accounting standards.

It consulted widely with pension experts, the administrators who run the military and RCMP plans.

Ferguson also raised the red flag that if the accounting wasn’t brought in line with standards, his office would issue a qualified opinion on the plan’s financial statements — a black eye on their credibility and the government’s management.

The size of the superannuation account will now be recorded as a note to the plan’s financial statement to be released Tuesday. If the change was applied to last year’s financial statements, removing the notional assets would increase the size of the plan’s deficit to more than $96 billion.

Robyn Benson, president of the Public Service Alliance of Canada, said the chief actuarial reports show the pension plan is adequately funded and viable but that the accounting change could confuse and mislead Canadians.

“The decision by the government to unilaterally remove the superannuation account from the Public Service Pension Plan’s financial statements is therefore unnecessary. Making billions disappear overnight is an attempt by the government to mislead the public on the viability of public sector pensions.”

The public service pension plan is the biggest in the country and critics, ranging from the groups like the Canadian Federation of Independent Business and the C.D. Howe Institute have assailed it as under-funded and unaffordable.

The Conservatives introduced reforms to the pension plan in 2012 that’s aimed at saving $2.6 billion by 2018 and an ongoing $900 million a year. Reforms included jacking up contribution rates so employees pay half and raising the retirement age to 65 for new hires from age 60.

The pension divide in Canada is a yawning public sector-private sector gap.

In the private sector, 76 per cent of employees don’t have a pension of any kind. In the public sector, 86 per cent do and they usually have the best kind.

By best kind, I mean a defined benefit plan where you receive a monthly amount for life when you retire. You don’t have to worry about how to invest the money or what it’s invested in. You can sleep easily at night.

Only 10 per cent of those in the private sector have this kind of plan and many are now grandfathered. In their place, companies are offering defined contribution plans – if they offer anything at all – which match money contributed by employees. Retiring employees have to figure out how to turn that cash into a reliable stream of income, a source of stress and anxiety

The gap is a growing source of friction, with some critics enviously eyeing public sector pensions and saying they are unaffordable and unfair. Far too generous. Wind them up, they say.

But would that really be a good idea?

If you own a business in Cobourg or Orillia, or St. Catharines or Collingwood, or for that matter in Toronto, the answer is no. You may wish you had as good a deal as your neighbour the teacher, the firefighter or nurse, but don’t wish their pension away.

The money they are paid is a huge economic energizer in the community where they live. The money they spend on groceries and restaurants, at the hardware store or taking yoga and fitness classes is greasing the local wheels.

A study by The Boston Consulting Group (BCG) commissioned by four of Ontario’s biggest pension plans, took a look at the relationship between pension income and the health of communities.

The 2012 study found that on average 14 cents of every dollar of income in Ontario communities come from pensions. The biggest chunk of that pension cash comes from defined benefit plans. The rest is from RRSPs, Canada Pension Plan and other supports like Old Age Security (OAS). That cash keeps smaller communities afloat because the money the defined benefit pensioners spend is someone else’s income.

In Toronto, pensions contribute 11 cents of every dollar of income in the city, the study found. In Elliot Lake, it is 37 cents, in Cobourg 27 cents, in Orillia, 24 cents and St. Catharines, 23 cents.

The four pension plans funding the research were Ontario’s biggest –Healthcare of Ontario Pension Plan (HOOPP), Ontario Municipal Employees Retirement System (OMERS), OPSEU Pension Trust (OPTrust) and Ontario Teachers’ Pension Plan (OTPP).

They were looking for support for the argument that defined benefit pension plans offer a lot more than cash in a pensioner’s pocket. Rather, they help with social cohesion and reduce pressure on government programs.

Here are some of the findings:

• In 2012, Canadian defined benefit plans paid out $72 billion to 3.5 million pensioners.
• Most of this money is spent where they live.
• In Ontario, 7 per cent of all income in our towns and cities, or $27 billion, is derived from defined benefit pensions.
• That $27 billion generated $3 billion in federal and provincial income tax, $2 billion in sales taxes and $1 billion in property tax on an annual basis.
• Seniors with defined benefit plans are confident consumers because the predictable income stream allows them to better plan their affairs.
• Defined benefit plans offer a broader social benefit, because people who get them rely less on benefits like the Guaranteed Income Supplement (GIS) to the tune of $2 to $3 billion a year.

“These pensions are an important part of income in their communities,” says Jim Keohane, HOOPP’s CEO. “You get different spending patterns because you don’t have to worry about running out of money.”

The study offers a six-point plan to encourage better pension coverage for all Canadians, something everyone wants but everyone is struggling with how to do it.

So we need more of them, not less.

The study concludes with some suggestions including:

• Make workplace pensions mandatory to force savings. The coming Ontario Retirement Pension Plan is an example of how that might happen, as is Britain’s Nest (National Employment Savings Trust.)
• Don’t wait. Governments should do something now, whether enhancing the CPP or going another way.
• Share the risk between employees and employers, so that pensioners aren’t left managing their money alone.

The study won’t reduce public sector pension envy, but it does explain why these plans are important. We need more like them, not less. The trick is finding a way for that to happen.

The consensus on Wall Street is that stocks will continue to rise ... until they stop. So the question now is: What can stop the market’s bull run?

This is especially pertinent in light of Monday’s surge. The Dow Jones Industrial Average gained a whopping 264 points to close at 17,976. This was the biggest increase in eight weeks.

The best way to answer the question posed in the headline is to determine what has not stopped the bull so far. Here are some items that come to mind:

• Europe’s problems have not;
• Greece’s issues have not;
• China’s slowdown has not;
• The Middle East has not;
• terrorism has not;
• deflation has not;
• falling oil prices have not;
• the strong dollar has not;
• the Ukraine conflict has not;
• domestic politics have not;
• the Federal Reserve might — but a rate increase is already priced into the market.

That said, our central bank has been supporting the stock market to an unprecedented degree since the economy took a tumble a number of years ago, so any increase in rates might have some unexpected side effects.

Keep an eye on corporate profits. Expectations for earnings in the first quarter, which is now coming to a close, are not high to begin with. Most analysts are looking for little or no growth compared with last year.

But even these estimates could wind up being too optimistic, since many assume that the economy grew by 2% or more in the first quarter. But as I said in my column of March 3, the severe weather may have reduced the first quarter’s rate of economic growth by a percentage point or more.

That could take a big toll on profits. For example, if first-quarter earnings fell from their year-earlier levels, it would be the first four-quarter drop in six years.

What really makes traders nervous is that this market has not had a 10% correction in three years. The stock market’s rise last year was the sixth annual gain and the longest skein since 1999.

Stocks have risen this fast in six years only twice before: in 1993-99 and 1923-29. Both instances were followed by a bear market and a recession.

Until this happens, party on!

The Lenape tribe got a better deal on the sale of Manhattan island than New York City’s pension funds have been getting from Wall Street, according to a new analysis by the city comptroller’s office.

The analysis concluded that, over the past 10 years, the five pension funds have paid more than $2 billion in fees to money managers and have received virtually nothing in return, Comptroller Scott M. Stringer said in an interview on Wednesday.

“We asked a simple question: Are we getting value for the fees we’re paying to Wall Street?” Mr. Stringer said. “The answer, based on this 10-year analysis, is no.”

Until now, Mr. Stringer said, the pension funds have reported the performance of many of their investments before taking the fees paid to money managers into account. After factoring in those fees, his staff found that they had dragged the overall returns $2.5 billion below expectations over the last 10 years.

“When you do the math on what we pay Wall Street to actively manage our funds, it’s shocking to realize that fees have not only wiped out any benefit to the funds, but have in fact cost taxpayers billions of dollars in lost returns,” Mr. Stringer said.

Why the trustees of the funds — Mr. Stringer included — would not have performed those calculations in the past is not clear.

Mr. Stringer, who was a trustee of one of the funds when he was Manhattan borough president before being elected comptroller, said the returns on investments in publicly traded assets, mostly stocks and bonds, have traditionally been reported without taking fees into account. The fees have been disclosed only in footnotes to the funds’ quarterly statements, he said.

The stakes in this arena are huge. The city’s pension system is the fourth largest in the country, with total assets of nearly $160 billion. It holds retirement funds for about 715,000 city employees, including teachers, police officers and firefighters.

Most of the funds’ money — more than 80 percent — is invested in plain vanilla assets like domestic and foreign stocks and bonds. The managers of those “public asset classes” are usually paid based on the amount of money they manage, not the returns they achieve.

Over the last 10 years, the return on those “public asset classes” has surpassed expectations by more than $2 billion, according to the comptroller’s analysis. But nearly all of that extra gain — about 97 percent — has been eaten up by management fees, leaving just $40 million for the retirees, it found.

Figuring out just how big a drag the fees were on the expected returns of the funds overall was not easy, Mr. Stringer said.

Scott Evans, the comptroller’s chief investment officer, had to work backward from the footnotes in the reports to estimate just how much had been paid each year to a long list of Wall Street firms that managed investments in the public markets. He then calculated that those fees, combined with the significant underperformance of the investments in private assets like real estate, amount to a whopping negative — a drag of more than $2.5 billion — since the end of 2004.

Leaders of unions whose members have stakes in the funds said they expected the analysis to lead to changes.

“The fees are exorbitant and we’re not getting a good return on our money,” said Henry Garrido, executive director of District Council 37 and a trustee of the New York City Employees’ Retirement System. “That’s an insane process to keep doing the same thing over and over.”

Mr. Garrido said he saw Mr. Stringer’s emphasis on the high fees as a continuation of the efforts of his predecessor, John C. Liu, to improve controls over the managers of the pension funds.

Michael Mulgrew, the president of the United Federation of Teachers, said he was happy that his union’s pension fund, the Teachers’ Retirement System of the City of New York, had been performing well. But he said the fees paid to some managers were “ridiculous” and should be renegotiated if those managers are retained.

“Education’s always being put under reform; maybe some of these financial practices should be put under reform as well,” Mr. Mulgrew said. He praised Mr. Stringer for taking aim at a line of business that has been very lucrative for Wall Street.

“You are talking about messing with a practice that they don’t want messed with,” Mr. Mulgrew said. “I give the comptroller credit. He’s jumping feet first into this one.”

Norway’s government kicked off a process that could open its $880 billion wealth fund to invest in infrastructure and to increase its share of real estate to spread risk and boost returns.

The government appointed an expert group that will report back no later than November 2015, according to a statement from the Finance Ministry.

“It’s important to consider the effect on expected returns and risk of opening up for unlisted infrastructure and increasing investments in real estate,” Finance Minister Siv Jensen said in an interview after a press conference.

The government has so far hesitated to let the fund expand into unlisted investments such as infrastructure. The fund is mandated by the government to hold about 60 percent in stocks, 35 percent in debt and 5 percent in properties. The investor, which gets its capital from Norway’s oil and gas wealth, has been lobbying to be allowed to move into new assets such as private equity to boost returns.

The government increased the so-called tracking error, or the amount it can deviate from its benchmark, to 1.25 percent from 1 percent after the fund in January requested a change to 2 percent. It raised the environment-related investment mandate to as much has 60 billion kroner ($7.4 billion) from 50 billion kroner and introduced a new rule to exclude companies “whose conduct to an unacceptable degree entails greenhouse gas emissions.”

Expanding Oversight

It also proposed to expand the central bank’s board by one more deputy governor to improve oversight and broaden the institution’s competence on investment management. The fund is a part of the central bank, which now has one permanent deputy governor and one governor.

“The Norwegian central bank has two extremely heavy assignments: one is more traditional central bank duties, the other is the management” of the fund, Jensen said during a press conference in Oslo. “The best answer in the short term is to expand the board with one deputy governor.”

Debate has been swirling over whether tighter oversight is needed for the fund, which owns 1.3 percent of global stocks, as it looks at broadening its asset base. Control of the wealth fund is split across various units in the government and the central bank.

Norway’s biggest opposition party, Labor, will support the proposal to add a deputy governor, said Torstein Tvedt Solberg, a lawmaker on parliament’s Finance Committee.

“The steps they are taking are very good,” he said.

The government also decided to follow the advice of a report it mandated last year not to exclude investments in companies producing coal or other fossil fuels.

Labor criticized that decision, vowing to seek a parliamentary majority to override the government on coal investments, Tvedt Solberg said.

The expert group on infrastructure is comprised of Stijn Van Nieuwerburgh, a professor of finance at New York University’s Leonard N. Stern School of Business, Richard Stanton, a professor of finance and real estate at the Haas School of Business, University of California, Berkeley and Leo de Bever, a former Bank of Canada official and pension fund executive.

The former CEO of the Alberta Investment Management Corporation (AIMCo) is to join a panel of experts to advise the world’s largest sovereign wealth fund on how to invest in—and make more from—real estate and infrastructure.

The three-strong group will include Leo de Bever, who oversaw significant investment in real assets at AIMCo, Professor Stijn Van Nieuwerburgh of New York University and Richard Stanton, professor at the University of California, the Norwegian government announced today.

In December, the Norwegian Finance Ministry said it would assess whether its 5% cap on real estate investment should be increased, as well as whether to permit the Norway Pension Fund-Global to invest in unlisted infrastructure. At the end of the year, just 2.2% of its $885 billion was held in real estate.

“The investment strategy of the fund has evolved gradually over time, based on comprehensive professional assessments,” said Norway’s Minister of Finance, Siv Jensen. “Such will also be the case for the current review of real estate and infrastructure investments.”

The government also announced it would be reviewing the investment advice given to the fund.

“Norges Bank and Folketrygdfondet have managed the Government Pension Fund Global and the Government Pension Fund Norway, respectively, in a sound manner over time,” the minister said. “We will build on that. In this report, the government proposes new steps to further develop the investment strategy of the two funds.”

The report, which is being submitted to parliament, proposes that the tracking error for the global fund against its benchmark be increased to from 1% to 1.25%. This will be accompanied by new requirements in the investment mandate for the fund, including supplementary reporting of the risk involved in asset management, the minister said.

Additionally, the central bank is to appoint a committee to review the Central Bank Act and the governance of Norges Bank. This group, led by a former governor of Norges Bank, “must take into account Norges Bank’s responsibility for the management” of the fund, the minister said.

Last year, Norges Bank announced a shake-up of the fund’s hierarchy and asset class silos. Two new CIO positions were created alongside that of a chief risk officer.

The Government Pension Fund Global seeks to take advantage of its long-term outlook and considerable size to generate high returns and safeguard Norway’s wealth for future generations.

The fund holds 60 percent of its assets in equities, 35 percent to 40 percent in fixed income and as much as 5 percent in real estate. The investments are spread globally outside of Norway.

Long-term returns

Norges Bank Investment Management seeks out exposure to risk factors that are expected to generate high returns over time and identifies long-term investment opportunities in specific sectors and companies.

The fund invests for future generations. It has no short- term liabilities and is not subject to rules that could require costly adjustments at inopportune times. The fund can withstand periods of great volatility in capital markets and is able to exploit opportunities that arise when other investors are forced to make short-term decisions.

A good long-term return depends on sustainable economic, environmental and social developments. Environmental, social and governance risks are considered in the fund’s management and exercise of ownership in companies.

Petter Johnsen, chief investment officer for equity strategies at the oil fund, told the Financial Times that the main goal was to increase transparency– one of the main requirements of the Norwegian government.

However, he added: “It is not a solicitation or a direct encouragement on how others should vote but of course we realise that by doing this – pre-disclosing our voting intentions on relevant or notable cases where we have firm views – that we could increase our influence as a shareholder.”

The CAAT Pension Plan today announced a 11.5% rate of return net of investment management fees of 77 basis points for the year ended December 31, 2014.The Plan’s net assets increased to $8 billion from $7.1 billion the previous year.

In its valuation filed as at January 1, 2015, the CAAT Pension Plan is 107.2 % funded on a going-concern basis with a funding reserve of $773 million.

During the past five years, the Plan has earned an annualized rate of return of 10.5% net of investment management fees.

Contributions to the CAAT Plan were $417 million in 2014, while net income from investments was $808 million. The Plan paid $369 million in pension benefits for the year.

The CAAT Pension Plan has 40,000 members – 24,700 are employed in the Ontario college system, which comprises 24 colleges and 12 associated employers, and 15,300 members who are retired or have a deferred pension.

The average annual lifetime pension for retired members and survivors is $25,800. In 2014, members on average retired at age 62.4 after 23.3 years of pensionable service.

“We continue to work diligently to earn and keep the trust of members and employers,” says Derek Dobson, CEO of the CAAT Pension Plan. “The security of existing benefits and the sustainability of the pension plan at stable and appropriate contribution rates is our primary focus.”

The 11.5% rate of return net of investment management fees outperformed the policy benchmark by 1.4%, adding value of $96 million.

The CAAT Plan seeks to be the pension plan of choice for single-employer Ontario university pension plans interested in joining a multi-employer, jointly sponsored plan in the sector. The postsecondary education alignment and similar demographic profile of university and college employees makes the university plans an ideal fit with the CAAT Plan’s existing asset and liability funding structures. The CAAT Plan has been in discussions with individual universities, employer and faculty associations, and government officials, about building a postsecondary sector pension plan that leverages the Plan’s infrastructure and experience, reducing costs and risks for all stakeholders.

Created at the same time as the Ontario college system in 1967, the CAAT Plan assumed its current jointly sponsored governance structure in 1995. The CAAT Plan is a defined benefit pension plan with equal cost sharing. Decisions about benefits, contribution rates, and investment risk are also shared equally by members and employers. The Plan is sponsored by Colleges Ontario on behalf of the college boards of governors, Ontario College Administrative Staff Association (OCASA), and Ontario Public Service Employees Union (OPSEU).

The 2014 CAAT Pension Plan Annual Report will be available on the Plan website by May 11.

Read more about the 2015 Valuation
2014 Investment performance
Shared governance is the key to stability

The CAAT Pension Plan is a jointly-governed pension plan. This means that employers and employees together share responsibility for the stability and security of the Plan (including the cost). This governance model fosters cooperation and flexibility, and encourages prudent and responsible decision-making.

The Sponsors of the Plan (OCASA and OPSEU representing employees and Colleges Ontario representing employers) appoint representatives to the Board of Trustees and Sponsors’ Committee.

In an interview with Bloomberg TV, billionaire investor Stan Druckenmiller said he was bullish on China and did not expect the Federal Reserve Bank to raise interest rates in 2015.

Druckenmiller talked about the spillover effect from a China stock market rally and China’s economy will pick up later this year. Bloomberg reported:

Chinese stocks have soared with the Shanghai Composite Index doubling in the last 12 months.

“Whenever I see a stock market explode, six to 12 months later you are in a full blown recovery,” he said.

After all, if retail investors, who are propelling 90% of the market turnover, are feeling richer from their stock investments, they may want to spend more and jump start the economy again.

The veteran investor also does not expect the Federal Reserve to raise interest rates this year:

“My fear is that we won’t see anything for a year and a half,” Druckenmiller, speaking of an interest rate increase, said in a Bloomberg Television interview. “I have no confidence whatsoever that we’ll see a rate hike in September or December.”

You can watch the entire 40-minute interview on the Bloomberg website (click here to view it).

In a morning note, Goldman Sachs seems to echo the sentiment, though on paper, the bank would have to be more conservative. Goldman now sees the Fed to raise rate this September, with rising probability of a December rate hike (hint, hint!). After all, the U.S. economy is not there yet, wrote analyst Charles P. Himmelberg:

The unemployment rate has only just reached the 5.5% level reached at the start of the 1998 and 2004 hiking cycles, and it is still comfortably between its 4.3% and 6.6% levels that marked the starts of the respective hiking cycles in 1999 (a surprisingly low-inflation period) and 1994 (a stubbornly high-inflation period). This comparison fails to account for differences in the magnitude of long-term unemployment, which is considerably higher today than in past cycles.

If Druckenmiller is right, is it possible that emerging markets will have a broad-based rally and outperform the S&P 500 for a change?

According to Goldman Sachs, which looked at historical stock performances, for emerging markets to broadly outperform, we need two conditions: a China bull and a dovish Fed. See my April 8 blog “Can A China Rally Lift Other Emerging Markets?“.

Year-to-date, the iShares MSCI Emerging Markets ETF (EEM) returned 10.6%, the Vanguard FTSE Emerging Markets ETF (VWO) rose 11.2%, versus the SPDR S&P 500 ETF Trust‘s (SPY) 2.8% gain. The iShares China Large-Cap ETF (FXI) jumped 25.5%, the Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF (ASHR) rose 25.8%.

Stan Druckenmiller is betting on the unexpected.

The billionaire investor, who has one of the best long-term track records in money management, is anticipating three market surprises: an improving economy in China and rising oil prices. He also doesn’t expect the Federal Reserve to raise interest rates in 2015, a move most investors are forecasting will happen in September after six years of keeping them near zero.

“My fear is that we won’t see anything for a year and a half,” Druckenmiller, speaking of an interest rate increase, said in a Bloomberg Television interview. “I have no confidence whatsoever that we’ll see a rate hike in September or December.”

Druckenmiller, who now runs a family office after closing his Duquesne Capital Management hedge fund in 2010, has repeatedly criticized the Federal Reserve for keeping interest rates near zero for too long. He told an audience at the Lost Tree Club in North Palm Beach, Florida, on Jan. 18 that monetary policy has been reckless.

“I’m not predicting a crash,” Druckenmiller, whose hedge fund returned 30 percent annualized over three decades, said in the television interview. “I’m just saying the risk reward of going early is better than going late.”

Financial Engineering

Extra-low rates are driving companies to take on debt and instead of deploying the cash to build businesses, they’re using it to finance mergers, repurchase stock at record levels and pursue leveraged buyouts -- practices he called “job reducers.”

“Every month that goes by we have more and more financial engineering,” he said.

Druckenmiller, who’s worth $4.4 billion, according to the Bloomberg Billionaires Index, is bullish on China, even as the country’s leaders are targeting a 7 percent growth rate this year, the lowest since 1990.

Chinese stocks have soared with the Shanghai Composite Index doubling in the last 12 months.

“Whenever I see a stock market explode, six to 12 months later you are in a full blown recovery,” he said.

A recovery in China, the world’s second-biggest economy, would influence securities and commodities prices around the globe, said Druckenmiller. For instance, it would send German government bond prices lower, boost European exporters and lift the price of oil, he said in a separate interview.

Oil Prices

Druckenmiller anticipates oil prices -- which plunged about 50 percent since June -- will rise by next year after companies slowed production and exploration.

Duquesne Family Office sold its retail and airline stocks, which benefit from lower oil prices, and has bought equities that benefit as energy prices climb, such as LyondellBasell Industries NV. The world’s biggest maker of polypropylene plastic rose as much as 3.1 percent today to $96.18, the highest price since October. He’s also buying crude futures.

In more conventional bets, Druckenmiller said that U.S. and Japanese stocks will continue to climb. He’s also wagering that the U.S. dollar will continue to strengthen against the euro, saying the European currency could eventually trade at 80 cents compared with about $1.06 today.

Greece will “probably” exit the euro zone, Druckenmiller said. There won’t be contagion though, given that banks don’t own Greek debt anymore and Mario Draghi, the European Central Bank President, has quantitative easing at his disposal.

“I prefer to see Greece stay in the euro zone, for a lot of economic market reasons and humanitarian reasons, but as a market participant I think it’s way overanalyzed.”

Russia denied on Saturday a German media report suggesting that it could sign a gas pipeline deal with Greece as early as Tuesday which could bring up to five billion euros into Athens' depleted state coffers.

German magazine Der Spiegel, citing a senior figure in Greece's ruling Syriza party, said the advance funds could "turn the page" for Athens, which is now struggling to reach a deal with its creditors to unlock new loans to avert bankruptcy.

"No, there wasn't (any agreement)," said Kremlin spokesman Dmitry Peskov, in comments made to Business FM radio and quoted by RIA news agency.

Peskov reiterated that the Greeks had not requested financial assistance during talks in the Kremlin earlier this month between Prime Minister Alexis Tsipras and Russian President Vladimir Putin.

"Naturally the question of energy cooperation was raised. Naturally ... it was agreed that at the expert level there would be a working-out of all issues connected with cooperation in the energy sphere, but Russia did not promise financial help because no one asked for it," Peskov was quoted as saying.

During his visit to Moscow, Tsipras had expressed interest in participating in a pipeline that would bring Russian gas to Europe via Turkey and Greece.

Under the proposed deal, Greece would receive advance funds from Russia based on expected future profits linked to the pipeline. The Greek energy minister said last week that Athens would repay Moscow after 2019, when the pipeline is expected to start operating.

Greek government officials were not immediately available to comment on the Spiegel report.

Speaking in Washington on Saturday, German Finance Minister Wolfgang Schaeuble said he would be happy if the Spiegel report proved correct and Greece received the advance funds, but added:

"I do not think that this would solve the problems Greece has in fulfilling the commitments of the memorandum of understanding (with its European partners)."

The new government in Greece has been talking with its euro zone partners for months to try to secure aid and avert a default which could push the country out of the single currency bloc. But progress has been slow and Athens has been exploring other sources of funding. 

The need to reform will not go away after the return to the drachma. Unlike Venezuela, Greece has no natural resources in sufficient abundance to sell to foreigners and generate the hard currency needed to purchase basic goods for their population. Therefore, Greece will end up in the same position as Venezuela but much more quickly. Just a few scenarios in my mind: significant immediate rise in unemployment, rampant inflation, shortage of basic goods/foods, load shedding by DEH, no fast ferries to the islands, no Aegean or Olympic Air, foreign debit and credit cards will no longer work in Greece. Unfortunately, the average Greek has no idea what is coming.

Most any fee, even a fraction of one per cent, will come to look big if it’s multiplied by tens of billions of dollars. So when New York City Comptroller Scott Stringer wanted to make a point recently about the fees the city’s public-sector pension system had paid to asset managers between 2004 and 2014, he didn’t have to work very hard to find an outrageous number. Over the past ten years, New York City public employees have paid out two billion dollars in fees to managers of their “public market investments”—that is, their securities, mainly stocks and bonds. Gawker captured the implication as well as any media outlet with its headline: “Oh My God Wall Street Is Robbing Us Blind And We Are Letting Them

Stringer’s office was barely more restrained, sending out a press release that called the fees “shocking.” The comptroller also issued an analysis that spelled out the impact of fees on the investment returns of the five pension funds at issue: those of New York’s police and fire departments, city employees, teachers, and the Board of Education. Though the comptroller didn’t specify which firms had managed the funds, they were likely a familiar collection of financial-industry villains. “Heads or tails, Wall Street wins,” Stringer said.

The rhetoric tended to brush past the fact that the pension funds didn’t actually lose money. In the analysis, their performance was being measured relative to their benchmarks, essentially asking, for every different class of asset, whether the funds performed better or worse than a corresponding index fund would have. For reasons unclear, the city’s pension funds have been recording their performance without subtracting the fees paid to managers, but the math shows that New York City’s fund managers outperformed their benchmarks by $2.063 billion across the ten-year period under review, and charged $2.023 billion in management fees.

Compared with the average public pension fund’s experience on Wall Street, this is actually, frighteningly, pretty decent. All too often, when researchers investigate pension-fund performance, they find that management fees have eaten up more than any outperformance the managers have generated. A study published in 2013 by the Maryland Public Policy Institute concluded that the forty-six state funds it had surveyed could save a collective six billion dollars in fees each year by simply indexing their portfolios.

I covered the institutional-fund-management industry as an analyst for ten years, and was never given specific information on the pricing of individual deals, but I would estimate, based on the growth of the funds from 2004 to 2014, the variance in the market (especially the crash of 2008), and the total fees, that New York City paid, on average, about 0.2 per cent, or what a fund manager would call “twenty basis points.” You would expect the trustees of such a large portfolio to strike deals on fees, and indeed twenty basis points is much lower than the average paid to managers of most actively managed mutual funds (between seventy-four and eighty basis points, according to the Investment Companies Institute). It is still far more, though, than the five basis points charged by the Vanguard index tracker fund to large institutional investors.

For extremely large pools, fees for equity funds tend to be between twenty and twenty-five basis points, and those for fixed-income funds potentially reach into the high single digits. New York’s pension portfolio is large and mature, so it ought to have a relatively high fixed-income weighting, which means that the city was probably paying too much. The fact that the funds were reporting their returns with the fees included shouldn’t fill the city’s public pension holders with confidence that the tendering and monitoring process was very sharp, either—$2.063 billion, gross of fees, is an inflated way of presenting the actual gains of forty million dollars, net of fees.

The bigger question is whether New York, and other places dealing with large public pension funds, ought to be paying these kinds of fees at all. The safest alternative, per the Maryland study, would be to index the pension funds at, say, five basis points. Following the presentation used by Stringer, this would mean, with close to certainty, that over a ten-year period New York City’s pension funds would pay five hundred million dollars to Wall Street and get no outperformance—a net cost of five hundred million dollars. A second possibility would be to keep the same fund managers and try to bargain down the fees, say to fifteen basis points. From 2004 to 2014, that would have meant one and a half billion dollars of fees paid for two billion dollars of outperformance, a net benefit of five hundred million dollars. But there would be no guarantee of outperformance in the future, and a considerable risk of underperformance.

There is a third possibility, one that Stringer’s office, in its disdain for Wall Street, might well be considering. To provide a little perspective, if the city’s pension pool were a sovereign wealth fund, its current value—a hundred and sixty billion dollars—would make it the twelfth biggest in the world, just below Singapore’s Temasek and quite a ways above Australia’s Future Fund. When you’re that big, it’s fair to ask why you’re paying external managers at all. (It’s sure not like New York City lacks fund managers to hire.) The Ontario Teachers’ Pension Plan, which is roughly the same size, carries out nearly all of its fund management in-house, and historically it has seen very good results.

Some—notably, Michael Bloomberg, in 2011—have proposed that the city move to a system along these lines. In 2013, Stringer himself identified a “yearning” among union trustees for this. Could it be that by directing public anger toward Wall Street, the comptroller is trying to move the debate in this direction?

There is a catch, though: however the funds are structured, outperformance won’t come cheap. The O.T.P.P. pays high salaries to attract its in-house managers. Its expenses were four hundred and eight million Canadian dollars in 2014 alone, well above the two hundred million dollars the New York funds averaged over ten years. That figure includes investments in private-equity operations such as 24 Hour Fitness and Helly Hansen, but this level of expense isn’t uncommon. Looking at a few sovereign-wealth funds, I didn’t find a single one of comparable size to New York City’s pensions that had paid as little as twenty basis points, whether their management was outsourced or not.

Which is to say that, while bashing Wall Street might help a shift toward another model, the city could end up paying just as much, or more, to generate the returns it wants. And if history teaches us anything, it’s that Americans tend to get upset when public employees are paid millions of dollars—unless, of course, they’re college-football coaches.

The plan’s expense rate is a miniscule 0.28 per cent. The average Canadian mutual fund has a management expense ratio of about 2 per cent.

Investment returns account for more than three-quarters, about 78 per cent, of the pension payouts that teachers receive in retirement. Member contributions account for 10 per cent and the Ontario government, as their employer, contributes 12 per cent.

I look at a partnership as an investment like any other company investment, like for eg. a listed operating company. Does one buy into an IPO and separate the underwriter fee or the CEO and executive team compensation? So the key question is whether you try to make a partnership look like a traditional public securities asset manager, or is it like an operating company whose business is the creation and operation of a portfolio, like a holding company styled business. It's really about what bias you bring when looking at this. CEM is just following its asset management industry bias, and trying to fit a PE partnership into that model.

Another way to look at things is since all costs in most partnerships must be recovered before carry, the base fee is really an advance against a profit share.

Either way, I find the CEM type of info good to know and measure for sure, but I do not find value in the total "cost" data aggregated across all activities in eg. a pension plan like CEM advocates.

Hedge-fund upstarts attracted as much money as the titans of the industry last year, a shift for investors who have long favored larger firms.

Managers with assets of less than $5 billion took in roughly half of the $76.4 billion committed to hedge funds after collecting 37% of new capital invested in 2013. That reversed an imbalance of the previous four years, when investors put $93 billion into larger funds while pulling $63 billion from small and mid-size funds, according to data collected for The Wall Street Journal by HFR Inc., which first started tracking the flows in 2009.

Some pension funds and endowments said they are investing with smaller managers such as Hutchin Hill Capital LLC and Birch Grove Capital LP in search of better performance and lower fees compared with celebrity-run megafunds that are typically viewed as safer bets.

“I’d rather invest in funds that are small or midsize where managers are highly motivated and more aligned with us,” said Jagdeep Singh Bachher, chief investment officer for the University of California, which has about $91 billion in investment assets.

Mr. Bachher added that he is negotiating investments in two first-time fund managers launching funds of less than $1.5 billion each and is looking for more such opportunities.

Investors aren’t abandoning large hedge funds altogether, and some of the largest, such as Och-Ziff Capital Management Group LLC, continue to get bigger. During periods of economic turmoil in 2009 and 2012, clients pulled money from smaller funds, according to the HFR data.

By some measures, megamanagers are the better performers. Funds managing more than $5 billion have returned 9% on average since 2007, compared with about 6% for funds below that threshold, according to HFR.

But in a separate analysis of 2,827 hedge funds that specialize in stock picking, investment consultant Beachhead Capital Management found that funds with assets of $50 million to $500 million showed returns that were 2.2 percentage points higher over 10 years than larger funds.

“There have been a number of recent studies that have demonstrated consistent outperformance of smaller funds compared with large hedge funds,” said Mark Anson, head of billionaire Robert Bass’s family investment firm. Mr. Anson has more than half of his hedge-fund investments in firms with less than $1 billion in assets.

Long revered in financial circles for their trading smarts, hedge funds have lost some of their exalted status amid a difficult stretch for the industry. They performed better than many investments during the 2008 financial crisis but struggled to repeat that success in recent years. Returns of HFR’s hedge-fund index have trailed the S&P 500 index every year since 2008 by an average of 10.31 percentage points.

Large backers responded by taking a more skeptical look at hedge funds and comparing their performance to more traditional investment managers who charge lower fees. Some decided to pull their investments. The California Public Employees’ Retirement System, the largest U.S. pension plan, said last year it would exit from hedge funds altogether in part because of concerns about expenses. Hedge-fund managers typically charge higher fees than other money managers, historically 2% of assets under management and 20% of profits.

Others are shifting allocations to more diminutive hedge funds even as they cut back.

The Public Employees Retirement Association of New Mexico decided to reduce hedge funds to 4% of assets from 7.7% but give more money to smaller managers because they rely more on performance fees for their own compensation than larger competitors that collect big management fees, said chief investment officer Jonathan Grabel.

The $14 billion public pension system made the adjustments after a review found its absolute-return hedge-fund investments had underperformed a benchmark index by 1.64 percentage points since inception, according to an internal report reviewed by The Wall Street Journal.

“There’s nothing magical in hedge funds,” Mr. Grabel said. “We have to hold them as accountable as any other managers—in fact I think the level of scrutiny has to be higher because of the fees we’re paying them.”

One firm benefiting from the flood of money into smaller funds is Hutchin Hill, founded by former SAC Capital Advisors LP trader and mathematician Neil Chriss in 2008. The New York fund had averaged 11% annual returns since its inception, a person familiar with the matter said, but it wasn’t until last year that inflows took off as assets expanded to $3.2 billion from $1.2 billion.

New launches also are taking advantage of the surge. Jonathan Berger started his Birch Grove Capital hedge fund in August 2013 with $300 million of seed capital.

Since then the fund has more than doubled to over $700 million, “with half the growth from large institutions and family offices attracted by 20 consecutive positive months of performance,” he said.

Smaller funds chasing the influx of new money are committing more on infrastructure to lure big investors. When Mark Black left Tricadia Capital Management LLC in 2013 to start his own firm, Raveneur Investment Group, he spent a year building accounting and disclosure systems and hired his chief financial officer from hedge-fund giant Fortress Investment Group, people familiar with the matter said.

The work delayed launch of the fund to mid-2014 but ensured he could meet the requirements of public pension funds and large asset managers. Blackstone Group Inc. has invested $150 million in Raveneur, the people say.

“Smaller managers understand that in order to attract allocations from bigger investors they have to be more flexible,” said Melissa Santaniello, founder of the Alignment of Interests Association, a nonprofit group that serves hedge-fund investors.

...the "sweet spot" [for Teachers] lies with funds managing between $500M and $2B. "Those funds are generally performance hungry and they are not focusing on marketing like some of the larger funds which have become large asset gatherers." He told me the hedge fund landscape is changing and he's dismayed at the amount of money indiscriminately flowing into the sector. "Lots of pension funds are in for a rude awakening."

Former Visium Asset Management and Sabretooth Capital Management alumnus Brian Wisk is prepping a quantitative trading fund that aims to profit from market dislocations. His recently launched firm, Asymmetric Return Capital, has contracted with Kirat Singh and Mark Higgins, the architects of prop desk trading and risk management systems at Bank of America, Goldman Sachs and JPMorgan, to design its risk management system.

"I was one of the last clerks to join the floor of the Chicago Options Exchange in the midst of everything becoming electronic," Wisk told Absolute Return. "When I went to the buy-side, I found a serious drop-off in the level of technology. It was something people were playing catch-up with, particularly in the options and derivatives space." Wisk aims to bring the capabilities of a large bank’s derivatives desk to his fund, which will capture data, such as macroeconomic indicators, down to a millionth of a second.

"Many institutional investors are still running their derivatives business in Excel. It’s unfortunate. Our specialized skillset post Dodd-Frank should be available to a large pension fund."

Wisk began his career as a primary market marker for Citigroup on the Chicago Board Options Exchange. He departed in 2006 for Visium Asset Management, where he served as a senior derivatives trader. He worked as an analyst at Tiger Management-seeded Sabretooth Capital Management in 2011, and departed in 2012, when the fund liquidated, to launch ARC.

According to portfolio manager Adam Sherman, ARC is poised to take advantage of increased volatility across asset classes as quantitative easing measures slow. "We are starting to see market dislocations as central bank policies shift," he said. "Correlations are starting to break down."

The fund will trade futures and options across asset classes, including commodities, equity indices, rates, and individual stocks. The portfolio will manage twenty to thirty themes—the differential between commodity and equity volatility was one example given—and will trade multiple securities within that theme (in the previous example, the fund may trade individual options on the S&P 500, WTI and Brent crude oil futures). The fund may hold up to 200 individual positions, and aims to balance exposure across asset classes. The fund will take long-term volatility bets, as well as conduct intra-day and episodic trading around volatility spikes.

Kirat Singh and Mark Higgins—the men Wisk has contracted to design his fund’s trading platform—have modernized Wall Street’s prop desks for over a decade.

Singh was the architect of SecDb (Securities Database) in the late nineties, Goldman Sachs’ framework for real-time derivatives pricing and risk management. SecDb has been touted as one reason why the bank made it through 2008 relatively unscathed, and Higgins co-implemented the platform while running Goldman’s foreign exchange and New York interest rate strategies teams.

The pair departed for JPMorgan Chase in 2006, pioneering the Athena program, a cross-asset trading and risk management system. Singh built the core group that deployed Athena, which began in the fixed income business and was later rolled out across the trading desks in JPMorgan’s investment bank. Higgins implemented the trading system while running the FX, commodities, and global emerging markets (GEM) quantitative research team. The pair parted ways in 2010 when Singh departed for Bank of America Merrill Lynch to design Quartz, a derivatives and securities trading and risk analytics platform. Higgins remained at JPMorgan, rising to co-head of the quantitative research group, and moved to the foreign exchange desk as a managing director in 2012.

The duo reunited in 2014, co-launching Washington Square Technologies, a consulting firm that delivers trading and risk management systems. While the pair are not in-house, they have reached an exclusive deal with Asymmetric Return Capital to design the fund’s risk management infrastructure.

Wisk eyes a June launch for Asymmetric Return Capital, which is based in Manhattan and has five employees, including chief executive Daniel King, who previously served as a managing director and head of the financial institutions group for interest rate sales at Bank of America Merrill Lynch; chief operating officer Steven Gilson, former director of operations at Visium Asset Management; portfolio manager Adam Sherman, who most recently served as a founding partner at Quantavium Management, a systematic fixed income fund; and portfolio manager Andrew Chan, a former portfolio manager at Chicago Trading Company .

The firm will launch with a founder’s share class, the terms of which were not disclosed.

Charlie Chan, a former Credit Suisse Group AG proprietary trader who now runs his own hedge fund, reduced bets the dollar will strengthen and added trades that would profit from a decline.

Chan said he trimmed his fund’s long dollar position versus the yen last week after the U.S. currency’s rally stalled following gains of more than 10 percent in each of the past three years. He’s now betting the greenback will weaken against Asian currencies including Singapore’s dollar, South Korea’s won and India’s rupee, the founder of Singapore-based Charlie Chan Capital Partners said.

A gauge of the dollar has slumped 0.9 percent in April, halting a nine-month rally that propelled it to the highest on record. U.S. retail sales, manufacturing and jobless claims have all missed estimates, leading traders to push back estimates for when the Federal Reserve will raise interest rates.

“The long dollar story was getting a little stale,” Chan said in an interview on Wednesday. “Then the U.S. numbers were coming out not as strong as it was anticipated initially.”

Chan said his Splendid Asia Macro Fund has returned more than 8 percent this year, adding to its 18 percent gain in 2014. Bets on a stronger dollar and an advance in Japanese stocks boosted its performance, he said. The fund invests in bonds, currencies and stocks in Asia. 

‘Probably Time’

The dollar has fallen almost 2 percent from a seven-year high of 122.03 yen reached on March 10 to trade at 119.65 at 8:32 a.m. in London. Chan predicts it will extend its decline to as low as 118. Strategists surveyed by Bloomberg estimate the dollar will appreciate about 4 percent versus the yen this year.

“The yen has weakened quite a lot and Japan has eased quite a lot,” Chan said. “So, it’s probably time to let all this easing work its way through the market. I’ve always held the view the dollar wouldn’t go much beyond 120.”

The Bank of Japan kept its record asset-purchase plan unchanged this month as Governor Haruhiko Kuroda sought to spur inflation that has stalled with the tumble in oil prices. Kuroda has made a 2 percent inflation target central to his campaign to revive the economy after two decades of stagnation.

Hedge funds and money managers cut bets to the least since October that the dollar will strengthen, according to data from the Commodity Futures Trading Commission. Net futures positions betting on a stronger greenback against eight major counterparts dropped to 329,939 as of April 14 from 361,335 a week earlier.

The currencies of Taiwan, Korea and India are among the top seven performers this year out of 31 major peers tracked against the U.S. dollar. Developing Asian economies are set to expand by 6.6 percent this year, outpacing global growth of 3.5 percent, according to April forecasts by the International Monetary Fund.

“I’m still mildly optimistic on Asia,” Chan said.

... if you ask me, there is another reason why the USD is rallying strongly versus all other currencies and it has little to do with Fed rate hikes that might come sooner than the market anticipates. When global investors are worried about deflation and another crisis erupting, they seek refuge in good old U.S. bonds. This has the perverse effect of boosting the greenback (USD) and lowering bond yields, which is why I'm not in the camp that warns the bond market is more fragile than you think.

The Fed has been “very well-intentioned,” Gundlach said, speaking in an interview on Sunday on Wall Street Week. “The ultimate consequences of all these extreme policies have yet to be felt and will be felt.”

The central bank has kept rates in the U.S. near zero and embarked on unprecedented monetary stimulus since the 2008 financial crisis. Known for his contrarian views and top returns, Gundlach said rating the Fed very highly at this point is “sort of like a man who jumps out of a 20-story building, and after falling 18 stories, says, ‘So far, so good.’”

Gundlach, who manages the $46.2 billion DoubleLine Total Return Bond Fund, has beaten 99 percent of peers over the past five years, according to data compiled by Bloomberg. He said last month that if the Fed increases interest rates by mid-year, they would have to reverse course. On Sunday, he said that the probability of a rate increase by the Fed in June is very low, because the economic data doesn’t support such a move.

“I think the Fed would like the data to corroborate their ability to raise interest rates but it isn’t there yet,” he said.

Gundlach reiterated caution on high-yield bonds, saying that default rates could go higher. He also cautioned investors that some mall real estate investment trusts are in a “death spiral.”

Gundlach started Los Angeles-based DoubleLine in 2009 after he was ousted as chief investment officer of TCW Group amid a dispute that led to a legal battle.

In the long run however, further yen weakness seems inevitable. The reason has to do with the sheer relative size of Japan's quantitative easing. Based on the latest projections, the BoJ's balance sheet will be above 90% of Japan's GDP within a year or so. This dwarfs other major central banks' monetary expansion efforts, including that of the ECB. Furthermore, given the scope and size of this program, it is unclear if the Bank of Japan can ever effectively exit it without a massive disruption to the nation's economy. While we could see the yen strengthen briefly in the near-term, the currency will remain under pressure for some time to come.

The Canada Pension Plan Investment Board, the country’s largest pension fund manager, on Friday joined a slew of other investors opposing Barrick Gold Corp’s executive pay structure.

Toronto-based CPPIB said it plans to come out against the advisory vote on executive compensation that Barrick will be having at its annual shareholder meeting next week.

It also said it plans to withhold support from Brett Harvey, one of Barrick’s board members and the chair of its compensation committee. CPPIB own roughly 8.1 million Barrick shares, or less than a per cent of the company’s outstanding stock.

Last week, two smaller Canadian pension funds, the British Columbia Investment Management Corp (BCIMC) and the Ontario Teachers’ Pension Plan Board, said they plan to withhold support from Barrick’s entire board in light of their concerns with Barrick’s executive compensation package.

This marks the second time in three years that Barrick is facing heat over its executive pay. The company lost an advisory vote on its executive pay structure in 2013, prompting it to lay out a new compensation program last year. However, the company’s recent disclosure that Executive Chairman John Thornton was paid $12.9 million in 2014 unleashed fresh complaints.

Barrick contends that with its new pay structure, its senior leaders’ personal wealth is directly tied to the company’s long-term success.

But its detractors including well known proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis contend that Thornton’s pay is not clearly tied to any established and measurable long-term performance metrics.

Separately, CPPIB’s much smaller pension fund rival OPTrust also expressed its dismay with Barrick’s pay structure, stating that it also plans to come out against the advisory vote on the pay structure.

“Where it comes to Mr Thornton, we cannot easily discern any link between pay and performance … OPTrust has decided to also withhold votes from returning compensation committee members,” said a spokeswoman for the pension fund manager.

The investor outrage comes amid a growing outcry about large pay packages for senior executives at some Canadian companies.

Canadian Imperial Bank of Commerce lost its advisory vote on its executive compensation structure on Thursday, in the face of blowback over mega payments to two retired executives.

CIBC shareholders had their say on executive pay at the bank’s annual meeting Thursday and they let it be known they weren’t happy — voting down the bank’s resolution on its compensation plan.

Shareholders voted 56.9 per cent against the bank’s executive pay plan, but outgoing CIBC chairman Charles Sirois said that he didn’t believe the vote was a commentary “on our overall approach to compensation.”

“Based on feedback, we believe this year’s vote result on CIBC’s advisory resolution was significantly impacted by one specific item: the post-retirement arrangement provided to our former CEO,” Sirois said at the meeting in Calgary, his last with the bank before John Manley takes over as board chair.

CIBC’s former CEO, Gerald McCaughey, was paid $16.7 million this year when the bank accelerated his retirement date. Similarly, the lender paid former chief operating officer Richard Nesbitt $8.5 million when it also sped up his departure from the company.

Analysts and investors have criticized both severance packages.

“Our belief is that shareholders were using the say-on-pay vote to express their dissatisfaction with the severance packages,” CIBC spokesperson Caroline van Hasselt said in an interview.

The vote marks the first time a Canadian company has failed a say-on-pay vote since 2013, according to Osler, Hoskin and Harcourt LLP. Sirois said a special committee would review the results of the vote, which is non-binding.

Two of the banks’ larger shareholders have said as much. The Canada Pension Plan Investment Board, which owns 404,000 shares of CIBC, and the Ontario Teachers’ Pension Plan, with 220,000 shares, voted against the motion.

Teachers said it “did not support the structure of the post-employment arrangements [with McCaughey and Nesbitt], believing them to be overly generous and not in the best interests of shareholders.”

For the same reason, Teachers’ also withheld its votes for the company’s nominated slate of directors – all of whom were re-elected although two with significantly less support than their peers.

Luc Desjardins and Linda Hasenfratz were both re-elected with 86 per cent and 85 per cent support, respectively. By contrast, every other member of the 15-person board was elected or re-elected with more than 90 per cent support.

Hasenfratz chaired the committee that oversaw executive compensation matters, of which Desjardins was also a member.

“We cannot support the members of the Management Resources and Compensation Committee based on our concerns with the succession planning process and post-employment arrangements made to both Mr. McCaughey and Mr. Nesbitt,” a statement from Teachers’ reads.

The CPPIB declined a request for comment.

Despite their dissatisfaction with CIBC’s executive compensation, shareholders voted down three additional resolutions, put forward by Montreal-based Movement d’éducation et de défense des actionnaires, that would have altered the bank’s pay policies.

Shareholders voted more than 90 per cent against resolutions that aimed to close the gap between executive pay and that of frontline staff, rework the retirement benefits of all executives and restrict the use of stock options as compensation.

A report on bank CEO pay by Toronto compensation consulting firm McDowall Associates shows base salaries for the new CEOs of Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Toronto-Dominion Bank are all down 33 per cent compared with the outgoing CEOs’ salaries, while the base salary for the new CEO of Royal Bank of Canada is down 13 per cent compared with his predecessor.

Targeted total direct compensation – which includes grants of share units and stock options – is down between 11 per cent and 25 per cent for all four CEOs, the report shows. For example, the analysis shows Scotiabank CEO Brian Porter earned $8-million in total direct targeted compensation (excluding pension costs) in 2014, which is 25 per cent less than the $10.7-million that predecessor Rick Waugh earned in total targeted compensation in 2013.

Bernie Martenson, senior consultant with compensation firm McDowall Associates and previously vice-president of compensation at Bank of Montreal, said it is too soon to conclude that the banks have permanently lowered CEO pay because it is common for CEOs to get raises as they spend more time in the job.

But she said a number of current pay practices, including reducing the proportion of pay awarded in stock options, suggest overall pay is likely to be lower for the new CEOs over the long-term.

“You would naturally think there would be a difference between someone of long tenure and someone who is new in the role,” Ms. Martenson said.

“But I think the reduction of stock options in the last few years is starting to have an impact in terms of wealth accumulation. If you were to look out eight or 10 years for these new CEOs and compare the value of their total equity to that of their predecessors, I think it would be lower.”

Bank CEOs are still well compensated of course, but restraint is increasingly evident. Ms. Martenson points to the CEO pension plans at all four banks. Toronto-Dominion Bank CEO Ed Clark, for example, has the largest pension of departing CEOs at $2.5-million a year, while his replacement, Bharat Masrani, will have a maximum possible pension of $1.35-million a year when he retires.

At Scotiabank, Mr. Waugh’s pension plan was capped at a maximum of $2-million a year at age 63, while Mr. Porter is eligible for a maximum pension of $1.5-million available at 65. Royal Bank’s Gord Nixon had a $2-million maximum pension at 60, while his successor David McKay will have a maximum pension of $700,000 at 55, increasing to a final maximum of $1.25-million at 60.

Retired CIBC chief executive Gerry McCaughey had no cap on the size of his pension, but his pensionable earnings that formed the base for his pension calculation were capped at $2.3-million. His successor, Victor Dodig, has his annual pension capped at $1-million.

A number of shareholder groups – including the Canadian Coalition for Good Governance – have urged companies to reform pension plans because they create expensive funding obligations that last for decades.

Michelle de Cordova, director of corporate engagement and public policy at mutual fund group NEI Ethical Funds, said bank CEOs continue to have very generous pensions “that most people can only dream of,” but she sees a sense of moderation in the trends.

Ms. de Cordova, whose fund has lobbied the banks to curb their executive pay and link CEO pay increases to those of average Canadians, hopes the pay reductions in 2014 are not a temporary trend.

“It does suggest that there is some sense that the levels that pay and benefits had reached were perhaps too high, and boards have decided they need to do something about that,” she said. “I’d say they are still very generous arrangements, but it does seem that there is a sense that there needs to be some moderation, which is welcome.”

The report says all five of Canada’s largest banks have cut the proportion of stock options they grant their CEOs in recent years.

Banks previously decided how much equity they wanted to grant CEOs each year, and split the amount evenly between grants of stock options and grants of share units. In 2014, however, stock options accounted for 20 per cent of total new equity grants at the median for the five banks, while share units accounted for 80 per cent of new equity grants.

Ms. Martenson said banks faced pressure from regulators to reduce stock options following the financial crisis in 2008 because they were deemed to encourage executives to take risks by quickly pushing up the company’s share price to reap a windfall from quickly exercising options. Share units, which track the value of the company’s shares and pay out in cash, are considered less risky because they must be held for the long-term or even until retirement, creating incentives to build long-term growth.

Three months of negotiations between the Greek government and our European and international partners have brought about much convergence on the steps needed to overcome years of economic crisis and to bring about sustained recovery in Greece. But they have not yet produced a deal. Why? What steps are needed to produce a viable, mutually agreed reform agenda?

We and our partners already agree on much. Greece’s tax system needs to be revamped, and the revenue authorities must be freed from political and corporate influence. The pension system is ailing. The economy’s credit circuits are broken. The labor market has been devastated by the crisis and is deeply segmented, with productivity growth stalled. Public administration is in urgent need of modernization, and public resources must be used more efficiently. Overwhelming obstacles block the formation of new companies. Competition in product markets is far too circumscribed. And inequality has reached outrageous levels, preventing society from uniting behind essential reforms.

This consensus aside, agreement on a new development model for Greece requires overcoming two hurdles. First, we must concur on how to approach Greece’s fiscal consolidation. Second, we need a comprehensive, commonly agreed reform agenda that will underpin that consolidation path and inspire the confidence of Greek society.

Beginning with fiscal consolidation, the issue at hand concerns the method. The “troika” institutions (the European Commission, the European Central Bank, and the International Monetary Fund) have, over the years, relied on a process of backward induction: They set a date (say, the year 2020) and a target for the ratio of nominal debt to national income (say, 120%) that must be achieved before money markets are deemed ready to lend to Greece at reasonable rates. Then, under arbitrary assumptions regarding growth rates, inflation, privatization receipts, and so forth, they compute what primary surpluses are necessary in every year, working backward to the present.

The result of this method, in our government’s opinion, is an “austerity trap.” When fiscal consolidation turns on a predetermined debt ratio to be achieved at a predetermined point in the future, the primary surpluses needed to hit those targets are such that the effect on the private sector undermines the assumed growth rates and thus derails the planned fiscal path. Indeed, this is precisely why previous fiscal-consolidation plans for Greece missed their targets so spectacularly.

Our government’s position is that backward induction should be ditched. Instead, we should map out a forward-looking plan based on reasonable assumptions about the primary surpluses consistent with the rates of output growth, net investment, and export expansion that can stabilize Greece’s economy and debt ratio. If this means that the debt-to-GDP ratio will be higher than 120% in 2020, we devise smart ways to rationalize, re-profile, or restructure the debt – keeping in mind the aim of maximizing the effective present value that will be returned to Greece’s creditors.

Besides convincing the troika that our debt sustainability analysis should avoid the austerity trap, we must overcome the second hurdle: the “reform trap.” The previous reform program, which our partners are so adamant should not be “rolled back” by our government, was founded on internal devaluation, wage and pension cuts, loss of labor protections, and price-maximizing privatization of public assets.

Our partners believe that, given time, this agenda will work. If wages fall further, employment will rise. The way to cure an ailing pension system is to cut pensions. And privatizations should aim at higher sale prices to pay off debt that many (privately) agree is unsustainable.

By contrast, our government believes that this program has failed, leaving the population weary of reform. The best evidence of this failure is that, despite a huge drop in wages and costs, export growth has been flat (the elimination of the current-account deficit being due exclusively to the collapse of imports).

Additional wage cuts will not help export-oriented companies, which are mired in a credit crunch. And further cuts in pensions will not address the true causes of the pension system’s troubles (low employment and vast undeclared labor). Such measures will merely cause further damage to Greece’s already-stressed social fabric, rendering it incapable of providing the support that our reform agenda desperately needs.

The current disagreements with our partners are not unbridgeable. Our government is eager to rationalize the pension system (for example, by limiting early retirement), proceed with partial privatization of public assets, address the non-performing loans that are clogging the economy’s credit circuits, create a fully independent tax commission, and boost entrepreneurship. The differences that remain concern how we understand the relationships between the various reforms and the macro environment.

None of this means that common ground cannot be achieved immediately. The Greek government wants a fiscal-consolidation path that makes sense, and we want reforms that all sides believe are important. Our task is to convince our partners that our undertakings are strategic, rather than tactical, and that our logic is sound. Their task is to let go of an approach that has failed.

"The pension system is ailing." I would say the Greek pension system is on the verge of collapse. The jobs crisis doesn't help but an even bigger problem is the total lack of proper governance surrounding Greek pensions. Instead of creating something akin to the Canada Pension Plan Investment Board, Greece has allowed their pensions to slowly wither away, much like its economy which is in desperate need of major reforms. Of course, the biggest problem in Greece remains its grossly over-bloated public sector which Syriza will fight for tooth and nail until its leaders are forced to implement drastic cuts (one way or another, cuts are coming, especially if Greece leaves the euro and goes back to the drachma). Mr. Varoufakis knows this. Tsipras knows this. They are playing a dangerous game with no leverage. Greeks are only fooling themselves if they can't see past Syriza's dangerous lies. It's time for Greeks to take responsibility for years of economic failure and finally bring their economy into the 21st century by implementing much needed reforms to make it more competitive and open to foreign investors. Varoufakis laments that Greece needs a new deal but he fails to see the world has its own problems to deal with and if Greece doesn't reform, it will be left out, or worse, thrown back into the Dark Ages.

When Yanis Varoufakis warned his fellow euro-area finance chiefs of the dangers of pushing his government in Athens too far, Peter Kazimir snapped.

Kazimir, Slovakia’s finance minister, launched a volley of criticism at his Greek counterpart, releasing months of pent-up frustrations among the group at the political novice. They’d had enough of what they called the economics professor’s lecturing style and his failure to make good on his pledges.

The others at the April 24 gathering in Riga, Latvia, took their cue from Kazimir -- they called Varoufakis a time waster and said he would never get a deal if he persisted with such tactics. The criticism continued after the meeting: eight participants broke decorum to describe what happened behind closed doors. A spokesman for Varoufakis declined to respond to their descriptions.

“All the ministers told him: this can’t go on,” Spain’s Luis de Guindos said the following day. “The feeling among the 18 was exactly the same. There was no kind of divergence.” The others who provided an account of the meeting in interviews asked not to be named, citing the privacy of the talks.

Varoufakis’s isolation raises the stakes, which include a potential default and keeping the euro indivisible. After more than five years as a ward of the European Union, Greece is virtually out of cash. The aid pipeline is shut until Prime Minister Alexis Tsipras, elected Jan. 25 promising to push back against budget cuts, bends to EU policy demands.

Alluding to the political conflict, Varoufakis borrowed a line from a 1936 speech by U.S. President Franklin D. Roosevelt. “They are unanimous in their hate for me; and I welcome their hatred,” Varoufakis said on his Twitter account on Sunday. The quotation is “close to my heart (& reality) these days,” he wrote.

Looming Payments

The breakdown came as Greece heads into a week of heightening fiscal tension. The first of two International Monetary Fund payments is due on May 6 and the government still doesn’t know if it has enough money to pay pensioners and state employees this week.

Varoufakis sought to squeeze aid from the rest of the euro area accepting the full slate of EU demands, a gambit rejected by the group’s leader, Jeroen Dijsselbloem.

Varoufakis described the talks as “intense” and said his country is ready to make “big compromises” for a deal.

“The cost of no solution would be enormous not only for us but also for all,” he said.

Varoufakis cut a lonely figure on Friday morning as he prepared for the meeting. The 53-year-old academic walked with no entourage through the lobby of the Radisson Blu Daugava Hotel clutching a mobile phone and a newspaper.

Pension Stalemate

In remarks to the assembled ministers, he defended protecting public pensions, a key sticking point in the negotiations. He threatened to walk away from talks if creditors pushed too hard.

When Dijsselbloem invited the group to respond, he was greeted by silence. He asked again, and Kazimir spoke up.

Varoufakis’s refusal to accept the conditions of its creditors particularly riled the Slovakian because his government has slashed the budget deficit and cracked down on tax evasion. His position also may have fallen on deaf ears among his hosts in Riga.

Latvia’s economy shrank by more than a fifth in 2008 and 2009 when the country was led by Valdis Dombrovskis, now vice president of the European Commission and a participant in the Friday meeting. Dombrovskis pushed through some of the world’s harshest austerity measures -- equivalent to 16 percent of gross domestic product. The Greek economy has shrunk by about a quarter since 2008.

Photo Shoot

Political gaffes have afflicted Varoufakis from the outset. He offended the Italian government, a potential ally, when he said Feb. 8 their country was close to bankruptcy. Most famously, he posed for a photo spread in Paris Match magazine, showing the minister and his wife on their roof terrace overlooking the Acropolis in Athens.

For any European governments sympathetic to the plight of Greeks, the picture made it harder to justify additional aid to their voters. The episode also hurt Varoufakis’s credibility and gave other ministers an easy way to needle him.

After his comments to the meeting in Riga, Varoufakis was approached by France’s Michel Sapin, a Socialist.

“I told him I had read Philosophie Magazine,” Sapin said, alluding to Varoufakis’s academic style. “It’s better than Paris Match.”

Varoufakis has the backing of a majority of Greeks, according to an Alco survey published in Proto Thema newspaper. Some 55 percent of respondents said they had a positive view of him, compared with 36 percent who said they viewed him negatively.

Still, the schadenfreude in ministers’ reactions was leavened with concern about the consequences of the policy deadlock.

Calls for Plan B

Greece needs to begin paying monthly salaries to civil servants and retirees on Monday, and faces a string of obligations leading up to a $770 million IMF payment on May 12.

Tsipras tried to bypass the finance ministers last week, who have to sign off on any aid disbursement, to make his case directly to German Chancellor Angela Merkel and French President Francois Hollande at a summit in Brussels.

With the prospect of a default hanging over the session, Slovenia’s Dusan Mramor urged the group to consider a “plan B” to mitigate the fallout if negotiations fail. Others echoed his calls. In their public comments, EU Economic Commissioner Pierre Moscovici and De Guindos both said there was no plan B, while Dijsselbloem refused to comment on the prospect, saying it would only fuel speculation in the media.

“Any mention of a plan B is profoundly anti-European,” Varoufakis said in an interview with Euronews.

Before the session broke up and Dijsselbloem briefed the media, Varoufakis implored him to say that progress had been made toward a deal on releasing aid.

“There are still wide differences to bridge,” Dijsselbloem said, standing alongside European Central Bank President Mario Draghi, Moscovici, and head of the European Stability Mechanism Klaus Regling. “Responsibility mainly lies with Greek authorities.”

According to two eurozone officials, Mr Dijsselbloem phoned Mr Tsipras from Riga in an effort to mend fences after Friday’s feisty eurogroup meeting, where Mr Varoufakis was rounded on by his eurozone colleagues.

In a sign that Mr Varoufakis’s combative approach is prompting concern in Greece as well, a senior Athens official said the Riga meeting was likely to lead to him being sidelined as Mr Tsipras and his deputy Yannis Dragasakis take a more hands-on role.

Amid the acrimony, differences over a new list of reforms that is to be agreed by Athens were barely discussed at the meeting, putting off indefinitely a deal to unlock access to the funds left from Greece’s €172bn bailout.

The approval rating for the government’s strategy has plunged to a measly 45.5%, from 72% just last month, according to a new poll. A terrible cliff dive.

On a scale of 0 to 10, the administration got whacked in its details, earning 4.6/10 on the economy, 3/10 on immigration, 3.7/10 on crime-fighting and security, 4.2/10 on education, 5.5/10 on foreign policy and defense, 4.5/10 on public administration, and 4.4/10 on health.

Only 3% of the Greeks were confident their household finances would improve over the next 12 months, while 26.5% expected their situation to get worse, and another 15% were certain it would get worse.

How did they feel about a “Grexit” – and a return to the drachma? “Fear!” That’s what 56% said – up from 45.5% in March. Only 23% claimed they were indifferent, down from 26.5% last month. And just 9% thought there was no chance of it happening, down from 17% in last month.

Greece’s exit from the Eurozone and return to the drachma, of which it could print an endless amount to pay its bills and salaries and other schemes, would entail a vertigo-inducing devaluation, and all that comes with it.

The Greeks know how that program works. They have experienced the drachma. They see it as a tool by which the government tries to steal from them. They don’t trust their government with the administration of a currency any more than they trust their banks. And Greek parliamentarians don’t want the drachma either. They want their rich pensions to be paid in euros, not in devalued drachmas.

Thus, a Grexit is off the table as far as threats is concerned. It might happen, but it can’t be used as a threat to extort better terms from donor countries. The Greek game-theoreticians can evoke it all they want to, through leaks and on the record, and they can bandy about the threat of blowing up the world markets, but if they want to stay in power and if they want to face their people at home, they can’t go down that road.

Alas, all their negotiating partners know that too. The global financial markets know that. They all could digest a Grexit, but the Syriza government could not. Time to stop playing games and start talking in earnest. Or face some very, very angry folks at home.