A new Fraser Institute report raises serious questions about the veracity of the Ontario government’s claim that a new provincial pension plan, intended as a supplement or alternative to restructuring and expanding the Canada Pension Plan, is needed because of a savings shortfall among retiring Ontarians.

The justification for the new pension plan, outlined in the Ontario Retirement Pension Plan Act — which was passed in the spring and is set to be implemented in 2017 — is that, “a significant portion of today’s workers are not saving enough to maintain their standard of living when they retire.”

As we have previously argued on this subject, however, the claim that retirees are not sufficiently funded — both with savings and existing pension benefits — is dubious. Indeed, a wealth of evidence suggests that a majority of Ontarians are saving enough through private and public investment vehicles to maintain their standard of living through retirement. On this ground alone, we should be skeptical of the Wynne government’s proposal.

But the Fraser report goes further in demonstrating that the fruit of more government-mandated savings schemes — which is what the Ontario Pension Plan will effectively be — would likely be offset in private savings. At least this is what happened before, according to the study, when mandatory increases to Canada Pension Plan (CPP) contributions came into effect in the late 1990s.

With each new percentage point of earnings mandated for contribution, the report finds, there was a “substitution effect,” namely a 0.895 per cent drop in voluntary savings. In other words, an additional dollar contributed to the CPP led to a proportionate decrease in the average household’s private savings. If such findings prove consistent with the implementation of this provincial plan, then the entire exercise will be a waste, leading to greater government control over retirement savings than is currently the case.

As co-author Charles Lammam told the Financial Post, “If (Canadians’) income and (lifestyle) preference(s) do not change, and the government mandates additional savings through government pension plans, Canadians will simply reshuffle their retirement savings, with more money going to forced savings and less to voluntary savings.”

The report also rightly points out that government-mandated savings offer less flexibility than private savings vehicles such as RRSPs, which allow Canadians to withdraw money to pay for a home or their education. Of course, reduced private savings mean not only fewer options for what one can do with those savings, but also greater dependence on government to doll out one’s retirement income.

Perhaps the worst part of this story is the way Ontario’s new pension plan is being sold as a kind of gift from the government, rather than a further burden to be borne by workers for the sake of questionable outcomes. The government will be taking your money for safe keeping, thus forcing you to save on its terms.

Moreover, maximizing the return to pensioners is not the only goal here: it is also going to provide “new pools of capital” for government projects; in other words, a tax hike under the guise of a retirement savings plan. And by diverting money from private investments, it will reduce the amount of capital available to the business world — the economic engine of our country that, unlike government, actually creates wealth and encourages job growth.

It would be far better to encourage private savings, thus giving individuals and households more control over their financial planning, rather than making them more beholden to the unreliable investment prerogatives of the government of Ontario. That would be a retirement savings plan worth supporting.

In a nutshell, here are the main benefits of DB pensions worth highlighting:

• Provide predictable retirement benefits not subject to vagaries of public markets
• Pool longevity risk and investment risk
• Lower costs significantly by bringing assets internally, avoiding fees charged by many closet indexers and external managers
• Invest in public and private markets directly or externally with some of the best global money managers. Private equity is trying to tap the DC pension space but this won't change the fact that DB pensions have an advantage because they invest directly into private markets and funds, and co-invest with GPs on large transactions.
• The alignment of interests is much better in DB pensions than DC pensions

Finally, there is one big myth that really irks me which I want to lay to rest. The assets of Canada's top ten and most other DB pensions are a product of investment gains over the long-run. Contributions from employees and sponsors make up a small part of assets. Over 2/3 of the growth in assets comes from investment gains, not contributions, a true testament of the power of compounding but more importantly, of  the governance of these plans which allows them to attract professionals who can add significant value-added over public market benchmarks, lowering the cost of these plans.

The world’s biggest hedge fund has turned on the world’s fastest-growing economy.

Bridgewater Associates LP, one of Wall Street’s more outspoken bulls on China, told investors this week that the country’s recent stock-market rout will likely have broad, far-reaching repercussions.

The fund’s executives once had been vocal advocates of China’s potential. But that was before panic in the country’s stock markets shaved a third of the value off Shanghai’s main index, battering hordes of mom-and-pop investors and hedge funds alike, before partially rebounding.

“Our views about China have changed,” Bridgewater’s billionaire founder, Raymond Dalio, wrote with colleagues in a note sent to clients earlier this week. “There are now no safe places to invest.”

Bridgewater, which has $169 billion under management, is renowned for its ability to navigate global economic trends—including the profit it turned in 2008, when most of its peers lost big. The company’s flagship fund reported its worst month in nearly a year in June, trimming its gains for 2015 to about 10%, a person familiar with the matter said.

A spokeswoman declined to elaborate on the fund’s changing views on China.

The move adds Mr. Dalio and Bridgewater to a growing chorus of high-profile investors who are challenging the long-held view that China’s rise will provide a ballast to a whole host of investments, from commodities to bonds to shares in multinational firms. For a generation, bets on China’s rising middle class have been commonplace on Wall Street and beyond as investors have looked to diversify their holdings.

But with the country’s stocks on a roller-coaster ride this summer, those beliefs are being tested. The world’s second-largest economy faces renewed questions about the sustainability of its growth and the government’s commitment to loosening its grip on the country’s heavily controlled markets.

Kingdon Capital Management LLC, a nearly $3 billion New York hedge-fund firm, told clients this week it had sold all its shares in Chinese companies listed on the Hong Kong exchange. It said it was spooked by the fallout from a surge in China in the use of borrowed money to purchase stocks, particularly after authorities cracked down on the practice, helping drag down Kingdon’s investments.

The firm said it would wait until the level of such borrowing in the market drops further before going in anew.

The shifts by Kingdon and Bridgewater follow a series of concerns raised publicly last week about China by other high-profile hedge-fund managers, including Elliott Management Corp. founder Paul Singer, Perry Capital LLC founder Richard Perry and Pershing Square Capital Management LP founder William Ackman. In China, few traders dare cross regulators by publicly expressing their concerns.

“It looks worse to me than 2007 in the United States,” Mr. Ackman said during an investment conference in New York, pointing to the unreliability of the government’s economic statistics. “Much worse.”

Mr. Ackman has a long-running bet against nutritional-products maker Herbalife Ltd., partly based on his belief that the firm’s fast-growing Chinese business is illegal and part of a global pyramid scheme.

Herbalife has denied the allegations.

The shifts are also a blow to Chinese leaders who have sought to woo international investors into their tightly controlled market. Even before the selloff, global investors from hedge funds to big mutual-fund firms had been reluctant to invest directly in the country, despite the Chinese government’s efforts to make it easier for foreign investors to buy mainland-listed stocks, known as A-shares. Aggressive measures to stem the rout underscored concerns about China’s unpredictable government and lack of transparency, investors say.

Overseas investors have pulled cash out of Chinese stocks via a trading link between Hong Kong and Shanghai for 12 of the past 13 trading days, according to Hong Kong stock-exchange data.

At its trough on July 8, the Shanghai Composite Index was off 32% from its June highs. Even days after the market began to climb back, about half of the 2,800 stocks listed on the Shanghai and Shenzhen markets remained suspended from trading, though many have since resumed.

The Shanghai Composite edged up 0.2% Wednesday but remains down 22% from its high in June. The smaller Shenzhen market, where nearly a quarter of stocks remain suspended from trading, rose 1% Wednesday.

The stock-market rout adds to a growing list of hurdles China faces. While its economy expanded at a 7% annual rate in the second quarter—a level many economists thought would be hard to reach—many areas, such as building and infrastructure investment, showed weakness even after a succession of recent interest-rate cuts. China’s political leaders are also pushing to reduce the dependence of its slowing economy on export-driven growth and to lessen the heavy debt load of state-owned firms.

Some big investors in the region still see a chance to pounce. Eashwar Krishnan, who runs the $3 billion Hong Kong-based Tybourne Capital Management (HK) Ltd., said in a note to investors earlier this month that he has been heartened by regulators’ efforts to clean up the market and is “now looking through the rubble for other diamonds in the rough” to bolster Tybourne’s sole A-shares position.

Mr. Krishnan, formerly the Asia head of Lone Pine Capital LLC, had previously steered clear of Chinese shares as Shanghai stocks doubled in a year due to Mr. Krishnan’s concerns over what he called “clear” market manipulation and a worrying surge in individual investors borrowing money to buy stocks. A firm spokesman didn’t respond to requests for comment.

The change by Bridgewater is a particularly sharp reversal. Mr. Dalio has gone out of his way in the past to praise Chinese President Xi Jinping and has compared the country’s economic environment to a patient undergoing a heart transplant by a skilled surgeon.

In a note to clients in June, Mr. Dalio said China’s problems “represent opportunities” because they give policy makers a chance to make positive reforms. As recently as earlier this month, Mr. Dalio wrote that the stock-market move was “not significantly reflective of, or influential on, the Chinese economy, Chinese investors, or foreign investors,” with the market still largely driven by a small pool of speculative investors in China.

But this week, Mr. Dalio said he was particularly alarmed about the psychological damage of the stock-market decline. While prices remain above their levels from two years ago, many ordinary investors are sitting on losses because they piled in more recently, he said.

“Even those who haven’t lost money in stocks will be affected psychologically by events, and those effects will have a depressive effect on economic activity,” Mr. Dalio wrote.

"The observations that were made simply noted that falling stock prices have a negative wealth and negative psychological effect. When a classic stock market bubble (supported by unsophisticated investors buying stocks on a lot of margin) bursts there are negative growth effects. When combined with the debt and economic restructurings underway, that will most likely result in slower growth, and more stimulative [sic] government policies to offset these downward pressures," Bridgewater said in a statement.

"Bridgewater's view that China faces debt and economic restructuring challenges, and that it has the resources and the capable leaders to manage these challenges, remains the same."

Copper traded near the lowest since 2009 as Chinese manufacturing data added to evidence that demand is slowing in the world’s biggest user of raw materials.

The preliminary Purchasing Managers’ Index from Caixin Media and Markit Economics unexpectedly fell to the lowest in 15 months. Goldman Sachs Group Inc. predicts lower copper prices, and traders and analysts were the most bearish since May in a Bloomberg survey.

“China is very negative for metals today,” John Meyer, a mining analyst at SP Angel Corporate Finance LLP in London, said by phone. “There’s been a significant slowing of the economy. Construction and infrastructure spending has collapsed.”

Copper for delivery in three months on the London Metal Exchange fell as much as 1.5 percent to $5,191.50, the lowest since 2009. Prices are heading for a 4.3 percent drop this week, the worst loss since January.

Expanding gluts have pummeled markets for raw materials, with the Bloomberg Commodity Index dropping to the lowest in 13 years. Goldman Sachs says demand for copper in China, which consumes about 40 percent of the world’s supply, is poised for the slowest expansion in almost two decades.

While Goldman is bearish, Citigroup Inc. predicts copper will climb more than 15 percent by the year-end, helped by rising demand in China from consumer goods and the power grid.

Accelerating Demand

“We think that sustainable copper demand will accelerate,” said Ed Morse, head of commodities research at Citigroup. Prices are “approaching the lows, if not at the lows,” he said on Bloomberg Television.

Copper pared declines on Friday after data showed stockpiles in warehouses tracked by the Shanghai Futures Exchange fell to the lowest level since December.

The Chinese factory gauge was at 48.2 for July compared with a median estimate 49.7. Numbers below 50 indicate contraction.

“We have continued to see unrelenting selling pressure from Chinese investors, which has been the main weight on metals prices this week,” Nicholas Snowdon, an analyst at Standard Chartered Plc in London, said by e-mail. “A larger net short position from China’s investors is possible.”

The slump is driving down shares and increasing pressure on miners to trim costs. Freeport-McMoRan Inc., the biggest publicly traded producer of copper, fell the most in six months on Thursday after Chief Executive Officer Richard Adkerson told investors that “all options are on the table,” including asset sales and curtailing operations.

Macquarie Group Ltd. said July 16 that copper will find support in the mid-$5,000s a metric ton. Barclays Plc said this month that there was a floor at $5,000 and the metal had the greatest upside potential.

Nickel lost 1.2 percent, while lead and zinc fell more than 0.3 percent. Aluminum gained 0.2 percent.

“There are a lot of macro headwinds coming together to press commodities lower,” Francisco Blanch, head of global commodities research at Bank of America Corp., said this week. “I envision a few more months of commodity weakness.”

Former Federal Reserve Chairman Alan Greenspan is sounding the alarm about a bubble that he believes is forming in the bond market.

In two television interviews in recent days, Greenspan said interest rates could shoot higher and derail the economy when the bubble bursts.

The former Fed chairman says the current situation in the bond market is comparable to what happens in the stock market during an equity bubble.

Noting that stock-market bubbles are typically characterized by extreme price-to-earnings ratios, Greenspan said extremely low yields are telling a similar tale for bonds.

“If you turn the bond market around and you look at the price of bonds relative to the interest received by those bonds, that looks very much like the usual spread which would concern us if it were equities, and we should be concerned,” Greenspan said in an interview with Fox Business Network.

In an earlier interview with Bloomberg Television, Greenspan said it was appropriate to be very afraid of the bubble. He said the bond market price-to-earnings ratio was at an “extraordinary unstable position.”

Greenspan said “normal” interest rates have always been in the 4% to 5% range.

Yields on the 10-year Treasury have been below 4% since the summer of 2008. The yield is up slightly to 2.217% in Wednesday morning’s trade.

“We have pressed the interest rates well below normal for a protracted period of time and the danger is they will come up to back up to where they have always been,” the former Fed chairman said.

“There are two possibilities. Either we move slowly back to normal, or we do it in a fairly aggressive manner. History tells us it’s the latter which tends to be more prevalent than the former,” Greenspan said.

The market impact will be “not good,” he said.
http://pensionpulse.blogspot.ca/2015/05/the-bigger-short.html
In an interview with MarketWatch last year, Greenspan said that when bubbles emerge, they take on a life of their own.

Treasury yields declined Thursday for a second day, trading at their lowest level since May 29, as traders take a more dovish interpretation of the minutes from the Federal Reserve’s July meeting.

A continuing slump in oil prices, with the September contract closing in on $40 a barrel, along with growing concerns about the disinflationary effects of China’s economic woes on the U.S. economy also weighed on Treasury yields.

While the content of the Fed’s minutes was mixed, with positive growth comments but evident uncertainty on inflation, “the Treasury market settled on a dovish interpretation,” said Jeff MacDonald, director of fixed-income strategy for Fiduciary Trust Company International.

That pushed yields lower both after the release of the minutes Wednesday afternoon and overnight. The decline persisted Thursday morning, after the Labor Department said the number of people who applied for U.S. unemployment benefits in mid-August rose for the fourth straight week. Even so, the number remains at a low level, which indicates the labor market is still improving.

The yield on the 10-year Treasury declined 2.1 basis points to 2.108%, the lowest point since May 29, according to Tradeweb. The yield on the two-year note inched 0.9 basis point higher to 0.666% and the yield on the 30-year bond shaved off 3.7 basis points to 2.782%, its lowest level since May 1.

Treasury yields fall when prices rise and vice versa.

The yields on short-term Treasurys rose slightly because they are more sensitive to rate-hike expectations. An interest-rate hike in September is still on the table, but its market-implied probability was reduced Thursday morning to 36%, while a move in December was marked down as 66% probability, according to data from London Capital Group.

Conversely, yields on long-term Treasury maturities were pulled down by declining inflation expectations and the concerns of the ripple effects on the U.S. economy of the Chinese yuan devaluation and emerging markets’ underperformance.

“The basic worry here is that the U.S. might soon be importing deflation,” MacDonald said.

Government bond yields declined in the eurozone as well, as European stocks slid and investors sold equity in favor of safer assets, like bonds. Investors also welcomed the news that Greece received its first tranche of bailout money from the European Stability Mechanism and repaid on Thursday morning 3.4 billion euros ($3.8 billion) to the European Central Bank.

The yield on the benchmark German 10-year bund declined by 5.3 basis points to 0.584%.

• The global jobs crisis: Jobs are vanishing all around the world at an alarming rate. Worse still, full employment jobs with good wages and benefits are being replaced with partial employment jobs with low wages and no benefits.
• Demographics: The aging of the population isn't pro-growth. As people get older, they live on a fixed income, consume less, and are generally more careful with their meager savings. The fact that the unemployment rate is soaring for younger workers just adds more fuel to the fire. Without a decent job, young people cannot afford to get married, buy a house and have children.
• The global pension crisis: A common theme of this blog is how pension poverty is wreaking havoc on our economy. It's not just the demographic shift, as people retire with little or no savings, they consume less, governments collect less sales taxes and they pay out more in social welfare costs. This is why I'm such a stickler for enhanced CPP and Social Security, a universal pension which covers everyone (provided governments get the governance and risk-sharing right).
• Rising inequality: The ultra wealthy keep getting richer and the poor keep getting poorer. Who cares? This is how it's always been and how it will always be. Unfortunately, as Warren Buffett and other enlightened billionaires have noted, the marginal utility of an extra billion to them isn't as useful as it can be to millions of others struggling under crushing poverty. Moreover, while Buffett and Gates talk up "The Giving Pledge", the truth is philanthropy won't make a dent in the trend of rising inequality which is extremely deflationary because it concentrates wealth in the hands of a few and does nothing to stimulate widespread consumption (I know, we can argue that last point but for the most part, you know I'm right).  
• High and unsustainable debt in the developed world: Government and household debt levels are high and unsustainable in many developed nations. This too constrains government and personal spending and is very deflationary.
• Technology: Everyone loves shopping on-line to hunt for bargains. Technology is great in terms of keeping productivity high and prices low, but viewed over a very long period, great shifts in technology are disinflationary and some say deflationary.

U.S. stock investors take a breather. The market is nearing its bottom, Jeffrey Saut, chief investment strategist at Raymond James, said Friday.

"Our timing models call for a low between Aug. 13 and Aug. 18, with a plus-or–minus three-day margin of error, so today it feels like capitulation," Saut said in a CNBC " Squawk Box" interview.

Saut made his remarks after U.S. equities recorded their worst trading day in about a year and a half. The Dow Jones industrial average fell nearly 360 points, while the S&P 500 turned negative for the year, as a massive fall in oil and global growth concerns weighed on investor sentiment.

"We're nearing the bottom. We knifed through the July support yesterday. It was pretty ugly. You would look for some kind of bottom either sometime today or the middle of next week," Saut added.

"I've been in this business for over 45 years and I've seen this act before," he said. "It's kind of like pornography. You know it when you see it."

Todd Gordon, founder of Tradinganalysis.com, also said in the same interview that investors need to relax.

"What has happened really? Has any real damage been done to the uptrend in the market? I'm not so sure. I mean, we have China falling down, emerging markets are seriously on the brink of another extended leg down, but there's a lot of talk that the [upward] trend has been broken, and I don't think there's any significant technical damage done," Gordon said.

"The stock market has done nothing but flatten out, which has allowed those longer-term moving averages to kind of play catch-up," he added.

Nevertheless, Saut of Raymond James also said it has been a while since he's seen this much fear in the market. "I have not seen this much fear since the spring of 2009, and we're only 4.5 percent off of the highs," he said.

China is becoming a fortress economy like the US, moving to its own internal rhythm. This is unpleasant for countries like Brazil that make a living supplying China with raw materials, but not for China itself. As Stephen Jen from SLJ Macro Partners puts it, the Chinese downturn is "soft on the inside and hard on the outside."

Nor is there any need to risk a currency war. The economy has been generating 1.2m jobs a month this year. There are still more vacancies than candidates.

The offers-to-seekers ratio has risen from 0.65pc in the early 2000s to 1.06pc. It has come down sharply this year - and needs watching - but the flood of migrant workers from the countryside has dried up as China's passes the "Lewis Point". The wages of migrant workers are still rising at a rate of 10pc. The labour market is tight.

None of this is to say that China's economy is healthy. Credit still rising by seven percentage points of GDP each year, pushing the debt ratio ever further into the danger zone. It will be 270pc by next year. This will end badly.

But China is not in immediate crisis. The Reserve Requirement Ratio (RRR) for banks is still 18.5pc. The PBOC can slash this to 6pc - as did in the late 1990s - flooding the system with $3 trillion of liquidity. It can even go to zero in extremis.

The time to worry is when China has exhausted this last buffer. This August scare of 2015 is a false alarm.

Chicago pension officials wanted to know where to deposit the $11 billion that the city’s teachers had saved for their retirement benefits, so they turned in 2014 to the outside consulting firm they’d hired for financial advice. Such consultants are employed to provide guidance that's expected to be impartial -- not shaped by private business relationships that might make its recommendations less than objective.

So when the firm, Callan Associates, told pension trustees at a February meeting to give the cash to a bank called Bank of New York Mellon (BNY), the board’s trustees agreed to follow the advice. What they were not told at that meeting, however, is that BNY pays Callan for both general consulting services and financial education programs.

Those payments, say financial experts, represent an inherent conflict of interest. They effectively strip consultants like Callan of their objectivity by giving them an incentive to push their pension clients to use banks that are paying the consulting firms, the experts say.

Government regulators and auditors have in recent years raised concerns about undisclosed business relationships between financial institutions and consultants who are supposed to provide objective counsel. Auditors have documented lower investment returns at pension funds that rely on consultants with divided loyalties.

In Chicago, the conflicts could prove particularly costly for the city’s taxpayers and 63,000 educators. That’s because the bank Callan recommended, BNY, is a Wall Street behemoth that has repeatedly faced law enforcement action for skimming money from its clients. In fact, just after Chicago handed over teachers’ money to the bank, BNY agreed to pay more than $700 million to settle federal charges against it for defrauding its pension fund clients. Callan had previously faced sanctions from the Securities and Exchange Commission (SEC) for failing to disclose to clients that it was getting payments from BNY Mellon in exchange for referring brokerage business.

Callan did not respond to International Business Times' questions about its financial relationships. In its marketing material and financial disclosure documents, the firm has said, "We are independently owned and operated with interests that are precisely aligned with those of our clients.”

Ted Siedle, a former SEC attorney, said he sees no alignment of interests for Callan clients.

“It’s clear that Callan has conflicts of interest, and it’s likely those conflicts have an adverse effect on performance," he told IBTimes.

Feds Taking ‘A Careful Look’

In recent years, conflicts of interest in the shadowy world of finance have drawn increased attention from regulators and policymakers. In the wake of the financial crisis, lawmakers uncovered evidence that banks were pushing clients into investments that the banks themselves were betting against. That prompted deeper concerns about conflicts of interest and ultimately led the U.S. Labor Department to propose a rule mandating that financial advisers to individual investors provide advice that is solely in the interest of their clients.

But while the department has considered a similar rule for those advising pension funds, such an initiative has not moved forward.

In the absence of such a regulation, Rep. George Miller, D-Calif., sent a letter to the Department of Labor in 2014 saying the agency needs to "take a careful look” at conflicts of interest with pension consultants. In response, Phyllis Borzi, the Labor Department official in charge of regulating pensions, said the department was “committed to addressing" such conflicts in regard to pensions.

Evidence of conflicts has been mounting. In 2005, the SEC surveyed 24 major investment consultants and found that 13 had significant conflicts of interests that they had disclosed to investors. One of those firms investigated was Callan Associates. Using the findings of the SEC’s 2005 review, the Government Accountability Office (GAO) later found that pension funds that used conflicted consultants had 1.3 percent lower rates of returns than those that did not. As of 2006, those consultants were helping manage $4.5 trillion of assets.

If the GAO’s estimates are accurate, conflicted consultants cost pension funds $58 billion in unrealized returns every year.

Controversies surrounding financial conflicts of interest have periodically generated headlines.

In 2004 , Mercer, a major consultant, was criticized for receiving money from asset managers it recommended to pension funds, specifically in Santa Clara, California. In 2009, Consulting Services Group was criticized in an investigation for recommending that the pension fund of Shelby County, Tennessee, invest in its own hedge fund, which paid large fees to the company. In 2013, New York's Superintendent of Financial Services Benjamin Lawsky subpoenaed documents from 20 of the largest investment consulting firms, reportedly to evaluate their potential conflicts of interest (the results of Lawsky’s investigation have not yet been made public).

Most recently, in December 2014, IBTimes reported that the San Francisco pension fund's consultant, Angeles Investment Advisors, was pushing the city to allocate 10 percent of its portfolio to hedge funds but did not disclose that its own firm reserves the right to collect additional fees from pension clients when those clients invest in hedge funds. Angeles was later fired by the pension fund in favor of a company that claims to have fewer conflicts of interest.

‘The Bank Was Stealing’

In Chicago, where the teachers pension fund trustees are both educators and appointees of Mayor Rahm Emanuel, questions about conflicts of interest were not about investments. Instead, they were about which bank should get the lucrative contract to receive and disburse the pension fund’s $11 billion in assets.

In February 2014, when Callan recommended that pension trustees choose BNY for these so-called custodial services, Callan’s representatives did not explicitly tell pension trustees of their firm’s relationship with BNY or the 2007 SEC enforcement action against the consulting firm. Callan’s 2013 report on Chicago’s private equity investments did briefly mention the firm’s business with BNY, but pension trustees interviewed by IBTimes said they were unaware of the relationship.

At the February meeting, Callan also did not mention any of the ongoing legal issues related to BNY Mellon and its performance as a custodian for pension funds, even though the bank was just then the subject of law enforcement scrutiny. Indeed, one month after Chicago’s gave BNY the deal for custodial services, BNY agreed to pay $714 million to settle claims against it for bilking its pension fund clients by manipulating the rate at which pension funds’ currency holdings are traded internationally.

U.S. Attorney Preet Bharara, who brought the federal charges against BNY, said at the time that public pension funds "trusted the bank to be honest about the financial services it was providing and to deal with them fairly.” But, charged Bharara, BNY "and its executives, motivated by outsized profits and bonuses, breached this trust and repeatedly misled clients” about the currency rates they were charging their clients. Specifically, prosecutors said, the bank got the best currency exchange “rates for itself, gave its customers the worst or close to the worst rates, and kept the difference for itself.”

The federal investigation and lawsuit had been ongoing since 2011 but went unmentioned by Callan in its recommendations. At the time of the settlement, the New York Times reported that a BNY Mellon employee had been quoted in an email asking if it was “time to retire after raping the custodial accounts.”

The $714 million paid by BNY Mellon is negligible, however, compared with estimates provided by investigator Harry Markopolos, who first blew the whistle on the scam in 2011. In an interview with King World News, reported by Business Insider, Markopolos placed the scale of damages far higher -- at more than $2 billion. 

IBTimes asked Chicago teachers pension staff members if they had been informed about Callan’s conflict of interest with BNY Mellon and if they are concerned that such a conflict may have encouraged Callan to avoid mentioning the problems surrounding BNY’s custodial services. The fund’s executive director, Charles Burbridge, said that he has “not had the opportunity to look into the issues."

BNY Mellon declined to comment in response to questions from IBTimes. In a statement in March, the bank declared that it is pleased to put the “matters behind us, which is in the best interest of our company and our constituents.”

Finance experts question whether pension funds should continue to trust their money with BNY Mellon.

“It's hard to see how any fiduciary can keep doing business with BNY Mellon after these revelations,” Susan Webber, principal of Aurora Advisors, a financial consulting firm, said. “BNY Mellon flagrantly misrepresented its foreign exchange trading practices to customers. Consistently reporting the worst or nearly the worst price of the day to clients means the bank was stealing.”

For Siedle, the former SEC attorney, Chicago’s relationship with its consultant and decision to deposit retirees’ money in BNY is a cautionary tale that should prompt action.

“With the nationwide attack on defined-benefit pensions,” he said, “it is now more urgent than ever that Chicago teachers and other pension funds across the country launch independent investigations into how conflicts of interest have affected their portfolio.”

Hundreds of school districts across Illinois cover either all or most of their teachers’ retirement contributions.

The issue is in the spotlight as Illinois’ largest district is in the middle of tense contract negotiations and the cash-strapped district is seeking help from legislators.

The Chicago Tribune reports thousands of teachers get a better deal than Chicago teachers.

Some districts, including in suburban Wheeling, say picking up pension costs helps keep them competitive. Some unions have also argued it’s a cost saver because if the money was paid as a salary it would be subject to payroll tax.

Mayor Rahm Emanuel wants teachers to pay the full contribution. The cash-strapped district has paid most of the 9 percent contribution. The Chicago Teachers Union argues that amounts to a pay cut.

Hedge-fund managers like to promise their investors protection from market swings. In the recent stock swoon, many were caught off guard.

Billionaire managers such as Leon Cooperman, Raymond Dalio and Daniel Loeb are deeply in the red this month, left flat-footed by the quick plunge for stocks world-wide. Mr. Cooperman’s Omega Advisors posted a 12% decline this month through Wednesday and 10% this year. Mr. Loeb’s Third Point LLC and William Ackman’s Pershing Square Capital Management are also down big, erasing their gains for the year.

Other traders suffered amid this week’s volatility. Monday, when the market collapsed more than 1,000 points in its largest ever intraday point decline, marked one of the worst days for many managers since the crisis.

That is a hit to an industry that has for years excused its relative underperformance compared with benchmarks by promising that collections of bets on and against markets—a so-called long/short strategy—would insulate the impact of any future market gyrations.

“We’ve struck out this month so far,” said one hedge-fund manager.

There is some evidence that hedge funds are offering some protection in the deluge, since many are doing better than the 7.8% drop in the S&P 500 index this month. Stock hedge funds are down on average 5% this month, according to researcher HFR Inc.

A turnaround may yet be in the cards for some star managers. Mr. Cooperman’s Omega, for instance, was down 15% through Tuesday, but found some relief Wednesday as bets on U.S. and Japanese equities began to recover some losses.

Omega was up 3% on Wednesday alone, and Mr. Cooperman maintains his conviction that the bull market is alive, according to a person familiar with his thinking.

Hedge funds collect some of the highest paydays on Wall Street because they promise to be uncorrelated, or move out of sync, with the markets at large.

“If you were expecting all hedge funds to be a hedge against market downside, that obviously wasn’t the case here,” said Neal Berger, chief investment officer at hedge-fund investor Eagle’s View Capital Management LLC. He said he preferred managers with less exposure to the stock market.

Problems have been compounded, in the short-term at least, by a widespread conviction that the recent plunge will be followed by a fast snap back. Managers bought a record number of stocks earlier this week, Morgan Stanley said. While the S&P 500 rose nearly 4% Wednesday, it remains down for the week.

Representatives of Mr. Loeb’s Third Point, for instance, have told clients he maintains convictions in Third Point’s core positions, and is looking to add to them on what the firm sees as a short-term dip.

Third Point was down about 7% for the month through early this week, people familiar said. Third Point was up 5.7% through the end of July.

Activist managers, who became the darlings of Wall Street in recent years, are struggling in particular.

The outspoken Mr. Ackman’s Pershing Square ran into a wall, losing more than 10% to fall into the red for the year. In a letter to investors Wednesday, the firm blamed “significant volatility” and fears about China.

Activist Nelson Peltz’s Trian Fund Management is down 5.7% through Wednesday, pushing the firm into negative territory for the year, according to a person familiar with the firm.

David Einhorn’s Greenlight Capital is in a worse spot, down about 5% this month alone through earlier this week, and in the red by double digits in the year to date, according to a person familiar with the matter. For Mr. Einhorn, who in his most recent quarterly letter told investors he was struggling to find new ideas when “perception supplants reality,” troubles are compounded by an emphasis on hard-hit stocks like Micron Technology Inc. and SunEdison Inc.

Even managers not yoked to the stock market, like the world’s biggest hedge fund, Bridgewater Associates, are struggling. With Bridgewater down 4.7% for the month through Friday, its boss Mr. Dalio sent a note to clients Monday—later posted publicly—with a rather contrary view: that the Federal Reserve may launch a fresh round of quantitative easing rather than dramatically tighten.

Market observers had lately coalesced around a view that the Fed was likely to raise its historically low interest rates in September for the first time since 2006.

Late Tuesday, as Mr. Dalio’s prediction began to gain attention, he added an addendum to the public note, hedging his assessment. “To be clear, we are not saying that we don’t believe that there will be a tightening before there is an easing,” Mr. Dalio wrote. “We are saying that we believe that there will be a big easing before a big tightening.”

Bridgewater remains in the black for the year.

Just after the Dow Jones Industrial Average plunged over 1,000 points on Monday morning, New York-based hedge fund manager Sahm Adrangi sent around his weekly note showing his fund lost 2 percent so far in August. His conclusion regarding the market turbulence: it's a buying opportunity.

Adrangi, whose $350 million Kerrisdale Capital is still up 10 percent so far this year, stands with several other well-known hedge fund managers in saying they're staying the course in U.S. equities markets, including Leon Cooperman's Omega Advisors and Larry Robbins' Glenview Capital. Omega has lost 11 percent this month and Glenview is down 5.5 percent.

Still, "we are not getting a signal from the corporate sector or our analysts that there has been any deterioration in outlook," said Steven Einhorn, a partner at Omega Advisors, who said his firm believes stocks will rebound.

While that view may not be shared by investors whose fortunes depend on such things as the price of oil or the health of the Chinese economy, most hedge fund managers contacted by Reuters remain upbeat about prospects for U.S. stocks even after the Dow tumbled 3.6 percent and the Standard & Poor's 500 index dropped 3.9 percent in a single day. For the year, the Dow is down almost 11 percent and the S&P 500 has lost 8 percent.

Helping accelerate the recent slide, many hedge funds' in-house risk managers have been ordering traders to sell to curb losses during the turbulence. And analysts at Bank of America estimate that hedge funds specializing in stock investments have recently cut their net long exposure to 35 percent from 39 percent.

For some, the selling frenzy indicates how at least part of the investing public is inclined to panic, said David Tawil, who runs Maglan Capital, a hedge fund with about $75 million in assets under management.

"This is like a runaway train and it speaks volumes to the temperament of today's market participants," Tawil said.

Meanwhile, Jeffrey Gundlach, co-founder of DoubleLine Capital, one of the most successful fixed-income fund companies, warned that the sell-off may not be over.

"The market is wounded and it takes time for people to get around to feeling good again," Gundlach said in a telephone interview with Reuters. "You don't correct all of this in three days."

Hedge funds' month end performance numbers are expected in about a week and so far, investors in these funds have shown little taste for racing for the exits. At the same time, managers are not going out of their way to soothe frayed nerves with special calls or intra-month reports.

MUTUAL FUNDS

Unlike hedge funds, which lock up their investors' capital for months at a time, mutual funds have to redeem their investments immediately if their investors, usually people saving for retirement, want out.

Mutual fund Longleaf Partners, run by Mason Hawkins, whose holdings include Chesapeake Energy and Wynn Resorts, is down 16.22 percent so far this year.

While it's not known whether Longleaf has suffered outflows this year, that sort of performance may have accelerated investor exits from U.S. stock funds in August, after clients had already pulled $79 billion out in the first seven months of 2015, marking the fastest annual outflows since 1993.

Hedge funds meanwhile took in $64.3 billion in new cash in all types of strategies in the first seven months of the year.

Some of that cash has flowed into so-called global macro funds that bet big on currencies and recently increased their bets on 10-year U.S. Treasuries, seen as a haven in times of market stress.

Global macro funds rose 0.17 percent for the year through the end of last week while the average stock hedge fund was down 0.16 percent, according to data from Hedge Fund Research.

By the end of Monday, the Balter Discretionary Global Macro, subadvised by Willowbrook Associates' Phil Yang, had gained 1.69 percent in August, partly on a bet that oil prices would keep falling.

Macro funds returned 5.5 percent in the first half of the year, prompting investors to add $8.5 billion in new money alone in July, data from eVestment show.

Rokos Capital Management will initially have the capacity to manage $3 billion, said the person, who asked not to be identified because the information is private. The 44-year-old is awaiting approval from U.K. regulators to start his London-based firm.

Rokos is courting investors three years after leaving Brevan Howard, the hedge fund he co-founded, where he had generated more than $4 billion. He’s starting out as macro funds have underperformed the industry in the last five years.

Rokos Capital’s assets will be divvied up between Rokos, Borislav Vladimirov, a former colleague at Brevan Howard, and Stuart Riley, who used to work as Asia-Pacific co-head of macro trading at Goldman Sachs Group Inc., the person said. Rokos Capital has about 50 employees and has made hires including economist Jacques Cailloux from Nomura Holdings Plc.

Once licensed, Rokos will offer clients a range of fees -- a management levy of 1 percent to 2 percent of assets and a 20 percent to 30 percent cut of profits, the person said.

Dormouse, which was founded in 2011 by former IKOS CIO Martin Coward and opened to outside capital in 2014, booked a gain in July of 5.86%. The tally brings the fund’s year-to-date return to 26.32%, compared with 0.93% for the HFRX Macro/CTA Index.

Dormouse is a quantitative systematic managed futures firm that utilizes rigorous scientific methodologies to test and develop rule-based strategies for investing in global financial markets.

When it opened to outside capital in 2014, Howard described the fund as a systematic multi-strategy fund focusing on identifying under- or over-priced liquid securities across stock indices, fixed income, rates, FX and commodities, and exploiting the increased correlation between asset classes.

Coward, who is generally considered to be one of the pioneers of European quantitative hedge funds, co-founded IKOS in 1992 and led it until December 2009. During his tenure, IKOS' unique trading strategies enabled it to become one of the most successful hedge funds in the world, with peak assets of $3.5 billion.

Following his departure from IKOS, Howard spent most of the next two years battling his estranged wife, IKOS chief Elena Ambrosiadou, in court; the two filed more than 40 lawsuits against each other in four countries, alleging spying, theft and a wide range of other alleged misdeeds.

The legal action culminated in mid-2013 when a British court determined the trading code developed by Howard while he was at IKOS were property of the firm.

A former top trader at Michael Platt’s BlueCrest Capital Management, Braga, 49, saw her fund gain 6.2 percent last month, putting it 3.1 percent up for the year, according to a person familiar with the matter. Her Geneva-based Systematica Investments now runs almost $9 billion, said the person, who asked not to be identified because the data is private.

Computer-driven hedge funds rely on algorithms to make trades and generally make money when trends are consistent. Oil, currencies, bonds and stock indexes all reversed direction in June, in part because of Greece’s decision to walk out of talks with creditors and China’s stock market plunge.

Gains for Braga’s fund, which opened at the start of the year, were more than matched by the smaller $2.9 billion quantitative program run by U.K. firm Cantab Capital Partners, which earned 6.3 percent in July after an 8.6 percent June decline, according to an investor letter seen by Bloomberg. Aspect Capital’s $890 million Diversified Fund rose 9.2 percent last month, a spokeswoman at the London-based firm said.

The gains reflect a wider trend for quant funds. The Newedge CTA Index showed the funds, which trade on futures, gaining 3 percent in July after averaging a loss of 4.2 percent the previous month.

The gain by Odey European, a $3.2 billion strategy that bets on rises and falls in stocks, pared its loss for the year to an estimated 5 percent as of Monday, the person said, asking not to be identified because the information is private.

Odey, 56, is among hedge fund managers profiting from the slump in China, which saw European stocks post the biggest losses since the financial crisis on Monday as the rout spread. His London-based firm, which manages $12.8 billion, told investors in a letter last month that a devaluation in China would mean deflation breaking out across the world.

Odey European’s bets on China had led to a record 19 percent loss in April. It was “attacked on all sides” after wagering China’s economic troubles would cause a slowdown that could embroil the developed world, it told investors.

Omni Macro Fund, managed by Stephen Rosen, is another hedge fund racking up profits. The fund, which manages more than $500 million, climbed 4.9 percent in the month through Aug. 21, a spokesman for the company said via e-mail. Its strategies include betting on the slowdown in China, over-valuation of global equities and a bearish view on commodities via copper futures, he said.

China’s stocks extended the steepest five-day drop since 1996 in volatile trading on Wednesday, as a rate cut failed to halt a $5 trillion rout.

The slump in global equities has resulted in many hedge funds nursing losses. The industry fell 2.3 percent this month through Aug. 21 and 1.1 percent this year, according to the HFRX Global Hedge Fund Index.

Stocks soared for the second day in a row, with the Dow Jones Industrial Average erasing its losses for the week, as renewed optimism about the U.S. economy eased concerns about the pace of global growth.

The gains came amid a broad rebound in financial markets, which had been pummeled by anxiety about China’s slowdown since the world’s second-largest economy shocked investors by devaluing its currency earlier this month.

Oil prices soared more than 10% to their biggest percentage gain in six years amid a surge in commodities.

The Dow Jones Industrial Average jumped 369.26 points, or 2.3%, to 16654.77. Coupled with Wednesday’s 619-point surge, blue chips are now up 1.2% for the week.

The gains are the latest in a week of wild swings for stocks. Traders say the deep declines of Monday and Tuesday left investors eager to snap up stocks on the cheap, although many remain concerned that bigger market swings are here to stay as uncertainty mounts over the course of interest-rate increases by the Federal Reserve.

“It certainly looks calmer, but it’s hard to know how sustainable these moves are,” said Patrik Schöwitz, a global multiasset strategist at J.P. Morgan Asset Management, which has about $1.8 trillion under management globally. “It’s definitely too early to say that the latest bout of volatility is over,” he said.

The S&P 500 gained 47.15 points, or 2.4%, to 1987.66, while the Nasdaq Composite added 115.17 points, or 2.45%, to 4812.71.

Investors have taken solace in the firming pace of U.S. economic growth, as emerging markets look increasingly shaky. Gross domestic product, the broadest measure of goods and services produced across the U.S., expanded 3.7% in the second quarter, the Commerce Department said Thursday, well ahead of expectations and up from an initial estimate of 2.3% growth.

The data showed upward revisions to consumer spending and business investment, while a separate report showed initial jobless claims fell more than expected last week, suggesting the labor market remains healthy.

Oil prices staged a rebound, rising 10% to $42.56 a barrel in New York. That helped spur a recovery in oil and gas stocks, with energy companies in the S&P 500 gaining 4.9%.

“The U.S. economy is still shining,” said Doug Cote, chief market strategist at Voya Investment Management.

The recent tumult in markets globally has left many investors questioning the Federal Reserve’s course on interest-rate increases. While the recent slide in stocks gives them leeway to keep interest rates lower for longer, the stronger pace of economic growth could place added pressure on the central bank, they said. Until recent weeks, many investors were gearing up for an increase in short-term rates at the Fed’s meeting next month.

“There is zero inflation across the globe, so the Fed has cover not to raise rates, but the economy is surging so I’m at 50-50 right now for September,” Mr. Cote said.

U.S. stocks snapped a six-day losing streak Wednesday and on Thursday the rally spread into Europe and Asia. The pan-European Stoxx Europe 600 closed 3.5% higher. The Shanghai Composite Index led Asian markets higher, closing up 5.3% after five consecutive days of losses.

Strategists at Rabobank said in a note to clients that markets were in a “fragile equilibrium.”

On Wednesday, Federal Reserve Bank of New York President William Dudley said the case for a September rate increase has grown “less compelling” given the market turmoil, reassuring investors who may have been concerned that higher rates would put additional strain on markets at a volatile time.

Ultralow interest rates since the global financial crisis have sent stocks sharply higher.

“Markets have for days been looking for some sort of positive cue,” said Paul Markham, an equity investor at asset manager Newton, which has $75.9 billion under management.

He said that cue had in part come from Mr. Dudley’s comments, but “it remains to be seen how long that shot in the arm will last.”

Investors will be watching for more clues from policy makers later Thursday when a conference of central bankers begins in Jackson Hole, Wyo.

Next week, the U.S. labor-market report for August will shed more light on the pace of jobs growth in the U.S.

In currency markets, the U.S. dollar rose against the euro and the yen following the stronger U.S. growth data.

U.S. 10-year Treasury yields were at 2.168%, down marginally. Yields fall as bond prices rise.

While the ECB is in one sense capping yields by buying bonds, this effect could be overwhelmed by fundamental forces if the markets start to price in higher growth. Yields rose rather than fell with each episode of QE in the US.

Bill Gross, the legendary bond guru at Janus, said in April that German Bunds were the “short of a lifetime”. Yields surged threefold and he made a windfall profit.

The great question for the bond market is whether Europe and America are caught in a permanent Japanese deflation trap, or whether their economies are breaking free and returning to normal after six years of chronic malaise. If the latter, the bond sell-off has barely begun.

Melody Petersen of the Los Angeles Times reports, In strategy shift, CalPERS looks to cut financial risk:

California taxpayers have never paid more for public worker pensions, but it's still not enough to cover the rising number of retirement checks written by the state's largest pension plan.

Even before the stock market's recent fall, staffers at the California Public Employees' Retirement System were worried about what they call "negative cash flows."

The shortfalls — which totaled $5 billion last year — are created when contributions from taxpayers and public employees who are still working aren't enough to cover monthly checks sent to retirees.

To make up the difference, CalPERS must liquidate investments.

With more than $300 billion in investments, the nation's largest public pension fund is in no danger of suddenly running out of cash.

But even its staff acknowledges in a recent report that despite fast-rising contributions from taxpayers, the pension fund faces "a significant amount of risk."

To reduce that financial risk, CalPERS has been working for months on a plan that could cause government pension funds across the country to rethink their investment strategies.

The plan would increase payments from taxpayers even more in coming years with the goal of mitigating the severe financial pain that would happen with another recession and stock market crash.

Under the proposal, CalPERS would begin slowly moving more money into safer investments such as bonds, which aren't usually subject to the severe losses that stocks face.

Because the more conservative investments are expected to reduce CalPERS' future financial returns, taxpayers would have to pick up even more of the cost of workers' pensions.

Most public workers would be exempt from paying any more. Only those workers hired in 2013 or later would have to contribute more to their retirements under the plan.

The changes would begin moving CalPERS — which provides benefits to 1.7 million employees and retirees of the state, cities and other local governments — toward a strategy used by many corporate pension plans. For years, corporate plans have been reducing their risk by trimming the amount of stocks they hold.

The plan is the result of CalPERS' recognition that — even with significantly more contributions from taxpayers — an aggressive investment strategy can't sustain the level of pensions promised to public workers. Instead, it could make the bill significantly worse.

At an Aug. 18 meeting, CalPERS staff members laid out their plan for the fund's board, saying the changes would be made slowly and incrementally over the next several decades.

That isn't fast enough for Gov. Jerry Brown. A representative from the governor's finance department addressed the CalPERS board, saying the administration wants to see financial risks reduced "sooner rather than later."

"We know another recession is coming," said Eric Stern, a finance department analyst, "we just don't know when."

Behind the growing cash shortfalls: the aging of California's public workforce. As more baby boomers retire, CalPERS estimates that the number of government retirees will exceed the number of working public employees in less than 10 years.

Another reason for the cash shortages: the large hike in pension benefits that state legislators voted to give public workers in 1999 when the stock market was booming.

CalPERS lobbied for those more expensive pensions. In a brochure, the fund quoted its then-president, William Crist, saying the pension-boosting legislation was "a special opportunity to restore equity among CalPERS members without it costing a dime of additional taxpayer money."

That has turned out to be wishful thinking. Now, cities and other local governments are cutting back on street repairs and other services to pay escalating pension bills.

Chris McKenzie, executive director of the League of California Cities, said governments are in the midst of a six-year stretch in which CalPERS payments are expected to rise 50%.

Some cities are now paying pension costs that are equal to as much as 40% of an employee's salary, according to CalPERS documents.

The cost is highest for police, fire and other public safety workers who often receive earlier and more generous retirements than other employees.

In recent years, three California cities have declared bankruptcy, in part, because of the rising costs.

McKenzie said that despite the escalating pension bills, most cities are in favor of the plan by CalPERS staff. Many city finance officials believe that CalPERS' investment portfolio is currently "too volatile," he said.

About 10% of cities don't support the plan, McKenzie said. "Some said they simply can't afford it," he added.

Representatives from two public employee labor unions speaking at the Aug. 18 meeting said they generally supported the plan.

The plan must be approved by CalPERS' board, which is scheduled to discuss it again in October.

Last year, governments sent CalPERS $8.8 billion in taxpayer money, while employees contributed an additional $3.8 billion, according to financial statements for CalPERS' primary pension fund. Those combined contributions fell $5 billion short of the $17.8 billion paid to retirees.

At the heart of the plan is the gradual reduction in what CalPERS expects to earn from its investments. Currently, CalPERS assumes its average annual investment return will be 7.5% — an estimate that has long been criticized as being overly optimistic.

After several years of double-digit returns, the giant pension fund's investments earned just 2.4% in 2014, according to preliminary numbers released in July.

Under the new plan, as CalPERS moved more money to bonds and other more conservative investments to reduce risk, the 7.5% rate would gradually be reduced.

CalPERS is still recovering from the Great Recession of 2008 and 2009, when it suffered a 24% loss on its investments.

Today its $300 billion in investments is estimated to be only about 75% of what it already owes to employees and retirees. A market downturn would create an even deeper hole.

In presentations, CalPERS told city finance officials that if its investments drop below 50% of the amount owed for pensions, even with significant additional increases from taxpayers, catching up becomes nearly impossible.

That last paragraph is sobering and I think a lot of delusional U.S. pension funds which are in much worse shape than CalPERS are already in a situation where they will never catch up and thus face very hard choices as they scamble to address their perpetual funding crisis.

Importantly, pension funding is all about matching assets with liabilities and it's very path dependent. What this means, in a nutshell, is you're starting point is critical. If you're already in a pension deficit, taking on more risk investing in stocks, high yield bonds, emerging markets, or even real estate, private equity and hedge funds, you might end up digging an even bigger hole for your pension, one you'll never climb out of.

On the investment front, CalPERS is doing what it has to do to reduce risk and stabilize the volatility of its funding level. It wisely nuked its hedge fund program which it never really took seriously and is now looking to reduce risk by increasing its exposure to bonds.

Bonds? Isn't the Fed ready to jack up rates? Why in the world would CalPERS invest in bonds now that so many financial gurus like Paul Singer and Alan Greenspan are warning of a big bond bear market? Shouldn't CalPERS double down here, especially after sustaining huge losses in energy investments, and just bet big on a global recovery?

No, CalPERS is doing the right thing and let me explain why. While we might be on the verge of a cyclical recovery in the global economy placing upward pressure on bond yields, make no mistake, deflationary forces are alive and well and the biggest structural risk going forward for all pensions is deflation, not inflation.

Why is deflation still a major threat? I've outlined six structural factors which are deflationary and bond friendly:

• The global jobs crisis: Jobs are vanishing all around the world at an alarming rate. Worse still, full employment jobs with good wages and benefits are being replaced with partial employment jobs with low wages and no benefits.
• Demographics: The aging of the population isn't pro-growth. As people get older, they live on a fixed income, consume less, and are generally more careful with their meager savings. The fact that the unemployment rate is soaring for younger workers just adds more fuel to the fire. Without a decent job, young people cannot afford to get married, buy a house and have children.
• The global pension crisis: A common theme of this blog is how pension poverty is wreaking havoc on our economy. It's not just the demographic shift, as people retire with little or no savings, they consume less, governments collect less sales taxes and they pay out more in social welfare costs. This is why I'm such a stickler for enhanced CPP and Social Security, a universal pension which covers everyone (provided governments get the governance and risk-sharing right).
• Rising inequality: The ultra wealthy keep getting richer and the poor keep getting poorer. Who cares? This is how it's always been and how it will always be. Unfortunately, as Warren Buffett and other enlightened billionaires have noted, the marginal utility of an extra billion to them isn't as useful as it can be to millions of others struggling under crushing poverty. Moreover, while Buffett and Gates talk up "The Giving Pledge", the truth is philanthropy won't make a dent in the trend of rising inequality which is extremely deflationary because it concentrates wealth in the hands of a few and does nothing to stimulate widespread consumption (I know, we can argue that last point but for the most part, you know I'm right).  
• High and unsustainable debt in the developed world: Government and household debt levels are high and unsustainable in many developed nations. This too constrains government and personal spending and is very deflationary.
• Technology: Everyone loves shopping on-line to hunt for bargains. Technology is great in terms of keeping productivity high and prices low, but viewed over a very long period, great shifts in technology are disinflationary and some say deflationary.

Keep these six structural factors in mind the next time you hear someone warning you of the scary bond market. With all due respect to Fed Vice Chairman Stanley Fischer, inflation isn't rebounding anytime soon and the Fed would be making a monumental mistake if it hikes rates in September thinking so. All this will do is send the mighty greenback higher, stoke a major crisis in emerging markets, and reinforce global deflation which will decimate pensions.

And when it comes to deflation, there's only one thing which will save you, nominal bonds. Period. Nothing else will save your portfolio from the ravages of deflation, especially if it's a virulent debt deflation spiral.

I want all of you smart senior pension officers to go back and read my analysis of HOOPP's 2014 results and Ontario Teachers' 2014 results. These are two of the best pension plans in the world. they're both fully funded and instead of cutting benefits, they're in the enviable position of increasing benefits by restoring their inflation protection.

Ron Mock, President and CEO of Teachers, told me bonds serve three functions in their portfolio: 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." Jim Keohane, President and CEO of HOOPP, shares the exact same views.

But investing in bonds when yields are at a record low ultimately means CalPERS will have to drop its pension rate-of-return fantasy and cut its rosy investment projection of 7.5% which is uses to discount future liabilities. And it's not just CalPERS. Most U.S. public pensions use insanely rosy investment projections. Neil Petroff, the former CIO of Ontario Teachers, once told me bluntly: "If they were using our discount rate, they'd be insolvent."

But cutting the discount rate has implications. Your liabilities go up and you have to make hard choices as to how you will shore up your plan to make up the difference. This is where I think California and other states are going to run into major problems.

Why? Because unlike Ontario Teachers', HOOPP and other Canadian plans, they have not implemented a shared risk plan. Read the article above. It clearly states:

"Most public workers would be exempt from paying any more. Only those workers hired in 2013 or later would have to contribute more to their retirements under the plan."

Unless you are moving out of town most people only buy once in California because of Proposition 13, which limits property taxes to a 2% increase per year anchored at the price you bought your home. There are homes right beside each other where one owner who has been there for 30 years or so is paying a measly $3000 in property taxes and the other owner just moved in and is paying $30000 even if both homes are identical in worth.

There is also no motivation to downsize because of the climate....little 95 year old granny living alone in a 6 bedroom home can get away with a space heater, or even just a good blanket, in her bedroom all winter long. She doesn't face the heating bills others face on east coast so no need to move to a condo until the inevitable, which by the way, happens on average a decade later around here.

Then you have the self serving local politicians who own homes and argue we can't possibly build densely or upwards because, oh my god, we might block the sun!!

Lastly, we have the IPOs from time to time (Google, Facebook, LinkedIn, etc.) that instantly make millionaires out of thousands of young adults who have no idea of home values. They just need somewhere to park their cash.

All of this equals expensive homes. We are lucky we got in at all....right after the 2008 crash when everybody was scared to death that the economy would collapse. So now of course we support everything stated above.

What is behind global financial markets’ extreme moves since China’s decision to allow its currency to move to a managed float? One explanation is that investors increasingly fear global disinflation is not a dragon that has been slain by muscular central bank measures, but a phoenix that is rising from the ashes.

Certainly, the direct impact of the renminbi fall on US and European inflation and economic activity — even if it extends to 10 per cent — is too small to justify the large falls seen in bond yields and inflation gauges.

The weight of China’s currency in the trade-weighted dollar and euro is about 20 per cent and, as a rule of thumb, a 10 per cent rise in the trade-weighted dollar and euro takes about 0.5-0.6 per cent off inflation and real GDP growth over 18 months. So even if the renminbi is devalued by 10 per cent, the effect would be to cut US and European inflation and growth by only 10 or 20 basis points over a year, other things being equal.

The same is true of the fresh fall in commodity prices. Yes, further weakness in commodities also weakens the near-term inflation outlook. But such falls wash out of year-on-year inflation data over time as base effects roll forward. And they amount to a tax cut for G10 producers and consumers. So although the renewed fall in commodity prices is striking, and its near-term effects undoubtedly significant, how it can directly justify a fall in long-term yields and inflation forwards is difficult to see.

Nonetheless, long-term bond yields and inflation forwards in the US and Europe have been falling quite dramatically. Since the end of June, 30-year US Treasury yields, which should reflect investors’ expectations for long-term inflation and economic growth, have fallen 50 basis points. And this in spite of the fact that two-year yields, which reflect expectations for the path of official interest rates, have barely changed.

One possible explanation for the bond and inflation markets’ recent behaviour is that it is just a short-term “risk off” move, together with the correction in stock markets, in thin summer trading, with consensus trades (short bonds, short US against Europe, long inflation) suffering the most.

But what if the explanation is that investors are growing more fearful that disinflation pressures are secular rather than cyclical, with the weakening in China’s currency just the latest in a series of unsettling factors? There have been other signals that disinflationary forces are still with us.

Pay growth in the US and UK, where rate rises are expected before anywhere else, remains sluggish in spite of falling unemployment. Core consumer price inflation (excluding energy and food) also remains below central banks’ policy targets, and is rising only slowly.

The recent change in bond yields has been driven almost entirely by falling inflation expectations. Since the change in the Chinese currency regime, in both the US and the euro area the five-year forward inflation rate (favoured by central bankers as an indicator of medium-term inflation expectations) has given up more than half of the gains made since January.

It is likely that during the coming months renewed fears of disinflation or deflation will increase rather than diminish. Weaker commodity prices and the renminbi devaluation mean surveys of inflation expectations are more likely to show a fall than rise in the near term; and the medium-term trajectory for inflation will be lower than previously thought.

If so, we could well be in for a revival of the debate about whether central banks really do have the ability to overcome structural downward forces on prices, notably globalisation, technological change and demographics, to which we now add the after-effects of the global financial crisis.

With the recent cyclical upswing, particularly the falls in US and UK unemployment, this debate has been in abeyance. The implicit assumption has been that the combination of zero interest rates, quantitative easing and economic recovery would bring about a revival in inflation.

But this assumption is apparently now being questioned. If that is the case, any decision to raise official interest rates could soon start to seem like a policy mistake.

For investors and for policymakers, worries about secular disinflation are proving difficult to slay.

Amari, speaking at a seminar, said the consumer price index was not the only way to judge whether the economy was out of deflation.

It was important for the economy to grow both in nominal and real terms and for the gross domestic product deflator to be positive, Amari said.

Among the clearest casualties of China's devaluation is the Bank of Japan. The chances were never high that Governor Haruhiko Kuroda was going to be able to unwind his institution's aggressive monetary experiment anytime soon. But the odds are now lower than even skeptics would have previously believed. 

The real question, though, is what China's move means more broadly for Abenomics. A sharply devalued yen, after all, is the core of Prime Minister Shinzo Abe's gambit to end Japan's 25-year funk. Abenomics is said to have three parts, but monetary easing has really been the only one. Fiscal-expansion was neutered by last year's sales-tax hike, while structural reform has arrived only in a brief flurry, not the avalanche needed to enliven aging Japan and get companies to raise wages.

China's devaluation tosses two immediate problems Japan's way. The first is reduced exports. As Beijing guides its currency even lower, as surely it will, the yen will rise on a trade-weighted basis. And Bloomberg's Japan economist Yuki Masujima points out that trade with China now contributes 13 percent more to Japanese GDP than the U.S., traditionally Tokyo's main customer.

"Given China's rise to prominence, the yen-yuan exchange rate now has far greater influence on Japan than the yen-dollar rate," Masujima says.

The other problem is psychological. Japanese households have long lamented their rising reliance on China, a developing nation run by a government they widely view as hostile. But the BOJ was glad to evoke China's 7 percent growth -- and the millions of Chinese tourists filling shopping malls across the Japanese archipelago -- to convince Japanese consumers and executives that their own economy was in good shape. Now, the perception of China as a growth engine is fizzling, exacerbating the exchange-rate effect.

"To the extent that the depreciation reflects weakness in China, then that weakness -- rather than the depreciation per se -- is a problem for Japan," says Richard Katz, who publishes the New York-based Oriental Economist Report.

It's also a problem for Abe, whose approval ratings are now in the low 30s thanks to his unpopular efforts to "reinterpret" the pacifist constitution to deploy troops overseas. The prospect that Abe will enrage Japan's neighbors by watering down past World War II apologies at ceremonies this weekend marking the 70th anniversary of the end of the war is further damping support at home.

The worsening economy, which voters hoped Abe would have sorted out by now, doesn't help. Inflation-adjusted wages dropped 2.9 percent in June, a sign Monday's second-quarter gross domestic product report for the may be truly ugly.

It's an open question whether such an unpopular leader can push painful, but necessary, structural changes through parliament. "Already," Katz says, "Abe has backpedaled on many issues to avoid further drops." After 961 days, all Abenomics has really achieved is a sharply weaker yen, modest steps to tighten corporate governance and marketing slogans asking companies to hire more women.

There could be a silver lining here: China's move may catalyze Abe to act. By undercutting Japan's devaluation, China might increase Abe's urgency to boost competiveness, innovation and wages.

Already, Abe's surrogates are setting the stage for more BOJ easing. One top advisor, Koichi Hamada, told Bloomberg News that "the magnitude of China’s shock is much larger than that from Greece." China's devaluation, he added, "can be offset" by fresh BOJ action.

But Abe would be wise to react with far more than just another yen devaluation. If Japan offers a cautionary tale, it's that weaker currency alone isn't the answer.If Abe had used the yen's 35 percent plunge since late 2012 to good effect -- passing big reforms on labor flexibility, import tariffs, tax policy, supporting startups, reducing red tape -- Japan might not be facing the prospect of another recession. Unless the prime minister changes course, Abenomics will be remembered as a policy that primarily benefited stock-trading hedge funds, not average households.

Yesterday, in a rare press briefing, China's central bank downplayed fears of huge moves that destabilize markets. Yet as growth sputters, Beijing will weaken the yuan as much as it can get away with geopolitically. Depending on how Tokyo reacts, this could be the moment Abenomics gains traction or becomes a $4.6 trillion casualty of China's ascendancy.

Private-equity firms are doubling down on energy, despite heavy damage from their last adventure in the oil patch.

These firms’ stakes in a dozen publicly traded energy exploration-and-production companies have lost more than $18 billion in value since last summer, when oil prices began their slide from more than $100 a barrel.

Yet with U.S. crude prices down to about $46.75 a barrel at Thursday’s close, private-equity firms are looking for opportunities to spend the hundreds of billions of dollars they have amassed to make new energy investments. They are hoping the commodity-price crash will open up opportunities to pick up assets and entire companies on the cheap.

“This is a temporary situation, and investments that are made in this low-price environment are going to look pretty good two or three years out,” said Mark Papa, who joined energy-focused firm Riverstone Holdings LLC earlier this year after retiring as chief executive at EOG Resources Inc., one of the largest U.S. energy producers.

So far, deals have been somewhat scarce. Earlier in the year, struggling energy producers raised record amounts of cash by issuing stock and selling new debt to investors willing to throw them lifelines.

Private equity bet big on the oil patch over the past decade. Many deals from the early years of the shale boom were immensely profitable for firms including Apollo Global Management LLC, KKR & Co., Warburg Pincus LLC and Blackstone Group LP. They arrived early to regions where new drilling technology unlocked reserves trapped in dense rock formations and made money selling the properties to big oil companies.

But after oil prices slid, many of their investments took a hit.

The value of a controlling stake in EP Energy Corp. held by an Apollo-led group is down roughly $3.4 billion since June 30 of last year as the oil producer’s shares have fallen 71%. About $8 billion in paper profits slipped away from a Warburg-led group that launched Antero Resources Corp. in 2007 and holds a majority stake in the Appalachian energy producer.

Stakes in public companies like EP and Antero offer only a glimpse at the damage low oil prices have done in private-equity funds, which lock up investors’ cash for several years and combine it with borrowed money to make investments. Closely held companies, which make up the majority of private-equity investments, also have declined in value. Samson Resources Corp., for example, is planning a bankruptcy filing that would wipe out about $4.1 billion that a KKR-led group pumped into the energy producer.

The diminished value of such holdings has stung even the best-performing funds. Annualized returns for investors in a Blackstone energy fund fell to 28% after fees as of June 30 from 52% a year earlier, according to securities filings.

The situation is far worse for some struggling funds. Energy-focused First Reserve Corp. told investors earlier this year that a pair of its funds, the two largest energy-only private-equity pools ever raised, fell below break-even. If they don’t return to positive territory, the $7.8 billion pool raised in 2006 and $8.8 billion fund raised two years later will join a small group of multibillion-dollar private-equity funds that have lost money over their lifespans for investors.

Annualized losses in a $900 million KKR natural-resources fund from 2010 grew to 38.9% after fees at the end of June 2014, more than double the percentage loss from a year earlier. That fund invested largely in producing wells and cut deals with companies to finance drilling projects.

But this being the deal business, the deal makers aren’t giving up.

Private-equity firms have $115.6 billion available for energy deals, according to Preqin, a private-equity data provider. And they are looking for more, pitching pensions, endowments and other big investors on 67 energy-focused equity funds that aim to raise about $29 billion more, the data provider said.

The firms also have amassed about $80 billion to invest in energy-company debt.

Including the borrowed money they typically use to fund deals, private-equity firms’ energy-buying power stands at more than $300 billion, roughly equal to the stock-market value of Exxon Mobil Corp. , said Ralph Eads, who leads energy banking at Jefferies Group LLC.

Where some private-equity firms tripped up in the past was treating drilling properties equally, said Riverstone’s Mr. Papa. “They really haven’t discriminated yet regarding what is good quality,” he said.

Private-equity executives and bankers say many firms have become smarter buyers since the first wave of deals, enlisting technical experts such as petroleum engineers and geologists as well as big-name oil executives to help them vet prospects. “The financial players are getting to where they can behave like an oil company,” Mr. Eads said.

“I see much more opportunity than I see downside for us in the energy space,” Apollo co-founder Joshua Harris told investors recently.

While volatile energy prices and cheaper financing sources have kept private equity on the sidelines, some firms are starting to open their coffers.

Blackstone’s debt-investing arm, GSO Capital Partners LP, recently reached a deal to help fund a closely held energy producer’s purchase of Encana Corp. ’s Haynesville natural-gas fields in Louisiana.

Declining natural-gas prices battered some earlier energy investments, such as KKR’s Samson, but lately the fuel has been popular among bargain-hunting private-equity investors.

The majority of private equity investors expect outperformance of more than 4 percentage points above public markets from their allocations to the sector, research from Preqin has found.

A survey of more than 100 institutional investors in June this year showed 49% were expecting such outperformance, compared to the 35% with similar expectations in June 2014. A further 39% quizzed this year felt their allocations should outperform listed stocks by 2 to 4 percentage points.

“Between 2013 and 2014, a notable period for bull market conditions with significant stock market highs, there was a decrease in the proportion of investors that expected their private equity portfolios to beat the public market by more than 2%,” Preqin reported.

The uptick in expectations may have been driven by “the apparent success of respondents’ private equity investments in the last 12 months,” the data firm suggested.

While the performance of private equity funds has undoubtedly improved in the short term—roughly a third of respondents (35%) said their expectations were surpassed in the past 12 months, compared to just 12% in June 2014—investors in different regions varied in their satisfaction with managers.

In North America, 35% of investors said performance “exceeded expectations”, compared with 43% in Asia and 50% in Europe. Investors outside of these regions were the least satisfied: just 25% reported better-than-expected returns for the year to June 30.

Paradoxically, while Europe had the most satisfied investors, it also had the greatest proportion of dissatisfied private equity buyers: 19% said their allocations had “fallen short of expectations”.

As the private equity sector grapples with increased scrutiny of fee practices, Preqin claimed that “the competitive fundraising market, with more than 2,200 private equity funds seeking commitments, has led to increased efforts from general partners in nurturing a healthy relationship with their investors, in order to secure more re-ups in the future.”

However, 40% of investors said alignment of interests could still be improved when it came to management fees, and 32% said the same for performance fees.

Preqin’s report showed continued signs of difficult conditions for the sector’s operators, however. Unused cash rose to $965 billion in June, nearly half the total estimated capital invested in private equity. In a July interview with “Wall Street Week”, industry luminary David Rubenstein argued that this capital was likely to be deployed as soon as there was a market correction—much like that seen at the end of August.

Fundraising fell in the first half of 2015 compared with the same period last year: $253 billion was raised by 509 funds, down from $272 billion in 656 funds in the first six months of 2014. Preqin speculated that the record amount of dry powder held by private equity funds was likely to blame for this, as performance and money returned to investors have continued on an upward trend.

Observers on the whole are amazed at the stickiness of private equity’s 2% management fee. “It was one thing when funds were a couple hundred million dollars and you needed to run a business. It’s another when the assets are in the tens of billions,” says Grabel.

The compensation model gives GPs incentive to think about money and valuations in a longer-term metric than others, says Centana’s Cukier. But on the flipside, “you have these mega-funds where the management fee starts driving a lot of economics.”

In the bifurcated market Scheer describes, LPs don’t have much fee power in the high end—although he believes that it is changing at the bottom end. Some asset owners view a co-investment program or separately managed account as a way to have more control and reduce management and carry fees. Based on this interest, more than half of the GPs in the Preqin report said they are aiming to increase their co-investment offerings.

But Grabel doesn’t believe it’s the “magic bullet” that some others do. “In some sense, I think that makes a concentrated portfolio that much more concentrated, which can potentially increase volatility of the outcome.I don’t know if most asset owners have the necessary skill to do the due diligence and make the decisions that private equity firms make. A fee-driven motivation in co-investing isn’t the right motivation.”

When Cukier started his first job in private equity in 1997, the head of the firm gave him an article from the New York Times about the industry’s imminent decline thanks to a falling rate environment, excess capital being raised, and a plethora of new market entrants.

“I read it and I was horrified,” he recalls. “What business did I just get into?” Then he saw the dateline—it was written in 1982. The death of private equity has been foretold many times.

“That being said, rising rates decrease asset values,” he says. “It’s Economics 101. As the cost of capital goes up, the value of properties decreases. To me, the market evolves much as it always has. Some will be washed out and some players will thrive. Much like what happened after 2008, the capital will pursue the winners and continue to be allocated. I don’t believe private equity as an asset class is anywhere near its end. But when the market falls dramatically, as history suggests at some point it will—I can tell you direction or timing but not both—some people will be hurt by it.”

There is even one commonly expressed view that the current boom is happening because the private equity market has become a proxy for going public. There is enough liquidity to make it more efficient than it used to be, and there are fewer regulatory burdens to an initial public offering than there once were.

“It is not a symptom of a bubble per se, but because of some of the inefficiency of the public markets,” Cukier says. “If you believe the theory that the private equity market is becoming a replacement for the public equity market, it actually has a long-term raison d’être.”

“Private equity is always cyclical, and the vintage year is very indicative of your returns,” says University of Cincinnati’s Scheer. “The other idea is that the KKRs and TPGs of the world have a real incredible ability to avoid realizing bad returns, because they control the timing. They have a pretty amazing ability to avoid the pain.”

Let’s hope they aren’t the only ones, and that asset owners have partnered with the right GPs in the currently crowded field—come rain or shine.

Two Canadian pension plans are part of a consortium that purchased South Korean supermarket chain Homeplus from British retailer Tesco for around US$6 billion on Monday.

The Canadian Pension Plan Investment Board said it spent US$534 million for a 21.5 per cent stake in the company.

The Public Sector Pension Investment Board, which manages investments for the federal public service and the Canadian Forces among others, was also a part of the deal but did not disclose its contribution.

The deal is expected to close in the fourth quarter of 2015, pending approval from the South Korean government and Tesco's shareholders.

Homeplus is South Korea's second-largest retailer, with more than 1,000 outlets across the country. It was originally founded as a joint venture between Samsung and Tesco in 1999.

South Korean private equity firm MBK Partners led the deal and said the consortium will invest US$831 million in the business over the next two years.

Canada's national pension plan makes more than it currently pays out in benefits, and the CPPIB invests the excess money. At the end of June, the fund totalled $268.6 billion.

Homeplus is facing criminal and civil lawsuits in South Korea after company executives including CEO Do Sung-hwan were indicted in February for selling the personal data of millions of customers to insurance companies for marketing purposes.

The won rose, erasing an earlier decline to a five-year low, as South Korea’s government unveiled a record spending plan for next year to boost growth in Asia’s fourth-largest economy.

The Finance Ministry on Tuesday proposed a 386.7 trillion won ($322 billion) budget for 2016, which is 2 trillion won more than this year’s. The announcement comes before Friday’s monetary policy review, at which the Bank of Korea is forecast to refrain from cutting its benchmark rate from a record low of 1.50 percent, according to 16 of 18 analysts surveyed by Bloomberg.

The won advanced 0.3 percent to 1,200.72 a dollar as of the 3 p.m. close in Seoul, data compiled by Bloomberg show. It dropped to 1,208.72 earlier Tuesday, the weakest since July 2010, and has lost 1.5 percent this month.

"There is some profit-taking" in the dollar versus the won, said Patrick Bennett, a strategist at Canadian Imperial Bank of Commerce in Hong Kong. "With monetary policy having done almost all it can do, it’s incumbent on the government to look at what they can do fiscally. It’s a positive for the economy."

South Korea’s exports have deteriorated amid a global economic slowdown, Trade Minister Yoon Sang Jick said in prepared comments released by the ministry on Monday after the country last week reported that shipments in August fell the most since 2009.

Government bonds fell, with the yield on securities due June 2025 rising one basis point to 2.24 percent, Korea Exchange prices show. The three-year yield climbed two basis points to 1.67 percent.

This year’s total Fund and absolute and relative returns demonstrate the benefits of a resilient portfolio that is broadly diversified across geographies and a mix of public and private asset classes. All of our investment departments generated significant investment income and dollar value-add.

CPPIB’s strong returns in fiscal 2015 are great news, as the income that the fund earned will continue to compound – however, we cannot place too much significance on our results in any given fiscal year. The CPP is designed to be exceptionally long-term in nature and that means we can afford to take on more risk (i.e. volatility in short-term returns) in order to achieve a higher long-term return. Our extraordinarily long investment horizon combined with the unique nature of the CPP simply allows us to invest differently from many other institutional investors.

A case in point is our view on currency hedging, which we describe on page 26 of the F2015 Annual Report. Many pension funds use substantial currency hedging to stabilize the values of their international assets in Canadian dollar terms. In comparison, for the most part, we do not hedge foreign currency holdings to the Canadian dollar. As a result we must tolerate significant impacts on our financial results in any given year due to currency gains/losses. For example, in fiscal 2010 alone the Fund experienced losses of $10.1 billion in the Canadian dollar value of our foreign holdings, however since fiscal 2010 we have realized gains of $16.1 billion, including $7.8 billion this year. Hedging to manage short-term results has a material financial cost with no expected benefit over the long term.

Our portfolio is highly resilient, but as an exceptionally long-term investor we cannot and should not escape exposure to general market movements. We have every reason to believe that the Fund will experience future shocks resulting in downward pressure, yet given our long investment horizon we can tolerate considerable negative short-term returns in continued pursuit of higher long-term returns. Thus, in the same way that we temper our enthusiasm for this year’s exceptional performance, we also do not let negative returns in any given period side-track our attention from our long-term strategy. The best measure of our performance is longer term and we must continue to focus on 10-plus year results.

The Fair Trade Commission on Monday fined discount hypermarket chain Homeplus 435 million won ($405,065) for collecting and selling the personal information of its customers to insurance companies.

The state-controlled antitrust watchdog said the nation’s second-largest retailer violated the Fair Labeling and Advertising Act.

The FTC said that when Homeplus advertised drawing events, it failed to clearly notify participants that their personal information would be provided to insurance companies for use in marketing.

For instance, to mark Korea’s participation in the FIFA World Cup last May and June, the retailer distributed coupons for a drawing to give away a Hyundai Genesis sedan. Participants were required to provide their names, birth dates, gender, telephone numbers, mobile numbers, number of children and signatures.

They also were asked to check two boxes permitting their information to be used by insurance companies, but the FTC said the fine print was too difficult to read.

“To participate in a drawing, the matter of providing personal information to insurance companies is the most important condition,” said Oh Hang-lok, director of the FTC’s Consumer Safety and Information Division. “But Homeplus did not explicitly inform consumers of the fact that it would provide the information to insurance companies.”

The FTC’s fine came after the prosecution indicted six former and current Homeplus executives in February for violating the Personal Information Protection Act.

According to the prosecution, executives received 14.8 billion won from selling information for about 7 million people to seven insurance companies. In addition, they sold information on about 2.9 million registered members of Homeplus for a total of 8.3 billion won.

Canada Pension Plan Investment Board (“CPPIB”) today announced that it has signed an agreement to acquire a stake of approximately 21.5% in Homeplus, Tesco’s South Korean business, for US$534 million. CPPIB made this acquisition as part of a consortium led by MBK Partners. The total transaction value is approximately US$6 billion.

Operating in South Korea since 1999, and with more than 1,000 retail outlets across the country, Homeplus is one of the largest multi-channel retailers in Korea and the number two player in both hypermarkets and supermarkets.

“We are pleased to invest alongside our longstanding partner, MBK Partners, in one of the leading retailers in South Korea,” said Pierre Lavallée, Senior Managing Director & Global Head of Investment Partnerships, CPPIB. “Homeplus is an attractive investment for CPPIB as it provides us with access to one of the largest retail markets in Asia through a well-established business with a strong cash flow profile.”

CPPIB has been investing in South Korea since 2008 and it remains a key investment market for CPPIB in Asia.

The buyer, Asian private equity firm MBK, is understood to have beaten two other bidding groups - Affinity Equity Partners (which was working with US giant KKR), and Carlyle Group - to snap up Homeplus, once considered the jewel in Tesco's crown.

MBK, which a led a consortium that included South Korea’s National Pension Service, the Canada Pension Plan and Singapore’s Temasek, will pay just over £4 billion before tax and other transaction costs, Tesco said in a statement.

Overall the deal gives Homeplus an enterprise value of £4.2 billion, it added.

The sale is part of a turnaround plan masterminded by Tesco chief executive Dave Lewis.

He took the helm a year ago after the grocer was hit by a £263 million accounting scandal and began urgent efforts to restore the company's balance sheet.

Today Lewis, a former executive at Unilever, said: “This sale realises material value for shareholders and allows us to make significant progress on our strategic priority of protecting and strengthening our balance sheet.”

HSBC acted as the lead financial adviser on the transaction, while Barclays' investment bankers were financial advisers and sponsor to Tesco for the deal.

A little-known New York hedge fund run by a former Yale University math whiz has been buying tens of billions of dollars of U.S. Treasury debt at recent auctions, drawing attention from the Treasury Department and Wall Street.

Element Capital Management LLC, led by trader Jeffrey Talpins, has been the largest purchaser in dozens of government-bond auctions over the past 10 months, people familiar with the matter said. The buying is part of an apparent effort by the fund to use borrowed money to exploit small inefficiencies in the world’s most liquid securities market, a strategy that is delivering sizable profits, said people close to the matter.

Mr. Talpins is an intense and reserved trader formerly at Citigroup Inc. and Goldman Sachs Group Inc. He is known for a tenacious style that can grate on rivals and once tested the patience of former Federal Reserve Chairman Ben Bernanke.

Element has been the largest bidder in many of the 62 Treasury note and bond auctions between last November and July, these people said. At many recent auctions, some of which involved sales of more than $30 billion of debt, Element purchased about 10% of the issue, these people said. That is an unusually large figure, analysts said.

Element’s activity has raised questions because the cumulative purchases far exceed the hedge fund’s $6 billion in assets under management. Treasury officials, who frequently meet with large auction participants, have asked Element about its activity, said someone close to the matter.

“Their buying is eyebrow-raising,” said a trader who once worked for a firm that deals in government securities and witnessed Element’s bidding (click on image below). These primary dealers often know the identity of other auction bidders. Element “never shared its strategy, but we often asked,” the trader said.

Treasury likes to know who is buying its bonds and why, partly because it prefers long-term holders such as pension funds, insurance companies and central banks. Treasury officials fear purchases by trading-oriented funds could result in sales that increase market swings and potentially drive up borrowing costs.

“If you’re issuing debt, your preference is those ‘sticky investors,’” said Scott Skyrm, a managing director at Wedbush Securities.

“Consistent with our policy, Treasury does not comment on individual investors in Treasury auctions or conversations with market participants,” a Treasury representative said.

Element is a “macro” fund, or one that wagers on global macroeconomic trends in bond, stock and currency markets. The firm uses a “unique probabilistic approach,” according to a presentation the firm made last year at the University of Pennsylvania’s Wharton School.

Element had been shorting, or betting against, bonds in anticipation of higher interest rates but has been exiting from that wager, according to someone close to the matter. That is one reason the fund has been a big buyer of Treasurys lately.

But people who have worked with the firm or are close to Mr. Talpins said there is another reason: Element is among the last to embrace “bond-auction strategies,” trading maneuvers that have become less popular since the financial crisis.

These trades aim to take advantage of the effects of supply and demand in the $12.8 trillion Treasury market. Demand for these bonds often fluctuates based on factors including investor perceptions of economic growth and market risk, while supply can be affected by regular auctions of different-maturity Treasury securities. A burst of new supply tends to slightly depress prices for short periods, sometimes for less than an hour.

In the past, Wall Street dealers and hedge funds scored profits shorting “when-issued” bonds. These are contracts conferring the right to purchase Treasury securities when they are sold days later at auction. Then, these traders would buy bonds during Treasury auctions at the slightly lower prices and use these newly purchased bonds to close out their short sales.

The difference between the higher price at which they sold the Treasurys and the lower price they paid at auction was their profit.

There are a number of variations to this strategy, traders said. The maneuver involves a bet against bonds, so traders usually purchased hedges such as Treasury futures or interest-rate swaps to protect against rising bond prices while the trade was under way, said Tom di Galoma, head of fixed-income and rates trading at ED&F Man.

After the 2008 financial crisis, bank traders pulled back as regulators discouraged trading risks. Some hedge funds also began shying away from bond-auction strategies. Wall Street banks have significantly cut back their lending to hedge funds.

The pullback by rivals has left Element with a large presence in bond auctions to complement strategies such as in foreign-currency derivatives, people close to the matter said. In 2008, the firm gained 35%, these people say, even as financial markets crumbled. The next year, Element was up 79%. Last year it rose just 2.9%.

But it was up 18.5% through July of this year, an investor said, beating most hedge funds and overall markets. Some recent gains came from bullish wagers on the U.S. dollar, according to the person. The firm’s annualized average return has exceeded 20% since its launch, investors said.

There are dangers with the auction strategy. Once in a while, the prices of bonds being auctioned jump, rather than fall, for reasons such as bad economic news that prompts an investor flight to safety. Hedges sometimes don’t work out. And the strategy relies on inexpensive borrowing because each trade usually yields minimal profits.

In the 1990s, hedge fund Long Term Capital Management used leverage to profit from small discrepancies in the Treasury market before a market reversal swamped the firm. LTCM used much more leverage than Element does.

Mr. Talpins graduated in 1997 from Yale, where he was a research assistant for Robert Shiller, the Yale economist who later won a Nobel prize in economics. In a 1996 letter, Mr. Shiller wrote that in terms of overall performance, he “put Jeffrey first out of the 52 Yale undergraduates” who attended his course Economics 252, Finance, Theory and Application.

“I thought he was particularly bright,” recalls Prof. Shiller.

Founded in 2005 by Mr. Talpins, Element is closed to new investments. When open it has required a $50 million minimum investment, an unusually large sum in an industry where $1 million is more typical. Friends say Mr. Talpins has been spending more time on philanthropy lately. But sometimes he rubs people the wrong way.

A year or so ago, Mr. Talpins was among 20 investors invited by a Wall Street firm to a private meeting with Mr. Bernanke, after his departure from the Fed. Mr. Talpins peppered Mr. Bernanke with about 10 successive questions, according to several people in the room.

Mr. Talpins elicited some detailed answers, such as who is in the room during interest-rate discussions. But he also asked questions that exasperated some investors because they seemed irrelevant. Mr. Bernanke looked increasingly weary under Mr. Talpins’s barrage, one participant said.

“Jeff was persistent and it got a little uncomfortable,” said another participant. “It was like, ‘Dude, let it go.’”

A spokesman for Mr. Bernanke declined to comment. Someone close to Mr. Talpins said he was eager to learn about the Fed’s inner workings because of his focus on interest-rate moves.

Element’s purchases appear compliant with rules that limit one buyer to 35% of debt sold in any auction. The limit most famously came into play in the 1991 Salomon Brothers scandal.

Element Capital Management, a hedge fund run by Jeffrey Talpins, is yet another example of everything that is wrong on Wall Street today. The issue here is not that Element is doing anything illegal or even shady, but rather just another example of the"anything goes" attitude that pervades U.S. financial markets. Taking advantage of a flawed system is not "good business". It does not create GDP or employment, it merely enriches Talpins and his investors and exacerbates the growing wealth inequality problem.

Apparently, Talpins is leveraging his $6 billion hedge fund to buy many times that amount of U.S. treasury notes and bonds at auctions, and then sell them back into the market again for a slight profit, often within just a few hours.

The moment a crisis breaks out, hedge-fund investors should pray they’re in a large fund, which has the capital and market influence to survive, right?

Just the opposite, it appears.

Researchers at City University London found that smaller funds hold up better when the world is going haywire, perhaps because of having fewer “flighty” investors who pull their money out at the first sign of trouble.

On Wall Street, bigger is often synonymous with better—bigger bonus, bigger office, bigger job. However, “on average, investors were better off investing with a small hedge fund instead of a large one in times of crisis,” concludes the July-dated working paper from the university’s Center for Asset Management Research.

For instance, in 2008, during the global financial crisis, the smallest 10% of funds returned negative 0.48% a month while the largest returned negative 1.28%, for a difference of 0.8 percentage point a month, or 9.6 points for the full year, according to data provided to The Wall Street Journal by the authors. In 2000, amid the bursting of the tech-stock bubble, the smaller funds again performed better, with a monthly return of 1.09% vs. 0.65% for the bigger funds, a difference of 0.44 point a month or 5.2 for the full year.

Professors Andrew Clare, Dirk Nitzsche and Nick Motson, all from City University’s Cass Business School, looked at data on almost 7,300 hedge funds drawn from Thomson Reuters’s Lipper Hedge Fund Database from January 1995 to December 2014.

The authors offer three possible explanations for the difference in performance. Assessing each will take further research, says Prof. Clare.

First, the report says that stakes in larger funds are more likely to be held by those flighty investors, often in a so-called fund of funds—an investment that holds stakes in other funds.“My experience of working in the hedge-fund industry is [that] as soon as the proverbial hits the fan, there is no obvious commitment to the hedge-fund industry by fund-of-funds investors,” says Prof. Clare.

Big hedge funds’ performance may have been hampered by those investors cashing out of their fund-of-funds positions, the report suggests. Those redemptions would force fund-of-funds managers to sell stakes in the big hedge funds, whose managers in turn might have been forced into sales of securities at a loss or at a smaller profit than a later sale would have brought.

Second, the authors suggest that smaller hedge funds may have had “more stringent gating arrangements,” or limits on withdrawals, that would have stemmed the flow of redemptions. For instance, they may have allowed redemptions only during certain periods each year or had minimum holding periods. “Clearly, small funds tend to be youngish funds,” says Prof. Clare. Such funds may have still had investor covenants in place that restricted cash-outs during the market’s crises, he adds.

Third, smaller hedge funds may have been less exposed to market risk than larger ones. By definition, small funds have less capital to invest, and that means they can put fewer investing ideas to work, explains Prof. Clare.

“The more ideas you apply, the more exposure to the general market you have,” he says.

Steven Brown, a professor of finance at New York University’s Stern School of Business, urges caution in acting on the paper’s findings. “I think there needs to be a lot more work done on this,” he says. “I would be careful about giving inexperienced funds large contributions.”

The biggest 10% of funds that were studied had an average of close to $900 million under management over the analysis period, while those in the smallest 10% averaged $1.2 million.

Despite the differences in performance, the average fund size of both large and small funds grew significantly over the period. Assets managed by the biggest 10% of funds nearly quintupled over the two decades, while the assets of the smallest 10% doubled.

When it comes to hedge funds, says the study, both big and small are “bigger than they used to be.”

Chris Flood of the Financial Times reports, Calpers’ support of private equity ‘propaganda’ slammed:

A board member of the largest US pension fund has written a scathing letter to its chief executive, criticising her for supporting private equity industry “propaganda”.

Joseph Jelincic, a board member of Calpers, which helps finance the retirement plans of teachers and firefighters, has sent a damning letter to Anne Stausboll, the pension plan’s CEO. He questioned the competency of Calpers’ investment staff regarding its private equity holdings.

A swath of US public pension plans, including Calpers, has come under growing pressure to provide accurate data on total private equity fee payments after failing to report how much has been paid in “carried interest”, or investment profits, to private equity managers.

Questions about Calpers’ $30.5bn private equity portfolio arose again at a meeting on August 17. Mr Jelincic wrote the letter because of his dissatisfaction with the information provided at that meeting.

“They are negotiating these [private equity] contract provisions on a daily basis but do not seem to understand the most basic aspects of their economics,” Mr Jelincic wrote.

Calpers employees were perpetuating the mythology of private equity managers by telling the board the fund was “receiving a better deal [from its private equity managers] than we actually are”, Mr Jelincic said.

“The role of Calpers staff is not to propagate [private equity managers’] propaganda but to guard against it,” he wrote.

A Calpers spokesperson said: “Calpers does not agree with Mr Jelincic’s opinions.”

John Chiang, state treasurer of California, told FTfm in July he would demand clear answers from the $300bn pension plan regarding why it does not know how much has been paid in carried interest over a period of 25 years to the private equity managers running Calpers’ assets.

Professor Ludovic Phalippou, a finance professor at the University of Oxford Saïd Business School, who specialises in private equity, added: “Calpers’ total bill is likely to be astronomical. People will choke when they see the true number.”

A meeting has been arranged between Ms Stausboll, Ted Eliopoulos, the pension fund’s chief investment officer, and Mr Jelincic for mid-September.

Yves Smith, a critic of the private equity industry on the Naked Capitalism website, said that the oversimplifications and mistakes made by Calpers’ management suggested it could not invest responsibly in private equity at all.

US regulators have been urged to improve reporting standards on fees and expenses by a coalition of senior elected state officials, which includes Mr Chiang, who sits on the board of Calpers along with Mr Jelincic.

Calpers has pledged to report total carried interest for the first time in the autumn. It made its first private equity investments in 1990 and employs more than 100 private equity managers. Calpers identified a need to track fees and carried interest better in 2011 but it has taken until now to develop a new reporting system.

Mike Heale, a principal at CEM Benchmarking, a Toronto-based consultancy, told FTfm: “Less than half of the very substantial private equity costs incurred by US pension funds are currently being disclosed.”

The Institutional Limited Partners Association, an industry group representing investors, last week launched an initiative to standardise the reporting of private equity fees.

It's about time the Institutional Limited Partners Association (ILPA) launches an initiative on standardizing the reporting of private equity fees.

Last week, the ILPA published a press release on its Fee Transparency Initiative, an effort to increase transparency in private equity.  The story was picked up by major media outlets and was the focus of Private Equity International’s Friday Letter.  The full press release and coverage from some of these outlets are provided on the ILPA's website here.

Getting back to the article above, I completely agree with Joseph Jelincic: “The role of CalPERS staff is not to propagate [private equity managers’] propaganda but to guard against it.” It hardly surprises me that "CalPERS does not agree with his opinions" but as I stated in a recent comment of mine on CalPERS' fiduciaries breaching their duties, it's utterly unacceptable for any limited partner (pension fund, sovereign wealth fund, insurance company, endowment, etc) not to know the fees it's doling out to private equity funds.

In another comment of mine, California Dreamin', I questioned the dual role of Mr. Jelincic as an investment officer for CalPERS' Global Real Estate and also a Board Member for the Board of Administration. But Mr. Jelincic was kind enough to subsequently email me to clarify the situation:

"Just so you know, my salary is set by negotiations between SEIU and the State of California. CalPERS is bound by that contract but doesn't negotiate it. (For the record I'm an Investment Officer III and at the top of the range.)

Because of the time I spend on the Board I do not participate in the IO III incentive program even through it is in the contract. (I estimate that costs me 10-15K a year.). So you can see I really don't have an economic conflict. Being on the Board has no impact (at least positively) on my income. It may make management uncomfortable but that is a different issue.

BTW the Sacramento Bee has a database that shows the salaries and bonuses for all the Investment Officers."

Chris Tobe of Stable Value Consultants had nothing but positive things to say on JJ Jelincic, sharing this with me:

"JJ. Jelincic in my opinion is by far the most effective trustee on a US public pension plan ever. He was elected by State employees.

My understanding is that he is on indefinite leave from his staff position at CALPERS, (but receives his full pay) to actually be a full time employee.

The conflict issues were dealt with years ago. I fear you are getting misinformation from the PE industry who want to retaliate against him for exposing them."

In the last CalPERS Investment Committee meeting, one of the most revealing incidents took place when Investment Director Christine Gogan repeatedly refused to answer a simple, direct question about a widely-used private equity tax abuse, management fee waivers, from board member JJ Jelincic. This was pure and simple insubordination and reveals serious governance problems at CalPERS. This is also not the first time we’ve seen staff show disrespect for a board member, but it is one of the most flagrant incidents.

Moreover, Gogan’s evasiveness suggests that she was not able to field a response, raising doubts about her ability to do her job. Finally, her misdirection served not simply to keep the board in the dark, but also conveyed inaccurate information to them.

Board Member JJ Jelincic: Okay. I won’t ask about offsets. Fee waivers. Can you explain to me what fee waivers are, how they’re used, and how the GP gets their money back?

Investment Director Christine Gogan: So by management fee waivers, just to make sure that we’re on the same page, what you’re talking about is the ability for a general partner to use a management fee waiver in place of a deemed contribution for their one to three percent…

Jelincic: Yes.

Gogan:…correct? And so your question is, to start with, you’re trying to get a sense of throughout our portfolio how common that arrangement is?

Jelincic: That’s a question that I had asked earlier. There’s some research apparently being done on it. But this question is just how does it work? What’s the process? What’s the economics of it? You know, quite frankly, I’m sure that the Wall Street hearts of private equity don’t say, you know, I overcharged you, I’m just not going to take the money.

Gogan: Well, I think, if I could, one thing that I would like to back up and offer up is that with respect to our entire portfolio, it’s important to note that the entire portfolio is audited. Everything is audited. Ninety-seven and a half percent of the portfolio is audited under standards that conform with U.S. GAAP. And so one of the questions without going into a lot of detail on how the management fee waiver mechanics work from partnership to partnership, and it depends to Réal’s earlier point on the waterfall computation, one thing that does give us comfort with respect to having assurance that the bottom line numbers that we’re relying upon are fairly stated, is that the majority of the portfolio, as I mentioned, the overwhelming majority is prepared in accordance with U.S. GAAP. And there are independent auditors typically, one of the top three, that provide a statement to us that provide information that we, as investors, are reasonable in relying on the fact that the financial presentation of the income statement, the balance sheet, and the capital accounts are materially accurate and fairly represent the financial position of the company.

Jelincic:And so how does the fee waiver function work?

Gogan: And so with respect to the fee waivers, to some degree, it’s going to depend on whether it is a European waterfall or whether it is a deal-by-deal waterfall. But my point in trying to go back to the audited financial statements is that in accordance with presenting the financial condition of the individual partnership, there are independent auditors that look every year to evaluate and assure that the computation of net income is consistent with the particular limited partnership agreement, and take into account each of the idiosyncratic conditions of the various waterfalls that exist for that particular partnership.

Jelincic: And the SEC would say they didn’t do a very good job of it.

As South Carolina Treasurer Curt Loftis wrote:

The staff responses are absurd.

Ms. Gogan failed a basic test of her fiduciary responsibilities. She is required to provide information in a timely and practical manner and she did neither. The Committee’s questions were direct and clearly stated and her replies were evasive, perhaps even obtuse.

Gogan’s repeated reliance on the audits for detail specificity is misplaced and is a “dodge.” GAAP audits are helpful but are not, as she implies, appropriate as the primary due diligence tool for PE fees, expenses and income. A sophisticated fund such as CalPERS has the ability and right to demand more stringent initial and on-going due diligence and the staff should be willing participants in that effort. Committee members should not be forced to “dance” with staff for information due them as a fiduciary.

As ugly as this picture is, it’s actually worse than Loftis indicates. If you watch the committee meeting in full, you’ll see again and again that if a staff member looks to be having difficulty answering a question, someone rides in quickly to their rescue. Here, no one more senior spoke up.

By contrast, recall our post last week where the CalPERS Chief Investment Officer, Ted Eliopoulos, described management fee waivers as beneficial to CalPERS when they are a tax dodge that  does not benefit limited partners like CalPERS. Eliopoulos had spoken up because the Managing Investment Director responsible for private equity Réal Desrochers was struggling to come up with the proper term of art, management fee waiver, in response to a question from board member Priya Mathur (and yes, the fact that Eliopoulos had to intervene was not a good sign). Similarly, when Jelincic was trying to get answers from Desrochers about another common provision in private equity limited partnership agreements, management fee offsets, Desrochers kept saying he’d be happy to answer the questions later, which almost certainly also meant out of the public eye.When Jelincic pressed onward, the chairman of the Investment Committee called Jelincic out of order, then reversed himself when Jelincic appealed the ruling and asked for a roll call vote.

Thus, as Gogan engaged in a heavy-handed form of obstructionism, no one intervened. By implication, her stonewalling of Jelincic had the full support of her boss, Réal Desrochers, and his superiors who were also present at the meeting, Eliopoulos and the Chief Operating Investment Officer, Wylie Tollette, as well as Mike Moy, CalPERS’ private equity consultant. In other words, staff and CalPERS’ outside advisors are apparently united in its position that the board is not entitled to honest and complete answers. As we discussed at length earlier this year, Tollette clearly and knowingly misdirected the board in trying tell them that it couldn’t get carried interest fees.

And most of the members of the Investment Committee seem to back staff’s apparently successful effort to tell board members as little as possible. You’ll notice that the chairman of the Investment Committee, Henry Jones, never once supported Jelincic’s efforts to pry information loose from the private equity team. Instead, he consistently weighed in on behalf of staff to uphold their apparent right to be less than forthcoming.

Gregg Polsky, former Professor in Residence in the IRS Office of Chief Counsel and now a professor of law at the University of North Carolina, surmised that the reason for Gogan’s slipperiness was that she could not answer Jelnicic’s question. That would be consistent with the performance of the rest of the senior staff. From Polsky via e-mail:

Gogan completely dodges the question, talking about financial statement audits and European versus deal-by-deal waterfalls. I can’t see any relevance at all of this to Jelincic’s questions.

There are two potential explanations for the dodging: she doesn’t actually know at all how fee waivers work or she’s defensive about where Jelincic is going with his questioning. I’d vote for the ignorance explanation for two reasons: (1) someone who knows the basics of fee waivers could have dodged whatever questions were coming without coming off as clueless (she could have fended off any criticism simply by noting that fee waivers can’t hurt CalPERS and she could have pointed out that, in any event, fee waivers are pervasive in the industry and the CalPERS lawyers thought fee waivers were fine at least until the recent guidance which requires them to take a fresh look); and (2) relatedly, there is no reason for someone well-versed in the basics of fee waivers to be all that defensive about them (at least from the LPs perspective). It’s a tax game between the GPs and the IRS; the LPs are really just bystanders.

Bottom line is that I think the exchange suggests that Gogan doesn’t know much about fee waivers. It’s like when I ask a law student in my class about something that he or she knows very little about even though they should know it. They change the topic to something they know about, even if it has little relevant to the topic at hand.

Actually, there could be a reason for Gogan to refer to waterfalls, but that would simply confirm that she indeed does not understand how management fee waivers work. The “distribution waterfall” determines how to divvy up the proceeds of the sale of a company between the general partner and the limited partners.

By focusing on the distribution of funds in the event of a sale, Gogan is cementing the misinformation that Eliopoulos also conveyed to board members in the same meeting, namely, that the management fees that the general partners forego are put at risk on the same footing as the monies provided by the investors. Earth to board members: they aren’t.As we discussed at length in a post last week, the general partners have the ability to gin up profits for purposes of recovering their waived management fees, including creating them even when there have been no sales of assets in the fund at all.

So take your pick. Gogan is either trying to cover for the fact that she is out of her depth or is choosing to mislead the board by doubling down on the false story that management fee waivers are a plus for CalPERS because they aligning the interests of the general partners with those of the limited partners.

At another point in the Investment Committee meeting, Gogan fails to answers a simple, direct question and shades the truth so heavily as to be engaging in distortion:

Board Member Dana Hollinger: In the past have we seen the financials of those underlying companies or no?

Chief Investment Officer Ted Eliopoulos: Well, I’ll turn that question over to Christine.

Gogan: With respect to what’s been occurring in the industry is there’s definitely been an evolution that’s occurred over time. And I would say we are moving towards an environment where we are receiving the much more detailed information with respect to the underlying. But to make a broad statement that we have always had access to the underlying detailed information in the portfolio companies is a stretch. It’s definitely improving.

The truthful answer to Hollinger’s question is “No, and we don’t typically get them now either.” Yet Gogan tries to give Hollinger the misleading impression that the limited partners get a considerable amount of disclosure, although she throws in some baffle-speak (“we are moving towards an environment”) to try to make her claim sound like less of a stretch than it is. Curt Loftis concurs:

Ms. Gogan’s response was bureaucratic gobbledegook. She chose to ramble incoherently for several minutes rather that submit a truthful and straightforward “no.”

Public pension plans should not accept as gospel the paltry representations from the GP as to the condition of the underlying investments, valuations and their attendant risk. The failure to perform the required due diligence and adequate ongoing oversight are unforgivable errors that will cost the fund substantial sums of money.

And that’s before you get to the fact, as we discussed in depth in a 2013 post, Why You Should Not Trust the Financials of Private Equity Owned Companies, that many general partners use a portfolio company software package called iLevel Solutions, which gives private equity general partners an unprecedented ability to cook the books of their portfolio companies while maintaining a facade of compliance. In other words, the portfolio company data that CalPERS does get is of questionable integrity. 

Gogan’s stonewalling shows the true face of CalPERS’ private equity staff: that they deem it to be acceptable to defy and mislead the board to protect private equity general partners. This warped sense of loyalties is proof of serious governance problems at CalPERS. But the sorry fact is that the board itself, save JJ Jelincic, has made clear by its failure to press for better answers that it fully supports this abject failure of governance and neglect of fiduciary duty.

The IRS is seeking to limit private-equity executives’ practice of reducing their tax bills by reclassifying how their management fees are taxed.

Rules proposed by the agency on Wednesday would make it harder for firms to convert high-taxed fees into lower-taxed carried interest, and by doing so take advantage of a 19.6 percentage-point difference in top tax rates.

The proposal represents one of the U.S. government’s most concrete attempts to limit the tax benefits enjoyed by private-equity managers.

The “modest move” by the Internal Revenue Service would stop some of the most abusive maneuvers by private-equity firms, said Victor Fleischer, a tax law professor at the University of San Diego.

“The regulations strike me as more taxpayer-favorable than I would have expected,” he said. “The regulations try to accommodate some arrangements that are common in the industry and that in my view ought to be treated as payments for services,” and taxed as ordinary income.

President Barack Obama wants to tax carried interest as ordinary income at rates as high as 43.4 percent instead of as capital gains at rates up to 23.8 percent. That effort fell short when Democrats controlled Congress and isn’t going anywhere with Republicans in charge of both chambers.

Typically, private-equity firms charge their investors a 2 percent fee on their assets and also keep 20 percent of profits, known as carried interest.

Profits Share

By using waivers, firms can forgo some of their fees and take a bigger share of the profits -- along with the tax benefit of doing so.

The rules, aimed at preventing “disguised payments for services,” say each case should be decided on the specific facts at hand, with weight given to whether fund managers bear a risk of losing money.

The Private Equity Growth Capital Council, an industry trade group whose members include the Carlyle Group, Silver Lake and TPG Capital, said it was still studying the proposal.

“It is important to remember that management fee waivers are and will remain legal, widely recognized, and part of negotiated agreements between the alternative investment community and investors, including pension funds and endowments,” Steve Judge, the group’s president and chief executive officer, said in a statement.

Capital Pledges

Private equity executives sometimes swap their cut of management fees into investments as a way to satisfy capital pledges they have made to funds managed by their firms.

The strategy surfaced as an issue in Mitt Romney’s 2012 presidential campaign, when documents from Bain Capital, which he co-founded and led, showed Bain used it to shave partners’ taxes by more than $200 million.

Apollo Global Management, another prominent firm, offered waivers to its partners until 2012, it said in a regulatory filing. Blackstone Group, the world’s largest private equity manager, and Carlyle have said they avoid the practice.

Fleischer said he was surprised at one example in the rules: fund managers were deemed to have enough at risk when they choose whether to reclassify their fees as few as 60 days before a tax year starts. By that time, future profits may be relatively certain.

“At the point where the general partner is making the decision whether to waive the fee,” he said, “they’re in a very good position” to know how successful the investments will be and can control the timing of realized gains and losses.

Hedge fund billionaire David Tepper said Thursday he's "not as bullish" as he could be—taking a more cautious view of the stock market almost five years to the day since his comments on CNBC sparked the "Tepper Rally" in the stock market.

"I have problems with earnings growth [and] problems with multiples," he said. "So I can't really call myself a bull [near-term]," said Tepper, founder and president of Appaloosa Management, which currently manages more than $20 billion.

Appearing on "Squawk Box" as investors look to next week's meeting of Federal Reserve policymakers, Tepper said it might be a good time to take money off the table, adding that he has lots of cash right now. 

"We have some longs and shorts and we're hedged in, but we don't have a huge equity book right now," he said.

Tepper called the stock market environment "challenging" and questioned whether earnings estimates for next year are too high.

Acknowledging he was not as definitive as usual, he said he's "not loving it," but if stocks were to fall 20 percent or so he'd be a buyer. He added that he still believes the market will go higher in the long term.

As for all the recent wild swings in the U.S. stock market, he blamed global reserve drawdowns. Money flows are not going in one direction anymore, he continued—warning the market should remain volatile as investors adjust to the new realities.

He said world economic growth is looking lower at a time when the Fed appears to be ready to raise interest rates while most other central banks are easing.

"The United States is not held hostage by the global economy. The U.S. stock market … which is 50-50 U.S. and the rest of the world is not the U.S. [economy]," Tepper said.

Tepper sees this as stock picker's market

Growth and margins for corporations matter more than the Fed, Tepper said, adding that it's a moment to pick individual stocks.

During a memorable appearance on "Squawk Box" in September 2010, the Appaloosa boss sparked the so-called "The Tepper Rally" when he said the Fed's asset-purchase program virtually guaranteed strength in stocks.

Since then, the S&P 500 has gained more than 70 percent.

In the current market, he thinks Apple is a cheap stock, which he has a small position in, "about 0.75 percent of our book."

"It does have a lot of Chinese exposure for it's growth, which is a bit of a problem. But the multiple is low so I can deal with it," Tepper said.

"[But] it's always going to have a lower multiple," he argued, "because it is still a device company that, even though people think it can't be replaced, still something can come along."

'I lost money in the Chinese market'

While Apple's exposure in China may not be that troubling for Tepper, he's pretty down on the stock market there.

"We were involved in China. I was reading the situation there wrong. I thought they were easing when they were not easing, and I lost money in the Chinese market," Tepper said, adding that he sold his stake in Chinese e-commerce giant Alibaba in early July.

"[The Chinese] just keep making policy mistake, after policy mistake, after policy mistake over there," he said. "It's a learning curve to get onto a market economy. You could say that. And maybe one day they'll get it."

But Tepper said it's not good when that "learning curve" is playing out in real time in the world's second-largest economy. "It's kind of bad when they're a $10 trillion or $11 trillion economy and they influence more than a third of the world's economy."

Tough year for hedge funds, but not Tepper

It's been a tough year for hedge funds with most seeing gains erased for the year, after August's wild market rout on China concerns.

Appaloosa on the other hand, is reportedly up over 12 percent net for the year through August, according to a person familiar with the matter. By comparison, the HFRI hedge fund index fell 1.87 percent for August—paring year-to-date gains to just 0.2 percent.

Though 2014 was a relatively low-key year for Appaloosa, up a meager 2.2 percent net of fees, Tepper's track record is undoubtedly one of the best in the industry.

The fund returned a record 42 percent in 2013 and has had only three down years in its history: 1998 (down 29 percent), 2002 (down 25 percent), and 2008 (down 27 percent), according to the book "The Alpha Masters."

But the years after those declines, the fund had record net performance in 1999 (up 61 percent), 2003 (up 149 percent) and 2009 (up 132 percent).

Appaloosa returned 10 to 20 percent of investor assets at the end of last year, the fourth-straight year of returning money to clients.

Tepper's past stock market calls

In some other past calls, Tepper told "Squawk Box"In May 2013 that the Fed had to taper its bond-buying to keep the stock market advance on an even keel. The term "taper" become common parlance on Wall Street, and gave rise to the phrase "taper tantrum."

In October 2013, Tepper told CNBC the Fed would not taper for "a long time now." The central bank started its gradual paring back of asset purchases in January 2014.

In May 2014, Tepper was more cautious, when speaking at SkyBridge Capital's SALT 2014 conference in Las Vegas, saying "don't be too frickin' long right now."

By December 2014, Tepper said in an email to CNBC: "This year rhymes with 1998. Russia goes bad. Easing [is] coming from Europe. Sets up 1999 … [oops] I mean 2015." He said he wasn't calling a top for in the market for the year. "You [just] have to be aware of the possibility for some sort of overvaluation of the markets."