In December 2010, the federal and provincial finance ministers examined Canada’s retirement system and concluded it was reasonably sound.

At most, the system seemed to be in need of nothing more than minor tinkering. Thoughts of increasing the pensions paid under the Canada/Quebec Pension Plan (C/QPP) were shelved indefinitely and the focus shifted to developing a new, voluntary retirement savings vehicle: Pooled Registered Pension Plans (PRPPs).

Two years later, the federal government stunned many pension observers by announcing it will reconsider expanding the Canada/Quebec Pension Plan after all. Various options for expansion will be discussed by the finance ministers in June. 
So what happened?

In 2010, Alberta and Quebec were both opposed to expanding the C/QPP with only Ontario keen to proceed. The recent election of a pro-labour government in Quebec, however, eliminated Quebec’s opposition and was enough to tip the scales in favour of revisiting “Big C/QPP.” In the meantime, Ontario’s conspicuous lack of enthusiasm for PRPPs seems to have infected the other provinces, which are now dragging their heels after an early show of enthusiasm.


On the surface, Big C/QPP seems a no-brainer. A pension equal to 25% of the average wage – which is what the C/QPP currently provides – is obviously not enough for middle-income households, even if you add in OAS. Surely it would be a good thing for all working Canadians to have bigger pensions, especially given that the coverage ratio within private pension plan is down to only 21% (yes, 21%) in the private sector. 


But when we take a closer look, the case for a bigger C/QPP is questionable at best, and if it is implemented poorly it can be a disaster. Here are five reasons why we should want to take it slow.

1. We don’t have a retirement crisis in spite of perceptions to the contrary, and none will develop for many years to come. The poverty rate among seniors is very low in absolute terms, less than half that of Canadians aged 18-64. An expanded C/QPP therefore starts to resemble a solution looking for a problem. The news is better than most of us realize. Nearly half of recent retirees have enough retirement income to replace more than 115% of their regular pre-retirement consumption.

2. The real looming problem in Canada is the rising cost of health care. We are already paying about $200-billion a year for health care and that is expected to rise by another 50% in real terms over the next 20 years. This is a serious problem because it will crowd out program spending for education and pensions. The rising healthcare bill will inevitably lead to higher taxes or user fees. Before we decide we’re ready to absorb higher C/QPP costs we should look more closely at where health costs are likely to end up.

3. We risk phasing in any improvements to the Canada/Quebec Pension Plan too quickly. This is what we did in 1966 when we provided a full C/QPP benefit after only 10 years of contributing a miniscule 3.6% of covered earnings and we are still paying the price today. The long-term cost of the Canada Pension Plan today is about 9.9% of covered earnings (it is about 11.2% in Quebec) though it should be closer to 6%. We are paying so much more because the previous generation didn’t pay enough into the C/QPP in its early years, leaving an unfunded liability that has to be amortized. 
If labour had its way, we would do the same thing again. The Canadian Labour Congress proposes a “small premium increase” to phase in a doubling of the CPP in just seven years. The fact is, the required contributions — employer and employee combined — would eventually have to climb to at least 16% of pay and possibly to over 20% if this doubling of the CPP is implemented retroactively. The quicker the phase-in the higher the ultimate cost. The situation is worse than it was in 1966-1976 because this time the 55-65 age group is so much larger. Quick phase-in means the next generation will be paying much more for their expanded C/QPP pension than it is worth. As if young people didn’t have enough reasons to resent the older generation!

4. An expanded CPP would enable us to continue to retire fairly early — the current average retirement age is 62 — and maybe even earlier. While this seems like a good thing, the worker to retiree ratio is dropping and will eventually fall from the present 4.4 to 1 to an estimated 2.3 to 1 by 2036. As this happens, we will need the 60-somethings to stay in the workforce longer to slow down this falling ratio. If we expand the C/QPP now so we can continue to retire early, employers and governments down the road will have find ways to reverse the effect in order to entice Canadians to do just the opposite. This is not exactly the most efficient strategy.

5. Fifth, expanding the C/QPP means we will be putting much more emphasis on just one pillar in our 3-pillar retirement system. One of the strengths of our current system (which ranks very highly internationally) is that Canadians get their retirement security from multiple sources. Indeed, we are praised by the OECD for the diversity of our sources of retirement income. An expanded C/QPP would induce us to contribute less to RRSPs and pension plans and increase our reliance on the government to provide for our retirement needs. This reliance is a little precarious. While we weathered the recent financial crisis much better than most countries, who is to say we won’t look more like Greece in 20 years?

If after all this, the consensus is that the C/QPP should be expanded, I would propose changes be phased in very gradually or better still, they should be implemented prospectively only (meaning no retroactive increases in benefits) so that we are paying for the increased pension we get rather than expecting our children to pay for it. Finally, we should use this opportunity to change the range of allowable retirement ages to anticipate when we expect we will be retiring in 20 to 30 years’ time. A quick survey of what is happening in social security systems around the globe suggests that a normal retirement age of 65 is becoming untenable.

Caisse de Depot et Placement du Quebec, Canada’s second-largest pension-fund manager, will increase investments in assets such as real estate, infrastructure and private equity to reduce volatility in its returns, Chief Executive Officer Michael Sabia said.

“The markets are no longer a good gauge of value,” Sabia told reporters today during a briefing in Montreal. “Markets are a source of volatility. We think this volatility will last quite some time.”

The Caisse plans to add C$10 billion ($9.97 billion) to C$12 billion in what it calls less-liquid investments in the next two years, Sabia, 59, said. The Montreal-based fund manager seeks to have about 30 percent of its assets in private equity, real estate and infrastructure by the end of 2014, up from 25 percent.

“We have to find a replacement for the performance in fixed-income that will no longer be there,” Sabia said. “We want to stabilize the performance of the organization.”

The Caisse oversees pensions for retirees in the French- speaking province of Quebec, with a dual mandate to maximize returns and foster economic growth in the province. It had net assets of C$165.7 billion as of June 30, including about 37 percent each invested in publicly traded stocks and fixed income.

“Our objective is not to be spectacular,” said Sabia, who has been running the Caisse since 2009. “We are a long-term investor and what matters is the performance over three, five or 10 years.”

Alternative Assets

Canada’s pension funds have been looking to invest more in alternative assets such as infrastructure and real estate, said Scott MacDonald, head of pensions, insurance and sovereign- wealth strategy for RBC Investor Services. (RY)

“Elite-sized plans in Canada have been investing a disproportionate amount of their assets in real estate and infrastructure,” MacDonald said in an interview. “Those returns have been very high and that trend towards investing in those asset classes will continue.”

The country’s defined benefit pensions returned a median 9.4 percent in 2012, according to a survey by RBC Investor Services, a unit of Royal Bank of Canada.
Global Leaders

The Caisse also wants to build up a fund it started in January to buy stakes in companies it considers global leaders. It will add its holdings in Nestle SA (NESN), HJ Heinz Co. (HNZ) and Qualcomm Inc. (QCOM) into the fund, said Roland Lescure, chief investment officer, also speaking at today’s event.

The fund, which will account for about 10 percent of the fund manager’s assets, will hold onto its investments for the long term, he said.

The shift will come as the Caisse pares investments in traditional index investing. “In two to three years we will have fewer traditional equity investments,” Lescure said.

The Caisse plans to also increase investments in emerging markets, Lescure said. Emerging economies such as India and Brazil accounted for 5 percent of total assets at the end of 2011, according to the Caisse’s most recent annual report.

About C$41.2 billion of the Caisse’s assets are located in Quebec, according to the pension-fund manager’s 2011 annual report. The Caisse has invested in more than 530 Quebec companies.

SNC-Lavalin

Sabia said the Caisse plans to stand behind its investment in SNC-Lavalin Group Inc. (SNC), the Montreal-based company embroiled in corruption and fraud probes in Canada and abroad.

“SNC-Lavalin is tarnished because of what happened, but it’s a company worth building,” Sabia said. “They face some challenges but we will be there because we’re convinced of the potential.”

Canada’s largest engineering and construction company has been grappling with $56 million in incorrectly booked expenses and a former executive’s arrest in Switzerland amid a probe of corruption in North Africa. Former chief executive officer Pierre Duhaime faces fraud charges related to a Quebec hospital contract.

“This is a time when a long-term investor like the Caisse needs to help the company build a bridge to a different future,” Sabia said. “If we weren’t convinced of that we would have already exited.”

Canada Pension Plan Investment Board is the country’s biggest public pension manager, with net assets of C$170.1 billion as of Sept. 30.

1. Volatile public markets: Historic low bond yields, sovereign bond concerns, volatile equity markets, massive quantitative easing by central banks, high-frequency trading, naked short-selling, hedge fund Darwinism and cannibalism. Even the world's biggest and best hedge fund is having trouble posting the returns it once did and other well known quant funds are chopping fees in half to stay competitive. In such an environment, how are large pension funds suppose to compete? One way is to take a long-term approach in both private and public markets. Also, illiquid investments aren't marked-to-market, so stale pricing due to infrequent valuations provides much needed return diversification for these large pensions.
2. Stable cash flows, more control: Pensions like the stable cash flows that come with illiquid asset classes like real estate and infrastructure. It makes it easier for them to plan for liquidity needs of paying out pensions. Also, Canadian pensions do a lot of direct investments in private equity, and co-invest with top funds, giving them more control over these private investments.
3. Leverage: Another reason pensions like illiquid asset classes is because they can use leverage to juice up their returns. Some pensions have internal limits on how much leverage they can use but this doesn't apply to their external private equity managers.
4. Managing reputation risk:  Pension funds have become so scared facing their depositors every time they lose money that they're working hard to develop a framework to insulate themselves from negative press articles and manage reputation risk. Notice how the focus shifts on absolute returns when they underperform public market benchmarks. The problem is that many pensions, including the Caisse, are not taking enough risks in public markets. It's less risky to do so in private markets where they can play around with fair value and benchmarks.
5. Much easier to fudge private market benchmarks: The fifth and equally important reason large Canadian pension funds love illiquid asset classes that it's easier to "fudge" these benchmarks, increasing the probability of beating their overall policy portfolio (beta) benchmark. This translates into big fat bonuses for senior managers at large Canadian pension funds. In other words, potential compensation influences their behavior and choice of asset classes. Without fail, if you take any annual report of all these large funds since the crisis, you'll see their president stating "significant value added was achieved in real estate, private equity and infrastructure." Duh! Because in most cases, private market benchmarks don't reflect the risks they're taking in these illiquid asset classes (ie. do not take into account illiquidity, leverage, and beta of the asset class).

Public benchmarks make no sense for private equity, and create huge perverse incentives. Might work when one looks back over ten years, but there is no actionable perspective that a public benchmark provides over any useful timetable. I can tell you many dysfunctions of public benchmarks, the whole fund secondaries businesses with discounts to NAV creates huge incentive to transact in this fashion as an obvious example.

And if private equity is supposed to be a diversifier, then in any give year why would aligning with public markets be expected? You will end up paying people for expected diversification effects. If it was so darn simple, do private equity and beat the public markets, and get diversification, holy grail!

Funny how it doesn't work out that way. CPPIB, net of costs and currencies has LOST money on private equity. Someday this will become a major problem for them. And OTPP doubled down with huge commitments at peak cycle too. Their returns on private equity are fading with time, and will not beat public markets long term. Inconvenient truths...too bad allocations continue to be made on the basis of "facts" that don't hold up to due diligence.

I think the strategy around illiquids is very superficial, and the risk of actually owning a company, rather just some shares, carries immensely more responsibilities and the skills and wisdom is beyond that of a "portfolio manager" with numerous other investments to attend to.. Few organizations have really been tested as owners, the institutional business model just does not lend itself to long term accountability landing on a specific individual.

Excellent article. I am always impressed to see that some investors still think that illiquid assets are less volatile. Most investors know that illiquid assets have their traditional risk measures (standard deviation, covariance, correlation and beta) underestimated due to stale pricing and infrequent “third-party” valuations. Of course, one can use relatively simple statistical adjustments to estimate the true underlying risk but many investors still prefer to stick with the underestimated risk measures.

Private equities generally use more leverage than the average public market investment. It is therefore not surprising to observe a statistically adjusted Beta higher than one. A leading edge Canadian investment organization assumes an average beta of 1.3 for its Private Equity portfolio.

If you don’t risk-adjust your returns, investing in levered strategies, high beta strategies, and private equities may look like a winning strategy. This will outperform when the public market goes up, and it will underperform in down markets. In the long run, assuming the markets go up, the strategy will work but with much more real volatility than its benchmark.

I have done some statistical analysis of a large investment organization using such approach and conclude that its departure from its benchmark in investing into levered strategies, high beta strategies, and private equities is statistically significant. I also find that its residual alpha is significant too but negative. Thus, if one has a negative investment skill (in the sense of stock picking, bond picking, etc), one can try to hide it by leveraging its Beta…

At the end of 2011, the Caisse’s benchmark had 24.4% exposure to private equity, infrastructure and Real Estate. The actual portfolio was slightly overexposed at 25.0% (down from 25.4% in 2010). The planned increases from 25% to 30% will significantly increase the active risk of the portfolio. The unadjusted (apparent) total risk may go down but the true (adjusted) total risk will significantly go up. The Caisse with the largest risk department in Canada (and one of the largest in the world) should know better.

As you mentioned, benchmarking is a major issue in private equities. And one should always be skeptical of changes in those benchmarks. Many such benchmarks are non-public and many suffer from survivorship bias. I have observed one major investor outperforming its benchmark by more than 20% in the first half of the year, then matching its new benchmark in the second half. Was the benchmark changed to lock-in an outperformance obtained by improper risk taking?

I also agree with your observation that the herd behavior of investors out of public equities, into private equities is changing the supply/demand relationship of these assets and therefore affecting their future return potential – something to keep in mind. If too many investors are chasing the same private equity deals, the higher pricing of these investments can only make future returns lower.

My last comment on the Caisse focusing on illiquid asset classes generated a few excellent responses, so I decided to follow-up on this topic. Let me begin with what a former pension fund manager shared with me after reading my comment:

Excellent article. I am always impressed to see that some investors still think that illiquid assets are less volatile. Most investors know that illiquid assets have their traditional risk measures (standard deviation, covariance, correlation and beta) underestimated due to stale pricing and infrequent “third-party” valuations. Of course, one can use relatively simple statistical adjustments to estimate the true underlying risk but many investors still prefer to stick with the underestimated risk measures.

Private equities generally use more leverage than the average public market investment. It is therefore not surprising to observe a statistically adjusted Beta higher than one. A leading edge Canadian investment organization assumes an average beta of 1.3 for its Private Equity portfolio.

If you don’t risk-adjust your returns, investing in levered strategies, high beta strategies, and private equities may look like a winning strategy. This will outperform when the public market goes up, and it will underperform in down markets. In the long run, assuming the markets go up, the strategy will work but with much more real volatility than its benchmark.

I have done some statistical analysis of a large investment organization using such approach and conclude that its departure from its benchmark in investing into levered strategies, high beta strategies, and private equities is statistically significant. I also find that its residual alpha is significant too but negative. Thus, if one has a negative investment skill (in the sense of stock picking, bond picking, etc), one can try to hide it by leveraging its Beta…

At the end of 2011, the Caisse’s benchmark had 24.4% exposure to private equity, infrastructure and Real Estate. The actual portfolio was slightly overexposed at 25.0% (down from 25.4% in 2010). The planned increases from 25% to 30% will significantly increase the active risk of the portfolio. The unadjusted (apparent) total risk may go down but the true (adjusted) total risk will significantly go up. The Caisse with the largest risk department in Canada (and one of the largest in the world) should know better.

As you mentioned, benchmarking is a major issue in private equities. And one should always be skeptical of changes in those benchmarks. Many such benchmarks are non-public and many suffer from survivorship bias. I have observed one major investor outperforming its benchmark by more than 20% in the first half of the year, then matching its new benchmark in the second half. Was the benchmark changed to lock-in an outperformance obtained by improper risk taking?

I also agree with your observation that the herd behavior of investors out of public equities, into private equities is changing the supply/demand relationship of these assets and therefore affecting their future return potential – something to keep in mind. If too many investors are chasing the same private equity deals,the higher pricing of these investments can only make future returns lower.

There are many excellent points in this comment. First, if you don't adjust returns for risk, private equity (and other illiquid asset classes like real estate and infrastructure) always outperform traditional stocks and bonds. This is why left unconstrained, asset allocation "optimization" models will allocate as much as possible into these illiquid asset classes because they underestimate the true risk of these investments (pension risk managers know this and adjust accordingly).

Moreover, academic studies have shown that there is substantial heterogeneity across private equity funds and that median returns underperform the S&P500. And unlike mutual funds, there is performance persistence among top funds, although lately there seems to be a changing of the old private equity guard.

Other studies using a select sample of funds have found private equity outperforms public markets net of fees but is highly correlated with public market conditions:

On average, our sample funds have outperformed the S&P 500 on a net-of-fee basis by about 15%, or about 1.5% per year. Performance and cash flows over time are highly correlated with public market conditions. Consequently, funds raised in hot markets underperform in absolute terms (IRR) but not relative to the S&P 500 (PME). Both capital calls and distributions are  more likely and larger when public equity valuations rise, but distributions are more sensitive  than calls, implying that net cash flows are procyclical and private equity funds are liquidity providers (sinks) when valuations are high (low). Controlling for public equity valuations, there is little evidence for the common view that private equity is a liquidity sink, except during the financial crisis and ensuing recession of 2007-2009, when unexplained calls spiked and distributions plummeted.

I won't get into the pros and cons of academic studies on private equity and hedge funds. Suffice to note that most of these studies are fraught with pitfalls, survivorship bias being one of the biggest (lots of hedge funds and PE funds don't survive, biasing performance data).

But the comment above from the former pension fund manager also elicited this detailed response from a private equity expert defending the asset class:

Lots of strongly felt assumptions going on here, many reflect familiar biases and presumptions that have plenty room for debate.

For example, valuations of companies do not in fact fluctuate as widely as values of minority bits and pieces of stocks in listed companies (why would they?). The only public company value that is comparable is a takeover bid, which is always at a premium, often significant (30 to 50 %) to the trading value implied market cap. The public market bias in those who evaluate private equity presume the way public markets are evaluated is sacrosanct. Stale pricing, or perhaps correct but simply necessarily subjective and therefore impossible to truly validate? Try unloading 100 % of the a listed company stock on the public market at the end of the trading day, and then you can mark to market.

Many private equity strategies are structured with much more downside protection than a trading common stock, and can mute valuation changes quite legitimately. Sure some firms have higher than public leverage, but the presumption is the public leverage is optimal in the first instance, it rarely is. In private equity, a company is worth what one can finance, a pretty good capitalistic indicator of value, not indicative of "excessive" leverage other than in hindsight.

Most mainstream private equity returns come from acquisition add-ons, or transformative mergers, which are challenging for staff and industries but otherwise have proven productivity enhancing outcomes, or stretch out the life of otherwise dying or fading businesses. Many also use growth capital, debt and equity to enhance existing businesses, and all employ management incentive structures that are far more focused than in most public companies.

To say alpha is negative is fine but presumes alpha makes any sense, that beta is always a rational known, and the time horizons for measuring (a quarter, a year? 10 years?) lead one to rethinking this and regress to old ideas, like seeking absolute returns (used to be called profits) like any other commercial enterprise, which simply makes more intellectual sense. Why should asset managers allocate capital so differently than commercial enterprise allocate their capital, ie. old style payback, hurdle rates and other types of project finance time tested ideas - that's what privately equity is actually structured around as an industry business model, for good reason. The whole alpha beta split is responsible for epic misallocation of capital. Parsing return attribution over short periods is a fools game, really one of compensation, and one that management's at institutions and their comp consultants exploit well.

The fact is that many private equity investment programs don't deliver, but a small but significant number do. All the analysis shows you is being median is a waste of time, while in the public markets median might still be ok. Rather than homogenize the whole industry and force an asset class definition, the portfolio objective is to diversify away from the public market culture and ecosystem, which is quite arguably very polluted, maybe even broken or at least has moved too far away from serving its business aims.

Private equity at its best goes back to old time business rather than investment values, and rewards risks in a way that is much more clearly aligned with investors ie. most comp is paid when cash is returned to investors - why do institutions not require this for hedge funds?Why do institutions say infrastructure is not really equity, because bond and risk guys say so, when it actually is (equity means massive ownership responsibility, not just a different stream of the cash flow), and is often even more levered than private equity? And traders get libor cost of funds, yet that cost of capital is not made available to other traditional investments when evaluating alpha? Why not?

Too many issues and biases for me to even address here. The point is, the reference point the commenter makes assume all other areas of investment and risk have been perfected, and private equity is driving a truck through the framework. Good to think through the potential dysfunctions, but it is far from uniquely in private equity.

You know I am a major sceptic of private equity and those that mislead their audiences and institutions, and I am far from being a shill for the industry. But the challenge is to do the task well, and keep the public market and asset management pollution out of the picture.

I think the Caisse is in its own way trying to escape the dysfunctions of our times, and trying to find a better way. Private equity and illiquids may not be the solution, but what is? They should be applauded for taking a view, however flawed or simplistic it may be.

I don't know if the Caisse is trying to "escape the dysfunctions of our times," but they have taken a clear view that bonds and stocks won't suffice to meet the target rate of returns set by their depositors and are thus allocating more into illiquid private markets.

And they're not alone. Following my last comment, another pension fund manager sent me a Bloomberg article discussing how Norway's plan to cut tariffs to ship gas through its pipelines by 90 percent will deal a blow to funds that have spent more than $5 billion since 2010 buying stakes in the infrastructure of western Europe’s largest gas producer.

The article specifically mentions the Canada Pension Plan Investment Board (CPPIB) and the Public Sector Pension Investment Board (PSPIB) as two of the major investors in these pipelines:

Statoil ASA (STL), which is 67 percent owned by the Norwegian state, sold a 24 percent stake in Gassled in 2011 for 17.35 billion kroner, bringing its holding down to 5 percent. The stake was bought by Solveig, a company owned by Canada Pension Plan Investment Board, Allianz Capital Partners, a subsidiary of Allianz, and Infinity Investments SA, a unit of the Abu Dhabi Investment Authority.

Total AS and Royal Dutch Shell Plc (RDSA) also sold stakes in Gassled in 2011.

Shell in September 2011 agreed to sell its 5 percent stake for 3.9 billion kroner to Infragas Norge AS, a unit of Canada’s Public Sector Pension Investment Board. Total in June 2011 agreed to sell its 6.4 percent stake for 4.6 billion kroner to Silex Gas Norway AS, owned by Allianz.

The pension fund manager who sent me the article noted "how do you model this risk?". And he's right, there are many regulatory risks and other risks in infrastructure that are difficult if not impossible to model.

One of the best comments on the risks of illiquid asset classes I received yesterday came from Jim Keohane, president and CEO of the Healthcare of Ontario Pension Plan (HOOPP). Jim notes the following after reading my last comment:

I find this whole discussion quite interesting. I agree with the commentary of the former pension fund manager. Private assets are just as volatile as public assets. When private assets are sold the main valuation methodology for determining the appropriate price is public market comparables, so you would be kidding yourself if you thought that private market valuations are materially different than their public market comparables. Just because you don’t mark private assets to market every day doesn’t make them less volatile, it just gives you the illusion of lack of volatility.

Another important element which seems to get missed in these discussions is the value of liquidity.At different points in time having liquidity in your portfolio can be extremely valuable. One only needs to look back to 2008 to see the benefits of having liquidity. If you had the liquidity to position yourself on the buy side of some of the distressed selling which happened in 2008 and early 2009, you were able to pick up some unbelievable bargains.

Moving into illiquid assets increases the risk of the portfolio and causes you to forgo opportunities that arise from time to time when distressed selling occurs - in fact it may cause you to be the distressed seller!Liquidity is a very valuable part of your portfolio both from a risk management point of view and from a return seeking point of view.You should not give up liquidity unless you are being well compensated to do so.Current private market valuations do not compensate you for accepting illiquidity, so in my view there is not a very compelling case to move out of public markets and into private markets at this time.

Got that folks? Current private market valuations do not compensate you for accepting illiquididty risk. Lots of pensions learned the value of liquidity the hard way during the 2008 crisis. When they needed it the most, they didn't have it and were forced to sell public market assets at distressed levels to shore up their liquidity.

Jim Keohane also shared his thoughts on Norway's proposed cut in tariffs:

The pipeline example illustrates the point. By investing in private assets you assume all the same risks that you assume when investing in public companies. In the case of infrastructure assets, you also face regulatory risks such as this. Generally speaking, local governments will take actions that favor their stakeholders – the voters in their country and don’t care whether it disadvantages a foreign pension plan. You would be naïve to think otherwise. Canadian governments and regulators act the same way.

I am sure that CPPIB and PSP are well aware that these types of political risks exist within these types of investments. Valuations are the critical factor. As long as you receive a high enough risk premium to compensate you for taking on these risks then it is an appropriate investment. I think that the point that this brings out is that investing in infrastructure is not a free ride. It has all of the risks contained in any other equity investment, so you need to go in with your eyes wide open!

Finally, a pension policy expert from British Columbia sent me this note:

Leo, I’m always impressed by the quality of the comments by the folks who comment on your postings. Shows you are becoming the most prominent commentator on pensions in Canada – and I suspect broader as well.

I’ve always been nervous about this whole private equity thing – not to mention real estate, as I’m not sure how accurate the valuation is. My suspicion has been that changes in value would generally lag the market, especially on the down side – that is just human nature – to think your assets are worth more than they really are, and I suspect the trend to upgrade valuations is most likely when the tide is rising.

Learning more about how the benchmarks are set for private equity and real estate make me even more cautious – especially when bonuses are related to benchmark outperformance. I suspect most boards do not have the expertise to assess the validity of the benchmarks their investment people are recommending them to approve. It seems a whole industry has build up around benchmarks.

Pension fund assets in the world's biggest markets rose by 8.9 percent in 2012 as retirement schemes shifted their attention to alternative investments to cope with economic volatility, a study showed.

Institutional pension fund assets in the 13 major markets grew by 9 percent, reaching a new high of $30 trillion, while UK pension fund assets hit an all-time high of 1.7 trillion pounds in 2012, a 5 percent increase from last year, the report by Towers Watson found.

The growth in pension assets in the 13 countries including Australia, Germany, Japan, Netherlands, Britain and the United States, was attributed to hiring more qualified people to manage pensions, outsourcing portfolios and better investment choices.

Towers Watson, a consultancy that advises institutional investors including pension funds on investment and risk management, said the countries' pension assets accounted for 78.3 percent of the GDP of their economies, below the 2007 level of 78.8 percent but above 2011's 72.2 percent.

Global pension fund assets have grown at over 7 percent on average per annum since 2002.

Funding levels of pension schemes are determined by factors like economic growth, equity market returns and yields on gilts.

Activity in the seven biggest pension markets within the top 13 countries showed that pension funds have steered away from investing in bonds and cash allocations in the past 18 years.

Australia, Canada, Japan, the Netherlands, Switzerland, Britain and the United States have upped alternative investments, such as property, hedge funds, private equity and commodities, from 5 to 19 percent since 1995, the study found.

Government gilts in particular, a staple for pension funds, have seen yields drop sharply since the crisis, making it more expensive for funds to match income to liabilities unless they add riskier, higher-yielding assets to portfolios.

Britain has increased its exposure to alternative assets the most, from 3 to 17 percent, followed by Switzerland, Canada, the United States and Australia.

"So many funds are buying fewer bonds than before, and those which are considering adding risk to their investment portfolios are most often diversifying into alternative assets rather than simply buying equities," said Chris Ford, EMEA head of investment at Towers Watson.

At the end of 2012, 47.3 percent of the assets allocation fell into equities, 32.9 percent into bonds, 1.2 percent cash and 18.6 percent into other assets.

The largest pension markets are the United States, Japan and Britain, representing 56.6 percent, 12.5 percent and 9.2 percent respectively. United States pension assets grew 10 percent, Japan's 0.5 percent and Britain's 9.9 percent.

Meanwhile, "defined contribution" (DC) pension scheme assets grew from 43 percent in 2002 to 45 percent in 2012, as governments try to phase out costly final-salary pension plans.

"Defined contribution funds continue to gain popularity around the world while various governments and companies battle the rising demographic tide by auto-enrolling," Ford said, referring to moves by governments including Britain's to make it compulsory, albeit with the chance to opt out later, for private sector staff to join workplace pension plans.

• At the end of 2011 pension assets for 13 markets in the study were estimated at USD 27,509 bn, representing a 3.9% rise compared to the 2010 year-end value.
• Global pension assets reached a record high this year, if measured in absolute terms. Pension assets relative to GDP reached 73.2% in 2011, still below the 2007 level of  78.9%, and also below the 2010 ratio of 75.5%.
• The largest pension markets are the US, Japan and the UK with 58.5%, 12.2% and 8.7% of total pension assets in the study, respectively. 
• In USD terms, the pension asset growth rate of these markets in 2011 was 5.9%, 2.0% and 5.0%, respectively.
• It is important to caveat the impact of currency exchange rates when measuring the growth of pension assets in USD terms, as in many cases results vary significantly with those in local currency terms.

•  The markets with a larger proportion of DC assets are Australia, Switzerland and the US, while Japan remains almost 100% DB. The Netherlands, also historically only DB, is showing signs of a shift to DC.
• The asset allocation pattern has changed somewhat compared to the end of 2010. Allocations to bonds increased while allocations to equities fell; cash remained stable and other investments suffered a slight decline.
• Australia, US and the UK have higher allocations to equities than the rest of the P7 markets.More conservative investment strategies -- more bonds and less equities -- occur in Japan, the Netherlands and Switzerland.
• The US pension market remains the market that invests the least in overseas equity markets (in %) while Canada has the lowest level of home bias.
• US and Canada have most of their fixed income investments domestic bonds, while Australia is the market with more foreign fixed income exposure than the rest of P7.
• Canada and Japan are the only two markets where the public sector holds more pension assets than the private sector.
• Assets under management of the top 300 funds represented 47.2% of the total global pension assets in 2010 with the top 20 funds accounting for 18.7% of the total pension assets globally.
• The lower Gini coefficient for GDP (62%) relative to pension market size (77%) suggests that the global pension asset pool is more concentrated in a few large markets than what would be suggested by their GDP levels. This could be explained by a number of factors including but not limited to a more developed capital market and a more mature pension pension system within the leading markets.

The Netherlands' Algemeen Burgerlijk Pensioenfonds (ABP), one of the world's biggest pension funds, said Friday it will trim benefits this year to strengthen its capital position, a move that will affect hundreds of thousands of pensioners.

ABP said it will lower payments for the first time since it was founded in 1922, even after it reported strong investment results over 2012. The fund, which covers about 2.8 million active and retired government and education workers, warned it might cut benefits further in 2014 if its financial situation hasn't improved by then.

The Dutch pension industry, considered one of the most solid in the world, has been pressured by market volatility since the global financial crisis struck in 2008. After suffering heavy investment losses at the start of the crisis, it was later squeezed by the low-interest rate environment. The problems have been aggravated by the Netherlands' aging population, which forces the funds to put more money aside.

Many funds are now planning cuts in benefit payments to improve their capital position. Although the reductions are relatively modest, they will further eat into household spending power at a time of sweeping government austerity measures.

ABP reported a 13.7% return on investments over 2012, thanks to a rally in stocks and bonds. That lifted its total assets to 281 billion euros ($380 billion) by the end of December, making it the world's No. 3 pension scheme, after funds in Norway and Japan.

The investment gains couldn't offset the negative impact of low rates and higher life-expectancy rates. ABP's funding ratio--which measures assets relative to liabilities--stood at 96% at the end of December, below the 105% legal minimum.

"I can see it's hard to understand that we, despite good investment results, have to lower pensions," ABP Chairman Henk Brouwer said in a statement. "It was a painful and difficult decision."

The payment cut of 0.5% will take effect in April. The average pensioner with ABP receives EUR700 in retirement benefits each month, on top of the state pension. The cuts will lower benefits by around EUR3.50, ABP said.

The Dutch central bank, the sector watchdog, in September allowed pension funds to use a more favorable benchmark to calculate their liabilities, which would ease the strain on their capital buffers. A planned increase in the retirement age should also provide some comfort, according to experts.

Japan's public pension fund, the world’s biggest manager of retirement savings, is considering the first change to its asset balance as a new government’s policies could erode the value of $747 billion in local bonds.

Managers of the Government Pension Investment Fund, which oversees about 108 trillion yen ($1.16 trillion) in assets, will begin talks in April about reducing its 67 percent target allocation to domestic bonds, President Takahiro Mitani said in a Feb. 1 interview in Tokyo. The fund may increase holdings in emerging market stocks and start buying alternative assets.

The GPIF, created in 2006, didn’t alter the structure of its holdings during the worst global financial crisis in 80 years or in response to the 2011 earthquake and nuclear disaster. Prime Minister Shinzo Abe and the Bank of Japan (8301) have pledged to restore economic growth and spur inflation, which will mean higher interest rates, Mitani said.

“If we think about the future and if interest rates go up, then 67 percent in bonds does look harsh,” said Mitani, who was appointed in 2010 after serving as an executive director at the Bank of Japan. “We will review this soon. We will begin discussions for this in April-to-May. Any changes to our portfolio could begin at the end of the next fiscal year.”

GPIF, one of the biggest buyers of Japanese government bonds, held 69.3 trillion yen, or 64 percent of total assets, in domestic debt at the end of September, according to its latest quarterly financial statement. That compares with 12 trillion yen, or 11 percent, in Japanese stocks; 9.6 trillion yen, or 9 percent, in foreign bonds; and 12.6 trillion yen, or 12 percent, in overseas stocks.

Relative Yield

The fund, which took over management of government employee retirement savings when it was set up, returned to profit in the three months ended Dec. 31 from a 1.4 percent loss in the first six months of the fiscal year, Mitani said. He declined to be more specific. It needs to raise about 6.4 trillion yen this fiscal year through March 31 to meet payments.

The yield on Japan’s 10-year government bond climbed 3.5 basis points to 0.8 percent as of 4:35 p.m. in Tokyo today. By comparison, the projected dividend yield for the Topix Index (TPX), the country’s broadest measure of equity performance, is 2.05 percent. The Topix added 1.4 percent today.

Japan’s bonds handed investors a 1.8 percent return in 2012, according to a Bank of America Merrill Lynch Index, compared with the 18 percent surge in the Topix.

Even as shares jumped amid optimism surrounding Abe’s stimulus plans, benchmark Japanese government bond yields have remained below their five-year average yield of 1.18 percent. Benchmark 10-year yields are the lowest in the world after Switzerland and are less than half the level in the U.S.

Rates Outlook

“JGBs were how we made money over the past 10 years,” Mitani said. “The BOJ said that they are increasing buying bonds, but they’re also putting power into lowering interest rates. If the economy gets better, then long-term interest rates like a 10-year yield at less than 1 percent are unlikely.”

The five-year JGB rate touched a record low 0.14 percent last month amid speculation the Bank of Japan will expand bond purchases as part of the monetary easing advocated by Abe.

The comments by Mitani show the pension manager needs to consider higher-risk, higher-yield assets to help fund retirements of the world’s oldest population. About 26 percent of the nation is older than 65, according to data compiled by Bloomberg.

Under Mitani’s leadership, the GPIF began buying emerging- market assets in September 2011 and started purchasing shares in countries included in the MSCI Emerging Market Index (MXEF) last year. Mitani said in July 2012 that the fund was selling JGBs to pay for people’s entitlements and might consider alternative investments as it seeks better returns.

100 Years

“We haven’t changed the core portfolio for a long time so it was thought that it’s about time to review this,” Mitani said. “The portfolio was based on a prerequisite of things such as long-term interest rates at 3 percent on average for the next 100 years. Whether this is good will be a possible point of discussion.”

Holdings have been broadly unchanged since inception, when the fund was formulated with an outlook for consumer prices to rise 1 percent annually. Instead, the nation’s headline CPI has fallen an average 0.1 percent each month since the start of 2006, according to data compiled by Bloomberg.

The Bank of Japan last month doubled its inflation target to 2 percent, a level last seen in 1997, when a sales tax was increased, with no sustained price gains of that magnitude in two decades. Falling prices reduce incentives to borrow and invest in new business projects, erode tax receipts and increase the attractiveness of saving in cash rather than spending or putting money into stocks or bonds.

Topix Surge

GPIF is the biggest pension fund in the world by assets, followed by Norway’s government pension fund, according to the Towers Watson Global 300 survey in August.

Japan’s Topix Index surged 30 percent from Nov. 14, when elections were announced, through Feb. 1 on optimism the Liberal Democratic Party will lead the economy out of recession and end deflation. The yen weakened almost 14 percent against the dollar in that time, and touched its lowest level since May 2010 last week.

Even after 12 straight weekly advances, the longest streak in 40 years, the Topix is still 67 percent below its December 1989 record high.

Relative Value

The measure trades for 1.1 times the value of net assets. That compares with 2.3 times for the S&P 500, 1.6 times for the Hang Seng Index and 1.9 times for the MSCI World Index. A reading above one means investors are paying more for a company than the value of its net assets.

The yen dropped 11 percent last year versus the dollar, the most since 2005. A weaker yen increases the value of exports and typically raises import costs, boosting consumer prices.

“Japanese stocks do not look expensive,” Mitani said. “We’re still in the middle of a rising stocks, weakening yen trend. It will continue for a while.”

Big bets with private equity[1] by public pension funds represent a perfect example of how misaligned incentives endanger public money. This can only hurt public employees and taxpayers in the long run.

In an attempt to achieve an aggressive target return of 8 to 8.5 percent in a low-yield investment climate, public funds are increasingly assuming risk from investing in illiquid, volatile assets, such as private equity and real estate. These investments often lack transparency.

Fund managers are hoping to benefit from the “illiquidity premium” to boost weak funded ratios battered by the Great Recession. Otherwise, failure to reap attractive returns on investment of pension assets would force sponsor governments to cough up additional annual pension contributions at the time of budget crunch, raise employee contributions, modify benefits or terminate public defined benefit plans altogether –- none may be politically attractive or feasible.

In 2011 private equity accounted for about 7 percent of total defined benefit assets among the top 200 U.S. retirement funds,[2] with higher allocations for some individual funds. Senior pension executives are steadily moving their money into “sub-asset” classes, such as emerging markets, high-yield bonds, and bank loans. Additionally, according to the U.S. Government Accountability Office, the percentage of large plans investing in hedge funds also grew from 47 percent in 2007 to 60 percent in 2010.[3]

According to a 2012 Pyramis Global Institutional Investor survey, this trend is likely to continue, with 67 percent of largest public pension systems indicating plans to boost their share of illiquid alternatives, and 37 percent increasing exposure to “sub-asset” classes. This is a dramatic investment paradigm shift from relying on a traditional blended portfolio of stocks and bonds, which historically generated real rolling returns of about 5 percent over a typical time horizon of 30 years.[4]

Equally worrisome is that investment decisions are increasingly “streamlined” to allow investment managers to take advantage of arbitrage opportunities and “dynamic management” of public funds through flexible mandates. This is bound to lead to poor oversight and lack of representation in portfolio allocation decisions, spelling trouble when markets turn in unexpected directions.[5]

Rewind a mere twenty years ago to the bankruptcy of Orange County, CA, which to date remains the largest municipal failure in the U.S. history with a $1.7 billion loss wiping out nearly 23 percent of its investment pool assets.[6] While in 1994 faulty bets on derivatives were responsible for Orange County’s unprecedented pension collapse, can excessive bets on private equity and exotic “sub-asset” classes lead to the next downfall of pension systems — this time at the systemic level?

Implications of such pension debacle would be dreadful for pension beneficiaries whose pension savings would be wiped out and for sponsoring governments already facing structural budget pressures which most certainly would fail to close the funding gaps with contributions. Millions of retirees would find themselves without annuities and millions more would approach retirement without any savings, overwhelming social safety net programs and spiraling down the standard of living at a time most localities, states and the federal government are already wrestling with debt crises of their own, as well as aging infrastructure.

This is a scenario we as a society simply cannot afford.

Given such dramatic societal costs of potential failure of pension systems, what guarding mechanisms exist to prevent collapse of pensions due to poor investment choices?

Shockingly, current incentives regarding costs and benefits encourage excessive risk taking with public money, privately accruing gains and socializing all losses. Fund managers are compensated lavishly for short-term gains, while bearing no responsibility for sour bets, with taxpayers — and public employees — remaining on the hook if any of these bets fail to pay off. The only real winners are investment managers and their staffs.

Under a similar context of perverse incentives, traders lost billions on Wall Street shocking markets. We now are doing it all over again with public funds. Compensation structures at pension funds, as well as aggressive target return rates encouraging funds to take excessive risk, deserve continued public scrutiny and oversight, since “we the people” will have to foot the bill when — not if — these “alternative investments” go wrong.

[1] “Pensions Bet Big With Private Equity.” Wall Street Journal, January 24, 2013.

[2] “Funds Boost Private Equity Investing By 38%.” Pensions & Investing, February 7, 2011.

[3] “Defined Benefits Plans: Recent Developments Highlight Challenges of Hedge Fund and Private Equity Investing.” GAO, February 2012.

[4] “Investment Return Assumptions for Public Funds: The Historical Record.” Callan Investments Institute Research. June 2010.

[5] “U.S. Publics: Seeking Less Correlation and Better Execution.” Pyramis Global Advisors, 2012.

[6] Jorion, Philippe. Big Bets Gone Bad: Derivatives and Bankruptcy in Orange County. Academic Press: 1995

I find this whole discussion quite interesting. Private assets are just as volatile as public assets. When private assets are sold the main valuation methodology for determining the appropriate price is public market comparables, so you would be kidding yourself if you thought that private market valuations are materially different than their public market comparables. Just because you don’t mark private assets to market every day doesn’t make them less volatile, it just gives you the illusion of lack of volatility.

Another important element which seems to get missed in these discussions is the value of liquidity.At different points in time having liquidity in your portfolio can be extremely valuable. One only needs to look back to 2008 to see the benefits of having liquidity. If you had the liquidity to position yourself on the buy side of some of the distressed selling which happened in 2008 and early 2009, you were able to pick up some unbelievable bargains.

Moving into illiquid assets increases the risk of the portfolio and causes you to forgo opportunities that arise from time to time when distressed selling occurs - in fact it may cause you to be the distressed seller!Liquidity is a very valuable part of your portfolio both from a risk management point of view and from a return seeking point of view.You should not give up liquidity unless you are being well compensated to do so.Current private market valuations do not compensate you for accepting illiquidity, so in my view there is not a very compelling case to move out of public markets and into private markets at this time.

Pension funds and other institutions are retreating from popular investments linked to commodities after finding they did little to protect their portfolios against inflation risk and the unpredictable returns of stocks.

Investors have yanked nearly $10 billion from tradable indexes tied to energy, food, metals and other commodities after two years of record outflows. That leaves about $133 billion, said Kevin Norrish, a managing director at Barclays PLC.

The trend is accelerating this year, analysts and investors said, driven by lackluster returns and looming U.S. regulations that could make these investments more complicated and costly. The reversal could affect the way commodities are traded and temper price swings in everything from cereal to gasoline to gold, some economists said.

Among those scaling back is the California Public Employees' Retirement System. Calpers, the nation's largest pension fund, pulled out 55% of its holdings in commodities indexes in October, after losing about 8% annually over five years, according to the fund's most recent financial statement. That left $1.5 billion of Calpers's assets in commodities indexes, 0.6% of the fund's total. The money was switched to inflation-linked bonds, under a policy that allows Calpers to make quick moves within investment areas based on market conditions, a spokesman said.

Calpers helped pioneer pension funds' push into indexes that track metals, wheat, energy and other commodities. Unheard of a decade ago, the indexes held $155 billion at the end of 2010, up from $65 billion in 2008, according to Barclays.

The money mainly flooded in from big institutions, such as pension funds and college endowments, embracing commodities as a diversification tool and a hedge against inflation risk. Commodities traditionally have delivered modest returns, in line with inflation, and are disconnected from the gyrations of stocks and bonds.

But the new money turned the market on its head. Many commodities seesawed beyond traditional supply-and-demand patterns, and some economists blamed these new "index speculators," who had no stake in the underlying commodities.

Farmers, airlines, oil companies and other producers and users found it more difficult to use futures contracts for their original purpose—to protect themselves against price swings.

The government has been wrestling with limiting investments by speculators. Separately, the financial-regulatory-overhaul law could increase costs and add complications by requiring Wall Street dealers to use a clearinghouse to settle derivatives transactions, including those connected to commodities indexes.

The indexes, meanwhile, have produced smaller returns and the wild price swings that investors were trying to avoid. In May, the Teachers Retirement System of the State of Illinois cited "volatility of commodity investments" in deciding to move $800 million in a $3.5 billion portfolio to "strategies that better protect TRS from inflation."

The performance troubles are evident in the S&P GSCI—formerly known as the Goldman Sachs Commodity Index—a benchmark that tracks a basket of contracts linked to energy products, precious and industrial metals as well as agricultural and livestock products. That index lost about 33% over five years, compared with inflation of more than 6%. Those who invested in another popular index, the Dow Jones-UBS Commodity Index, lost a total of about 25% overall over five years. The declines stem partly from the way commodities contracts work. Unlike stocks, commodities contracts expire, typically monthly or quarterly, and then need to be rolled over into new contracts.

Speculators account for more than half of futures contracts in certain commodities, according to the Commodity Futures Trading Commission. But signs of cooling abound. In April 2012, for example, investors held 225,869 contracts for a wheat traded in Chicago, a record. Now, they are down to 144,487 "Chicago wheat" contracts, the lowest point in several years.

"Calpers turning around and getting out is sending this signal to other institutions," said David Frenk, research director for Better Markets Inc., a Washington-based advocate of financial change. "There is a huge transformation starting to take place."

The group has been a critic of index investing, arguing that pension funds are risking losing money and influencing prices of underlying assets.

Mr. Frenk flew to California in November 2010 to urge the California State Teachers' Retirement System to reconsider an investment of about $2.5 billion it was considering making in commodities, including the DJ-UBS, minutes of the meeting show. The pension fund allocated just $150 million but hasn't invested the money. Given that the index has lost 13% since the meeting, Mr. Frenk estimated, "they saved about $300 million."

Also on the sidelines is the Los Angeles Fire and Police Pensions, which put aside 5% of its $15.2 billion for commodities. So far, though, it has invested only in publicly traded commodities companies. "We haven't gone into indexes," said Tom Lopez, chief investment officer, "but the plan is to be there."

Index investing continued slowing this year, said Michael Lewis, a Deutsche Bank analyst. "The role of commodities as a diversification strategy is being questioned because of an extreme market distress."

Chinese financial website Finet quotes Phil Ren, chief of the China Coal Importers Association, as saying at an industry conference in Singapore, China's coal imports may reach 400 million – 500 million tonnes within three years.

That would constitute massive growth from current levels. China imported 234.3 million tonnes of coal in 2012, which constituted a huge jump – 28.7% – over the year before.

Ren said that the Chinese market is highly sensitive to price movements and would import coal even when it is able to satisfy coal demand from domestic sources.

The China National Coal Association announced yesterday that production in the country reached 3.66 billion tonnes in 2012, up by 4% compared to the year before.

Growth in coal consumption in China has been even more spectacular than its output growth – growing for 12 years in a row – according to newly released international data from the US Energy Information Administration (EIA):

China's coal use grew by 325 million tons in 2011, accounting for 87% of the 374 million ton global increase in coal use. Of the 2.9 billion tons of global coal demand growth since 2000, China accounted for 2.3 billion tons (82%). China now accounts for 47% of global coal consumption—almost as much as the entire rest of the world combined.

Robust coal demand growth in China is the result of a more than 200% increase in Chinese electric generation since 2000, fueled primarily by coal. China's coal demand growth averaged 9% per year from 2000 to 2010, more than double the global growth rate of 4% and significantly higher than global growth excluding China, which averaged only 1%.

While Australian and Indonesian coal miners have been the main beneficiaries of Chinese growth, the US coal industry – struggling to compete with cheap natural gas at home– has been thrown a lifeline by upping exports (click on image below).

US exports are on track for a record year in 2012 of more than 125 million tonnes. That is up from just 40 million tonnes a decade ago and in line with the all-time record set in 1981.

While metallurgical coal used in steel-making still constitutes the bulk of US exports, all the growth has come from increased steam coal exports.

A jump in interest rates could spark an unruly exit from the $12 trillion corporate bond market, according to a new analysis.

Investors have been flocking to the relative safety of corporate and government debt while interest rates have stayed low and stock market tensions have run high.

But an expected shift out of fixed income - particularly top-quality investment grade - and into stocks coupled with a commensurate rise in interest rates and a much more easily traded corporate debt market could send tremors through the space, Bank of America Merrill Lynch said. (Read More: 'Easy Money' Will Help Stocks for Foreseeable Future: Roubini)

"A disorderly rotation out of bonds - characterized by higher interest rates and wider credit spreads - is the biggest risk for investment grade corporate bond investors this year," Hans Mikkelsen, credit strategist at BofA, said in a note to clients. "However, history offers little guidance about how much of an increase in interest rates would prompt such disorderly scenario and how it would play out."

Some indicators about this move, though, could be flashing now.

Stocks turned in their best January in 16 years to start 2013 and Treasury yields rose in unison. (Read More: Better Enjoy the Market Rally While You Can: Marc Faber)

The current 10-year yield at 2.02 percent does not meet Mikkelsen's criteria for what would trigger a "disorderly rotation" from investment grade corporates, but it is moving in that direction. The benchmark note began the year at 1.86 percent.

Mikkelsen estimates that a 2.5 percent yield would lead to what he would consider an orderly move out of the market, but a continued trek higher past 3.0 percent would be the game-changer.

BofA is not alone in its aversion to fixed income - Wells Fargo recently cautioned its clients about fixed income amid dangers from rising rates, and advised shifting 5 percent of their bond positions into stocks.

Because the corporate bond landscape has changed so much, history offers little guide about what could happen in a disorderly rotation. However, conditions in 1994 and 1999 are two periods that saw significant interest rate changes and corresponding outflows from the market.

Those cases saw investors pull about 10 percent of total assets out of corporate bonds. But even then, the parallels are different to draw primarily because of the different vehicles investors use to buy company debt.

In those days mutual funds were a bit player in the space, and exchange-traded funds even less.

But fixed income flows have surged and occupy huge parts of the fund industry, with $3.43 trillion in bond mutual funds, compared to nearly $6 trillion in equity funds.

Bonds now are the biggest player in the $1.4 trillion ETF market with $238 billion of total assets, outpacing even large-cap stocks, which have $227 billion under management, according to industry tracker XTF.

Corporate bonds had long been an illiquid asset - difficult to trade as investors usually either held bonds to duration or until the debt was called. But because ETFs trade like stocks and generally carry lower fees than mutual funds, they have changed the way the market operates. (Read More: Money Pouring Into Stocks 'Is Usually a Negative Sign')

"The key problem is that, with the rise of bond funds and ETFs, individual investors now have a means to trade illiquid corporate bonds in a much more liquid manner," Mikkelsen said. "When interest rates rise and (net asset values) decline, we are concerned that redemptions will lead to a situation where too many illiquid underlying corporate bonds come out of funds - especially as dealers have little capacity to act as buffer in the new regulatory environment."

Corporate bonds are now 42 percent of mutual fund assets, compared to 24 percent in 1994 and 31 percent in 1999, while mutual funds and ETFs combine own nearly one-fifth of the entire corporate bond market, including high yield bonds.

Households, meanwhile, have shifted assets as well, with 13 percent of their portfolios consisting of bonds, according to BofA figures.

"Thus, if we were to experience outflows from bond funds of the magnitude seen in 1994 and 1999, the impact on corporate bonds this time would be much more severe," Mikkelsen said. "There is reason to suspect that households will play a more active role in rebalancing out of bonds, into stocks as interest rates increase."

The Supreme of Court of Canada has rejected a lower court's decision that the pension plan of restructured company Indalex should be reimbursed before financial backers and other stakeholders get a crack at assets.

The top court handed down its ruling Friday.

Indalex was an aluminum manufacturer that began restructuring proceedings under the Companies' Creditors Arrangement Act (CCAA) in 2009.

At the time, Indalex had two underfunded pension plans, but the United Steelworkers union — on behalf of the employees —had argued that those plans should be replenished before creditors received the proceeds, as has traditionally been the case in insolvencies under Canadian law.

In 2011, the Ontario Court of Appeal ruled on the side of the pensioners. But in a 5-2 decision released Friday, Canada's top court overturned that decision.

"The United Steelworkers appeal should be dismissed," the court said in the ruling.

In the case, Indalex assets were sold to a U.S. company, Sapa Group, after the former ran into some financial difficulty in 2009. While that was happening, the company was ordered to pay back the creditors who had kept it afloat during CCAA proceedings, which moved the company's pensioners and their $6.75 million pension shortfall further down the hierarchy of who would be paid, and how much they would get.

That funding was known as a "debtor-in-possession" loan and is common in insolvencies and restructurings. DIP funding gives companies cash to keep the business going, and those who give them typically do so in part because they are guaranteed to get their money back ahead of other claimants should a dispute arise.

The original court sided with the DIP creditors, until an Ontario Court of Appeal ruling raised legal eyebrows by throwing a wrench into that long-held tradition. It decided the pensioners should take priority because they had formed an entity known as a trust, and should be considered secured creditors.

Precedent-setting case

The Ontario court also ruled that the people overseeing the company had breached their fiduciary duty to the employees by concealing the company's financial difficulties. In the 5-2 split decision, the dissenters on the Supreme Court agreed with that view.

"The employer not only neglected its obligations towards the beneficiaries, but actually took a course of action that was actively inimical to their interests," the court ruled. "The seriousness of these breaches amply justified the decision of the Court of Appeal to impose a constructive trust."

But ultimately, the court's decision largely upheld the status quo on a federal level.

"As a result of the application of the doctrine of federal paramountcy, the [creditors] supersedes the deemed trust," the court said. That's the Supreme Court's way of affirming that no provincial law should be able to supercede the federal legislation for companies that undergo restructuring through the Companies' Creditors Arrangement Act.

The case has implications for any Canadian company with a pension plan, because it reasserts the supremity of existing legislation, which holds that secured lenders always take precedence over other stakeholders when a company sells assets and divests the proceeds during a restructuring.

Business groups were watching the case closely because they saw the Ontario Court of Appeal ruling as a threat in the current economic climate, where restructuring is often a necessity.

"They restored the original order that pension plan members were unsecured creditors," lawyer Brian Rogers, who has no stake in the case, told CBC News. "The pensioners are now back where they were when this all started."

The employees will still receive what they paid into the plan, but they will lose about half of what they would have received under their full pensions.

The Supreme Court of Canada has ruled that the U.S. parent of an insolvent Toronto company is entitled to the Canadian entity’s last $6.75-million, instead of a group of the firm’s retirees, whose pensions were cut after their employer went under.

The court’s ruling in the case of Indalex Ltd., which plunged into bankruptcy protection in 2009, was is expected to have broad implications for other companies and pension plans across the country.

It comes amid widespread concern over the viability of many companies’ pension schemes and public outrage after former employees of Nortel Networks Corp. and other large firms have been left with little after their employers went belly up.

Friday’s decision reverses a controversial 2011 Ontario Court of Appeal ruling that surprised bankruptcy lawyers by siding with Indalex’s retirees, who had fought for a piece of the proceeds from the sale of the company’s assets to restore their pensions, which had been slashed cut by more than half.

While many cheered that Ontario ruling as a breakthrough victory for pensioners, bankruptcy law experts warned the decision would radically reorder Canada’s insolvency regime. They said it could make it more difficult for struggling companies with large defined-benefit pension plans to borrow the money they need to weather financial storms.

Normally, in the scramble for money after a company has filed for bankruptcy protection under the federal Companies’ Creditors Arrangements Act, pension plans rank far below the banks and hedge funds that lend last-ditch money to distressed companies. These “debtor-in-possession” or DIP loans usually come on the condition of a court-ordered guarantee they will be repaid first.

Indalex, an aluminum processor, had a $6.75-million pension shortfall when it entered bankruptcy protection. But all of the cash from the sale of its assets was bound for the company’s U.S. parent, Sun Indalex Finance LLC, to cover some of its costs for paying back DIP loans made to Indalex by a group of banks.

The Ontario Court of Appeal’s 2011 ruling said the money should go to the pensioners because Indalex had breached its duties to its retirees by failing to keep their pension plans fully funded and by failing to give proper notice that it was plunging into bankruptcy protection.

On Friday, Bay Street bankruptcy lawyers welcomed the Supreme Court’s reversal of that decision, saying it restores certainty for DIP lenders. But they also singled out part of the decision as at least a consolation prize for pensioners – and something that could still create concern for those who lend money to companies.

Although it ultimately determined that the DIP lenders rank first because the court orders that grant them priority come under a federal law, the court also surprised observers by ruling the full amount of a pension shortfall at a plan’s windup should be considered a “deemed trust” under Ontario’s pension law. That could push pensioners’ demands further ahead in the line of creditors, but still second to DIP lenders.

A lawyer for Sun Indalex Finance LLC said the company had no comment.

Andrew Hatnay, a Toronto lawyer with Koskie Minsky LLP who acted for former executives with Indalex whose pensions were slashed, said U.S. bankruptcy judges are much more likely to use their discretion in such cases to help employees:“The Supreme Court [of Canada] has gone in the opposite direction … leaving more room for potential abuse of the bankruptcy system.”

Robert Leckie, a former executive with Indalex who lives in San Antonio, Tex., and whose pension was slashed in half, said he was disappointed with the Supreme Court’s decision.

“To allow a pension plan to be underfunded by this amount, it’s an indictment of the whole system, really,” said Mr. Leckie, who recently had a bone marrow transplant to treat his leukemia.

The 65-year-old said he keeps his troubles in perspective: “On the one hand, it is outrageous, and I miss the money and I need the money. On the other hand, I am so aware that there’s so many people both in Canada and in the United States that have been suffering these last few years that are so much worse off than I am.”

The creditor claims of long term disabled insureds, who are covered by employer sponsored, or self-insured, disability benefit plans, now have a priority that is below Ontario pensioners in CCAA proceedings. The creditor claims of long term disabled insureds in this situation are unsecured creditors, at the bottom of the list of creditors in CCAA proceedings.

Initial media headlines on the SCC Indalex decision were misdirected at the loss of priority of pension deficits over DIP financing. DIP financing is rightfully super-priority. The war victory was that the whole pension deficit is now defined to be a deemed trust, where trusts are equal to secured creditors under CCAA.

Banks are surprisingly quiet on this. It may be that they expect to convince CCAA judges to put provincial pension deficits’ deemed trusts below secured creditors due to paramountcy of Federal CCAA and CCAA purpose to be the facilitation of a successful restructuring as an ongoing concern. Nonetheless the SCC Indalex decision is a good one, because it forces the CCAA judge to be very attentive to whether a company is actually planning to restructure over is simply conducting a lock stock and barrel sale of its businesses or the company as a whole.

Having said this, in Nortel CCAA case, J. Morwetz always referred to the need for him to facilitate a restructuring of Nortel throughout this case, even though Nortel had announced it was liquidating by June 2009. The pension fund beneficiaries’ court appointed lawyers need to file motions to stop this abusive use of the term restructuring to cover liquidations.

However, these pension fund beneficiaries’ court appointed lawyers are in the bankruptcy lawyers’ cartel and are paid by the corporation sponsors of pension plans. As a consequence, they rarely, if ever, challenge the corporation or judges who mischaracterize what is actually going on in terms of liquidation rather than restructuring.

“We recommend that the CAW Canada and its membership support the temporary solvency funding relief,” said CAW Local 444 president Dino Chiodo in a letter posted on the union’s website. “Chrysler is a viable corporation. Extending the pension funding period does not put the plan at significant risk.”

In fact, rejecting Chrysler’s request could jeopardize the pension plan, Chiodo warned.

“Without solvency relief, we see the employer coming to the next set of negotiations with demand for converting to defined contribution pension plans.”

Chrysler is among a growing number of employers seeking temporary solvency funding relief under an Ontario government regulation that took effect Nov. 1, 2012.

Under the changes, which apply only to defined benefit pension plans, companies can either consolidate the current solvency payments into one new schedule payable over five years, or fund any new solvency shortfall over 10 years instead of the normal five.

The 2011 was a difficult year for defined benefit pension plans in Canada, the CAW letter noted. “Low interest rates mean poor investment returns on pension plan assets and increase liabilities. The overall funded status of pension plans deteriorated in 2011. The Ontario government estimates that pension solvency levels fell from a median funded level of 87 per cent in 2010 to 72 per cent last year.”

Chrysler has sent letters to CAW members outlining its plans to seeking funding relief, Chiodo said.

Chrysler’s plan warrants the union’s support because the automaker is “a viable corporation. Extending the funding period does not put the plan at significant risk,” Chiodo said.

Also, interest rates are likely to increase in the coming years, which will improve the funding status of pension plans, he said.

As at Jan. 1, 2011, there were 8,807 active plan members, 8,505 retirees, 1,835 surviving spouses or beneficiaries, 1, 045 disabled members and 1,429 terminated vested members, according to Jo-Ann Hannah, director of pensions and benefits at the CAW national office.

Air Canada says it has charted a path to sustained profitability after turning in its first annual profit in five years in 2012 - but all of its efforts will be for naught if the country's largest carrier is unable to get a little help from the federal government on its pension funding obligations at the start of next year.

The airline reported Thursday modest net earnings of $53 million, or 19 cents per share, for 2012. Returning to the black is a significant achievement for the airline, which lost roughly $850 million in 2008 before current chief executive Calin Rovinescu embarked on a massive restructuring. But there are plenty of issues Air Canada must still tackle in the year ahead.

"We are mindful that we have much to do to achieve our goal of sustained profitability year after year after year. But as today's results show, we're on the right course," Rovinescu said on a conference call.

The pension funding obligations will be the largest hurdle in front of Air Canada after years of low interest rates and poor equity markets saw its pension solvency deficit balloon to $4.2 billion at the start of 2012.

The airline successfully negotiated a reduced funding schedule for its pension obligations as part of a restructuring in 2009. But that will expire at the end of 2013.

So far, Finance Minister Jim Flaherty has played his cards close to his chest on whether an extension will be granted. The Department of Finance declined to comment on the matter Thursday.

Air Canada's management said it was in the midst of calculating where the solvency deficit sat at the start of 2013, noting that its recently implemented labour agreements should reduce the figure by $1.1 billion, though that won't take effect until Jan. 1, 2014. The company estimated a one percentage point decrease in the discount rate would result in a $1.84-billion reduction to the pension solvency liability, but there has been no indication that it can bank on that.

After spending years dogged by unpaid debts, California labor leader Charles Valdes filed for bankruptcy in the 1990s—twice. At the same time, he held one of the most influential positions in the American financial system: chair of the investment committee for the California Public Employees’ Retirement System, or CalPERS, the nation’s largest pension fund for government workers. Valdes left the board in 2010 and now faces scrutiny for accepting gifts from another former board member, Alfred Villalobos—who, the state alleges, spent tens of thousands of dollars trying to influence how the fund invested its assets. Questioned by investigators about his dealings with Villalobos, Valdes invoked the Fifth Amendment 126 times.

California taxpayers help fund CalPERS’s pensions and ultimately guarantee them, so they might wonder: How could a financially troubled former union leader occupy such a powerful position at the giant retirement system, which manages roughly $230 billion in assets? The answer lies in CalPERS’s three-decade-long transformation from a prudently managed steward of workers’ pensions into a highly politicized advocate for special interests. Unlike most government pension funds, CalPERS has become an outright lobbyist for higher member benefits, including a huge pension increase that is now consuming California state and local budgets. CalPERS’s members, who elect representatives to the fund’s board of directors, ignored concerns over Valdes’s suitability because they liked how he fought for those plusher benefits.

CalPERS has also steered billions of dollars into politically connected firms. And it has ventured into “socially responsible” investment strategies, making bad bets that have lost hundreds of millions of dollars. Such dubious practices have piled up a crushing amount of pension debt, which California residents—and their children—will somehow have to repay.

When California’s government-employee pension system was established in 1932, it was a model of restraint. Private-sector pensions were still rare back then, but California lawmakers had a particular reason for wanting a public-sector pension system: without one, unproductive older workers had an incentive to stay on the job and just “go through the motions” to get a paycheck, as a 1929 state commission put it. Pensions would encourage those workers to retire. The commission cautioned, however, against setting a retirement age so low that it would “encourage or permit the granting of any retirement allowance to an able-bodied person in middle life.”

Accordingly, California set its initial retirement age for state workers (and, beginning in 1939, for local-government employees) at 65, at a time when the average 20-year-old entering the workforce could expect to live for another 46 years, until 66. The system’s first pensions were modest, though far from miserly. An employee’s pension equaled 1.43 percent of his average salary over his last five years on the job, multiplied by the total number of years he had worked. That formula typically provided workers with pensions equal to half or more of their final salaries, noted California’s Little Hoover Commission, a government agency, in a 2010 study. For example, a state worker who retired at 65 after 40 years on the job would qualify for a pension equal to 57.2 percent of his average final salary (that’s 40 times 1.43). If that salary was $50,000, his pension would be nearly $29,000.

The pensions were funded by three sources: contributions from employers (that is, state and local governments); contributions from employees (though some governments opted to cover that expense); and money that the pension fund would gain by investing those contributions. With the 1929 stock-market crash in mind, California opted for a cautious investment approach, allowing the fund to buy only safe federal Treasury bonds and state municipal bonds. “An unsound system,” the 1929 commission warned, would be “worse than none.” The employees’ contributions were fixed, so if investment returns weren’t sufficient to fund the promised pensions, the employers’ contributions would have to increase to make up the difference.

In 1961, California enhanced non-public-safety state workers’ retirement packages by enrolling them in federal Social Security, a program that’s optional for state and local government employees. But the state made few other changes to the pension system over its first 30 years.

Then came the late sixties, a time of rapidly growing public-sector union power. In 1968, the California state legislature added one of the most expensive of all retirement perks, annual cost-of-living adjustments, to CalPERS pensions. Other enhancements followed quickly, including, in 1970, a far more generous pension formula: a worker’s pension was calculated from 2 percent, not 1.43 percent, of his average final salary, and he could start getting his pension at 60, rather than 65. Thus, an employee who worked for 40 years and retired at 60 with an average final salary of $50,000 could collect an annual pension equal to 80 percent of that sum, or $40,000; if he kept working for another five years, his pension fattened to 90 percent of his final average. In 1983, public-safety workers got an even better pension formula: 2.5 percent of average final salary for every year worked, which could be taken starting at 55. A police officer or firefighter who began work at 20 and retired 35 years later with a final average salary of $50,000 now qualified for a yearly pension of almost $44,000.

As benefits increased, so did pressure to pay for them by boosting CalPERS’s investment returns. The shift started in 1966 when voters approved Proposition 1, a measure, promoted by CalPERS, that let it invest up to 25 percent of its portfolio in stocks. The timing wasn’t ideal, since the long economic stagnation of the late sixties and seventies had left equity markets struggling for gains. But by the early eighties, markets were roaring again, and CalPERS asked for permission to invest up to 60 percent of its portfolio in stocks. Voters rejected that ballot initiative but approved another, Proposition 21, in 1984, which likewise let CalPERS expand its investments —and didn’t specify a percentage limit. Instead, Prop. 21 supposedly protected taxpayers with a clause that held CalPERS board members personally responsible if they didn’t act prudently. The proposition received the enthusiastic backing of government unions and CalPERS board president Robert Carlson, former head of the powerful California State Employees Association. CalPERS’s conservative investment approach, Carlson and other supporters argued, was shortchanging the state’s taxpayers. After all, the better the investment returns were, the less state and local governments would need to pay into the pension fund.

Despite the new investment strategy, the costs of the enlarged pensions weighed heavily on California’s budget. In 1991, with the nation mired in a recession and the state in a fiscal crisis, the California legislature closed the existing pension system to new workers, for whom it created a second “tier.” This less expensive plan no longer required the worker to make a pension contribution, and it lowered the value of his pension to 1.25 percent of his final average salary for every year he had worked; further, he could begin to receive the pension only at 65. A 40-year veteran with a final average salary of $50,000 would thus qualify for a $25,000 pension, plus Social Security benefits.

The state’s public-sector unions hated the new tier, of course, and their growing influence over CalPERS’s board of directors meant that it, too, was soon lobbying against the 1991 reform. Six of the board’s 13 members are chosen by government workers, and as union power grew in California, those six increasingly tended to be labor honchos. Two more members are statewide elected officials (California’s treasurer and controller), and another two are appointed by the governor—so by 1999, when union-backed Gray Davis became governor and union-backed Phil Angelides became state treasurer, the CalPERS board was wearing a “union label,” noted the New York Times. As the newspaper added, critics worried that the board had become so partisan that its “ability to provide for the 1.3 million public employees whose pensions it guarantees” was in doubt.

The critics were right to worry about CalPERS’s bias. In 1999, the fund’s board concocted an astonishing proposal that would take all the post-1991 state employees and retroactively put them in the older, more expensive pension system. The initiative went still further, lowering the retirement age for all state workers and sweetening the pension formula for police and firefighters even more. Public-safety workers could potentially retire at 50 with 90 percent of their salaries, and other government workers at 55 with 60 percent of their salaries.

CalPERS wrote the legislation for these changes and then persuaded lawmakers to pass it. In pushing for the change, though, the pension fund downplayed the risks involved. A 17-page brochure about the proposal that CalPERS handed to legislators reads like a pitch letter, not a serious fiscal analysis. The state could offer these fantastic benefits to workers at no cost, proclaimed the brochure: “No increase over current employer contributions is needed for these benefit improvements.” The state’s annual contribution to the pension fund—$776 million in 1998—would remain relatively unchanged in the years ahead, the brochure predicted.

CalPERS board members also minimized the plan’s risks. Board president William Crist contended in the press that the bigger benefits would be covered by the pension fund’s market returns. Labor leader Valdes blasted critics who warned about potential stock-market declines, saying that they were trying to deny workers a piece of the good times. What the board members didn’t mention was that California law protected government pensions, so that taxpayers would be on the hook for any shortfall in pension funding. In essence, the CalPERS position was that government workers should carry zero risk, sharing the bounty when the fund’s investments did well but losing nothing when the investments went south.

But the board members knew that there was a downside. CalPERS staff had provided them with scenarios based on different ways the market might perform. In the worst case, a long 1970s-style downturn, government contributions to the fund would have to rise by billions of dollars (which is basically what wound up happening). CalPERS neglected to include that worst-case scenario in its legislative brochure. And though the board later claimed that it had offered a full analysis to anyone who asked, key players at the time deny it. Even the state senator who sponsored the law, Deborah Ortiz, says that lawmakers received little of substance from the fund’s representatives. “We probed and probed and asked questions 100 times,” she told the San Jose Mercury News in 2003. “The CalPERS staff assured us that even in the worst-case scenario the state’s general fund would take a $300 million hit,” a manageable sum in a $99 billion state budget. (The actual cost to the state budget, it turned out, was more than ten times that estimate—and it’s still climbing.)

CalPERS also misled legislators and the press about the 1991 pension tier that it was pushing to repeal. In its brochure, the fund implied that the retirement pay that rank-and-file service workers got under the 1991 plan was tantamount to poverty. It didn’t mention that many state workers also received Social Security payments, which add substantially to retirement income.

California lawmakers easily passed the new pension deal in 1999. The bill, signed by Governor Davis with little fanfare, immediately generated pressure on local governments to match the new benefits for their own employees. In 2001, legislators passed a measure allowing municipal workers covered by the CalPERS system to bargain for the same benefits that the state workers had just won. Like state legislators, many local officials believed that CalPERS surpluses would pay for the benefits. Expensive new benefits spread across the state “like a grass fire,” Tony Oliveira, president of the California State Association of Counties, remembered in 2010.

That frenzy to expand benefits took place even though the air was already coming out of the economy. The tech-stock bubble deflated in the spring of 2000, shattering the NASDAQ market and driving down the Dow Jones Industrial Average. The American economy plunged into recession the following year, a slowdown made far worse by the terrorist attacks of September 11. By the close of trading on September 17, 2001, the Dow stood at 8,920.70, down nearly a quarter from its early-2000 all-time high of 11,722.

CalPERS has the exclusive power to determine the size of state and local governments’ contributions into the fund. As its investments tanked, it quickly boosted those contributions to compensate. By mid-decade, local officials were frantically telling the California press that the contributions were squeezing out other forms of spending. Glendale, a Los Angeles suburb, watched its annual pension bill rocket from $1.3 million in 2003 to $13.7 million in 2007—nearly a tenfold increase. San Jose’s tab almost doubled, from $73 million in 2001 to $122 million in 2007, and then rose even faster over the next three years, hitting a jaw-dropping $245 million in 2010. San Bernardino’s annual pension obligations rose from $5 million in 2000 to about $26 million last year. The state budget took a massive hit, too, its pension costs lurching from $611 million in 2001 to $3.5 billion in 2010.

Even those sums understated the problem. As a backlash grew to the larger bills that it was sending to municipalities and the state, CalPERS used a series of fiscal gimmicks to limit the immediate impact on balance sheets. Typically, to protect governments from violent swings in contributions every year, pension funds like CalPERS average their investment returns over three years, hoping that good years offset bad years. In 2005, CalPERS extended the performance average to 15 years, an extraordinarily long period that blended the fund’s losses in the 2000s with its gains way back in the 1990s—thus reducing state and local governments’ immediate costs, which remained overwhelming nevertheless. Then, in 2009, CalPERS told governments that they could pay off the higher bills from the previous year’s scary market drop over the next three decades, pushing the bill for the financial meltdown to the next generation. The pension fund made a similar move in 2011: after revising downward its absurdly optimistic predictions of future investment gains, it gave governments 20 years to finance the higher resulting costs.

Both Governor Arnold Schwarzenegger and his successor, Jerry Brown, scorched CalPERS for the tricks. “The state should decline to participate in any effort to shift more costs to our children,” said Schwarzenegger, who offered to give CalPERS $1.2 billion more out of his budget for pensions. Still trying to minimize the impact on current budgets, the fund declined and took a $200 million hike instead.

CalPERS contended that the state’s escalating pension costs shouldn’t be blamed on the expensive 1999 legislation. The real culprit, it claimed, was the stock market’s slump, which hurt investment returns. But back when it was promoting the legislation in 1999, CalPERS had hyped Pollyannaish projections of 8 percent average annual returns, which proved crucial to getting the change through the legislature.

Another reason not to buy CalPERS’s stock-market excuse is that its losses have been far worse than they should have been, thanks to a number of overly risky investment practices. Wilshire Consulting reported last year that CalPERS’s returns over the past five years have trailed those of 99 percent of large public pension funds.

Why? Recall that back in 1984, Proposition 21 gave CalPERS’s board greater latitude in allocating investments. Initially, the shift seemed to bolster the fund’s assets: CalPERS’s investment income rose from $1.5 billion in 1982 to $3.3 billion in 1985 to $6.1 billion in 1990. Even more spectacularly, CalPERS earned $68 billion during the tech boom of 1994 through 1998. But those rich gains had an unforeseen consequence: they prompted the call for higher benefits that resulted in the lavish new pension deal of 1999, which, in turn, led to a search for even greater investment returns in progressively riskier investment strategies.

CalPERS’s investments in real estate, which had begun cautiously in the 1960s, exemplify the wrong turn. The fund started expanding its real-estate portfolio during the 1990s tech boom. Then, as its stock investments slid at the turn of the millennium, it chased even higher returns in real estate. Between 2004 and 2006, as the country’s real-estate bubble was inflating, CalPERS pumped $7 billion into the sector, most of it in a few places that later became ground zero for the housing bust. By 2008, the fund owned 288,000 homes and lots, 80 percent of them in property-bubble states California, Florida, and Arizona. The fund’s real-estate portfolio grew from 5 percent of its assets in mid-2005 to 10 percent by June 2008, even as real estate was already collapsing in CalPERS’s biggest markets.

The portfolio included a $500 million bet on two large apartment complexes in New York City—Peter Cooper Village and Stuyvesant Town—that went bust in a high-profile default. There was also an investment of nearly $1 billion in Landsource Communities, which planned to develop some 15,000 acres in California’s Santa Clarita Valley but eventually filed for bankruptcy. By 2011, the value of the fund’s real-estate holdings had declined by 49 percent, resulting in $11 billion in losses.

Desperate for higher returns, CalPERS also bought the riskiest portions of collateralized-debt obligations, accumulating $140 million of them by 2007. These were the packages of debt, largely subprime mortgages, whose defaults helped trigger the 2008 financial meltdown. According to a 2007 story by Bloomberg News, CalPERS bought these investments, known as “toxic waste” on Wall Street, from Citigroup, one of the sinking firms that the government later bailed out. “I have trouble understanding public pension funds’ delving into equity tranches, unless they know something the market doesn’t know,” Edward Altman of New York University told Bloomberg about the CalPERS buys. “If there’s a meltdown, which I expect, it will hit those tranches first.”

The decline in property values also squeezed CalPERS’s cash flow, forcing the fund to sell off weakened stocks “at exactly the wrong time,” concludes a study by Andrew Ang, a professor at Columbia University’s business school, and Knut Kjaer, an investment manager. Their paper on Cal- PERS’s panic selling in 2008 notes that the cash-hungry fund sold 2.3 million shares of Apple Inc. for $370 million; those shares would be worth nearly $1.5 billion today.

Prop. 21 had another effect that proved disastrous for CalPERS’s performance: turning the fund into a mammoth would-be activist. The initiative passed at a time when many companies were closing down their own corporate-directed pension funds and switching to defined-contribution plans, in which the assets are directed by the wishes of individual employees, not concentrated in a single fund. As a consequence, the newly empowered CalPERS was left one of the biggest shareholders in America. And over time, the CalPERS board started using its newfound power to enforce its own political agenda, often without meeting its fiduciary responsibility to invest the fund’s money wisely.

Leading the charge after becoming state treasurer in 1999 was Phil Angelides, who announced that he wanted to “mobilize the power of the capital markets for public purpose.” During Angelides’ tenure, according to a Sacramento Bee analysis, a third of his office’s press releases concerned his actions on the boards of CalPERS and of CalPERS’s sister fund, the California State Teachers’ Retirement System (CalSTRS). For example, soon after Angelides took his board seats, he persuaded CalPERS and CalSTRS to divest shares in tobacco companies. Depressed at the time, those shares soon began to rise; a 2008 CalSTRS report estimated that the funds missed $1 billion in profits because of the divestiture. CalPERS also banned investments in developing countries like India, Thailand, and China because they didn’t meet Angelides’ labor or ethical standards. A 2007 CalPERS report calculated that its investments in developing markets underperformed an international emerging-markets index by 2.6 percent. Cost to the fund: $400 million.

Angelides wasn’t alone. Union officials and other CalPERS board members pursued their own political agendas, demanding, for instance, that the fund not invest in firms and countries that lacked worker-friendly labor policies. By 2011, according to a Mercer Consulting report, CalPERS had adopted 111 different policy statements on the environment, social conditions, and corporate governance, all dictating or restricting how its funds could be invested.

CalPERS leaped into “social investing” at exactly the wrong time. That trend had gained currency in the 1990s with an emphasis on buying into environmentally “clean” companies. Tech firms were high on the list, so the 1990s Internet start-up boom made social investing seem like a sound financial strategy. But when CalPERS debuted its Double Bottom Line initiative in 2000—so called because it would supposedly produce both good returns and good social policy—the tech bubble had already popped.

Many socially conscious investors then turned their attention to another industry that didn’t pollute: finance. One social-investing research firm named Fannie Mae the leading corporate citizen in America from 2000 through 2004. Other finance firms that attracted big cash from social investors included AIG, Citigroup, and Bank of America, according to an analysis by American Enterprise Institute adjunct fellow Jon Entine. When the market for shares of these firms imploded in 2008, so did the performance of social investors.

Yet another feature of CalPERS that has cost taxpayers is double-dealing by the board, ranging from awarding contracts to political donors to alleged outright corruption. In 2010, Jerry Brown, California’s attorney general at the time, launched a lawsuit accusing Alfred Villalobos of trying to bribe current board members (including Charles Valdes) to win investment business for his clients, mostly large financial firms that wanted a piece of the huge CalPERS portfolio. Villalobos pulled in $47 million as a go-between, the suit charged. A month after the lawsuit was announced, Villalobos filed for personal bankruptcy, temporarily blocking the suit. In 2011, the Internal Revenue Service accused him of intentionally depleting his assets while in bankruptcy, including gambling some away in Nevada casinos. News reports revealed that Villalobos had previously filed for bankruptcy, a decade before serving on the CalPERS board.

The lawsuit also accused former CalPERS chief executive Fred Buenrostro of accepting gifts from Villalobos. Separately, a Securities and Exchange Commission lawsuit filed last year accused Buenrostro of forging a document to help Villalobos win a big payment from a client. An internal CalPERS investigation quoted Buenrostro’s wife as calling her husband a “puppet” of Villalobos. The report also pointed out that Buenrostro often intervened with the CalPERS staff on behalf of his acquaintances in the investment world—“friends of Fred,” as the staffers called them.

Buenrostro and Villalobos have denied any wrongdoing, and investigations continue. In December 2011, after more than a year’s delay, a judge finally ruled that the state’s case against Villalobos could proceed, his bankruptcy filing notwithstanding.

These blockbuster allegations of influence-peddling came after nearly a decade of warnings of apparent conflicts of interest within CalPERS, prompting Businessweek to observe “an unpleasant whiff of pork-barrel politics rising from the board.” One example involved Ron Burkle, a major political donor in California. Burkle was a significant giver to Angelides’ campaign for treasurer, and he employed another board member, former San Francisco mayor Willie Brown, to do legal work for him. But Burkle’s closest ties were with Governor Gray Davis: he gave $600,000 to Davis’s gubernatorial campaign and appointed Davis’s wife to the board of directors of one of his companies. CalPERS invested some $760 million in Burkle’s private equity funds from 2000 through 2002.

Another disturbing case involved board member Sean Harrigan, also an officer of the United Food and Commercial Workers International Union. Between 2000 and 2004, the Sacramento Bee reported, Harrigan openly solicited donations for a union campaign fund from various investment companies that won multimillion-dollar deals from CalPERS. The companies ponied up $300,000. A CalPERS spokesperson said that the fund was unaware that Harrigan was soliciting donations from firms that did business with it, adding that there was no prohibition within CalPERS against the practice.

Criticized for scandals and for its staggering long-term pension debt, CalPERS has endorsed a series of minor reforms. They include an assessment of the board’s performance every two years by an independent auditor and the online posting of board members’ and staffers’ travel expenses. CalPERS also now limits to $50 the gifts that board members can receive from anyone doing business with the fund. However, Governor Brown’s proposal to reform the CalPERS board by adding two new members with financial expertise failed to make it past the union-friendly state assembly, which argued that any changes to the board’s composition should be negotiated between government unions and the state. For now, it seems, CalPERS will remain under union control.

CalPERS and its legislative allies keep resisting the one reform that would truly free California taxpayers from this ruinous pension system: moving it toward a 401(k)-style defined-contribution plan, as other states and municipalities, including Utah and Rhode Island, have done. In a defined-contribution plan, the government’s commitment ends after it makes its annual required contribution into a worker’s retirement account; the taxpayer’s liability also ends there. Under the CalPERS regime, by contrast, employees are guaranteed benefits even if the government hasn’t put aside money to pay for them, placing all the future liability on the taxpayer. Defined-contribution systems like Utah’s also aren’t as easy to manipulate politically as CalPERS-style pension plans because the money goes into workers’ individual accounts, not into a massive portfolio controlled by a politically appointed or an elected board of directors.

Right now, the pension bill that Californians owe because of CalPERS is enormous. In a December 2011 study, former Democratic assemblyman Joe Nation, a public finance expert at Stanford University, estimated that CalPERS’s long-term pension debt is a sizable $170 billion if CalPERS achieves an average annual investment return of 6.2 percent in years to come. If the return is just 4.5 percent annually—a rate close to what more conservative private pensions often shoot for—the fund’s long-term liability rises to a forbidding $290 billion. By contrast, CalPERS itself estimated its long-term unfunded liability at merely $80 billion, using a lofty projected annual investment return of 7.75 percent. (The fund has recently cut that estimate to 7.5 percent.)

Last August, California did pass modest pension reforms, which apply mostly to new workers hired starting this year. Nation estimates that the reforms cut the state’s long-term pension debt by 10 percent at most. Clearly, the state needs to do much more. In the last five years, three California municipalities—Vallejo, Stockton, and San Bernardino—have filed for bankruptcy, each citing retirement costs as a significant factor. But bankruptcy may not afford cities any relief from pension costs; CalPERS argues that cities have no right in federal bankruptcy court to reduce pensions, since the fund is not a creditor of these municipalities but an arm of state government. Vallejo, which has already emerged from bankruptcy, did nothing to reduce its pension costs in Chapter 9, and its employee costs remain sky-high. To employ a cop in Vallejo still requires $230,000 a year, including $47,000 in annual CalPERS costs.

Meanwhile, CalPERS’s rejoinders to its growing chorus of critics continue to mislead. Responding to a September 2012 opinion piece by Gary Jason, a California State University professor, about the impact of pension costs on municipal bankruptcies, CalPERS claimed that pensions were only a small part of the problem, accounting for just 10 percent of Stockton’s budget, for instance. But in 2011, when Stockton declared a fiscal emergency, it listed $29 million in payments to CalPERS and $7 million to repay previous pension borrowings, which together equaled 21 percent of its total general-fund spending of $168 million. In a March 2011 analysis of its fiscal plight, city officials blamed “uncontrolled pension, health, and other benefit cost increases.”

CalPERS also understates the growing financial stress caused by pension obligations. This past August, for instance, board member Rob Feckner published a disingenuous op-ed in the Sacramento Bee responding to critics of CalPERS’s most recent poor investment performance. Feckner said that the media misunderstand the fund’s investment strategy, which focuses not on a single year but on long-term results. He noted that over the last 20 years, the fund had hit its investment targets more frequently than it had missed them. Yet he ignored the sharp increases in taxpayer contributions that CalPERS demanded when it missed its targets, as well as the fiscal smoothing gimmicks that it wielded to keep contributions from rising even more.

CalPERS’s advocacy for higher benefits and its poor investment performance in recent years have locked in long-term debt in California and driven up costs, problems for which there are no easy solutions. As former Schwarzenegger economic advisor David Crane, a California Democrat, has said of the fund’s managers and board: “They are desperate to keep truths hidden.”

EVERYBODY envies public pensions, except in Canada, because the various individual schemes launched elsewhere are proving to be inadequate. South of the border, the baby boomers were sold a bill of goods when they bought into the self-directed IRA plans. It appealed to the young baby boomers to "do their own thing" and have "control" over their money. The financial community loved it. The atomized nature of the personalized pensions meant the banks and brokers were able to earn retail rates on what had been managed on a pooled, wholesale, basis by pension funds.

Sadly, the contributions to the IRA's and 401(k)s were not adequate, nor was investment acumen demonstrated by most first-time investors. No training was given before the responsibility for portfolio management was handed over to a generation of workers. Add to that the volatility of the markets since 1986, and the results on average have been poor (for many professionals, as well). What is worse, many desperate unemployed baby boomers raided their IRA's or borrowed against their 401k's to tide themselves over, when faced with housing or medical bills. To top it off, no one planned for the reality that after age 80, only about half of individuals can balance a checkbook. How does a sick person continue to manage investments in such an environment, with "safe" investments yielding zilch?

Even worse, there are many very healthy 80+ year old people who will outlive their meager savings, since individual retirement accounts have no provision for insurance against longevity risk. Social Security payments are a small palliative, assuming that the next generation of workers continues to foot the bill. The era of impoverished retirements is about to begin, south of the border.

Early withdrawals from 401(k) and 403(b) retirement accounts can have significant effects on a nest egg. Even borrowing against those accounts can stunt their growth.

And yet a new study shows that more than one out of four households dips into such accounts — sometimes emptying them out — often with significant future consequences.

The study, by HelloWallet, shines a spotlight on the issue and offers an unorthodox prescription for some employees with financial problems: they shouldn’t participate in an employer’s 401(k) program until they have sufficient emergency savings.

Financial planners use different amounts for that emergency fund. HelloWallet defines it as savings equal to three months’ income. Without that, the report said, “an economic shock, such as a car maintenance or health problem, may force the household to breach their retirement savings.” And, it added, “Insufficient emergency savings has the strongest association with breaching that we find.”

The study, published last month, focused on workplace-based plans, primarily 401(k) and 403(b) plans. It did not look at Individual Retirement Accounts, which are also retirement savings and can be invaded before retirement, with penalties.

The report, “The Retirement Breach in Defined Contribution Plans,” found that withdrawals for nonretirement purposes by account holders under 60 amount to $60 billion a year, or 40 percent of the $176 billion employees put into such accounts each year and nearly a quarter of the combined $294 billion that workers and employers contribute.

The study found that another $10 billion leaked out of 401(k) and 403(b) plans through loans when employees borrowed against their accounts.

HelloWallet’s chief executive, Matt Fellowes, called that combined $70 billion a “shocking figure” and expressed dismay that it was increasing at a faster rate than overall contributions were increasing.

He described HelloWallet as “a technology-based financial guidance software application.” It is distributed, he said, “by very large employers who provide it as a workplace benefit” to employees, who use it to get financial planning advice online. HelloWallet’s service can be purchased on its Web site. But it does not advertise for or seek individual customers, he said.

He said the study could not determine what amount or percentage of an account the average premature withdrawal involved because data was limited, but that the authors did know that the median 401(k) account had less than $17,000.

The analysis, based on surveys by the Federal Reserve and the Census Bureau, found that nearly three-quarters of those who took a premature full distribution from a retirement account did so because of “everyday basic financial management problems, from trouble paying bills to general expenses that they feel like they cannot keep up with.” Only 8 percent cited joblessness, and only 6 percent “frivolous” reasons like a vacation or a purchase.

The study found a correlation, not surprisingly, between household income and early withdrawals; 35 percent of households with less than $50,000 in annual income went into a retirement account prematurely, but only 12 percent of those with incomes over $150,000 did so. It also found higher rates of early withdrawals among black and Hispanic workers than white ones. And it found that people age 40 to 49 were most likely to make premature withdrawals, followed by those 50 to 59. Those who seek to tap their retirement funds must comply with Internal Revenue Service regulations and the rules of the employer that sponsors the plan.

The I.R.S. allows withdrawals only in the event of hardships, which are defined by each plan. They often include looming foreclosure or significant medical expenses. The rules are complicated because every plan is unique, Mr. Fellowes said, and there are gray areas about what constitutes a hardship. The I.R.S. has added expenses like college tuition and up to $10,000 to buy a first home to the list of allowed withdrawals.

Withdrawals are limited to half of an account, to a maximum of $50,000 for accounts of $100,000 or above, Mr. Fellowes said. But those limits do not apply to ex-employees. Someone who leaves a job, or loses one, can withdraw the entire balance.

Withdrawals, whether while still employed or not, come at a stiff cost. Whatever is taken out is subject to income tax, unless it is taken from one of the new Roth 401(k) or 403(b) accounts. Withdrawals are also subject to a 10 percent early withdrawal penalty, according to the I.R.S., if the account holder is younger than 59 1/2 (or, for ex-employees, younger than 55 or totally disabled) unless they are for high medical expenses, higher-education costs or a new home. Withdrawals from some Roth rollover accounts are not subject to the penalty. HelloWallet estimated that 85 percent of withdrawals were subject to penalties.

Taxes and penalties are one reason an employee with no financial cushion should consider creating an emergency savings account before contributing to a retirement plan. Another reason, the report said, is that retirement plans “come with a hefty set of unnecessary fees and inappropriate investment choices for many workers.”

Mr. Fellowes said that not investing in a retirement plan until a worker had an emergency fund might be wise even if the employee lost an employer’s matching contributions. One reason, he said, is that matches usually do not vest immediately, so they are not available to be withdrawn.

Noreen Perrotta, the editor of Consumer Reports Money Adviser, was somewhat uneasy with opting not to contribute. “I would be reluctant to advise someone not to put money into a retirement account,” she said. “Our advice is that they should contribute at least up to the match,” although she said that advice might not apply to someone with no financial cushion at all.

An alternative for the cushionless, she said, could be to put money into a Roth I.R.A., because there is no penalty for withdrawing principal from it.

Taking a loan from a retirement account might not seem as drastic a step as taking money out of it, especially because the interest the borrower pays goes back into the account, along with the principal as it is repaid, and there are no taxes or penalties if the repayments are on time.

But loans can still sharply affect a retirement account, Mr. Fellowes said.

He said borrowers typically did not make new contributions to their retirement plans while paying off loans — usually over five years — so the total amount contributed is reduced. Only the most disciplined borrowers make new contributions while also paying off a loan from the plan.

“You’re taking money out of a long-term investment,” Mr. Fellowes explained. “You take a big cut against retirement security because you lose the benefit of compounding over time.”

EVERYBODY envies public pensions, except in Canada, because the various individual schemes launched elsewhere are proving to be inadequate. South of the border, the baby boomers were sold a bill of goods when they bought into the self-directed IRA plans. It appealed to the young baby boomers to "do their own thing" and have "control" over their money. The financial community loved it. The atomized nature of the personalized pensions meant the banks and brokers were able to earn retail rates on what had been managed on a pooled, wholesale, basis by pension funds.

Sadly, the contributions to the IRA's and 401(k)s were not adequate, nor was investment acumen demonstrated by most first-time investors. No training was given before the responsibility for portfolio management was handed over to a generation of workers. Add to that the volatility of the markets since 1986, and the results on average have been poor (for many professionals, as well). What is worse, many desperate unemployed baby boomers raided their IRA's or borrowed against their 401k's to tide themselves over, when faced with housing or medical bills. To top it off, no one planned for the reality that after age 80, only about half of individuals can balance a checkbook. How does a sick person continue to manage investments in such an environment, with "safe" investments yielding zilch?

Even worse, there are many very healthy 80+ year old people who will outlive their meager savings, since individual retirement accounts have no provision for insurance against longevity risk. Social Security payments are a small palliative, assuming that the next generation of workers continues to foot the bill. The era of impoverished retirements is about to begin, south of the border.

On Friday, February 1, 2013, the Supreme Court of Canada released its highly anticipated decision in Indalex Limited (Re). The ruling stemmed from an appeal of an Ontario Court of Appeal decision that had created commercial uncertainty for financing transactions. The primary issue for lenders was a priority dispute between a court ordered super-priority charge granted to a lender that had provided "debtor-in-possession" (DIP) financing under the Companies' Creditors Arrangement Act (Canada) (CCAA), and deemed trusts under the Ontario Pension Benefits Act (PBA), in respect of wind up deficits in defined benefit pension plans.

The Supreme Court of Canada decision included the following*:

1. Unanimous confirmation of the priority of a court ordered charge granted in insolvency proceedings under federal legislation over the interests of provincial pension claims;
2. Affirmation of the broad scope of a provincial statutory deemed trust over the full value of a pension wind up deficiency if the defined benefit plan has been wound up prior to the time of determination of the priorities;
3. Statements regarding the extent to which courts can harmonize the federal insolvency priority regime under the Bankruptcy and Insolvency Act (Canada) (BIA) and priorities under CCAA proceedings; and
4. Elimination in these circumstances of the uncertainty introduced by the Court of Appeal in respect of the applicability of equitable/constructive trust remedies to secured claims.

These issues will be considered further below, followed by some practical implications of the decision.

Background

Indalex had obtained creditor protection under the CCAA. In the CCAA proceedings, beneficiaries of two underfunded defined benefit pension plans, sponsored and administered by Indalex opposed a motion to distribute the proceeds from the sale of the company's assets to satisfy a secured claim. The secured claim was a court ordered super-priority charge granted in connection with DIP financing provided to Indalex. It is important to note that in Indalex, there were no secured pre-filing claims in competition with the pension deficiency claim and no bankruptcy proceedings had been initiated by the secured DIP creditors.

The beneficiaries argued that assets of Indalex with value equal to the full funding deficiencies (not just unpaid amounts due to be paid) were deemed to be held in trust pursuant to provisions of the PBA and equivalent proceeds of sale should be remitted to the plans on a priority basis, regardless of the court ordered super-priority of the secured claim. The beneficiaries also argued that there were governance, fiduciary duty and notice issues inherent in Indalex's CCAA process, and the treatment of pension interests therein, that justified the imposition of the equitable remedy of a constructive trust in priority to the secured claim. The CCAA court nevertheless approved the distribution to satisfy the secured DIP claim.

The Ontario Court of Appeal overturned the CCAA court's decision and found that where a pension plan is wound up the deemed trust provisions of the PBA apply to all amounts required to liquidate pension plan wind up liabilities, even if those amounts are not yet due under the plan or the regulations. The Court of Appeal held that the deemed trust amount should be paid in priority to the holder of a super-priority DIP charge over the assets of Indalex, despite the CCAA court order creating the charge specifying that it ranked in priority over trusts "statutory or otherwise". The Court of Appeal also found that Indalex had breached its fiduciary obligations in the course of acting as administrator of the plans (in part through steps taken within the CCAA proceedings). Based on this finding, the Court imposed a constructive trust over Indalex's assets with respect to the wind up deficiencies in the plans, a constructive trust that was senior to the super-priority DIP charge.

Priority of the Court Ordered Super-Priority DIP Charge

The Supreme Court of Canada unanimously confirmed the ability of a Court exercising authority under the CCAA to order a super-priority charge for a DIP loan to prime an interest protected by a statutory deemed trust under provincial legislation such as the PBA. This decision was based upon the doctrine of paramountcy which resolves conflicts between the application of valid and overlapping provincial and federal legislation in insolvency matters in favour of the federal provision.

The Court's reasons specifically referred to the order of the CCAA court that the DIP charge ranked in priority to "all other security interests, trusts, liens, charges and encumbrances, statutory or otherwise." Since it was impossible to comply with both the priority of the PBA deemed trust and that of the DIP charge, the Court held that the DIP charge issued under the federal CCAA was paramount and superseded the provincial deemed trust.

The Scope of the Deemed Trust

A majority of the Court affirmed the expansion of the scope of the provincial statutory deemed trust in the PBA in respect of a pension plan being wound up to include the entire wind up deficiency of the pension plan, even if those amounts are not yet due under the plan or the regulations. In Justice Deschamps' reasons, this finding was based upon statutory interpretation, the broadening scope of the deemed trust protection in the legislative history of the PBA and the remedial purpose of the PBA deemed trust provisions - to protect the interests of plan members.

Application of the BIA Priority Regime in CCAA Proceedings

As noted, Indalex did not involve the consideration of pre-filing secured creditors' rights, there was no bankruptcy process and the issues related only to provincially registered (as opposed to federally registered) defined benefit pension plans. There were, however, some brief comments made by the Supreme Court regarding whether federal paramountcy would apply in any CCAA proceedings if no bankruptcy orders were issued. The effect of these comments, which did not form part of the rationale for the priority judgment, may impact recent judgments, including of the Supreme Court, intended to curtail 'statute shopping' and apply a harmonized interpretation to Canada's two primary insolvency statutes (the CCAA and BIA), particularly in respect of priority entitlements.

No Constructive Trust Imposed

The majority of the Court determined that while Indalex had breached its fiduciary duty as plan administrator, a constructive trust in respect of the plan deficiency was not an appropriate remedy in this case. The application of a constructive trust had been a particularly troubling issue arising from the Court of Appeal decision for financers who generally require a level of predictability of outcome on matters such as priority.

Some Practical Implications

Following the somewhat unexpected findings of the Ontario Court of Appeal in April of 2011, lenders to businesses with defined benefit pension plans in Ontario often took additional protective measures. These measures included greater due diligence in respect of defined benefit plans, stricter contractual terms in respect of such plans and, in some areas such as asset-based lending, reserving up to 100% of any plan funding deficiency against the availability under the applicable credit facilities. In other cases, access to credit may have been restricted due to uncertainty regarding these issues, including for companies seeking DIP financing in the context of CCAA proceedings.

While the brief, obiter comments noted above may raise concern about the automatic subordination of the pension deficiency deemed trust in any CCAA proceedings, the Court in Indalex did not deal expressly with the ability of a secured creditor to bring a motion to initiate bankruptcy proceedings following a failed attempt to restructure or complete a liquidation under the CCAA – a common and successful tactic used in insolvencies with court approval by secured creditors looking to 'reverse the priorities.' Rather, the Court addressed whether a motion brought by the debtor, Indalex, to permit an assignment in bankruptcy (in part for the purpose of reversing priorities) amounted to a breach of fiduciary duty by Indalex in respect of the plan beneficiaries. As a result, it is likely that prior case law permitting a secured creditor to pursue a motion to lift a CCAA stay and petition a debtor into bankruptcy to reverse priorities is still effective.

With the removal of the equitable remedies aspect of the case, we believe asset-based lenders (ABL lenders) will feel much more comfortable in financing companies with provincially registered (as opposed to federally registered) defined benefit plans in a deficiency position and will not automatically reserve from availability all such deficits. Instead, we expect that ABL lenders will consider whatever uncertainties remain on a case-by-case basis. Those considerations will certainly include a greater likelihood that full cash dominion will be required, and will be required to be continued during any restructuring attempt, in order to ensure that past advances (which cannot be prioritized by a court order in the same manner as DIP advances) will be repaid and all disbursements during the restructuring will enjoy the protection of the DIP order similar to the one included in the Indalex case.

We also expect that lenders will continue to include similar representations, warranties and covenants (including default triggers and prohibitions on wind ups and creating new defined benefit plans) and to take federal Bank Act security wherever possible, as they have been doing prior to the Supreme Court decision.

It is early days yet but, in an insolvency context, we foresee an increased frequency of 'pre-packaged' restructuring plans framed under BIA proposal proceedings at the insistence of the lenders and parties offering interim financing in insolvency cases because the default for a failed restructuring attempt is bankruptcy (and the relatively high likelihood of BIA priorities applying), not a contested lift of stay motion within a CCAA to permit a bankruptcy to ensue to bring BIA priorities into play.

* While perhaps not a direct issue for lenders, the Supreme Court decision gave rise to some uncertainty regarding the relevant time when a plan must be wound up in order for the PBA deemed trust to apply in the context of CCAA proceedings. The Court was unanimous in concluding that the PBA deemed trust for wind-up deficiencies did not apply to the one Indalex pension plan that had not been wound up at the relevant time. However, in our view, uncertainty remains regarding the determination of what is the relevant time when a plan must be wound up in order for the PBA deemed trust to apply in the context of CCAA proceedings and what restrictions may exist on a pension regulator ordering a plan wind-up after CCAA proceeding have commenced. Since the timing of plan wind up can impact the scale of any plan deficiency and the priority of payments in respect of that deficiency, we anticipate further debates in CCAA proceedings in cases where a pension regulator is seeking to order a plan wind up until these issues are clarified.

The Supreme Court of Canada (SCC) decision referred to as, Sun Indalex Finance v. United Steelworkers 2013 SCC 6 , was one of losing the battle, but winning the war for the pensioners. This new decision buries the long term disabled self-insureds deeper in the ditch.

Pensioners Won the War

Pensioners won the war within this recent SCC Indalex decision because the whole pension deficit is now accepted as a deemed trust under the wording of the Ontario Pension Benefits Act. Plus, the deemed trust is a trust, which is defined to be a secured creditor under the Federal Companies’ Creditors Arrangement Act (CCAA.) So the whole pension deficit, being a deemed trust, is now above the unsecured creditors for corporations under CCAA. Before this decision, only the employer contributions owing and not yet paid up to the date of the pension plan wind-up were considered to be in the deemed trust and treated as a secured creditor claim. Previously, the whole pension plan deficit calculated at the time of the plan’s wind-up were ranked lower and treated equally with the unsecured creditors.

Typically, bank loans are secured creditor claims, while the publicly-traded bonds are unsecured creditor claims. Both banks with secured creditor claims and bond owners with unsecured creditor claims at corporations with pension plans that have deficits are now in a weaker position in the event the corporation needs to file for bankruptcy protection under CCAA. Nonetheless, I have done research on this subject and concluded that when pension deficits are given priority over the unsecured creditors, the impact on the bond market as a whole is not significant.

Pensioners Lost the Battle

The Toronto Star Feb. 7, 2013 article entitled, “Worried about your pension if your company goes bust?” was correct in its conclusion that the battle between pension plan deficits and Debtor-In-Possession Financing (DIP financing) was lost. DIP financing is provided by banks and other financial institutions to fund a financially distressed corporation’s operating expense after it has announced its intention to restructure under CCAA. S. 11.4 of the CCAA gives judges the power to assign super-priority for repayment of the DIP financing above the other secured creditors of the corporation. S. 57(4) of the Ontario Pension Benefits Act, and S. 30(7) of the Ontario Personal Property Security Act places the deemed trust above all other provincial priorities over certain assets of the plan sponsor. If the Provincial legislation applied, then the whole pension deficit is above the DIP Financing, which is in conflict with the Federal CCAA that places the whole pension deficit below the special DIP Financing.

The SCC Indalex decision applies the legal principle of paramountcy of federal laws over provincial laws, making the whole pension deficit, as a deemed trust, rank below the DIP Financing. I think this aspect of the SCC Indalex decision is appropriate since the DIP financing is necessary to allow the corporation to survive and avoid being place into bankruptcy where all the assets are liquidated and the cash proceeds are distributed to its creditors. A restructured corporation is a better outcome for all stakeholders including current employees. Lenders would not provide DIP financing without being the first to be repaid in the precarious situation of corporation restructurings.

This SCC Indalex decision does not apply to the Nortel pensioners, since Don Sproule and David Archibald on the Nortel pensioners representative committee, accepted the March 30, 2010 settlement agreement that says the Nortel pensioners agree to be treated equally with the unsecured creditors of Nortel. The whole pension deficit now being a deemed trust equal to a secured creditor claim, would have placed the Nortel pension deficit above the unsecured creditors, had the March 30, 2010 settlement not been signed.

Nortel Pensioners at the Short End of the Stick

Koskie Minsky LLP advised the Nortel pensioners representative committee to accept the March 30, 2010 settlement agreement, even though the same law firm retained by 18 Indalex executives in one of the Indalex pension plans asserted deemed trust claims for the whole Indalex pension plan deficit at the July 20, 2009 CCAA court hearing approving the sale of Indalex’s assets. Sack Goldblatt Mitchell LLP represented the United Steelworkers in this Indalex court case and made the same legal arguments on the whole deficit being a deemed trust. The Supreme Court of Canada adopted the two law firms’ premise that the whole pension plan deficit was a deemed trust on the plain wording of the deemed trust sections of the Ontario Pension Benefits Act, words already there at July 20, 2009. It is unusual that a law firm would be taking two different legal positions for two different pensioner groups at the same time. Nortel pensioners have received the short end of the stick on this one.

Long Term Disabled Self-Insureds Left Unprotected by Ontario Government

The creditor claims of long term disabled insureds, who are covered by employer sponsored, or self-insured, disability benefit plans, now have a priority that is below Ontario pensioners in CCAA proceedings. The creditor claims of long term disabled insureds in this situation are unsecured creditors, at the bottom of the list of creditors in CCAA proceedings.

Instead of protecting the disabled, the Ontario Government is facilitating the supply of unsafe disability insurance by employers:

1. The Ontario Government’s Insurance Act explicitly exempts the requirement for insurer licensing of a corporation that has a fund for making payments on the happening of death, sickness, infirmity, casualty, accident, disability or any change of physical or mental condition; or, provides an insurance in connection with the corporation.

2. The Ontario Government refuses to enforce the Ontario Consumer Protection Act to prevent deceptive or misleading representations of disability insurance and related services supplied by employers and administrative services only (ASO) insurers. The reasons for enforcing this Act to provide a regulatory remedy for the Nortel disabled’s poverty caused by corporate wrongdoings are as follows:

i. the plain meaning of the words of consumer and consumer transactions defined in this Act do give jurisdiction for this Act (For example, the Nortel long term disabled insureds bought disability insurance supplied by their employer to raise their coverage from 50% to 70% of their pre-disability income rather than purchasing disability insurance from a licensed insurer, reasonably expecting that Nortel used their money to buy disability insurance from a licensed insurer and expecting Nortel’s disability insurance to be safe even after being told that Nortel plays a role similar to that of an insurance company for its employees.)
ii. the disability insurance supplied by employers and ASO insurers is not on the long list of exemptions for application of this Act)
iii. the Explanatory Notes on the Legislative Assembly of Ontario website indicate this Act is to apply to all consumer transactions, subject to limited exceptions
iv. Hansard transcripts of Ontario Legislature debates on this Act document the legislative intent for a broad and flexible scope of the Act
v. the Act has an Anti-Avoidance clause that applies says a court or other tribunal shall consider the real substance of the entity or transaction and in so doing may disregard the outward form

3. The Ontario Government has no work in progress to require that Ontario based employers who offer disability income benefits to buy disability insurance from licensed insurers. The Federal Government has made this a new requirement for Federally regulated corporations within the Canada Labour Code through Bill C-38 Mandatory Disability Insurance at Federal Employers , which went into force on June 29, 2012.

My reading of the Osler commentary is that the secured lenders have the right to force a bankruptcy under the BIA, which places the Ontario-based pension deficit below the secured lenders, unlike what is the new situation within the CCAA for secured claims to be equal to the pension deficit claims in a deemed trust. If a restructuring or liquidation started in CCAA, the secured lenders would seek to transfer the court proceeding to be under the BIA. . Also, with the so-called pre-packaged restructuring under CCAA, I think Osler is saying the restructuring proposal would contain the threat to have a liquidation under the BIA as an alternative to the restructuring, where the BIA has a more favourable ranking of the secured creditors over the pension deficit claims.

Nonetheless, I still think that the whole pension deficit being considered a deemed trust equal to secured creditor claims under the CCAA is a big win. Hopefully, the judges will see through the gaming of legislation shopping between the CCAA and BIA and make their decisions accordingly and for the protection of vulnerable seniors. This would be most applicable in the case of liquidations, where there is simply an allocation of money going on and not an expedient effort to restructure the business as an ongoing concern.

Corporations should be forced to pick a route of CCAA or BIA and suffer the consequences, and do not have the choice of the best of both worlds.I think one of the main reasons why lock stock and barrel sales of businesses, such as Nortel, have been done under CCAA and not BIA, is because there is a greater capacity to pay post CCAA filing executive retainer bonuses. If the CCAA is picked for this reason, then the corporations cannot be in CCAA to benefit the executives and then transfer to the BIA at the end to benefit the bankers, all the while taking estate dollars away from the pensioners.

For an elite group of the world’s most successful and secretive hedge funds, only one bet has mattered for the past three months: the “Abe trade”.

Shorting yen and buying Japanese equities, inspired by the dovish monetary bent of Japan’s new prime minister, Shinzo Abe, has been one of the most successful hedge fund wagers in years.

And many believe it is a harbinger of greater macroeconomic dislocations and greater opportunities.

Since 2010, the blue-bloods of the world’s $2tn hedge fund industry – so-called global macro managers – have been cowed by rangebound markets that have been dominated by choppy “risk on, risk off” movements. Global macro stars, who specialise in trading interest rates, bonds and currencies to play the ups and downs of the world economy have not just struggled to make money, they have struggled not to lose it.

Indeed, according to Hedge Fund Research, the average global macro specialist made just 3.5 per cent in the three years to November 2012.

But thanks to events in Japan, the past months have marked a dramatic return to historical form. “The big macro trade right now is shorting the yen, long Japanese equities,” said one fund manager who specialises in macro hedge funds.

Japan was the main topic of conversation at all the new year investment conferences, he added, be it talk of shorting the yen, buying Japanese equities or derivatives on volatility.

Hedge fund giants that piled into short yen positions included Caxton Associates, Moore Capital and Tudor Investment Corporation. All have seen their bets pay off handsomely.

According to information from investors, who declined to be named, Caxton saw its flagship fund make more than 6 per cent in the last two months of 2012. The fund is up a further 4 per cent this year.

Tudor, meanwhile, made 5 per cent in the last two months of the year and a further 4.3 per cent in January.

Moore, which was shaken earlier in 2012 by the departure of its once-feted trader Greg Coffey, made nearly 5 per cent in November and December and was up 3.6 per cent in January.

“The number one driver of P&L for a lot of hedge funds has been Japan,” says Ben Funk, head of research at funds of funds Liongate Capital, which invests money in hedge funds.

“It has definitely been a huge contributor for a lot of funds in the past few months.”

Others that have fared well include the Fortress Investment Group’s global macro fund, which an investor said made close to 5 per cent in the past two months and Pharo Capital’s flagship fund, which made 7 per cent in the same period.

Most macro hedge funds came to Japan in November. It was increasingly clear to many that the county’s demographic and fiscal challenges were ready to again take centre stage as Japanese political alignments shifted.

Mr Abe, president of the then opposition Liberal Democratic Party, made clear on several occasions in the run-up to the mid-December general election that he was a strong supporter of greater monetary easing by the Bank of Japan to stimulate growth. With the bank’s governor and two deputy governors set for replacement this year, Mr Abe’s stance pointed towards the possibility of a permanently more dovish BoJ.

Short positions against the yen hit a five-year high in early December as the likelihood of Mr Abe’s election as the country’s next prime minister grew.

“People were hesitant to talk about these trades at first because for so long shorting the yen or JGBs [Japanese government bonds] has been known as a graveyard trade,” says Anthony Lawler, portfolio manager at fund of hedge funds GAM.

“But once a situation materialised where there were some really strong statements [from Mr Abe] in favour of easing, it became a more obvious trade to many seasoned macro managers. It was an asymmetrical trade in one of the world’s deepest, most liquid markets.”

Mr Lawler adds: “It’s fair to say that these opportunities haven’t been abundant. There have been big moves in areas like FX for the past few years, but they haven’t been caught because they haven’t been well telegraphed through policy or they have come as big surprises.”

Well-connected global macro managers are now hopeful that “Abenomics” is the beginning of a trend towards greater volatility and more big, directional moves in global markets.

For many of them, the prospect of “currency wars” and a breakdown in the international economic consensus will make for the kind of investment opportunities they have been desperate for since 2008.

The next few months are rich with potential opportunities, they believe, whether shorting sterling in anticipation of laxer monetary policy from incoming Bank of England governor Mark Carney; buying up equities to trade on institutional investors’ rotation away from bonds; or investing in commodities such as palladium to capitalise on a race for devaluation among the world’s big currencies.

“I think it’s the rebirth of global macro,” says the head of one of the world’s top five global macro hedge funds. “For the last three years we have had this rangebound environment, and now it looks like individual currency actions, individual countries acting, are going to start to dominate.”

Some of the biggest U.S. hedge-fund investors have made billions betting against the yen, exploiting Japan's determination to weaken its currency and boost its economy.

Wagering against the yen has emerged as the hottest trade on Wall Street over the past three months. George Soros, who made a fortune shorting the British pound in the 1990s, has scored gains of almost $1 billion on the trade since November, according to people with knowledge of the firm's positions. Others reaping big trading profits by riding the yen down include David Einhorn's Greenlight Capital, Daniel Loeb's Third Point LLC and Kyle Bass's Hayman Capital Management LP, investors say.

The growing trade has itself helped pressure the yen, which has slid almost 20% in about four months. That, in turn, is helping fuel what could become a world-wide currency war. Countries such as Germany and France have criticized Japan's policies, while others have threatened to take action to reduce the value of their own currencies to remain competitive with Japan. Like Japan, many countries depend on exports, which are more profitable when their own currencies are lower.

Investors began jumping into the trade late last year, ahead of the election of Shinzo Abe as Japan's prime minister. When Mr. Abe and others were unusually open in their rhetoric about driving down the currency, traders added to their positions, helping the yen weaken. Soon, salespeople and traders at banks were telling hedge funds and other investors that the time was right to make big bets against the yen.

Mr. Abe's election, and the selling by hedge funds, had a big impact. On Wednesday, the dollar bought about 93 yen, from about 79 yen in mid-November. "It's a bet on Abe-nomics" someone close to the Soros firm says.

Many others have come to the same conclusion. Among the most vocal proponents of the trade is Robert Ettinger, the head of Bank of America's BAC -0.25% options trading group for currencies in the Group of 10, investors say. Mr. Ettinger has spoken about how he "loves" the bearish yen trade, according to an investor who heard him speak recently. Bank of America's trading desk also has made money on the trade, according to people with knowledge of the firm's positions. Mr. Ettinger declined to comment.

Few investors, though, have made as much money as Mr. Soros. The 82-year-old investor's $24 billion Soros Fund Management has made close to $1 billion of paper profits since mid-November wagering on yen weakness, according to people close to the matter.

The firm, which returned cash to outside investors last year, still invests money for Mr. Soros and his family. It manages about $15 billion itself and allocates the rest to other investors. Soros Fund Management has been led since last summer by Scott Bessent, who increased the yen position late last year. The Soros firm also has done well owning Japanese stocks, which have been rallying. Japanese shares represent about 10% of the firm's internal portfolio, according to people close to the firm.

Betting against the yen isn't for the faint of heart. Japan had for years failed in its efforts to lower its currency and reignite its economy and stock market. Many who adopted short positions on the yen and on Japanese government bonds during that period got pounded when the currency and the bonds instead strengthened. Shorting Japan became known on Wall Street as a "widow maker."

"You aren't a macro trader if you haven't lost money betting against Japan," one trader said.

Japan's new economic policies are expected to be widely discussed at this weekend's meeting of the Group of 20 finance ministers in Moscow. This week saw rocky trading in the yen after a series of conflicting reports about whether the smaller Group of Seven nations were supportive of Mr. Abe's policy. After global criticism, Mr. Abe and his advisers have toned down their talk about weakening the yen. Instead, its central bank has promised a significant new easing in monetary policy by buying bonds—similar to strategies enacted by the U.S. Federal Reserve and the European Central Bank—which policy makers say is aimed at ending Japan's long bout of deflation and often has the side effect of lowering a currency.

As quickly as investors raced to short the yen they could just as easily rush to end this trade, sending the currency higher again, especially if investors conclude the Japanese government is backing off its anti-deflation campaign.

Some hedge funds already have been trimming their bearish yen positions. "People recognize there are concerted efforts on hand to end two decades of deflation," Chris Ayton of Alternative Investment Group, which invests in hedge funds for clients. "But I don't see genuine belief out there yet that this time is different. There's still a significant amount of skepticism."

It isn't clear who is feeling pain as the yen falls. Some Japanese exporters with receivables tend to sell dollars and buy yen in the futures market, which could mean they currently are sitting on losses, some traders and analysts say.

"Japanese exporters need to buy yen, and they've been doing that a bit more recently, believing the yen weakness wouldn't last," says David Woo, Bank of America's head of global rates and currencies research.

Shares of exporters have been helped by the recent rally in Japanese stocks, of course. The Japanese economy isn't as export-dominant as it once was, reducing the impact of a falling yen, some analysts argue.

Unlike Mr. Soros's early short of the British pound, the recent moves by Mr. Soros and other hedge funds are unlikely to destabilize Japan or its currency, partly because trading of Japanese yen is a deeper market that is harder for investors to dictate. Nearly all of Japan's debt is owned by domestic investors, another reason short positions on the country by bearish investors haven't had much impact.

At the same time, Mr. Soros's gambit against the pound was in opposition to policies of the Bank of England, while hedge funds now are making trades in hopes the Bank of Japan succeeds in its policy of defeating deflation.

Lately, a rush of new investors has become involved in the yen trade. As more investors jump on the bandwagon and search for ways to place their own wagers against Japanese currency, some worry the latecomers may regret their newfound ardor for shorting the yen, much like those who piled into shares of Apple Inc. AAPL +0.05% just before its recent tumble.

Many investors bailed out of earlier bearish-yen trades a while ago, unable to withstand losses they suffered. It is similar to how some mortgage specialists removed long-held bets against subprime mortgages before the housing market finally weakened in 2007. They then missed out on the profits when the market turned.

Others, like Greenlight Capital's Mr. Einhorn, have held on. His firm gained over 3% in January thanks in part to his yen bet.

"We put the trades on about three years ago and the trade wasn't fun for the first two years and number of months," Mr. Einhorn says. He expects further weakness.

Investors have wagered against the yen in various ways, from complicated derivatives to simple put options, the kind that Mr. Einhorn says he bought.

Others have had to switch gears, quickly. Bridgewater Associates, the world's largest hedge-fund firm with $141 billion, had expected strength for the yen for most of 2012, but removed its bullish yen positions in the fourth quarter of last year. Bridgewater is "now modestly short" the yen, according to a January letter to investors.

A "huge bet" on Greek government bonds has seen a fund for pension schemes in Greece almost double assets under management (AUM) in around six months.

This is a boon for its clients following the restructuring of Greek debt in March 2012, in which the crisis-hit country's pension funds, which were heavily invested in domestic bonds, lost an estimated total of €10bn.

However, compensation for the losses promised to Greek pension funds by the government has yet to materialise.

The Athens-based Hellenic Pension Mutual Fund Management Company (HPMF), which manages pooled funds exclusively for state retirement schemes, saw assets under management slump from €496m in January 2012 to €384m at the end of June.

However, as at 23 January 2013, HPMF's assets jumped to €674.6m.

John Kyriakopoulos, managing director at HPMF, said the results were down mainly to the performance of one the company's two funds, the Mixed Balance Fund.

"After the June elections in Greece, it was clear to us the country would stay in the euro, so our investment committee decided to take a huge bet and invest €100m of the Mixed Balanced Fund in Greek government bonds," he said.

"It was very risky, but we took the view that we believed in the long-term stability of Europe."

Following the bond write-down on 12 March 2012, the Mixed Balanced Fund was left with 7% Greek bonds (mostly government), 25% European Financial Stability Fund (EFSF) bonds, 25% cash and 43% Greek equities.

In the actively managed fund, AUM dropped to €285.8m from €312.8m at the start of 2012.

Kyriakopoulos said: "At the end of July, we began liquidating, at zero loss, the EFSF bonds at par, and we started buying the new Greek bond strip at between 13% and 24% NPV [net present value], which today is at approximately 47%."

The fund's €100m investment in Greek debt was made by divesting €60m from EFSF bonds and €40m from cash reserves.

The audacious move paid off, with the Mixed Balance Funds reaching €500.57m on 23 January 2013.

The fund's benchmark for the period 29 June to 20 December 2012 increased 26%, while HMPF's balanced fund delivered growth of 72%.

Kyriakopoulos said: "The risk of loss was extremely high because, in the period between July and November, the general view of the Greek refinancing programme was extremely negative. But, based on intuition, we decided to do it."

Under the March 2012 bond restructuring deal, in which government bonds lost as much as half of their value, pension funds in Greece are supposed to receive state-owned property.

This compensation is to match the value of the €10bn that the pension funds have lost collectively.

However, almost one year on, pension schemes are still waiting for the compensation, with commentators branding the proposed deal vague.

The delay is a particular blow for HPMF, which is in line to manage the property on behalf of pension funds in a real estate investment trust.

Kyriakopoulos said: "The fund has not been established, and it is unclear when it will happen."

In the meantime, HPMF's bold move will lift the portfolios of its four clients, which include three of the largest state pension schemes in Greece.

With the Greek pension system almost entirely in the first pillar, this is a welcome boost for many austerity-hit Greeks.

The three schemes are those of the social security organisation, known as IKA, which accounts for 30% of HPMF's assets under management; OGA, the pension fund for agricultural workers, with 15%; and OAEE, the pension scheme for self employed people, with 15%.

The remaining 40% of HPMF's assets are from the Greek central bank, the National Bank of Greece.

The bank administers around 77% of the surplus cash of the country's pension funds.

HPMF's big bet was a one-off, however, Kyriakopoulos said.

"We achieved a necessary improvement, but now we need to preserve value, so, going forward, we will be more conservative," he added.

The Mixed Balance Fund's present asset allocation is 58% Greek bonds, 5% cash and 37% Greek equities.

Within the Greek equity portfolio, over the past six months, HPMF has been rebalancing away from an overweight position in Greek banks towards a more diversified mix of the top 20 Greek listed companies.

HPMF did not allocate a significant portion of its other mutual fund, the European Bonds Fund, to Greek government bonds over the summer.

Kyriakopoulos said this was because, at the time of the bond write-down, known as private sector involvement, the government set new rules for the fund, restricting it to investing in a well diversified mix of European bonds.

The fund had previously been called the Greek Bonds Fund and comprised 95% Greek government bonds.

The strategy was set by the government when HPMF, which is a private company, was founded in 2000.

This was based on the belief domestic bonds would provide protection for pension funds, a strategy Kyriakopoulos described as "hopelessly out of date".

The managers of a fund for Greek pension schemes have doubled its assets by following the example of aggressive investors who netted windfall gains buying junk-rated Greek government bonds last year.

The Hellenic Pension Mutual Fund Management Company’s investment committee took a bet last June that Greece would manage to get its economic reform programme back on track and avoid crashing out of the euro.

“It was risky because there was so much scepticism about Greece’s fate as a eurozone member,” said John Kyriakopoulos, HPMF’s managing director. “But we made more money than the hedge funds that played with Greece.”

HPMF, which manages funds pooled by three of Greece’s biggest state pension funds and National Bank of Greece, a commercial lender, saw its Mixed Balanced Fund’s assets rise from €240m at the end of June to €500m on January 31.

Its holdings now consist of 58 per cent Greek bonds, 37 per cent Greek equities and 5 per cent cash.

Smaller Greek state pension funds, which are only able to invest in Greek government bonds that are held by the central bank as custodian, together had losses close to €10bn over the same period.

The decision to invest €100m in Greek bonds – just over 40 per cent of the fund’s assets – was taken after consulting HPMF’s Athens-based investment advisers, National Bank of Greece and Eurobank, Mr Kyriakopoulos said.

“We were getting information on what hedge funds were doing, and we followed spreads on Greek bonds over German Bunds very closely . . . It was clear something positive was happening,” he said.

Even though the mixed balance fund is actively managed, and the bond purchase fell within its investment benchmarks, the decision “clearly marked a departure from its usual practice”, said an asset manager at a private Greek bank.

Mr Kyriakopoulos said: “Importantly, we saw consensus on the political front, among partners in the coalition government that emerged from the June election and between the coalition and the troika [the EU, International Monetary Fund and European Central Bank] on resuming reforms.”

HPMF sold at par its entire €60m of European Financial Stability Facility bonds acquired in March as part of the debt restructuring without incurring any losses. It took €40m from its cash reserves to make the investment.

It bought the Greek “strip” – a basket of securities with mixed maturities that investors received in exchange for their old bonds in the restructuring – at between 13 cents and 24 cents on the euro in tranches of €5m-10m over the summer.

Yet unlike many hedge funds, HPMF decided against participating in a €11bn buyback of Greek debt last December priced at 33 cents on the euro. The strip is currently trading just below last month’s peak of 47 cents.

“We held on to the bonds because we saw some more upside potential,” Mr Kyriakopoulos said. “Business confidence is up, mattress money is coming back to the banks, and the government is tackling the reform agenda.”

Hedge fund heavyweights from Leon Cooperman's Omega Advisors to Barry Rosenstein's Jana Partners threw in the towel on Apple Inc in the fourth quarter, while other managers found discount retailers Dollar General Corp and Dollar Tree Inc attractive, regulatory filings showed on Thursday.

Apple has been the topic du jour since last week, when prominent hedge fund manager David Einhorn sued the company to get it to deploy its $137 billion cash pile more effectively and halt a 35 percent drop in its share price from a record high in September.

Cooperman, whose hedge fund had $7 billion in assets as of last November, sold his entire stake of 266,404 Apple shares; Rosenstein sold all of the 143,000 shares he held.

However, Einhorn's Greenlight Capital, holder of roughly 1.3 million Apple shares, found some company: David Tepper's Appaloosa Management increased its Apple stake to 912,661 shares and billionaire George Soros added about 100,000 Apple shares during the fourth quarter.

Herbalife, which has been under scrutiny after hedge fund manager Bill Ackman called the nutritional supplements company an unsustainable pyramid scheme, drew the attention of the market late Thursday. Billionaire investor Carl Icahn said he now owns 14 million shares in the company, taking his ownership to nearly 13 percent of Herbalife. The news sent shares up 17 percent in after-hours trading.

Consumer- and retail-related stocks appear to have been the flavor of the fourth quarter.

Patrick McCormack's $2 billion Tiger Consumer Management LLC took a new, 2.15 million-share stake in discount retailer Dollar Tree, while Farallon Capital Management LLC bought 4.3 million shares of Dollar General.

Maverick Capital Management also increased its position in Family Dollar Stores, to 4.2 million shares from 2.8 million shares, during the fourth quarter. Family Dollar shares were losers in January, down 11.4 percent.

The quarterly disclosures of hedge fund stock holdings - in so-called 13F filings with the U.S. Securities and Exchange Commission - are always intriguing for investors trying to divine a pattern in what savvy traders are selling and buying.

The filings also offer insight into how managers positioned themselves at year end to benefit from the big run-up in stock prices in early 2013.

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

Still, the filings can offer a glimpse into what hedge fund managers saw as opportunities to make money on the long side. The filings don't disclose short positions, bets that a stock will fall in price. And there's also little disclosure on bonds and other securities that don't trade on exchanges.

Here then are some of the hot stocks and sectors in which hedge fund managers either took new positions or exited from in the fourth quarter.

CONSUMER AND RETAIL

Farallon, founded by recently retired billionaire Thomas Steyer, took a new stake in retailer Sally Beauty Holdings of 4.7 million shares, and Jana initiated a new position in retailer Fifth & Pacific Companies (formerly Liz Claiborne Inc) of 3.3 million shares.

Tiger Consumer Management cut its stake in luxury retailer Michael Kors Holdings Ltd by 394,269 shares to 1.6 million.

Eton Park Capital Management, a $12 billion hedge fund run by former Goldman Sachs trader Eric Mindich, initiated a new position in Best Buy Co of 1.6 million shares during the fourth quarter. Best Buy was one of the best performing stocks in January, up over 37 percent.

Tiger Global Management, a roughly $6 billion fund run by Chase Coleman and Feroz Dewann, loaded up on Amazon Inc. Tiger Global now owns 1.23 million shares, up from 480,000.

TECHNOLOGY

Tiger Global trimmed its stake in Apple, to 1.05 million shares from 1.3 million, and sold all of its 698,000 shares of Google Inc and its 11.7 million-share stake in Facebook Inc. Tiger slashed its Yahoo Inc position to 14 million shares from 25 million.

JAT Capital, founded and run by John A. Thaler, slashed its stake in Facebook to about 530,000 shares, significantly down from 6.1 million. But JAT opened a new stake in Yahoo of 2.8 million shares. It also re-entered LinkedIn with about 340,000 shares, after dissolving a stake some time in the third quarter.

Tiger Global has been a darling of the investment community for delivering a string of strong returns at a time many hedge funds were up only low single digits. Industry legend Julian Robertson gave the fund its start.

SOLAR

Tiger Global also opened a new 1 million-share stake in First Solar, which was one of January's biggest losers, down 8.75 percent.

But JAT Capital slashed its stake in First Solar during the fourth quarter to about 790,000 shares, from about 1.6 million shares.

FINANCIALS

Activist investor Daniel Loeb's Third Point LLC accumulated a $148.2 million stake in Morgan Stanley, buying 7.8 million shares of the securities company. The disclosure is the first public acknowledgement of the size of the hedge fund's position, which was mentioned in an investor letter last month.

Greenlight's Einhorn unloaded his entire 658,700 stake in Genworth Financial Inc during the fourth quarter. John Paulson's Paulson & Co and credit-focused trader Boaz Weinstein of Saba Capital Management may have had better timing.

Paulson took a 3.9 million-share position and Saba added roughly 2.3 million shares in Genworth during the fourth quarter. The stock was one of January's best performers with a gain of 22 percent.

Eton Park sold its entire 148,000-share stake in U.S. lender CIT Group Inc and Bruce Berkowitz's Fairholme Funds cut a its exposure to 3.2 million shares from 11.1 million shares.

CIT held preliminary talks over the past year and a half to sell itself to banks, including Toronto-Dominion Bank and Wells Fargo & Co, but nothing came of the conversations, according to three people familiar with the specialty finance company.

Institutional investors should be required to publicly disclose equity holdings within two days after the quarter ends, instead of 45 days, NYSE Euronext said in a petition to U.S. regulators.

A shortened time frame will help investors and public companies receive timely information and technological advances make it possible, NYSE and corporate governance and investor relations groups wrote in a letter dated Feb. 1 to the U.S. Securities and Exchange Commission. The rule applies to pension funds, investment advisers and other investors with at least $100 million that currently must file a 13-F form.

The time frame is “unnecessarily long, and to that extent the current delay period runs contrary to the interests of investors and public companies,” according to the petition, which was written by NYSE, the Society of Corporate Secretaries and Governance Professionals and the National Investor Relations Institute.

While institutions owned the majority of the U.S. shares outstanding in 2009, the delay means that individuals and public companies will get “little meaningful information” from the 13F filings, the letter said. The 45-day period has been in existence for more than three decades, the groups said.

John Nester, an SEC spokesman, said the commission would seek public comment on the petition. The agency isn’t required to respond to petitions for rulemaking or take action on them, although they are studied by the SEC staff.

Petition Reviewed

“Staff reviews the petitions as appropriate and they can and do inform our work,” Nester said, declining to comment specifically on the NYSE’s request.

Investors would benefit from seeing holdings sooner and companies would be better able to identify shareholders and communicate with them, according to the letter. Reducing the time period would be in line with the purpose of the 13F filing, which is to inform other shareholders and companies when large investment managers accumulate shares, it said.

“Investors are denied the ability to track institutional investor holdings in their investments because by the time the reporting deadline occurs, the investor would have no way of knowing whether the information reported in the Form 13F remains current,” the groups said in the petition.

For the first time since the New Deal, a majority of Americans are headed toward a retirement in which they will be financially worse off than their parents, jeopardizing a long era of improved living standards for the nation’s elderly, according to a growing consensus of new research.

The Great Recession and the weak recovery darkened the retirement picture for significant numbers of Americans. And the full extent of the damage is only now being grasped by experts and policymakers.

There was already mounting concern for the long-term security of the country’s rapidly graying population. Then the downturn destroyed 40 percent of Americans’ personal wealth, while creating a long period of high unemployment and an environment in which savings accounts pay almost no interest. Although the surging stock market is approaching record highs, most of these gains are flowing to well-off Americans who already are in relatively good shape for retirement.

Liberal and conservative economists worry that the decline in retirement prospects marks a historic shift in a country that previously has fostered generations of improvement in the lives of the elderly. It is likely to have far-reaching implications, as an increasing number of retirees may be forced to double up with younger relatives or turn to social-service programs for support.

“This is the first time that Americans are going to be relatively worse off than their parents or grandparents in old age,” said Teresa Ghilarducci, director of the Schwartz Center for Economic Policy Analysis at the New School for Social Research.

Advocates for older Americans are calling on the federal government to bolster Social Security benefits or to create a new layer of retirement help for future retirees. Others want employers and the government to do more to encourage retirement savings and to discourage workers from using the money for non-retirement purposes.

But those calls have been overwhelmed by concern about the nation’s fast-growing long-term debt, which has left many policy­makers focused on ways to trim Social Security and other retirement benefits rather than increase them.

The economic downturn exacerbated long-term factors that were already eroding the financial standing of aging Americans: an inexorable rise in health-care costs, growing debt among older Americans and a shift in responsibility from employers to workers to plan for retirement.

The consequence is that the nation is facing a huge retirement savings deficit — as much as $6.6 trillion, or about $57,000 per household, according to a U.S. Senate report.

Using data on household finances collected by the Federal Reserve, the Center for Retirement Research estimates that 53 percent of American workers 30 and older are on a path that will leave them unprepared for retirement. That marks a sharp deterioration since 2001, when 38 percent of Americans were at risk of declining living standards in old age. In 1989, 30 percent faced that risk (click on image below).

The center’s findings are similar to those recently uncovered by researchers at the New School, the Heritage Foundation and the Senate’s Committee on Health, Education, Labor and Pensions.

“There is a mismatch between retirement needs rising and retirement benefits contracting,” said Alicia H. Munnell, director of Boston College’s Center for Retirement Research.

The precarious situation comes after a long period of change that improved life for the nation’s seniors starting with the enactment of Social Security in 1935.

By the 1960s, retirees also benefited from universal health insurance through Medicare and Medicaid, sharp increases in Social Security benefits and new protections enacted by the federal government for workers who received traditional pensions, which for decades were a standard employee benefit.

The changes rescued millions of retirees from poverty, while lifting millions of others to prosperous retirements symbolized by vacation cruises, recreational vehicles and second homes.

But now problems for future retirees seem to be closing in from all sides. Half of American workers have no retirement plans through their jobs, leaving people on their own to save for old age.

Meanwhile, four out of five private-sector workers with retirement plans at work have only 401(k)-type defined contribution accounts, rather than traditional pensions that pay retirees a fixed benefit for life. Numerous studies have found that workers with defined-contribution accounts often put aside too little money, make too many withdrawals or employ the wrong investment strategies to save enough for old age. Overall, people ages 55 to 64 have a median retirement account balance of $120,000, Boston College researchers have found, which is enough to fund an annuity paying about $575 a month, far short of what they will need.

Officials at money-management firms that handle 401(k)-type investments argue that the tools are in place for Americans to retire comfortably. The problem, they say, is that employers and workers are not using them correctly.

Robert L. Reynolds, president and chief executive of Putnam Investments, noted that 2006 changes in federal law gave employers the power to automatically enroll workers in retirement accounts. But too few choose to do that and even when they do, companies typically set aside only 3 percent of pay — far less than the estimated 10 percent that experts say workers need to set aside to fund a sound retirement.

“I would be adamant that there is nothing wrong with 401(k)s that can’t be fixed by taking better advantage of the current system,” Reynolds said.

Daniel J. Houston, president of retirement, insurance and financial services at the Principal Financial Group, contended that defined contribution accounts are better tailored than old-fashioned pensions to today’s highly mobile workforce. Workers can take them when they switch jobs. But that control also is a weakness, allowing Americans to tap them for non-retirement purposes.

The retirement savings shortfall is revealing an economic divide separating those who are well prepared for retirement from those who are not. Recent policy changes aimed at bolstering Americans’ retirement prospects have only contributed to the growing inequality.

The government grants at least $80 billion a year in tax breaks to encourage retirement savings in 401(k)-type accounts. But the biggest benefits go to upper-income people who can afford to put aside the most for retirement, allowing them to reap the biggest tax breaks.

Someone making $200,000 a year and contributing 15 percent of pay to a retirement account would receive about a $7,000 subsidy from the federal government in the form of a tax break, whereas workers earning $20,000 making the same 15 percent contribution would get nothing because they don’t earn enough to qualify for a deduction. Someone making $50,000 and making the 15 percent contribution would receive only about a $2,100 tax deduction.

Even many of the diminishing share of workers who are enrolled in traditional pension programs face uncertainty as an increasing number of plans are under­funded, causing employers to freeze benefits.

The hits to retirement income come as many Americans are living longer and health-care costs continue to grow, meaning they need to salt away more money for retirement.

Workers have limited options for closing the gap. More are going to have to work longer. After many decades of decline, average retirement ages have already been creeping up in the past 20 years.

A recent survey by the Conference Board found that nearly two-thirds of Americans ages 45 to 60 say they plan to delay retirement. Two years earlier, 42 percent said they would work longer.

Some lawmakers and other advocates say the best way to cope with the growing gap would be to further expand Social Security and Medicare benefits, or to add another layer of taxpayer-subsidized savings that workers could use only for retirement.

“We need to do more to help American families cope with this looming retirement crisis,” Sen. Tom Harkin (D-Iowa), chairman of the Committee on Health, Education, Labor and Pensions, said at a hearing late last month. “Hard­working Americans deserve to be able to rest, take a vacation and spend more time with their grandkids when they get older.”

But many policymakers are pushing to rein in the nation’s debt by trimming Medicare, Medicaid and Social Security benefits. Those programs are the primary drivers of the long-term deficit but are also financial mainstays for the vast majority of the nation’s retirees.

Both Medicare and Social Security already are on course to provide reduced benefits for future retirees — reductions that will grow deeper if lawmakers follow through on new proposals to further trim the programs.

With the Social Security retirement age moving to 67 under a federal law passed in 1983, people who leave the workforce earlier — and the vast majority do — will see smaller payouts.

Health-care costs continue to outpace inflation, meaning more out-of-pocket expenses for future seniors. Retirees are also slated to pay more for their health care with Medicare premiums, which are deducted from the Social Security checks of senior citizens, set to rise from 12.2 percent to 14.9 percent by 2030.

James G. Marzano, 60, was on his way to a comfortable retirement when he lost his job at a telecommunications firm in 2002. “People talk about a lost decade; that’s what I’ve been through,” he said.

Marzano, a Tampa resident who is married to a retail worker and has a son who is a high school senior, spent most of the past decade in and out of contract jobs and other posts that paid far less than he was used to. He was forced to dip into his 401(k) account to make ends meet, and even now that he has found a good job, he says, his savings is maybe 60 percent of what it was 10 years ago.

“If everything had stayed status quo from 2002 until 2012, I might be doing what I wanted to do today,” he said. “But, as it stands, I am nowhere near ready to retire.”

The head of one of Canada’s largest banks is proposing a dramatic overhaul of the country’s pension regime, arguing that average Canadians need more certainty and simplicity from their savings than existing investment tools provide.

Canadian Imperial Bank of Commerce chief executive officer Gerry McCaughey said Canada should reform the Canada Pension Plan to allow people to make voluntary contributions that are beyond what they already pay through their salaries.

The move could give many Canadians something they do not have with RRSPs and other investment vehicles tied to the markets: a predictable payout when they retire.

Much as Canadians understand exactly how long it will take to pay off their mortgage when they buy a house, average earners should have a pension system that helps them forecast how much money they will have at retirement, and allows them to accelerate their contributions, Mr. McCaughey said in a speech to the National Summit on Pension Reform in Fredericton on Tuesday night.

“It would give Canadians the choice to put aside more – a little at a time – with the confidence of clearly knowing what benefits it will bring,” he said. “It would improve the future of Canadians who choose to opt in – through forced savings and no withdrawals – over the arc of 40 years.”

The country faces a looming pension crisis. Persistently low market returns and the erosion of defined-benefit pensions in corporations are leaving many people, particularly those in low to medium income brackets, with less certainty about their future financial security. One analysis suggests that Canadians now in their late 20s and early 30s could see a 30-per-cent drop in their standard of living when they retire.

A stronger, easier-to-understand pension system is better for the economy, Mr. McCaughey said, which is ultimately better for banks. While he still advocates the benefits of RRSPs and tax-free savings accounts, he said CPP is more reliable and clear on how much it will provide, which encourages saving. “This is not a solution that addresses every problem and meets every need,” he said. “But it’s a … starting point that gets to the heart of what a large number of Canadians need most – and that’s certainty of outcome.”

Pushing for a greater focus on the federally run CPP is remarkable coming from one of Canada’s top bankers, since the sector derives considerable revenues from investment products such as mutual funds in RRSPs.

But the suggestion comes at a time when Ottawa is concerned about falling savings rates. As Canadian companies scaled back their pension offerings over the past five years, the federal government has laid the groundwork for the creation of Pooled Registered Pension Plans, or PRPPs, which are essentially private funds operated by financial institutions. Banks and insurance companies and other financial institutions are expected to offer them once they gain provincial regulatory approval. In December, federal Finance Minister Jim Flaherty said he would work with the provinces in 2013 on ways to expand CPP for all Canadians.

Mr. McCaughey believes CPP is the best vehicle for boosting retirement savings, since it promises a certain payout on a specified date (age 65, or 60 if taken early at a reduced amount) and the contributions are committed over a long period – meaning they can’t be withdrawn on a whim. This allows the funds to compound. However, banks cannot operate funds that deny customers access to their money, leaving CPP as the best option, he said.

Savings rates are falling in Canada, but home ownership is among the highest in the world. Mr. McCaughey believes this shows Canadians understand the value of putting money into a home.

“Canadians go into a mortgage knowing that if they keep up their end of the bargain – if they make their payments – they are, on a specific date in the future, going to own that home free and clear. So, over the long term, housing has proven to be an effective vehicle for future savings,” Mr. McCaughey said. “Why does the home ownership system work so well? Because Canadians understand it. It’s date-certain and amount-certain. It’s predictable and transparent. There’s good governance. And the outcomes are clear.”

CIBC economists predict that Canadians now in their late 20s and early 30s can expect, on average, a 30 per cent drop in standard of living when they retire, based on current savings rates.

“We’re not talking about the normal reduction in income that individuals typically see in retirement,” he said. “We’re talking about a real and significant decline in living standards as measured by consumption power,” Mr. McCaughey said.

“Today, for many Canadians, there’s a bigger emphasis placed on investing – on rates of return – than on the critical need to actually set aside money. Individuals are more focused on how they’re investing their money rather than on how much they’re putting away, and for how long.”

If there’s one thing Americans should have learned from the recession, it’s the importance of diversifying risk. Middle-class households had too much of their net worth tied up in their homes and were too exposed to stocks through 401(k)s and other investments.

Despite the hit many Americans took, there’s little sign they’ve changed their dependence on homes as the mainstay of their wealth. Last year, Christian Weller, a professor at the University of Massachusetts, looked at Federal Reserve data for households run by those over 50. The number of families with what Weller calls “very high risk exposure”—a low wealth-to-income ratio, more than three-quarters of their assets in housing or stocks, and debt greater than a quarter of their assets—had almost doubled between 1989 and 2010, to 18 percent. That number didn’t decline during the deleveraging years from 2007 to 2010; its growth just slowed to a crawl.

The Fed will conduct a new wealth survey in 2013, but don’t look for a rational rebalancing. The same pressures that drove families to save less before the recession are still in place: low income growth, low interest rates, and high costs for health care, energy, and education. Families have been borrowing less since 2007, but the rate of the decline has slowed. As soon as banks start lending again, Weller says, people will put their money back into housing. “The trends look like they’re on autopilot,” he says. “They don’t suggest that people properly manage their risk.”

• Unlike defined-contribution (DC) plans, DB plans guarantee a payment to retirees based on years of service and contributions. This means someone about to retire is not vulnerable to the whims of the market at the end of their career, jeopardizing their retirement dreams.
• Large, well governed DB plans are able to pool resources and significantly lower costs and fees. Moreover, they are able to invest directly and indirectly in public and private markets using their own investment managers or through the best public, private equity and hedge funds in the world.
• The long investment horizon of large pension plans is what gives them a significant advantage over mutual funds and other funds that face pressures to deliver returns on a much shorter investment horizon.

Economists talks about productivity as the key determinant of the wealth of a nation but few talk about how having a good job with great benefits actually enhances productivity. I don't care if it's Microsoft, Google, Costco or Ford, companies that take care of their employees are the ones that thrive in an ultra competitive environment.

But because most companies cannot offer defined-benefit plans -- and indeed those that do offer them are cutting them to new employees -- I argue that the government should step in and create large, well-governed defined-benefit plans that covers all citizens. Let businesses worry about business, not pensions. This way workers can have portable pensions and are not at risk if a company goes under. It's logical and makes good economic sense for the long-term fiscal health of any nation.

The CPP Investment Board, with headquarters in Toronto and offices in London and Hong Kong, is a professional investment management organization that invests the funds not needed by the Canada Pension Plan to pay current benefits.

In the latest triennial review released in November 2010, the chief actuary of Canada reaffirmed that the CPP remains sustainable at the current contribution rate of 9.9 per cent throughout the 75-year period of his report. That includes the assumption that the fund will attain an annualized four per cent real rate of return.

The 10-year annualized nominal rate of return of the fund currently is 6.7 per cent, although the five-year rate is 3.1 per cent.

The latest chief actuary report also indicates that CPP contributions are expected to exceed annual benefits paid until 2021, providing an eight-year period before a portion of the investment income from the CPPIB will be needed to help pay pensions.

While going long the stock market has been a great trade so far in 2013, betting that the bond market would suffer as a result could be the worst.

True, equities in a broad sense have outperformed their fixed income counterparts.

But the so-called Great Rotation trade that many market professionals had been looking for has failed to show any signs of materializing.

"Redistribution is not the same as rotation," said Kevin Ferry, president of Cronus Futures Management in Chicago and a trader not in the Great Rotation camp.

Ferry's point is not an arcane one - indeed, it goes to the heart of whether the 2013 market will be driven by an accelerated risk-on trade that finally will fulfill all those prophecies that the bond bull market is over, or if the safety play remains viable for investors' portfolios even if the stock market grows.

(Read More: Money Pouring Into Stocks 'Is Usually a Negative Sign')

The rotation play holds that investors will reverse four years of money flowing out of equities and into bonds.

So far, flows show that only half that trend has occurred.

In the first month and a half mutual funds that invest in stocks have taken in a robust $43.8 billion, a post-financial crisis high. If the rotation theme held, it would be likely to see a similar amount come out of fixed income mutual funds.

Instead, bond funds have taken in $37.6 billion - less than equities to be sure, but still a strong allocation and not indicative of a pronounced move out of bonds and into stocks.

So where has the equity side gotten all this money?

Money market funds - the dead pool that became so popular after the crisis - have lost $37 billion so far, helping explain the boon to stocks, and revealing an investor mentality in which the stock market is seen as a much better store of wealth than the zero-yielding alternative.

This has been pretty much the whole idea as the Federal Reserve has rolled through three rounds of bond buying known as quantitative easing designed to force yields down so much that investors will have no other choice but to seek out risk.

"It works until it doesn't," Ferry said. "That's what QE does - it turns the capital markets into an ATM machine. As long as there's not an exogenous event, you're OK."

(Read More: Central Banks Gone Wild: What Can Investors Do?)

If there has been a rotation, in fact, it probably is more from safer fixed-income instruments such as the benchmark 10-year Treasury note into higher-yielding bonds such as corporate junk.

Broadly, bonds as measured by the Barclays Composite Index have returned about 3 percent in 2013, but Treasurys have lost 3.5 percent. Corporate high-yield has returned 1.3 percent, while dividend growth is up nearly 6 percent.

Conversely, the Standard & Poor's 500 stock market index has gained 6.5 percent.

(Read More: Spending Cuts Loom as 'No. 1 Threat' to Market)

Looking purely at fund flows, exchange-traded products have seen about $1.2 billion come into bond funds, but double that for higher-yielding riskier offerings.

Ferry said the bond market actually has performed efficiently this year, with yields rising but in tandem, indicating that the yield curve remains constructive.

Still, Bank of America Merrill Lynch, one of the loudest proponents of the Great Rotation, insists that the trade is only in its early days even if appearances suggest otherwise.

"The Great Rotation theme is risk supportive, but even assuming volatility stays low and the macro remains in a trading range, the best outcome is for equities and other risk assets is to grind higher in coming months," Michael Hartnett, BofA's chief investment strategist, said in a note.

The firm is bullish on high yield, neutral on government bonds in emerging markets, and bearish on government, investment grade and similar traditional safe-haven bets.

Bond dealers have $47.6 billion in short positions on Treasurys, the highest level since before the crisis, according to RBC.

Meanwhile, a BofA sentiment indicator is now more bullish than 99 percent of its readings since 2002, Hartnett said, and the firm itself, despite espousing the Great Rotation theme, believes that bonds are not heading for a crash.

The bearish levels on Treasurys and bullishness on stocks are both approaching contrarian levels, meaning that the unraveling of both trades could be near.

So investors looking to position for the times ahead by betting heavily on stocks in anticipation of money rolling out of bonds may want to hold off.

"The disconnect between weak economic fundamentals, ebullient investor sentiment and elevated stock prices form an unhealthy and potentially toxic cocktail," said Doug Kass, head of Seabreeze Partners. " I am as bearish on stocks as I have been in some time."

Overseers of government worker pension funds pressed JPMorgan Chase & Co. to strip chief executive Jamie Dimon of his additional title of chairman after the London Whale fiasco, renewing a proxy battle the bank won only narrowly last year.

Pension funds, including that of the American Federation of State, County and Municipal Employees (AFSCME), said on Wednesday they filed a shareholder resolution that says the bank would be better run if the chairman and CEO jobs were held by different people.

Backers cited in a statement what they called “mounting investor concerns with the board’s oversight” following more than $6-billion (U.S.) of losses last year from bad derivatives trades linked to a London-based trader – known as the London Whale for his outsized bets.

The group also cited other problems such as the cease-and-desist orders the bank received from regulators last month that require it to improve its internal controls, which Mr. Dimon oversees.

“It is impossible to imagine how board oversight of the company’s affairs will be strengthened while CEO Jamie Dimon leads the very board that is charged with overseeing his own shortcomings,” said Denise L. Nappier, the Connecticut Treasurer who oversees the Connecticut Retirement Plans and Trust Funds, which are part of the group.

Other filers of the proposal include those overseeing the pension assets of New York City teachers, police and firefighters, according to their joint statement.

The issue of splitting the chairman and CEO jobs has become a staple argument of shareholder activists and reformers.

Proponents say having the roles filled by a single person concentrates too much corporate power and can lead to conflicts of interest. Many companies defend the practice, however, saying it can be more efficient and that other measures can assure the board’s independence and oversight.

AFSCME last year filed a similar resolution that won 40 per cent support from JPMorgan shareholders. Later filings showed backers of the resolution included mutual funds sponsored by American Funds, which before had voted with management on a similar resolution.

JPMorgan spokesman Mark Kornblau declined to comment.

Last year the bank argued the split was not necessary because other directors were independent. AFSCME filed, then withdrew, a similar proposal last year at Goldman Sachs Group Inc. after the bank agreed to appoint an independent lead director.

AFSCME last week said it has filed similar proposals this year calling for independent chairs to be named at companies including General Electric Co., Lazard LLC and Wal-Mart Stores Inc.

Another backer of the resolution at JPMorgan this year is Hermes Equity Ownership Services, an adviser owned by BT Pension Scheme, which operates pension funds for British Telecom employees.

Citigroup Inc (C.N) said on Thursday it has overhauled an executive pay plan that shareholders rejected last year as overly generous, revising it to tie bonus payments more closely to stock performance and profitability.

The company also said it will pay new Chief Executive Mike Corbat $11.5 million for his work in 2012, in line with remuneration for his peers at other major banks.

The new plan was crafted after board Chairman Michael O'Neill and other directors met with "nearly 20" shareholders representing more than 30 percent of Citigroup stock, Citi said in a filing.

"At first blush, the package appears to be responsive to a number of the issues we raised," said Michael Garland, an assistant comptroller overseeing corporate governance matters for the City of New York.

New York City's pension funds, which own about 7.4 million shares of the bank, met O'Neill in August to discuss senior executive pay, Garland said.

Citigroup's previous pay plan was rejected by shareholders in a non-binding vote at the company's annual meeting in April last year, in what was seen as a stinging rebuke to the bank's management and directors, and helped hasten departure of then-chief executive Vikram Pandit.

Compensation analysts had criticized the plan for giving directors too much discretion to set pay, and for setting the bar too low for bank executives to receive high payouts.

Under the previous profit-sharing plan, Citigroup would pay millions to executives if Citigroup earned more than $12 billion before taxes over two years, a figure the company easily topped in 2010 and 2011.

Under the new plan, 30 percent of the bonus for top executives will be paid in cash based on how much the company earns on assets and on total shareholder return compared with peers over three years through 2015. Another 40 percent will be a simple cash bonus and the final 30 percent will be deferred stock.

TICKING BOXES

Still, elements of the bank's proposed pay package could be better, said Paul Hodgson, a corporate governance analyst in Camden, Maine.

For example, the pay plan would ideally reward executives more for their performance. But too much of the stock bonuses are awarded mainly for the employee staying with the company, Hodgson said.

There were positives, including the fact that the bank needs to show stronger performance over the longer term than before, Hodgson said.

"They have done enough to check the boxes, basically," Hodgson said.

Charles Elson, director of a corporate governance center at the University of Delaware, said the new pay plan could be followed by other banks because it reduces the discretion of the board, a sore point for bank investors.

"At a lot of these financial institutions, people distrust the board, so moving away from discretion makes some sense," Elson said.

The 2012 pay for Corbat, who was named CEO in October, was based partly on the new pay plan.

Corbat's $11.5 million payment was based on his work as CEO and on his prior performance as head of the Europe, Middle East and Africa region, the company said. The board's compensation committee noted that Corbat had quickly moved as CEO to finalize the 2013 budget, including a restructuring plan to save $1.2 billion a year.

Of the payment, $1 million is base salary, $4.18 million is cash bonus, $3.14 million is deferred stock and $3.14 million is in new "performance share units" which deliver cash payments depending on profits and stock performance compared with peers.

Pandit, who was pushed out as CEO in October, received a symbolic $1 in 2010 and $128,741 in 2009, far less than rivals, after the company received more than $45 billion of government bailout money over three rescues during the financial crisis.

Pandit was paid $15 million in 2011.

Citigroup did not disclose pay for other top executives. It did, however, say that "performance share units" valued at $3.14 million had been awarded to Manuel Medina-Mora, the co-president, and that $1.95 million of the units had been awarded to CFO John Gerspach.

For 2012, JPMorgan Chase (JPM.N) Chief Executive Jamie Dimon received $11.5 million, and Bank of America's (BAC.N) Brian Moynihan was paid $12.1 million.

Norway's gigantic $650 billion sovereign wealth fund has just published an important note on what it expects in terms of corporate governance from the companies it invests with.

The sheer size of the fund, the world's largest sovereign wealth fund, makes its "expectations" influential. Its equity portfolio is worth $380 billion. The fund is a minority shareholder in more than 7,000 companies world wide. It says it is among the 10 largest shareholders in 2,400 companies and among the five largest in 800 companies. So when Oslo-based Norges Bank Investment Management—the groups that manages the fund—speaks, you can be sure people are listening.

NBIM is interested in protecting minority shareholder rights and board accountability, of course. But what makes the note so interesting is that it questions the popular idea of formalizing good governance into regulatory or legislative codes. Or even of attempting to apply a voluntary code of good governance across all companies.

"Such a perspective has led the firm to question the basis for the near-universal consensus in support of features appearing in corporate governance codes, given that NBIM finds gaps in academic evidence for many of them," writes Gavin Grant, the fund's head of active ownership, in an introduction to the NBIM note for the Harvard Law School Forum on Corporate Governance and Financial Regulation.

In other words, NBIM recognizes that codes cannot substitute for judgment, in part because different companies face a diversity of challenges that can justify a wide variety of governance structures.

From the note (emphasis mine):

The original 1992 UK code of good governance (by informal tradition referred to as the "Cadbury Code"), on which many subsequent national and international codes have been based, was not intended to lay down the law on how companies should be governed. It was, explicitly by design, a statement of recommended good governance practices. It was then for boards to implement in ways which made sense to them and to their shareholders. Corporate governance would then be correctly positioned as a contract between a company and its investors.

In the intervening twenty years, these well-founded best-practice recommendations have been somewhat corrupted – first into principles and then into hard and fast rules. This has largely occurred for reasons of expediency and convenience. It is also an outcome of international portfolio diversification and a tradition of global standards and benchmarks in other important areas of investment: accounting, financial reporting, financial ratio analysis etc. A separate corporate-governance lexicon has been created which is now technical and perhaps largely impenetrable to the generalist investor.

It almost goes without saying that this corruption from best practices to principles to hard and fast rules describes exactly the direction of corporate governance in the United States for the last decade or so. From Sarbanes-Oxley to say-on-pay, we've increasingly mandated and federalized corporate governance rules. Indeed, many self-styled corporate governance experts appear to regard "progress" in this area as synonymous with homogenization.

Norway's dissent from this movement is a welcome development.