Short-seller Jim Chanos lambasted his hedge fund industry peers for investing in drug company Valeant, saying it is was based on a business model which was a "big lie."

"Valeant epitomizes everything that went wrong with the marketplace," Chanos said at the Evidence-Based Investing conference in New York on Tuesday. It was "the largest single security loss hedge funds have incurred, greater than Lehman, Enron, AIG."

The founder and managing partner of Kynikos Associates estimated the $1 trillion long-short hedge fund industry lost $40 billion being long Valeant. The stock ticked off a number of factors that Chanos looks for in a potential short such as growth by acquisition, fraudulent accounting and crowded shareholder base.

Valeant's business model was "based on the big lie...that it could buy neglected orphan drugs going off patent, that you can purchase portfolio of drugs as opposed to develop them," he said. The stock is down 80 percent this year as investors await the outcome of government investigations into its business practices.

Chanos is known for his bearish calls against high-flying companies like Enron and has been outspoken about his bets against Tesla Motors and Alibaba. Short selling is a form of trading in which traders can bet against a company by selling shares they do not own and buy them back later at a lower price to make a profit.

The money manager also revealed the area of the market he hates the most right now...

While the redemptions represent only about 1 percent of hedge funds’ total assets, the threat of withdrawals has given investors leverage on fees.

Firms from Brevan Howard to Caxton Associates and Tudor Investment Corp. have trimmed fees amid lackluster performance.

William Ackman’s Pershing Square Capital Management last month offered a new fee option that includes a performance hurdle: It keeps 30 percent of returns but only if it gains at least 5 percent, according to a person familiar with the matter.

The offer came after Pershing Square’s worst annual performance, a net loss of 20.5 percent in 2015. Pershing Square spokesman Fran McGill declined to comment.

“They had a terrible year and they have to be extremely worried about a loss of assets under management,” said Tom Byrne, chairman of the New Jersey State Investment Council, which had about $200 million with Pershing Square as of July 31. “You’re losing clients because your prices are too high? Lower your price. That’s capitalism.”

• Some Of The Most Notable Changes This 13F Season
• Soros dissolves SPDR Gold trust shares in third-quarter, Paulson stays in (good move George)
• Why George Soros Tripled His Amazon Investment in Q3 and how he's now bullish on China (not sure if he dumped those positions and there is more to his holdings than emerging markets).
• Warren Buffett Reports Buying 3 Airline Stocks, Cuts Walmart (anther good move but take profits on those airlines as they have gone parabolic!)
• Billionaire David Tepper Re-Buys Apple, Ups FB Stake: 13F Filing (FB, AAPL)
• Billionaire John Paulson Trims JNJ, Teva, Adds CVS: 13F Filing (JNJ, CVS)  

[...] at one point a rising US dollar impedes growth and is deflationary and if you ask me, the rise of protectionism will cost America jobs and rising unemployment is deflationary, so even if Trump spends like crazy on infrastructure, the net effect on growth and deflation is far from clear.

All this to say I respectfully disagree with Ray Dalio, Bob Prince and the folks at Bridgewater which is why I recommended investors sell the Trump rally, buy bonds on the recent backup in yields and proceed cautiously on emerging markets as the US dollar strengthens and could wreak a deflationary tsunami in Asia which will find its way back on this side of the Atlantic.

Unlike Ray Dalio and others, I just don't see the end of the bond bull market and I'm convinced we have not seen the secular low in long bond yields as global deflation risks are not fading, they are gathering steam and if Trump's administration isn't careful, deflation will hit America too.

This is why I continue to be long the greenback and would take profits or even short emerging market (EEM), Chinese (FXI),  Metal & Mining (XME) and Energy (XLE) shares on any strength. And despite huge volatility, I remain long biotech shares (IBB and equally weighted XBI) and keep finding gems in this sector by examining closely the holdings of top biotech funds.

And in a deflationary, ZIRP & NIRP world, I still maintain nominal bonds (TLT), not gold, will remain the ultimate diversifier and Financials (XLF) will struggle for a long time if a debt deflation cycle hits the world (ultra low or negative rates for years aren't good for financials).

As far as Ultilities (XLU), REITs (IYR), Consumer Staples (XLP), and other dividend plays (DVY), they have gotten hit lately partly because of a backup in yields but also because they ran up too much as everyone chased yield (might be a good buy now but be careful, high dividend doesn't mean less risk!). Interestingly, however, high yield credit (HYG) continues to perform well which bodes well for risk assets. 

No country on the planet is better prepared to pay for its aging population than Denmark. But a nation whose pension industry has been ahead of the curve for decades is now bracing for a fundamental shift that most people probably aren’t prepared for, according to the financial regulator.

Jesper Berg, the director general of the Financial Supervisory Authority in Denmark, wants to warn policy makers of the backlash he says they may face once households understand the risks they run. More specifically, Berg says people haven’t grasped that they will lose money if their banks or the investments their funds make fail.

“While people applaud if money doesn’t go out of their pocket as a taxpayer, they have yet to realize that it will go out of their pocket as a depositor or pensioner or investor,” Berg said in an interview in Copenhagen. “These are enormous amounts of money, so this is an important discussion to have.”

Berg says the FSA has called for talks with politicians and industry representatives to take place in March to discuss the issue.

Privatizing Risk

Denmark’s life insurers hold more than $650 billion in assets, which is roughly 2 1/2 times the size of the economy, according to UBS’s Pension Fund Indicators 2016. At $118,214, assets per capita are among the highest in the world. In Switzerland, the figure is $98,287. In the Netherlands, it’s $79,721.

Berg says the redrawing of financial regulation since the crisis of 2008 has had some profound consequences. New solvency rules for pension funds mean clients are being pushed out of defined benefit plans and into defined contributions plans, to help providers cut their capital requirements. That helps insurers stay solvent. It also frees them to take riskier bets. But, crucially, that risk is transferred to pensioners on an individual basis.

This privatization of risk that has followed the global regulatory overhaul is “the new reality” that “we need to discuss,” Berg said.

Global Leader

Denmark’s warning is worth heeding. The country has been at the forefront of pension reform, ensuring that companies can meet their obligations and that people have enough savings to live comfortably in retirement. It’s repeatedly topped rankings in the Melbourne Mercer Global Pension Index on adequacy and sustainability.

In practical terms, the risk is that a pension fund invests in something “that makes huge losses with the result that pensioners lose money and have to live with lower pensions or stay in the labor market longer,” Berg said.

And demand for risky assets is growing as funds look for ways to generate returns in an era of record-low interest rates. Denmark’s regulator has started looking more closely at funds’ investments in less liquid assets and found that holdings of so-called alternative investments surged 66 percent from 2012 to 2015.

Berg says it’s not the role of the supervisor to question the model. But he’s worried about how well it’s understood.

“While I believe in the economic incentive to privatize risk, my biggest fear is that people aren’t aware of that, and as a consequence we’ll have a backlash,” he said.

A new regulation called the prudent person principle guides funds’ investments, but it’s “still a very general principle,” Berg said. It is for the politicians to decide whether additional rules are necessary and the FSA will provide them with options, “but I just want that discussion to be taken before we have the first meltdown.”

[...] last week was a great week for savers, 401(k)s and global pensions. The Dow chalked up its best week in five years and stocks in general rallied led by banks and my favorite sector, biotechs which had its best week ever.

More importantly, bond yields are rocketing higher and when it comes to pension deficits, it's the direction of interest rates that ultimately counts a lot more than any gains in asset values because as I keep reminding everyone, the duration of pension liabilities is a lot bigger than the duration of pension assets, so for any given move in rates, liabilities will rise or decline much faster than assets.

Will the rise in rates and gains in stocks continue indefinitely? A lot of underfunded (and some fully funded) global pensions sure hope so but I have my doubts and think we need to prepare for a long, tough slug ahead.

The 2,826-day-old bull market could be a headache for Trump but the real headache will be for global pensions when rates and risk assets start declining in tandem again. At that point, President Trump will have inherited a long bear market and a potential retirement crisis.

This is why I keep hammering that Trump's administration needs to include US, Canadian and global pensions into the infrastructure program to truly "make America great again."

Trump also needs to carefully consider bolstering Social Security for all Americans and modeling it after the (now enhanced) Canada Pension Plan where money is managed by the Canada Pension Plan Investment Board. One thing he should not do is follow lousy advice from Wall Street gurus and academics peddling a revolutionary retirement plan which only benefits Wall Street, not Main Street.

So what in a nutshell did Bob Prince say? Here are the main points that I jotted down:

• Higher debt and low rates will impact asset values, limit credit growth and economic growth over next decade
• Monetary policy and asset returns are skewed  (so you will see bigger swings in risk assets)
• Currency swings matter a lot more in a low rate/ QE world (expect higher currency volatility)
• Low rates and low returns are here to stay (expected returns in public markets will be in low single digits over next decade)
• We are reaching an important inflection point where valuations of illiquid assets are nearing a peak at the same time where dollar liquidity dries up.

I emphasized that last point because it's bad news for many pensions, insurance companies, sovereign wealth funds and endowments piling into illiquid assets like private equity, real estate and infrastructure at historically high valuations.

Not that they have much of a choice. Bob Prince said in this environment, you have three choices:

1. Do nothing and accept the outcome
2. Take more risk
3. Take more efficient risk (like in illiquid assets)

Institutions have been taking more efficient risk in illiquid asset classes but the pendulum may have swing too far in that direction and if he's right and we're at an important inflection point, then there will be a big correction in illiquid asset classes.

Even if he's wrong, expected returns on liquid and illiquid asset classes will necessarily be lower over the next decade, so the diversification benefits of illiquid assets won't be as strong going forward.

[Note: Admittedly, this is a bit of self-serving point made by the co-CIO of the world's largest hedge fund which invests only in liquid assets. He's trying to steer investors away from illiquid to more liquid alternatives like Bridgewater but he forgets that pensions and other institutional investors have a very long investment horizon, so they can take a lot more illiquidity risk.]

The rise in Treasury yields slowed this week, highlighting skepticism in some quarters that Donald Trump’s presidency will usher in a period of rising inflation.

The yield on the 10-year Treasury note, which falls as prices increase, fell Wednesday, following a muted rise on Tuesday, while the 30-year bond yield fell both Tuesday and Wednesday.

Yields had surged since the U.S. presidential election on the view that Mr. Trump’s tenure will generate a period of rising inflation, as he pursues policies such as tax cuts, regulatory rollbacks and infrastructure spending to boost economic growth (click n image below). Market-based inflation indicators were rising before Mr. Trump’s victory last week, following sharp declines earlier in 2016.

But some investors say factors including the size of the U.S. debt load could limit the effectiveness of any fiscal-stimulus efforts. The more debt that is outstanding, the less bang for any given dollar of spending, some say.

These skeptics insist the bond selloff has gone too far.

“I was rolling my eyes so many times in the past few days that I thought I was going to go blind,” said David Rosenberg, chief economist and market strategist at Gluskin Sheff & Associates Inc. “The inflationistas have a lot to account for because history is not on their side.”

Other quarrels with the pro-inflation narrative focus on the numerous premature inflation calls of the past decade.

Some economists and businessmen wrote an open letter in 2010 warning then-Federal Reserve Chairman Ben Bernanke that monetary stimulus would have inflationary consequences, a view that now seems thoroughly discredited. Inflation has failed to hit the Federal Reserve’s 2% annual target for more than four years.

The U.S. producer-price index for final demand, a measure of business prices, held flat in October compared with the prior month, data showed Wednesday. Prices were up 0.8% from a year earlier.

Lacy Hunt, executive vice president at Hoisington Investment Management Co. in Austin, Texas, has long invested his fund in Treasurys with faraway maturities, reasoning that the economy is too weak to generate inflation that would erode the gains on those securities.

Since the election, he has been bombarded with calls from clients wondering whether the bond selloff is the death knell for the bond rally that began in 1981.

On Wednesday, the 30-year yield fell to 2.925%, while the 10-year yield fell to 2.222% (last week's data).

A bond-market gauge that compares nominal Treasury yields with inflation-protected counterparts forecasts that inflation will climb at 1.88% annually over the next 10 years, up from 1.4% in July, according to Tradeweb.

Mr. Hunt’s answer: No way. “There is always this rush to judgment when there’s a major policy change,” he said. He is investing new client money in long-term Treasurys, those maturing in 10 years or more.

One reason he thinks inflation is set to stay low is the nation’s $19.8 trillion debt load. The increase in debt stands to make each dollar go less far in spurring growth, he said. From 1952 to 1999, it took about $1.70 in nonfinancial debt for gross domestic product to expand by $1. In the year through June, it took $4.90 to do the same.

The national debt could increase $5.3 trillion over a decade should Mr. Trump cut taxes and boost spending as he has said during the campaign, according to the nonpartisan Committee for a Responsible Federal Budget.

Even after stimulus projects are completed, their impact on inflation isn’t necessarily positive. Improving roads and rails to make transportation more efficient can actually cut per-unit costs, Mr. Rosenberg said. He cited the New Deal package in the 1930s and the highway-construction spending of the 1950s as big stimulus measures that didn’t in their own right boost prices.

Still, many investors think inflation is headed higher as part of a broader economic reckoning. Prices had been rising in the months before the election, and a policy pivot could boost that, some say.

Market factors like higher interest rates and a stronger dollar also may have a damping effect on inflation because they can restrain the economy.

“There is a good chance that we are at one of those major reversals that last a decade,” Ray Dalio, chairman and chief investment officer at Bridgewater Associates, said in a LinkedIn post Tuesday. He suggested inflation was set to climb.

Even those who don’t see inflation in the cards suggest that some elements of Mr. Trump’s policy proposals may work toward that purpose, such as his vow to cut the corporate tax rate to 15% from 35%.

Yet the experience of tax cuts during President Ronald Reagan’s administration suggests this took a long time to filter through to the economy, Mr. Hunt said.

Last week, I discussed the global pension storm, noting the following:

[...] last week was a great week for savers, 401(k)s and global pensions. The Dow chalked up its best week in five years and stocks in general rallied led by banks and my favorite sector, biotechs which had its best week ever.

More importantly, bond yields are rocketing higher and when it comes to pension deficits, it's the direction of interest rates that ultimately counts a lot more than any gains in asset values because as I keep reminding everyone, the duration of pension liabilities is a lot bigger than the duration of pension assets, so for any given move in rates, liabilities will rise or decline much faster than assets.

Will the rise in rates and gains in stocks continue indefinitely? A lot of underfunded (and some fully funded) global pensions sure hope so but I have my doubts and think we need to prepare for a long, tough slug ahead.

The 2,826-day-old bull market could be a headache for Trump but the real headache will be for global pensions when rates and risk assets start declining in tandem again. At that point, President Trump will have inherited a long bear market and a potential retirement crisis.

This is why I keep hammering that Trump's administration needs to include US, Canadian and global pensions into the infrastructure program to truly "make America great again."

Trump also needs to carefully consider bolstering Social Security for all Americans and modeling it after the (now enhanced) Canada Pension Plan where money is managed by the Canada Pension Plan Investment Board. One thing he should not do is follow lousy advice from Wall Street gurus and academics peddling a revolutionary retirement plan which only benefits Wall Street, not Main Street.

You should read my comment on the global pension storm to understand why I continue to worry about global deflation, the rising US dollar and why bond yields are likely to revisit new secular lows, placing even more pressure on global pensions in the years ahead.

This is why I respectfully disagree with Bob Prince and Ray Dalio at Bridgewater who called an end to the 30-year bond bull market after Trump's victory. I have serious concerns on Trump and emerging markets and I wouldn't be so quick to rush out of bonds (in fact, I see the big backup in bond yields as an opportunity to buy more long dated bonds (TLT) and will cover this in a separate comment).

• High structural unemployment in the developed world (too many people are chronically unemployed and we risk seeing a lost generation if trend continues)
• Rising and unsustainable inequality (negatively impacts aggregate demand)
• Aging demographics, especially in Europe and Japan (older people get, the less they spend, especially if they succumb to pension poverty)
• The global pension crisis (shift from DB to DC pensions leads to more pension poverty and exacerbates rising inequality which is deflationary)
• High and unsustainable debt (governments with high debt are constrained by how much they can borrow and spend)
• Massive technological disruptions (Amazon, Priceline, and robots taking over everything!)

[...] at one point a rising US dollar impedes growth and is deflationary and if you ask me, the rise of protectionism will cost America jobs and rising unemployment is deflationary, so even if Trump spends like crazy on infrastructure, the net effect on growth and deflation is far from clear.

All this to say I respectfully disagree with Ray Dalio, Bob Prince and the folks at Bridgewater which is why I recommended investors sell the Trump rally, buy bonds on the recent backup in yields and proceed cautiously on emerging markets as the US dollar strengthens and could wreak a deflationary tsunami in Asia which will find its way back on this side of the Atlantic.

Unlike Ray Dalio and others, I just don't see the end of the bond bull market and I'm convinced we have not seen the secular low in long bond yields as global deflation risks are not fading, they are gathering steam and if Trump's administration isn't careful, deflation will hit America too.

This is why I continue to be long the greenback and would take profits or even short emerging market (EEM), Chinese (FXI),  Metal & Mining (XME) and Energy (XLE) shares on any strength. And despite huge volatility, I remain long biotech shares (IBB and equally weighted XBI) and keep finding gems in this sector by examining closely the holdings of top biotech funds.

And in a deflationary, ZIRP & NIRP world, I still maintain nominal bonds (TLT), not gold, will remain the ultimate diversifier and Financials (XLF) will struggle for a long time if a debt deflation cycle hits the world (ultra low or negative rates for years aren't good for financials).

As far as Ultilities (XLU), REITs (IYR), Consumer Staples (XLP), and other dividend plays (DVY), they have gotten hit lately partly because of a backup in yields but also because they ran up too much as everyone chased yield (might be a good buy now but be careful, high dividend doesn't mean less risk!). Interestingly, however, high yield credit (HYG) continues to perform well which bodes well for risk assets. 

A growing number of seniors could face poverty if the federal Liberals proceed with proposed legislation enabling Crown corporations and federally regulated private sector employers to back out of defined benefit pension plans, Essex MP Tracey Ramsey said Monday.

“With less and less retirement security, seniors in Windsor-Essex are living more precariously than they ever have because of the erosion of benefits,” said Ramsey.

In Windsor-Essex, one in 11 seniors was living in poverty, according to figures compiled by the Windsor-Essex County United Way. For a single family household, the low income cutoff totalled about $19,900 a year.

The NDP member and labour groups are sounding the alarm over Bill C-27, which would amend the Pension Benefits Standards Act, and allow federally regulated employers and Crown corporations to replace defined benefit plans with target benefit plans.

More than 820,000 people, or six per cent of all Canadian workers, are employed in such sectors as banking, rail, air and ferry transportation, radio and television broadcasting.

Introduced by Finance Minister Bill Morneau last month, the bill has yet to be debated in the House of Commons.

The legislation is “an attack on retirees and working people,” Ramsey said. “There couldn’t be a more wrong-headed approach. When we talk about defined benefits, that’s deferred wages. That’s something workers know they can count on. These new target plans are extremely unstable.”

Defined benefit pensions guarantee a specified payment upon an employee’s retirement. Any funding shortfall must be covered by the employer. Target pension plans borrow attributes from defined benefit plans and defined contribution pension plans, which absolve employers from covering any funding deficits. Target benefits plans can place limits on the volatility of employer contributions; in the event of a funding deficit, part or all of it can be compensated by reducing benefits. A traditional defined benefit plan would require the entire deficit to be made up by the employer.

The proposed federal legislation will broaden the scope of retirement savings opportunities, a Department of Finance spokesman said in an emailed statement.

Target benefit plans “represent a new, voluntary, sustainable and flexible pension option for employees in federally regulated private sector and Crown corporation pension plans,” the statement said. “For those who choose this option, (target benefit plans) will provide a lifetime pension that benefits from the pooling of market risk and protects against the risk of outliving one’s retirement savings. At the same time, transferring benefits from an existing plan to a (target benefit plan) is optional.”

Hussan Yussuff, president of the Canadian Labour Congress, viewed the move as yet another attempt by employers to shift workers out of defined benefit plans.

“Currently, defined benefit pensions provide stability and security to employees because employers are legally obliged to fund employees’ earned benefits,” said Yussuff. “Bill C-27 removes employers’ legal requirements to fund plan benefits, which means that benefits could be reduced going forward or even retroactively. Even people already retired could find their existing benefits affected.”

Yussuff said the former federal Conservative government attempted a similar move but, after holding public consultations, dropped the plan ahead of the October 2015 election.

The Liberals, on the other hand, introduced the proposed legislation, without consulting Canadians, unions or pensioners, he said. “This proposal directly contradicts Prime Minister Justin Trudeau’s campaign promise to help the middle class by improving retirement security.”

It also smacks of hypocrisy given the fact that MPs are enrolled in defined benefit pension plans, noted Yussuff. “They maintain a defined benefits plan for themselves, and I don’t have an issue with that. But why would they treat workers with such disregard?”

Pension numbers

4,402,000 Canadian employees were in defined benefit pension plans in 2013, down 0.5 per cent from 2012.

71.2 per cent of employees in a registered pension plan in 2013 had defined benefits, compared with more than 84 per cent a decade earlier.

1,037,000 employees were in defined contribution plans in 2013, up 0.6 per cent from 2012.

86 per cent of employees with defined contribution plans in 2013 worked in the private sector.

746,000 employees belonged to other pension plans, such as hybrid or composite, in 2013 — up two per cent from 2012.

Source: Statistics Canada

For both concerned employers and employees, Bill C-27 is a poor, inappropriate and unduly complex solution to the possibly real, but generally highly overestimated debt of Defined Benefit (DB) plans sponsored by employers for their employees.

Such pension debt overestimates are caused by the DB plans-related legislation, i.e. the 1985 Pension Benefits Standards Act (PBSA), which compels these plans to be evaluated on a solvency as opposed to a realistic ongoing concern basis.

And as Bill C-27 allows any DB plan sponsor to shift to active and retired plan members the responsibility to assume any debt of the DB plan upon the effective date of its conversion into a Target Benefit (TB) plan, it plainly corresponds to an unfair and inappropriate legalized embezzlement of some pension benefits by the plan sponsor.

Actually, Bill C-27 is a replicate of the so-called Shared Risk Plan (actually and more precisely a TB plan that fully shifts the risks to, rather than shares risks with, plan members) introduced in New Brunswick on January 1, 2014, with the exception that DB plan members would have to consent to its conversion into a TB plan. It is to be reasonably feared that DB plan members would give such consent only pursuant to a misunderstanding of the complex TB plans provisions envisioned by Bill C-27.

By virtue of Bill C-27, a DB plan converted into a TB plan would no longer be subject to solvency valuations. Besides, the onus of any still emerging deficits would be assumed entirely by active and retired members.

Indeed, pension deficits would naturally continue to emerge from time to time as would surpluses. In this vein, Bill C-27 fails to address the existing unsuitable PBSA provision allowing plan sponsors to take possession of DB and TB pension plans surplus through contribution holidays (CH). These CHs are a sure recipe for financial disaster and are a very, if not the most important cause of financial difficulties encountered by DB plans.

In light of the above considerations, I have been steadily promoting since 2013 the following three amendments to the PBSA, which would be much more sensible, effective and appropriate than Bill C-27 and would also counteract its severe inadequacies:

1. Evaluation of DB plans on a realistic (i.e. margin-free best estimate assumptions erring on the safe side, no asset value averaging, etc.)going concern basis rather than a solvency basis.
2. Full prohibition of contribution holidays.
3. Amortization of emerging surplus over 15 years, just as already are emerging deficits, i.e. through a generally small decrease or increase, respectively, in the contribution rate. This would well address one of the DB pan sponsors’ main aversion for DB plans, i.e. their highly fluctuating and unpredictable costs. In case where a given DB plan sponsor would still envision the higher stability of contribution rates under a TB pension plan, then there would be a case to maintain the DB plan (as opposed to convert it into a TB plan) and negotiate with plan members the transfer to them of the very light contribution rates volatility of my proposed DB plan financing policy.

I had the privilege to meet legendary investor Warren Buffett in Omaha last Friday. He occasionally meets with university students and Concordia University, where I have been teaching since 2006, was selected. For more than two hours, a group of 15 students accompanied by a few teachers could ask questions to The Oracle. I have always admired the human and professional qualities of Warren Buffett. Not only is he an outstanding investor but he is also an excellent communicator. You will find attached to this email a summary of his comments.

His thoughts coincide with our advantageous structure at Tonus Capital. As expected, Mr. Buffett mentioned that few opportunities are present on the market. He recommends to remain very patient and to have a concentrated portfolio (he would personally have only 4 or 5 stocks in his). These are exactly the advantages provided by our investment policy; namely the flexibility to hold cash and wait for great opportunities and the concentration in approximately fifteen to twenty stocks. Over the past nine years, we have been building the image and reputation of Tonus Capital and we will continue to put investors’ interest at the forefront in order to maintain your trust.

For those comfortable in French, I recommend reading the following articles published this week in journal La Presse and Les Affaires.

******

Meeting with Warren Buffett in Omaha, November 18th, 2016

People

At Berkshire, there are no contracts with senior managers. Being financially independent, they are passionate and driven. For them, working for Mr. Buffett and Berkshire is the opportunity of a lifetime.

Bonds

“Interest rates are to stocks what gravity is to matter”. Mr. Buffett believes that long term interest rates are too low. He does not short sell at Berkshire but if he could he would short long-term bonds. He does not believe the stock market is currently overvalued and much prefers stocks over bonds right now. He mentions that if market participants believed that long-term rates would remain at current levels for some time, it would mean stocks are grossly undervalued. The reality is probably in between, and bonds are likely to lose some value in the future.

Active vs. passive investing

Because the market is an average, over time, both active and passive investing will yield similar (average) gross returns. To justify their higher fees, active managers must outperform over the long-term. Few will succeed, and the hard task for asset allocators (individuals, consultants, pension funds) is to identify these outperformers. Buffett considers the following factors enabling one to outperform the market:

• Being a good investor has nothing to do with IQ. It is more about emotional discipline and the talent to pick good stocks with good management. It is critical that the portfolio manager has a good temperament in order not to panic when fear prevails. Fear is very contagious in the financial markets.
• Smaller assets under management should increase the probability of outperforming. There are few great opportunities in the markets and when they arise, the manager must be quick and flexible.
• Buffet strongly believes in portfolio concentration. He would only have 4 or 5 investments in his portfolio if he was managing a smaller amount.

Technology

Many think that computers will replace humans in finance (and in many other sectors). Computers’ advantage lies in their speed. Buffett thinks that the majority of these high frequency and algorithmic funds use the same strategy and make very similar trades which will likely lead to more volatility as they simultaneously try to unwind their trades. Fundamental investors with a good temperament should be able to take advantage of the opportunities created by such volatility. Buffett does not believe that computers can determine the durability of the long-term competitive advantages of a company nor can it assess the motivation and passion of management. Given fundamental analysis is not about speed, he does not believe computers will replace analysts.

National debt

As long as the Federal Reserve can print bank notes, Mr. Buffett does not believe that the national debt is a problem in the United States (but other problems could emerge from printing currency, namely, inflation). He thinks that health care costs, now representing 17% of GDP, are a bigger issue.

Clearly Buffett foresaw the looming public pension catastrophe but does this mean he's against well-governed defined benefit plans?

I'm not sure. When I recently covered Warren Buffett's pension strategy, I stated the following:

What does the article say about Buffett's strategy for managing the defined-benefit plans Bershire inherited through acquisitions? First and most important, there is no talk of switching people out of defined-benefit to defined-contribution plans. Buffett plans to honor those commitments (Interestingly, I've tracked a lot of activity on my blog from Omaha, Nebraska over the last few years. Could it be the Oracle of Omaha?).

Second, fees matter a lot and Buffett isn't going to waste his time farming out the bulk of these pension assets to outside managers using useless investment consultants when he has the expertise to manage them in-house There is no mention of allocating money to hedge funds or private equity funds either. Again, fees matter a lot to Buffett and so does liquidity and performance. He is handily winning on a wager he made in 2008 with Protégé Partners, a fund of hedge funds manager, betting the S&P500 would beat a group of hedge fund managers selected by Protégé.

Third, Buffett and his team are not just great stock pickers, they also know how to engage in more sophisticated derivatives strategies. Buffett might have called derivatives "financial weapons of mass destruction," but the truth is Berkshire made a killing on the same long-term option strategy that allowed HOOPP to gain 17% in 2012.

Fourth, and hardly surprising, Buffett is not bullish on bonds given the current near record low interest rates. In this regard, he joins pensions that are massively betting on a rise in interest rates. This is understandable given that Buffett made his fortune picking great companies and he prefers stocks over bonds in the long-run. He thinks market timing is a loser's proposition and many long-term investors (like Doug Pearce at bcIMC) agree with him.

Keep in mind, however, that Buffett enjoyed the greatest bull market in stocks and never managed money during a prolonged debt deflation cycle (doubt he will ever see one in his lifetime). Also, the Fed's quantitative easing (QE) policy has been a boon for risk assets and I'm seeing a lot of activity in the stock market reminiscent of the 1999 liquidity melt-up in tech stocks. Momentum chasers trading high-beta stocks are loving it but be careful as the market's darkest days might be ahead.

Trust me, I am no fan of hedge funds, think the bulk (90%++) of them stink, charging outrageous "alpha" fees for leveraged beta, or worse, sub-beta performance. Moreover, I agree with Steve Cohen and Julian Robertson, there is too much talent in the game, watering down overall returns, but there are also plenty of bozos and charlatans in the industry which have no business calling themselves hedge fund managers.

But all these self-righteous investment experts jumping on the 'bash the hedge funds' bandwagon annoy me and if we get a prolonged deflationary cycle where markets head south of go sideways for a decade or longer, I'd love to see where they will be with their "keep buying low cost ETFs" advice (Buffett, Munger and Bogle will be long gone by then but Siedle and Seides will still be around).

I believe in the Ron Mock school of thought. When it comes to hedge funds and other assets, including boring old long bonds, always diversify as much as possible and pay for alpha that is truly worth paying for (ie. that you cannot replicate cheaply internally).

I will repeat what Ron told me a long time when we first met in 2002: "Beta is cheap. You can swap into any equity or bond index for a few basis points to get beta exposure. Real uncorrelated alpha is worth paying for but it's very hard to find."

One of the world’s most conservative investors has found an unlikely new ally in one of its most flamboyant politicians: Donald Trump.

The unconventional president-elect’s victory is helping Japan’s giant pension fund in two important ways. First, it’s sending stock markets surging, both at home and overseas, which is good news for the largely passive equity investor. Second, it’s spurred a tumble in the yen, which increases the value of the Japanese manager’s overseas investments. After the $1.2 trillion Government Pension Investment Fund reported its first gain in four quarters, analysts are betting the Trump factor means there’s more good news to come.

“The Trump market will be a tailwind for Abenomics in the near term,” said Kazuhiko Ogata, the Tokyo-based chief Japan economist at Credit Agricole SA. “GPIF will be the biggest beneficiary among Japanese investors.”

While most analysts were concerned a Trump victory would hurt equities and strengthen the yen, the opposite has been the case. Japan’s benchmark Topix index cruised into a bull market last week and is on course for its 12th day of gains. The 4.6 percent slump on Nov. 9 now seems a distant memory. The yen, meanwhile, is heading for its biggest monthly drop against the dollar since 2009.


GPIF posted a 2.4 trillion yen ($21 billion) investment gain in the three months ended Sept. 30, after more than 15 trillion yen in losses in the previous three quarters. Those losses wiped out all investment returns since the fund overhauled its strategy in 2014 by boosting shares and cutting debt. It held more than 40 percent of assets in stocks, and almost 80 percent of those investments were passive at the end of March.

Tokyo stocks are reaping double rewards from Trump, as the weaker yen boosts the earnings outlook for the nation’s exporters. The Topix is the fourth-best performer since Nov. 9 in local-currency terms among 94 primary equity indexes tracked by Bloomberg.

Global Rally

But they’re not the only ones. More than $640 billion has been added to the value of global stocks since Nov. 10, when many markets around the world started to climb on bets Trump would unleash fiscal stimulus and spur inflation, which has boosted the dollar and weakened the yen. The S&P 500 Index closed Wednesday at a record high in New York.

Bonds have tumbled for the same reasons, with around $1.3 trillion wiped off the value of an index of global debt over the same period. Japan’s benchmark 10-year sovereign yield touched a nine-month high of 0.045 percent on Friday, surging from as low as minus 0.085 percent on Nov. 9.

GPIF’s return to profit is a welcome respite after critics at home lambasted it for taking on too much risk and putting the public’s retirement savings in jeopardy.

The fund’s purchases of stocks are a “gamble,” opposition lawmaker Yuichiro Tamaki said in an interview in September, after an almost 20 percent drop in Japan’s Topix index in the first half of the year was followed by a 7.3 percent one-day plunge after Britain’s shock vote to leave the European Union. Prime Minister Shinzo Abe said that month that short-term losses aren’t a problem for the country’s pension finances.

Feeling Vindicated

“I’d imagine GPIF is feeling pretty much vindicated,” said Andrew Clarke, Hong Kong-based director of trading at Mirabaud Asia Ltd. “It must be cautiously optimistic about Trump.”

Still, the market moves after Trump’s victory are preceding his policies, and some investors are questioning how long the benefits for Japan -- and GPIF -- can last. Trump already said he’ll withdraw the U.S. from the Trans-Pacific Partnership trade pact on his first day in office. The TPP is seen as a key policy for Abe’s government.

“It looks good for GPIF for now,” said Naoki Fujiwara, chief fund manager at Shinkin Asset Management Co. in Tokyo. But “whether the market can continue like this is debatable.”

In a response to Bernard Dussault, Canada's former Chief Actuary, Bob Baldwin, a consultant and former board of director at PSP Investments, sent me his thoughts on Bill C-27, DB, DC and target benefit plans (added emphasis is mine):

Bernard Dussault has circulated an article and slide presentation in which he has provided a endorsement of DB workplace pension plans coupled with an expression of concern about certain design features of DB plans that he sees as discriminatory. I share his preference for DB. But, I think his account of DB is incomplete and avoids certain issues and problems in DB that DB plan members, people with DB governance responsibilities and DB advocates should be aware of.

In his article “How Well Does the Canadian Landscape Fare?” Bernard says: “… DB plans offer better retirement security because they attempt to provide a predetermined amount of lifetime annual retirement income at an unknown periodic price.” The unknown nature of the price is unavoidable given the factors that determine the price that have magnitudes that cannot be foreseen such as: future wages and salaries, investment returns and longevity.

In context, two attributes of DB in its pure form are important to note. First, all of the uncertainty will show up in variable contribution rates and none in variable benefits. Second, the plan sponsor or sponsors have an unlimited willingness and ability to contribute more to the plan if need be.

The second of these attributes is, in principle, largely implausible. There simply are not sponsors who can and will contribute more without limit. Moreover, as I have noted in several publications, in practice when combined employer and employee contributions get up to the 15 to 20 per cent level, even jointly governed plans that were purely DB begin allocating some financial risk to benefits – usually by making indexation contingent on the funded status of the plan.

Moreover above some level, escalating pension contributions begin to depress pre-retirement living standards below post retirement levels. Even recognizing that the impact on living standards of a particular combination of benefit levels and contributions will vary from member to member in a DB plan (you can’t make it perfect for everyone), it is still desirable to try to avoid depressing pre-retirement living standard below the post-retirement level. The object of the workplace pension exercise is to facilitate the continuity of living standards and depressing pre-retirement living standards below the level of post-retirement living standards is not consistent with that objective. You can have too much pension!

The contributions that are relevant to the question whether contributions are depressing pre-retirement living standards to too low a level include both employer and employee contributions. This is because in most circumstances, the economic burden of employer contributions will fall on the employee plan members. This happens because rational employers will reduce their wage and salary offers to compensate for foreseeable pension contributions. There may be circumstances where an employer cannot shift the burden fully in the short term. But, in the normal case, the burden will be shifted. To the extent that required pension contributions are varying through time and being shifted back to the employee plan members, the net replacement rates generated by DB plans are clearly less predictable than the gross replacement rates.

Under the subheading “Strengths of DB plans”, Bernard’s slides include the following statement “investment and longevity risks are pooled, i.e. not borne exclusively by members, be it individually or collectively.” Having introduced the word “exclusively” the statement is probably correct. But, there are a variety of risks to plan members in DB plans. As was noted in the previous paragraph, there is a risk in ongoing DB plans that the pre-retirement living standards will be depressed below post-retirement levels. There is also a risk that a DB plans will get into serious financial difficulty and benefits will be reduced for future service and/or the plan will be converted to DC for future service. Both of these outcomes focus financial risks on young and future plan members as does escalating contributions. Finally, in the event of the bankruptcy of a plan sponsor, all members will face benefit reductions if the plan is not fully funded.

Bernard’s article and slides include reference to provisions in DB plans that he finds discriminatory. For me, the provisions on which he focuses raise a related issue.

The key factors that determine outcomes in all types of workplace pension plans are the same: rates of contributions, salary trajectories, returns on investment, longevity and so on. So what is it that allows a DB plan to provide a more predictable outcome? It is basically two distinct but related things: varying the contribution (saving) rate through time to meet a pre-determined income target; and, cross-subsidies within and between different cohorts of plan members.

In and of itself, the existence of cross-subsidies is not a bad thing. It is fundamental to all types of insurance and insurance is worth paying for. But, what DB plans could do much better than they do is to help plan members understand what the cross-subsidies are and how much they cost. This would allow plan members to decide what cross-subsidies are “worth it” and which ones are not worth it. My guess would be that within limits established by periods of guaranteed payments, members would accept cross-subsidies based on differential longevity in order to have a pension guaranteed for a lifetime. There may be less enthusiasm for a cross-subsidy from members whose salaries are flat as they approach retirement to those whose salaries escalate rapidly.

With respect to the plan features that Bernard has identified as discriminatory, my first and strongest inclination is to shine light on them so plan members have a chance to decide what is and is not acceptable.

The relatively predictable outcomes of DB plans in terms of the benefits they provide are clearly desirable. DC plans – especially those that involve individual investment decision-making and self-managed withdrawals – impose too much uncertainty on plan members with respect to the retirement incomes they will provide and demand excessive knowledge, skills and experience of plan members – not to mention time.As a renown professor of finance put it, a self-managed DC arrangement is like asking people to buy a “do it yourself” kit and perform surgery on themselves.

It is unfortunate however, that so much of the discourse about the design of pension plans is presented as a binary choice between DB and DC. There are several reasons why this is unfortunate.

First, the actual world of pension design is more like a spectrum than a binary choice. In Canada and across the globe, there are any number of pension plan designs that combine elements of DB and DC. Financial risks show up in both benefits and contributions.

Second, sometimes plans are managed in ways that are not entirely consistent with formal design features of plans. In the 1980s and 1990s when returns on financial assets were high and wage growth low, many DB plans ran up surpluses on a regular basis and these were often converted into benefit improvements. Many DB plans were managed as if they were collective DC plans (investment returns were determining benefits) with DB guarantees. The upside investment risk was not converted into variable contributions.

Third and finally, some plans that are labelled DB fall well short of addressing all of the financial contingencies that retirees will face. This is most strikingly true of DB plans that make no inflation adjustments. What is defined – in terms of living standards – only exists during the period immediately after retirement.

The difficulty in knowing exactly what we are referring to in using the DB and DC labels has not rendered the terms totally meaningless. As noted above, there are plans that are mainly DB but allocate some financial risk to the indexation of benefits. There are also a few grandfathered Canadian DC plans that include minimum benefit guarantees. The union created multi-employer plans have fixed rates of contribution like DC plans, pool many risks like a DB plan, but allow reductions in accrued benefits. The point is not to get stuck on the DB and DC labels but to understand how financial risks are being allocated.

The basic strength of DB plans in providing a relatively predictable retirement income is not diminished by the issues raised above. But, it is clear that for the well being of plan members and sponsors, the basic strength of DB has to be reconciled with acceptable levels and degrees of volatility of contributions. It also has to be reconciled with reasonable degrees of cross-subsidization within and between cohorts of plan members. With regard to cross-subsidies between cohorts, a regime in which accrued benefits cannot be reduced places all financial risk on young and future plan members. Target benefit plans try to avoid this problem by spreading the risk sharing across all cohorts as in the union created multi-employer plans.

Bernard’s article and slides touch on a number of regulatory issues. The only one of these that I will comment on is the prohibition of contribution holidays. This suggestion is put forward along with the use of realistic assumptions that err on the safe side.

In an environment where investment returns are consistently greater than the discount rate (e.g. the 1980s and 1990s), the practical effect of banning contribution holidays will be to build up surpluses that will significantly exceed what is required to protect against downside risks that plans may face. Rather than mandate the banning of contribution holidays, an approach that would create downside protection without building up excess surplus would be to mandate the adoption of funding policies that prohibit the use of surplus to reduce contributions or increase benefits until threshold levels of surplus have been achieved. The threshold levels should take account of the riskiness of the pension fund’s investments and the maturity of the plan. Funding policies of this general sort have begun to emerge in large Canadian plans and should be made to be common practice.

Unlike Bernard Dussault and public sector unions, however, I don't think DB plans can be bolstered just by prohibiting contribution holidays (something I agree with). I believe that some form of risk-sharing is essential if we are to safeguard DB plans and make sure they are sustainable over the long run. Target benefit plans are not the solution but neither is maintaining the farce that DB plans can exist with no shared-risk model.

[Note: To be fair, after reading my comment, Bernard sent me his proposed DB pension plan financing policy which "promotes true risk sharing at any level (ideally 50%/50%) between the plan sponsor and the plans members, in such a way that not only would both parties share the cost but also the 15-year amortization of surpluses and deficit."]

I take Denmark's dire pension warning very seriously and so should many policymakers and unions who think we can just continue with the status quo. We can't, we need to adapt and be realistic about what defined-benefit pensions can and cannot offer in a world of low or negative rates.

On that note, let me once more end by sharing this nice clip from Ontario Teachers' Pension Plan on how even minor adjustments to inflation protection can have a big impact on plan sustainability.

The future of pensions will require bolstering defined-benefit plans, better governance and a shared-risk model, which is why pensions like OTPP, HOOPP, OMERS, OPTrust, CAAT and other pensions will be able to deliver on their promise while others will struggle and will face hard choices.

I sense that the description of my proposed financing policy for DB pension plans deserves to be further clarified as follows:

My proposed improved DB plan is essentially the same as Bill C-27's TB plan except that under my promoted improved DB:

1. Deficits affect only active members' contributions (via 15-year amortization, i.e. through a generally small increase in the contribution rate), and not necessarily the sponsor's contributions, as opposed to both contributions and benefits of both active and retired members under Bill C-27.
2. Not only are contribution holidays prohibited, but any surplus is amortized over 15 years through a generally small decrease in the members' and not necessarily sponsor's contribution rate.

Therefore, my view is that if my proposed financing policy were to apply to DB plans, TB plans would no longer be useful. They would just stand as a useless and overly complex pension mechanism.

Rather than mandate the banning of contribution holidays, an approach that would create downside protection without building up excess surplus would be to mandate the adoption of funding policies that prohibit the use of surplus to reduce contributions or increase benefits until threshold levels of surplus have been achieved. The threshold levels should take account of the riskiness of the pension fund’s investments and the maturity of the plan. Funding policies of this general sort have begun to emerge in large Canadian plans and should be made to be common practice.

It’s not just pension funds that have to worry about liability risks.

Hedge funds with high exposures to funding level risks “severely underperform” less exposed funds, according to research from the Copenhagen Business School.

“A good hedge fund follows alpha-generating strategies and simultaneously manages the funding risk that arises from the liability side of its balance sheet, that is, the risk of investor withdrawals and unexpected margin calls or increasing haircuts,” wrote PhD candidate Sven Klinger.

“If not managed properly,” he continued, “these funding risks can transform into severe losses because they can force a manager to unwind otherwise profitable positions at an unfavorable early point in time.”

At a time when many institutional investors are pulling out of hedge funds, proper management of liability risk is particularly essential—and failure to manage those risks can lead to a slippery slope, Klinger argued.

“If a fund generates higher losses than expected, investors get concerned about the possibility of unexpected future losses,” he wrote. “These concerns lead a fraction of the investors to withdraw their money from the fund, which, in turn, causes further losses for the bad fund.”

For the study, Klinger analyzed hedge fund returns between January 1994 and May 2015 using data from the TASS hedge fund database. He found that funds with low exposures to common funding shocks earned a monthly risk-adjusted return of 0.5%—while hedge funds taking higher liability risks earned zero risk-adjusted returns.

“Hedge funds that are exposed to more funding risk generate lower returns,” he wrote. “More precisely, hedge funds that generate lower returns when funding conditions deteriorate generate subsequent lower returns.”

These hedge funds also face larger withdrawals than hedge funds with lower exposure to liability risks, Klinger added—though they can temper risks by imposing strict redemption terms on investors.

“Higher risk should correspond to higher (expected) returns,” Klinger concluded. “Although this rule may hold for traded assets, it can be violated for hedge funds… a situation in which more risk-taking indicates less managerial skill.”

Read the full paper, “High Funding Risk, Low Return.”

William A. Ackman is a big-moneyed, swaggering hedge fund manager with a long list of accomplishments.

He played tennis against Andre Agassi and John McEnroe. He bought one of the most expensive apartments in Manhattan because he thought it would “be fun.” And three years ago, his hedge fund beat the competition to the pulp.

Now the silver-haired billionaire is on the verge of notching another accomplishment, but it is a dubious one. He is on pace to record a hefty double-digit loss for investors in his firm, Pershing Square Capital Management, for the second year in a row.

It is a rare accomplishment in hedge funds, as investors like public pension funds have grown impatient with disappointing returns and more than a handful of well-known firms have been forced to shut down as a result.

Yet Mr. Ackman is not like most of his peers. He has brushed off questions about whether his investors were worried and frustrated with his steep losses, countering that over time his firm had “a good batting average.” Together with his analysts, he told clients last week that the companies in which he has made big bold bets remain “unique,” “successful,” “fantastic” and “terrific.”

“We all know someone like him,” said Doug Kass of Seabreeze Partners Management, a small hedge fund firm. “Ackman is the smartest guy in the room who tells you he is the smartest guy in the room.”

It has helped that Mr. Ackman has structured Pershing Square so that investors have to wait as long as two years to take their money out. While some big investors have withdrawn their money recently, others believe that his firm will turn the corner.

The question is how much latitude investors will give to a man who fancies himself the next Warren E. Buffett. Over the last two years, investors have either withdrawn or announced plans to redeem more than $1 billion from his hedge fund, including New Jersey’s state pension fund, the Public Employees Retirement Association of New Mexico and the Fire and Police Pension Association of Colorado.

There is one mistake Mr. Ackman has admitted to making: Valeant Pharmaceuticals International. The drug company has come under political attack for its pricing policy and has faced regulatory scrutiny over its accounting practices. In April, Mr. Ackman was called to Washington to testify at a Senate hearing, where he was questioned over his aggressive support of the company. A flustered Mr. Ackman was forced to concede, “I regret that we didn’t do more due diligence on pricing.”

His investors have regretted it, too. Shares of the troubled pharmaceutical company have plunged to about $18 a share from the average $190 a share he said his firm paid in 2015 to acquire a big stake. As shareholders began to question the company and the stock plummeted, he bought a bigger stake in a show of confidence. Mr. Ackman has secured two board seats to try to position a turnaround.

“I have an enormous stomach for volatility,” he told an audience last week at the DealBook conference sponsored by The New York Times.

Privately, Mr. Ackman has told some investors that in six months or so, Valeant’s situation should start to look better as it sells off divisions to pay down debt obligations.

But now Pershing Square Holdings, a publicly traded version of his private hedge fund, is on course for a second year of double-digit annual loss and is currently down 20.7 percent, after dropping 20.5 percent last year. The losses are somewhat smaller at the private portfolios in his hedge fund in part because differences in leverage can magnify losses.

“He’s 50 years old. He has no boundaries to his ambitions,” said Ruud Smets of Theta Capital Management, an investment firm in the Netherlands. “So he is someone who will make his way back and is realistic about the mistakes he’s made and what they should do better,” he said, referring to Pershing.

Making its way back to positive territory will be challenging for Pershing, however. Its position in Valeant has helped wipe out a nearly 40 percent gain that the firm had in 2014.

Pershing started 2015 with more money than it had ever managed — $18.5 billion — including money raised from the public listing in Amsterdam of Pershing Square Holdings. Today the firm’s assets are down to $11.6 billion, and two years of losing performances threatens to chip away at Mr. Ackman’s reputation as one of the more successful investors in the $3 trillion hedge fund industry.

But Mr. Ackman has a knack for turning things around. He had to wind down his first hedge fund firm, Gotham Partners, after an investment in a golf course went sour. With Pershing, a remarkable run of lucrative payoffs from investments in General Growth Properties, the Howard Hughes Corporation and Canadian Pacific made him a celebrity and helped him raise huge sums of money from big state pension plans and other institutional investors.

And he can change. While he has long been known for favoring liberal causes and contributing mainly to Democrats, Mr. Ackman spoke glowingly of Donald J. Trump last week at the DealBook conference after his election.

“I woke up bullish on Trump,” Mr. Ackman said, surprising some in the audience. He clarified later in an interview that he was referring to Mr. Trump’s approach to the economy, adding, “I don’t agree with his views on immigration, on deportation and certain other social issues.”

His flexibility when it comes to national politics is at odds with the reputation he has earned at times of being a stubborn investor and a firm believer in his own views — qualities his Wall Street critics contend have informed his firm’s money-losing investment in Valeant.

Some on Wall Street have quietly compared him to another hedge fund hotshot, John Paulson, who made nearly $15 billion for his investors by betting on the collapse of the housing market during the financial crisis, but has struggled at times since then. Mr. Paulson’s firm now manages about $12 billion in assets, down from $36 billion five years ago.

Mr. Paulson, who is also bullish on Mr. Trump and was an economic adviser to him during the campaign, is the second-biggest shareholder in Valeant after Mr. Ackman.

But while predicting Mr. Ackman’s downfall has become something of a sport for some of his enemies on Wall Street, the prediction has yet to come true.

Over all, Mr. Ackman’s hedge fund firm has had more success than failure. Since 2004, the firm has registered nine winning years and four losing years, including the partial results for 2016. In four of those years, one of the firm’s main funds showed an annual gain more than 30 percent.

He also scored a moral victory this year with his bet against shares of the food supplement company Herbalife. The Federal Trade Commission took the company to task over its marketing and sale practices. The agency’s order endorsed many of Mr. Ackman’s claims that Herbalife had taken advantage of consumers, but regulators stopped short of declaring the company an illegal pyramid scheme, as Mr. Ackman had hoped.

Four years ago, Mr. Ackman announced at a conference that he had wagered $1 billion that Herbalife would either collapse on its own or be forced to close by regulators. But so far neither has happened, and Herbalife shares trade above the price they were at when he first disclosed his bearish trade.

“You can either view it as he has the courage of his convictions or he is being foolish,” said Damien Park, managing partner at Hedge Fund Solutions, who specializes in analyzing activist investors.

Still, some investors have put new money into Pershing Square recently. In August, Privium Fund Management, in a note to clients, said it had reinvested in Mr. Ackman’s publicly traded fund.

“He didn’t become stupid overnight,” said Mark Baak, a director at Privium, an Amsterdam-based investment firm that manages about $1.4 billion. “His prevailing track record wasn’t luck. Even if he was overrated prior to Valeant, he is still a very good investor.”

Maybe next year will be different for Mr. Ackman, who recently took a large stake in the burrito chain Chipotle Mexican Grill.

If nothing else, he will be on the move. His firm plans to relocate from its perch in Midtown Manhattan overlooking Central Park to a new office on the Far West Side near the Hudson River. Mr. Ackman’s new hedge fund home will be in Manhattan’s so-called auto dealership row.

One of the selling points of the new office is a rooftop tennis court that Mr. Ackman asked for.

In their Bloomberg article, Hedge-Fund Love Affair Is Ending for U.S. Pensions, Endowments, John Gittelsohn and Janet Lorin note the following:

While the redemptions represent only about 1 percent of hedge funds’ total assets, the threat of withdrawals has given investors leverage on fees.

Firms from Brevan Howard to Caxton Associates and Tudor Investment Corp. have trimmed fees amid lackluster performance.

William Ackman’s Pershing Square Capital Management last month offered a new fee option that includes a performance hurdle: It keeps 30 percent of returns but only if it gains at least 5 percent, according to a person familiar with the matter.

The offer came after Pershing Square’s worst annual performance, a net loss of 20.5 percent in 2015. Pershing Square spokesman Fran McGill declined to comment.

“They had a terrible year and they have to be extremely worried about a loss of assets under management,” said Tom Byrne, chairman of the New Jersey State Investment Council, which had about $200 million with Pershing Square as of July 31. “You’re losing clients because your prices are too high? Lower your price. That’s capitalism.”

Let me put it bluntly, Bill Ackman's fortunes are riding on Valeant, it's that simple. Luckily for him, he's not the only one betting big on this company. Legendary investor Bill Miller appeared on CNBC three days ago to say battered Valeant stock worth double the current price.

Britain's mammoth funding gap for gold-plated company pensions stands at nearly a third of the country's economic output despite a £50 billion boost in November.

A report by PricewaterhouseCoopers shows the deficit for so-called defined benefit pensions - such as final salary schemes, which guarantee an income in retirement - narrowed by £50 billion to £580 billion last month.

This marks the third month in a row that the funding gap has improved after hitting a record high of £710 billion in August.

But the pensions black hole is still £110 billion higher than it was at the start of the year and is equivalent to almost a third of the UK's entire gross domestic product (GDP).

PwC's Skyval Index gives a snapshot of the health of the UK's 6,000 defined benefit pension funds.

It reveals the battering that pension schemes have taken since the Brexit vote, with rock-bottom interest rates taking their toll after the Bank of England halved its base rate to 0.25% in August.

BT recently revealed its pension deficit surged to £9.5 billion at the end of September from £6.2 billion three months earlier.

Barclays has also seen its pension fund slip into the red by £1.1 billion from a surplus of £800 million last December, while Debenhams likewise suffered a reversal to a £4.1 million deficit in September against a surplus of £26.2 million in August last year.

Firms have blamed a sharp reduction in bond yields, which increases the pension liabilities, as a result of the Bank's economy-boosting action after the EU referendum vote.

This peaked in August, when the pension deficit shot up by £100 billion, with bond yields since having recovered a little.

Businesses are now under pressure to pump cash into their company schemes to address the shortfalls, especially after BHS's £571 million pension deficit contributed to its high profile collapse in April.

But Raj Mody, partner at PwC and global head of pensions, said companies should have realistic funding plans in place over longer timescales - up to 20 years rather than the nine or 10 year average.

He said: "Pension funding deficits are nearly a third of UK GDP. Trying to repair that in, say, 10 years could cause undue strain, akin to about 3% per year of potential GDP growth being redirected to put cash into pension funds.

"This would be like the UK economy running to stand still to remedy the pension deficit situation."

Younger generations are being told to prepare to wait even longer for their pensions, with former minister Steve Webb suggesting that the retirement age for a state pension will rise to 70.

I can understand why some policymakers seeking to cut the costs of state support for pensioners are attracted to the idea of continually raising pension ages, but I believe this is potentially damaging to certain social groups.

The justification for such an increase is based on forecasts of rising average life expectancy. But just using average life expectancy as a yardstick ignores significant differences in longevity across British society. For example, people living in less affluent areas, or who had lower paid or more physically demanding careers, or started work straight from school, have a higher probability of dying younger. Continually increasing state pension ages, and making such workers wait longer for pension payments to start, prolongs significant social disadvantage.

The state pension qualification criteria depend on national insurance contributions. Normally, workers and their employers make contributions that can amount to around 25% of their earnings. Even now, a significant minority of the population does not live to state pension age, or dies very soon thereafter, despite having paid significant sums into the system. By raising the state pension age, based on rising average life expectancy, this social inequality is compounded.

Increasing the state pension age is a blunt instrument. A stark cutoff fails to recognise the needs of millions of people who will be physically unable to keep working to the age of 70, because of particular circumstances in their working life, their current health, or environmental and social factors that negatively impact on specific regions of the country.

State pension unfairness is even greater, because those who are healthy and wealthy enough can already get much larger state pensions than others who cannot afford to wait. If you can delay starting your state pension until 70 – assuming you either have a good private income or are able to keep working – the new state pension will pay over £200 a week. But if you are very ill, caring for relatives, or for whatever reason cannot keep working up to state pension age (now 65 for men and between 63 and 64 for women) you get nothing at all.

In fact, just reforming state pensions is not the best way to cope with an ageing population. It is important to rethink retirement too. Those who can and want to work longer could boost their own lifetime incomes and future pensions, and also the spending power of the economy and national output, if more were done to facilitate and encourage later life working. Having more older workers in the economy, especially given the demographics of the western world, is a win-win for all of us. Even a few years of part-time work, before full-time retirement, can benefit individuals and the economy. But this should not be achieved by forcing everyone to wait longer for a state pension and ignoring the needs of those groups who cannot do so.

There is no provision, for example, for an ill-health early state pension, or for people to start state pensions sooner at a reduced rate. Politicians have entirely ducked this question but such a system would acknowledge the differences across society. There are, surely, more creative and equitable ways of managing state pension costs for an increasingly ageing population, using parameters other than just the starting age.

Indeed, raising state pension ages has already caused huge hardship to many women born in the 1950s. These women believed their state pension would start at 60, but many discovered only recently they will need to wait until 66. Many women have no other later life income, therefore they are totally dependent on their state pension.

Rather than just considering increasing the pension age, the government could consider having a range of ages, instead of one stark chronological cutoff. Allowing people an early-access pension, possibly reflecting a longer working life or poorer health, could alleviate some of the unfairness inherent in the current system. Increasing the number of years required to qualify for full pensions could also help.

Raising the state pension age is rather a crude measure for managing old-age support in the 21st century.

Pension funds are too focused on holding liquid assets to the detriment of the long-term health of their investment portfolio, according to research by Cambridge Associates, the global provider of investment services. If they considered switching from liquid public equities to illiquid private investments, they could improve their chances of closing the funding gap and reduce the likelihood to requiring additional capital injections to honour their commitments to pension fund members.

The average UK pension fund can have a staggering 90-95 per cent of their assets in liquid assets -- those easily convertible into cash. This amount is far more than they need in order to be able to pay pension fund members. "Many schemes do not need to set aside more than 5-10 per cent of assets for benefit payments in any given year for the next 20 years," according to Alex Koriath, head of Cambridge Associates' European pensions practice. "By having such liquid portfolios, they are giving up return opportunities and face having to deal with the risk of a widening funding gap."

Already, as of October 2016, the average UK pension scheme holds assets that cover just 77.5 per cent of their liabilities, according to data from the UK's Pension Protection Fund. Even though the value of "growth" assets -- such as equities -- has soared over the past 5 years, this funding gap has continued to widen because the dramatic fall in interest rates has increased the value of liabilities at an even faster rate.

For a typical scheme, some 40 per cent of the liquid assets is invested in "liability-matching" assets such as gilts, while around 60 per cent is held in growth assets such as equities, credit and other such asset classes. Of the 60 per cent, some 5-10 per cent is invested in illiquid assets such as real estate, private equity, private credit, venture capital and other less liquid investments.

But this allocation may need to change because many pension funds are facing difficult choices. As their member population ages, trustees understandably want to "de-risk" by buying more liability-matching assets and selling more volatile assets such as equities. However, de-risking also means that fewer assets can earn the higher return that is needed to plug the large funding gap. Even a pension scheme that hedges just 40 per cent of its liabilities faces a more than one third chance of seeing its funding level fall by 10 per cent at least once during the next 20 years. "In other words," said Mr Koriath, "the scheme could very well find itself needing a capital injection."

A New Solution: The "Barbell Approach"

To close the funding gap, Cambridge Associates proposes considering a "barbell approach". Here, trustees target substantially higher returns in a small part of the portfolio -- say, 20 per cent -- by focusing this portion on private investments. The rest of the portfolio -- as much as 80 per cent -- can then be focused on gilts and other liability-matching assets in order to reduce liability risk. Himanshu Chaturvedi, senior investment director at Cambridge Associates in London, said: "This approach to pension investing can deliver a hat-trick of benefits: plenty of liquidity, reduced volatility and appropriate rates of return to close the current funding gap."

The 80 per cent allocation to liability-matching assets should address the volatility and liquidity issues facing pension funds. The increased hedging reduces the risk of a slump in funding levels, while the large allocation to liquid assets should provide ample liquidity to pay benefits without needing any liquidity from the growth assets. According to Cambridge Associates, a representative scheme that is mature and closed to future accrual (say 70 per cent funded on a buyout basis with liabilities split 75 per cent/25 per cent between deferred members and pensioners) only has to make annual benefit payments of between 3 per cent to 7 per cent of assets in any given year for the next 10 years. Meanwhile, the 20 percent allocation to private investments should help address the return requirements of pension funds, allowing them to target higher return opportunities in return for accepting illiquidity in this small part of the overall portfolio.

Mr Chaturvedi said: "In our view, even a growth portfolio purely focused on public equities, typically the highest expected return option available in public markets, will not close the funding gap fast enough for most schemes." In the 10 years to September 2015, the MSCI World Index saw returns of 6.4 per cent. By contrast, the Cambridge Associates Private Equity and Venture Capital Index saw annualised returns of 13.4 per cent.

The Challenges of the Barbell Approach

In its analysis, Cambridge Associates found that there were two important requirements for successful implementation of the barbell approach. One is governance. As Mr Chaturvedi said: "A program of private investments takes years to put into place -- perhaps two cycles of trustees. So it can't be the passion of one group of trustees."

The other requirement is astute manager selection. "Finding high quality managers is not easy," said Mr Koriath. "At Cambridge Associates, we track more than 20,000 funds across all private investments and in any given year we only see about 200 that merit our clients' capital." But the benefits of getting it right in private investments are substantial. Over a 10-year time frame, the annual difference between the top and bottom quartile managers of public equities is about 2 per cent. By contrast, for private equity and venture capital managers, the annual difference is as large as 12-18 per cent.

Eighty-seven percent of UK pension funds say executives at UK listed companies are paid too much, a survey by the Pensions and Lifetime Savings Association said on Thursday, as Britain proposes changes to the way companies are run.

Britain began consultations on encouraging better corporate behaviour and curbing executive pay this week, part of Prime Minister Theresa May's campaign to help those who voted for Brexit in protest at "out of touch" elites.

"It's time companies got the message and started to reduce the size of the pay packages awarded to their top executives," said Luke Hildyard, policy lead for stewardship and corporate governance at the PLSA.

The number of shareholder revolts, defined as cases where more than 40 percent of shareholders voted against pay awards at FTSE 100 company annual meetings, rose to seven this year from two in 2015, the PLSA's analysis found.

The PLSA said it will publish guidelines encouraging pension funds to take a tougher line on the re-election of company directors responsible for setting company pay.

The average pay of bosses in Britain's FTSE 100 index rose more than 10 percent in 2015 to an average of 5.5 million pounds ($6.9 million), meaning CEOs now earn 140 times more than their employees on average, according to a survey by the High Pay Centre released in August.

The PLSA's members include more than 1,300 UK pensions schemes with 1 trillion pounds in assets.

Institutional investors worldwide are expecting to make more asset allocation changes in the next one to two years than in 2012 and 2014, according to the new Fidelity Global Institutional Investor Survey. Now in its 14th year, the Fidelity Global Institutional Investor Survey is the world’s largest study of its kind examining the top-of-mind themes of institutional investors. Survey respondents included 933 institutions in 25 countries with $21 trillion in investable assets.

The anticipated shifts are most remarkable with alternative investments, domestic fixed income, and cash. Globally, 72 percent of institutional investors say they will increase their allocation of illiquid alternatives in 2017 and 2018, with significant numbers as well for domestic fixed income (64 percent), cash (55 percent), and liquid alternatives (42 percent).

However, institutional investors in some regions are bucking the trend seen in other parts of the world. Many institutional investors in the U.S. are, on a relative basis, adopting a wait-and-see approach. For example, compared to 2012, the percentage of U.S. institutional investors expecting to move away from domestic equity has fallen significantly from 51 to 28 percent, while the number of respondents who expect to increase their allocation to the same asset class has only risen from 8 to 11 percent.

“With 2017 just around the corner, the asset allocation outlook for global institutional investors appears to be driven largely by the local economic realities and political uncertainties in which they’re operating,” said Scott E. Couto, president, Fidelity Institutional Asset Management. “The U.S. is likely to see its first rate hike in 12 months, which helps to explain why many in the country are hitting the pause button when it comes to changing their asset allocation.

“Institutions are increasingly managing their portfolios in a more dynamic manner, which means they are making more investment decisions today than they have in the past. In addition, the expectations of lower return and higher market volatility are driving more institutions into less commonly used assets, such as illiquid investments,” continued Couto. “For these reasons, organizations may find value in reexamining their investment decision-making process as there may be opportunities to bring more structure and accommodate the increased number of decisions, freeing up time for other areas of portfolio management and governance.”

Primary concerns for institutional investors

Overall, the top concerns for institutional investors are a low-return environment (28 percent) and market volatility (27 percent), with the survey showing that institutions are expressing more worry about capital markets than in previous years. In 2010, 25 percent of survey respondents cited a low-return environment as a concern and 22 percent cited market volatility.

“As the geopolitical and market environments evolve, institutional investors are increasingly expressing concern about how market returns and volatility will impact their portfolios,” said Derek Young, vice chairman of Fidelity Institutional Asset Management and president of Fidelity Global Asset Allocation. “Expectations that strengthening economies would build enough momentum to support higher interest rates and diminished volatility have not borne out, particularly in emerging Asia and Europe.”

Investment concerns also vary according to the institution type. Globally, sovereign wealth funds (46 percent), public sector pensions (31 percent), insurance companies (25 percent), and endowments and foundations (22 percent) are most worried about market volatility. However, a low-return environment is the top concern for private sector pensions (38 percent). (click on image)

Continued confidence among institutional investors

Despite their concerns, nearly all institutional investors surveyed (96 percent) believe that they can still generate alpha over their benchmarks to meet their growth objectives. The majority (56 percent) of survey respondents say growth, including capital and funded status growth, remain their primary investment objective, similar to 52 percent in 2014.

On average, institutional investors are targeting to achieve approximately a 6 percent required return. On top of that, they are confident of generating 2 percent alpha every year, with roughly half of their excess return over the next three years coming from shorter-term decisions such as individual manager outperformance and tactical asset allocation.

“Despite uncertainty in a number of markets around the world, institutional investors remain confident in their ability to generate investment returns, with a majority believing they enjoy a competitive advantage because of confidence in their staff or access to better managers,” added Young. “More importantly, these institutional investors understand that taking on more risk, including moving away from public markets, is just one of many ways that can help them achieve their return objectives. In taking this approach, we expect many institutions will benefit in evaluating not only what investments are made, but also how the investment decisions are implemented.”

Improving the Investment Decision-Making Process

There are a number of similarities in institutional investors’ decision-making process:

• Nearly half (46 percent) of institutional investors in Europe and Asia have changed their investment approach in the last three years, although that number is smaller in the Americas (11 percent). Across the global institutional investors surveyed, the most common change was to add more inputs – both quantitative and qualitative – to the decision-making process.
• A large number of institutional investors have to grapple with behavioral biases when helping their institutions make investment decisions. Around the world, institutional investors report that they consider a number of qualitative factors when they make investment recommendations. At least 85 percent of survey respondents say board member emotions (90 percent), board dynamics (94 percent), and press coverage (86 percent) have at least some impact on asset allocation decisions, with around one-third reporting that these factors have a significant impact.

“Institutional investors often assess quantitative factors such as performance when making investment recommendations, while also managing external dynamics such as the board, peers and industry news as their institutions move toward their decisions. Whether it’s qualitative or quantitative factors, institutional investors today face an information overload,” said Couto. “To keep up with the overwhelming amount of data, institutional investors should consider revisiting and evolving their investment process.

“A more disciplined investment process may help them achieve more efficient, effective and repeatable portfolio outcomes, particularly in a low-return environment characterized by more expected asset allocation changes and a greater global interest in alternative asset classes,” added Couto.

The complete report with a wealth of charts is available on request.
For additional materials on the survey, go to institutional.fidelity.com/globalsurvey.

About the Survey

Fidelity Institutional Asset ManagementSM conducted the Fidelity Global Institutional Investor Survey of institutional investors in the summer of 2016, including 933 investors in 25 countries (174 U.S. corporate pension plans, 77 U.S. government pension plans, 51 non-profits and other U.S. institutions, 101 Canadian, 20 other North American, 350 European, 150 Asian, and 10 African institutions including pensions, insurance companies and financial institutions). Assets under management represented by respondents totaled more than USD $21 trillion. The surveys were executed in association with Strategic Insight, Inc. in North America and the Financial Times in all other regions. CEOs, COOs, CFOs, and CIOs responded to an online questionnaire or telephone inquiry.

About Fidelity Institutional Asset Management℠

Fidelity Institutional Asset Management℠ (FIAM) is one of the largest organizations serving the U.S. institutional marketplace. It works with financial advisors and advisory firms, offering them resources to help investors plan and achieve their goals; it also works with institutions and consultants to meet their varying and custom investment needs. Fidelity Institutional Asset Management℠ provides actionable strategies, enabling its clients to stand out in the marketplace, and is a gateway to Fidelity’s original insight and diverse investment capabilities across equity, fixed income, high‐income and global asset allocation. Fidelity Institutional Asset Management is a division of Fidelity Investments.

About Fidelity Investments

Fidelity’s mission is to inspire better futures and deliver better outcomes for the customers and businesses we serve. With assets under administration of $5.5 trillion, including managed assets of $2.1 trillion as of October 31, 2016, we focus on meeting the unique needs of a diverse set of customers: helping more than 25 million people invest their own life savings, nearly 20,000 businesses manage employee benefit programs, as well as providing nearly 10,000 advisory firms with investment and technology solutions to invest their own clients’ money. Privately held for 70 years, Fidelity employs 45,000 associates who are focused on the long-term success of our customers. For more information about Fidelity Investments, visit https://www.fidelity.com/about.

The majority of institutional investors worldwide are seeking to increase their investments in riskier alternatives that are not publicly traded such as hedge funds, real estate and private equity over the next one to two years to combat potential low returns and choppiness in public markets, a Fidelity survey showed on Thursday.

The Fidelity Global Institutional Investor Survey showed that 72 percent of institutional investors worldwide, from public pension funds to insurance companies and endowments, said they would increase their exposure to these so-called illiquid alternatives in 2017 and 2018.

The survey, which included 933 institutions in 25 countries overseeing a total of $21 trillion in assets, found that the institutions were most concerned with a low-return investing environment over the next one to two years, with 28 percent of respondents citing it as such. Market volatility was the second-biggest worry, with 27 percent of respondents citing it as their top concern.

Private sector pensions were most concerned about a low-return environment, with 38 percent of them identifying it as their top worry, while sovereign wealth funds were most nervous about volatility, with 46 percent identifying it as their top concern.

"With the concern about the low-return environment as well as market volatility, as a result we’re seeing more of an interest in alternatives, where there’s a perception of higher return opportunities," said Derek Young, vice chairman of Fidelity Institutional Asset Management and president of Fidelity Global Asset Allocation.

Investors seek alternatives, which may invest in assets such as timber or real estate or use tactics such as betting against securities, for "uncorrelated" returns that do not move in tandem with traditional stock and bond markets.

Young noted, however, that illiquid alternatives can also be volatile without it being obvious, since they lack daily pricing and as a result may give the perception of being less volatile.

"We would hope and would expect that institutional investors would appreciate the volatility that still exists within the underlying investments," he said in reference to illiquid alternatives.

The survey, which was conducted over the summer, found that despite their concerns, 96 percent of the institutions believed they could achieve an 8 percent investment return on average in coming years.

U.S. public pension plans, on average, had about 12.1 percent of their assets in real estate, private equity and hedge funds combined as of Sept. 30, according to Wilshire Trust Universe Comparison Service data.

Low returns and market volatility topped the list of concerns in Fidelity Investments’ annual survey of more than 900 institutional investors with US$21 trillion of investable assets.

Thirty per cent of respondents cited the low-return environment as their primary worry, followed by volatility at 27 per cent.

“Expectations that strengthening economies would build enough momentum to support higher interest rates and diminished volatility have not borne out, particularly in emerging Asia and Europe,” said Derek Young, vice chairman of Fidelity Institutional Asset Management and president of Fidelity Global Asset Allocation.

The Fidelity Global Institutional Survey, which is now in its 14th year and includes investors in 25 countries, also showed that institutions are growing more concerned about capital markets.

Despite these issues, 96 per cent of institutional investors surveyed believe they can beat their benchmarks.

The group is targeting an average return of approximately six per cent per year, in addition to two per cent alpha, and short-term decisions are being credited for those excess returns.

Institutional investors remain confident in their return prospects due to their access to superior money managers. They also have demonstrated a willingness to move away from public markets.

On a global basis, 72 per cent of institutional investors said they plan to increase their exposure to illiquid alternatives in 2017 and 2018.

Domestic fixed income (64 per cent), cash (55 per cent) and liquid alternatives (42 per cent) were the other areas where increased allocation is expected to occur.

However, institutional investors in the U.S. are bucking this trend, and seem to have adopted a “wait-and-see” approach.

The percentage of this group expecting to move away from domestic equity has fallen from 51 per cent in 2012, to 28 per cent this year. Meanwhile, the number of respondents who plan to increase their allocation to U.S. equities has risen to just 11 per cent from eight per cent in 2012.

“With 2017 just around the corner, the asset allocation outlook for global institutional investors appears to be driven largely by the local economic realities and political uncertainties in which they’re operating,” said Scott Couto, president of Fidelity Institutional Asset Management.

He noted that with the Federal Reserve expected to produce its first rate hike in 12 months, it’s understandable why many U.S. investors are hitting the pause button when it comes to asset allocation changes.

1. They have a very long investment horizon and can afford to take on illiquidity risk.
2. They believe there are inefficiencies in private markets and that is where the bulk of alpha lies.
3. They can scale into big real estate and infrastructure investments a lot easier than scaling into many hedge funds or even private equity funds.
4. Stale pricing means that private markets do  not move in unison with public markets, so it helps boost their compensation which is based on four-year rolling returns (privates dampen volatility of overall returns during bear markets).

The stakes are high as the CalPERS board debates whether to significantly decrease the nation's largest public pension fund's assumed rate of return, a move that could hamstring the budgets of contributing municipalities as well as prompt other public funds across the country to follow suit.

But if the retirement system doesn't act, pushing to achieve an unrealistically high return could threaten the viability of the $299.5 billion fund itself, its top investment officer and consultants say.

“Being aggressive, having a reasonable amount of volatility and (being) wrong could lead to an unrecoverable loss,” Andrew Junkin, president of Wilshire Consulting, the system's general investment consultant, told the board at a November meeting. CalPERS' current portfolio is pegged to a 7.5% return and a 13% volatility rate.

The chief investment officer of the California Public Employees' Retirement System and its investment consultants now say that assumed annualized rate of return is unlikely to be achieved over the next decade, given updated capital market assumptions that show a slow-growing economy and continued low interest rates.

Still, cities, towns and school districts that are part of the Sacramento-based system say they can't afford increased contributions they would be forced to pay to provide pension benefits if the return rate is lowered.

A decision could come in February.

Unlike other public plans that have leaned toward modest rate of return reductions, a key CalPERS committee is expected to be presented with a plan in December that's considerably more aggressive.

That was set in motion Nov. 15 at a committee meeting when Mr. Junkin and CalPERS CIO Theodore Eliopoulos said 6% is a more realistic return over the next decade.

At that meeting, it also was disclosed that CalPERS investment staff was reducing the fund's allocation to equities in an effort to reduce risk.

Only a year earlier, CalPERS investment staff and consultants had agreed that CalPERS was on the right track with its 7.5% figure. So confident were they that they urged the board to approve a risk mitigation plan that did lower the rate of return, but over a 20-year period, and only when returns were in excess of the 7.5% assumption.

Two years of subpar results — a 0.6% return for the fiscal year ended June 30 and a 2.4% return in fiscal 2015 — reduced views of what CalPERS can earn over the next decade. Mr. Junkin said at the November meeting that Wilshire was predicting an annual return of 6.21% for the next decade, down from its estimates of 7.1% a year earlier.

Indeed, Mr. Junkin and Mr. Eliopoulos said the system's very survival could be at stake if board members don't lower the rate of return. “Being conservative leads to higher contributions, but you still have a sustainable benefit to CalPERS members,” Mr. Junkin said.

The opinions were seconded by the system's other major consultant, Pension Consulting Alliance, which also lowered its return forecast.

Shifting the burden

But a CalPERS return reduction would just move the burden to other government units. Groups representing municipal governments in California warn that some cities could be forced to make layoffs and major cuts in city services as well as face the risk of bankruptcy if they have to absorb the decline through higher contributions to CalPERS.

“This is big for us,” Dane Hutchings, a lobbyist with the League of California Cities, said in an interview. “We've got cities out there with half their general fund obligated to pension liabilities. How do you run a city with half a budget?”

CalPERS documents show that some governmental units could see their contributions more than double if the rate of return was lowered to 6%. Mr. Hutchings said bankruptcies might occur if cities had a major hike without it being phased in over a period of years. CalPERS' annual report in September on funding levels and risks also warned of potential bankruptcies by governmental units if the rate of return was decreased.

If the CalPERS board approves a rate of return decrease in February, school districts and the state would see rate increases for their employees in July 2017. Cities and other governmental units would see rate increases beginning in July 2018.

Any significant return reduction by CalPERS, which covers more than 1.5 million workers and retirees in 2,000 governmental units, would cause ripples both in and outside the state. That's because making such a major rate cut in the assumed rate of return is rare.

Mr. Eliopoulos and the consultants are scheduled to make a specific recommendation on the return rate at a Dec. 20 meeting. But they were clear earlier this month that they feel the system won't be able to earn much more than an annualized 6% over the next decade.

Gradual reductions

Thomas Aaron, a Chicago-based vice president and senior analyst at Moody's Investors Services, said in an interview that many public plans have lowered their return assumption because of lower capital market assumptions and efforts to reduce risk. But Mr. Aaron said the reductions have happened “very gradually, it tends to be in increments of 25 or 50 basis points.”

Statistics from the National Association of State Retirement Administrators show that 43 of 137 public plans have lowered their return assumption since June 30, 2014. But NASRA statistics show only nine plans out of 127 are below 7% and none has gone below 6.5%.

“CalPERS is the largest pension system in the country; definitely if CalPERS were to make a significant reduction, other plans would take notice,” said Mr. Aaron.

Mr. Aaron said it would be hard to predict whether other public plans would follow. While there has been a general trend toward reduced return assumptions given capital market forecasts, some plans are sticking to higher assumptions because they believe in more optimistic longer-term investment return forecasts.

Compounding the problem is that CalPERS is 68% funded and cash-flow negative, meaning each year CalPERS is paying out more in benefits than it receives in contributions, Mr. Junkin said. CalPERS statistics show that the retirement system received $14 billion in contributions in the fiscal year ended June 30 but paid out $19 billion in benefits. To fill that $5 billion gap, the system was forced to sell investments.

CalPERS has an unfunded liability of $111 billion and critics have said unrealistic investment assumptions and inadequate contributions from employers and employees have led to the large gap.

Previously, CalPERS officials had said that any return assumption change would not occur until an asset allocation review was complete in February 2018. But Mr. Eliopoulos on Nov. 15 urged the board to act sooner, saying the U.S. could be in a recession by that date.

Richard Costigan, chairman of CalPERS finance and administration committee, said in an interview that he expects a recommendation and vote by the full board meeting in February, adding there is no requirement to wait until 2018 to consider the matter.

Some board members at the Nov. 15 meeting said CalPERS was moving too fast to implement a new assumption. “I'm a little confused at the panic and expediency that you guys are selling us right now,” said board member Theresa Taylor. “I think that we need to step back and breathe.”

But other board members suggested CalPERS needs to take immediate action even if it is uncomfortable.

Already adjusting

In a sense the system already has. Even without a formal return reduction, members of the investment staff have embarked on their own plan to reduce overall portfolio risk by reducing equity exposure, a policy supported by the board.

Mr. Eliopoulos said Nov. 15 that a pitfall of CalPERS' current rate of return is the need to invest heavily in equities, taking more risk than might be prudent. He also said the system was reviewing its equity allocation.

The system's latest investment report, issued Aug. 31, shows equity investments made up 51.1% or $155.4 billion of the system's assets, down from 52.7% or $160 billion as of July 30 and down from 54.1% in July 2015.

CalPERS took $3.8 billion of the $4.6 billion in equity reduction and increased its cash position and other assets in its liquidity asset class. Liquidity assets grew to $9.6 billion as of Aug. 31 from $5.8 billion at the end of July.

But an even bigger cut in the equity portfolio occurred after the September investment committee meeting, when board members meeting in closed session reduced the allocation even more, sources said. It is unclear how big that cut was, but allocation guidelines allow equity to be cut to 44% of the total portfolio.

Board member J.J. Jelincic at the Nov. 15 meeting disclosed the new asset allocation was made at the September meeting closed session. But Mr. Jelincic said based on revisions the board approved in the system's asset allocation, he felt the most CalPERS could earn was 6.25% a year because it was not taking enough risk.

Mr. Jelincic did not disclose the new asset allocation but said in an interview: “We are taking too little risk and walking away from the upside by not investing more in equities.”

Hedge funds have had a rough year.

They have delivered unimpressive returns. They're battling one another for a stagnant pool of investor money. They're steadily lowering fees. The pressure is bifurcating the $3 trillion industry, helping to make big hedge-fund firms even bigger while sending many smaller ones into extinction (click on image).

Firms with more than $10 billion of assets under management can more easily afford to reduce fees and customize strategies. And that’s exactly what they’re doing, according to a recently released Ernst & Young global hedge-fund report.

Bigger firms have lowered fees more than smaller ones, which makes them more appealing to clients such as pension funds and insurers. Consider Brevan Howard, for example, which earlier this year cut some management fees to zero for certain clients. The once-average 2 percent management fee has fallen to 1.35 percent this year, Ernst & Young data show.

There have already been a slew of studies, some conflicting, about whether big or small hedge funds tend to outperform. The matter hasn't been settled.

But it certainly seems as if a higher concentration of money in a smaller group of firms will raise the financial importance of the largest ones. And this could be problematic if the risk isn't properly monitored. This is especially true among hedge funds, which tend to use leverage and derivatives.

While regulators have pushed more derivatives through clearinghouses to reduce the potential systemic risk from firm failures, the financial system is hardly immune to hiccups. For example, a Dec. 1 study from the U.S. Treasury's Office of Financial Research found that large firms that are significant net sellers of credit-default swaps could pose a significant threat to the financial system.

Meanwhile, this shift toward larger hedge-fund firms will only accelerate as fees continue to decline. Survival becomes a scale game. If a hedge-fund firm has enough assets, it can cut costs by outsourcing human resources, legal and back-office services and pay more to attract talented programmers and traders. It'll also have an easier time negotiating with its prime brokers. (click on image)

If not, the firm will likely go out of business in short order. Many have already done so this year, with the fastest pace of hedge-fund liquidations relative to new formations since 2009, according to HFR data (click on image).

Investors want to pay less for bigger returns. The result will likely be a smaller clutch of dominant, behemoth asset managers and a revolving door of smaller upstarts. While this may help cut costs, it also puts the onus on regulators and institutional investors to closely oversee any concentrated risks that may develop.

Despite the dueling claims that smaller PE fund managers lack sophistication or sufficient scale, or that larger fund managers lack the nimbleness, operational focus and expertise necessary to improve portfolio companies, returns across different fund sizes are relatively uniform in the long term. 10-year horizon IRRs for PE funds of any size bucket are all between 10% and 11%.

When comparing returns on a horizon basis, it’s important to remember that the data is indicative of market conditions over time, and not the returns of any one vintage. For example, a lower IRR across the industry between the five- and 10-year horizon is not indicative of a loss of alpha-generating capacity after the five-year mark, but rather a reflection of the stretched hold periods and asset write-offs that plagued many PE portfolios during the recession. Similarly, the three-year horizon IRR is the highest we observe, due to the fact that these investments were made before the recent run-up in valuations and have been subsequently marked as such—even though many of these returns have yet to be fully realized through an exit.

Interestingly, funds with less than $250 million in AUM have underperformed the rest of the asset class on a one- and three-year horizon. This is at least partially due to the aforementioned run-up in valuations which stemmed from cash-heavy corporate balance sheets that went looking for inorganic growth through strategic acquisitions—a strategy that often doesn’t reach the lower middle market (LMM) of PE. Only in the last few months have valuations started to rise in the LMM and below, as PE firms of all stripes increasingly look for value plays through add-ons and smaller portfolio companies.

Note: This column was previously published in The Lead Left.

For more data and analysis into PE fund performance, download our new Benchmarking Report.

Ontario’s municipal workers pension fund has sold a majority stake in marine-services company V.Group to buyout firm Advent International in the first sale by the Canadian fund’s private equity arm in Europe.

Pension funds and other institutional investors are a growing force in direct private investment as they seek to bypass investing in traditional buyout funds and boost returns against a backdrop of low global interest rates.

As part of the shift to more direct investment, the Ontario Municipal Employees Retirement System (OMERS) set up a private equity team (OPE) and now has about $10-billion invested.

It started a London operation in 2009 and two years later it bought V.Group, which manages more than 1,000 vessels and employs more than 3,000 people, from Exponent Private Equity for an enterprise value of $520-million (U.S.).

Mark Redman, global head of private equity at OMERS Private Markets, said the V.Group sale was its fourth successful exit worldwide this year and vindicated the fund’s strategy. He said no more private equity sales were in the works for now.

“I am delighted that we have demonstrated ultimate proof of concept with this exit and am confident the global team shall continue to generate the long-term, stable returns necessary to meet the OMERS pension promise,” he said.

OMERS, which has about $80-billion (Canadian) of assets under management, still allocates some $2-billion Canadian dollars through private equity funds, but OPE expects this to decline further as it focuses more on direct investments.

OPE declined to disclose how much Advent paid for 51 per cent of V.Group. OPE will remain a minority investor.

OPE targets investments in companies with enterprise values of $200-million to $1.5-billion with a geographical focus is on Canada, the United States and Europe, with a particular emphasis on Britain.

As pension funds increasingly focus on direct private investments, traditional private equity houses are in turn setting up funds which hold onto companies for longer and target potentially lower returns.

Bankers say this broad trend in the private equity industry has led to higher valuations as the fundraising pool has grown bigger than ever.

Advent has a $13-billion (U.S.) fund for equity investments outside Latin America of between $100-million and $1-billion.

The sale announced on Monday followed bolt on acquisitions of Bibby Ship Management and Selandia Ship Management Group by V.Group.

Goldman Sachs acted as financial advisers to the shipping services company; Weil acted as legal counsel and EY as financial diligence advisers.

America will need “some miracle” to survive the looming economic disaster of $1.3 trillion worth of underfunded government pensions, a former Federal Reserve adviser has warned.

“The average state pension in the last fiscal year returned something south of 1%. You cannot fill that gap with a bulldozer, impossible,” Danielle DiMartino Booth told Real Vision TV.

The median state pension had 74.5 percent of assets needed to meet promised benefits, down from 75.6 percent the prior year. The decline followed two years of gains. The shortfall for states overall was $1.1 trillion in 2015 and has continued to grow.

“Anyone who knows their compounding tables knows you don't make that up. You don't get that back unless you get some miracle,” Business Insider quoted the president of Money Strong as saying.

“The baby boomers are no longer an actuarial theory,” she said. “They're a reality. The checks are being written.”

Pressure on governments to increase pension contributions has mounted because of investment losses during the recession that ended in 2009, benefit increases, rising retirements and flat or declining public payrolls that have cut the number of workers paying in. U.S. state and local government pensions logged median increases of 3.4 percent for the 12 months ended June 30, 2015, according to data from Wilshire Associates.

State and local pensions count on annual gains of 7 percent to 8 percent to pay retirement benefits for teachers, police officers and other civil employees. The funds are being forced to re-evaluate projected investment gains that determine how much money taxpayers need to put into them, given the recent run of lackluster returns.

And while many aging Americans have accepted the “new reality” that they would be retiring at 70 instead of 65, any additional extension won’t be welcome. “They're turning 71. And the physiological decision to stay in the workforce won't work for much longer. And that means that these pensions are going to come under tremendous amounts of pressure,” she said.

“And the idea that we can escape what's to come, given demographically what we're staring at is naive at best. And it's reckless at worst,” DiMartino Booth said. “And when you throw private equity and all of the dry powder that they have -- that they're sitting on -- still waiting to deploy on pensions’ behalf, at really egregious valuations, yeah, it's hard to sleep at night,” she said.

DiMartino Booth cited Dallas as an example of the pensions crisis, where returns for the $2.27 billion Police and Fire Pension System have suffered due to risky investments in real estate.

“We're seeing this surge of people trying to retire early and take the money. Because they see it's not going to be there. And if that dynamic and that belief spreads-- forget all the other problems,” DiMartino Booth said. “The pension fund -- underfunding is Ground Zero.”

DiMartino Booth warned of public violence if her pensions predictions come to fruition. Large pension shortfalls may lead to cuts in services as governments face pressure to pump more cash into the retirement systems.

“This is where the smile comes off my face. We are an angry country. We're an angry world. The wealth effect is dead. The inequality divide is unlike anything we've seen since the years that preceded the Great Depression,” she said.

To be sure, New Jersey became the state with the worst-funded public pension system in the U.S. in 2015, followed closely by Kentucky and Illinois, Bloomberg recently reported.

The Garden State had $135.7 billion less than it needs to cover all the benefits that have been promised, a $22.6 billion increase over the prior year, according to data compiled by Bloomberg. Illinois’s unfunded pension liabilities rose to $119.1 billion from $111.5 billion.

The two were among states whose retirement systems slipped further behind as rock-bottom bond yields and lackluster stock-market gains caused investment returns to fall short of targets.

So, CalPERS is getting real on future returns? It's about time. I've long argued that US public pensions are delusional when it comes to their investment return assumptions and that if they used the discount rates most Canadian public pensions use, they'd be insolvent.

And J.J. Jelincic is right, taking too little risk in public equities is walking away from upside but he's not being completely honest because when a mature pension plan with negative cash flows the size of CalPERS is underfunded, taking more risk in public equities can also spell doom because it introduces a lot more volatility in the asset mix (ie. downside risk).

When it comes to pensions, it's not just about taking more risk, it's about taking smarter risks, it's about delivering high risk-adjusted returns over the long run to minimize the volatility in contribution risk.

Sure, CalPERS can allocate 60% of its portfolio to MSCI global stocks and hope for the best but can it then live through the volatility or worse still, a prolonged recession and bear market?

This too has huge implications because pension plans are path dependent which means the starting point matters and if the plan is underfunded or severely underfunded, taking more risk can put it in a deeper hole, one that it might never get out of.

...

The main reason why US public pensions don't like lowering their return assumptions is because it effectively means public sector workers and state and local governments will need to contribute more to shore up these pensions. And this isn't always feasible, which means property taxes might need to rise too to shore up these public pensions.

This is why I keep stating the pension crisis is deflationary. The shift from defined-benefit to defined-contribution plans shifts the retirement risk entirely on to employees which will eventually succumb to pension poverty once they outlive their meager savings (forcing higher social welfare costs for governments) and public sector pension deficits will only be met by lowering return assumptions, hiking the contributions, cutting benefits or raising property taxes, all of which take money out of the system and impact aggregate demand in a negative way.

This is why it's a huge deal if CalPERS goes ahead and lowers its investment return assumptions. The ripple effects will be felt throughout the economy especially if other US public pensions follow suit.

European shares hit their highest level for 11 months, and were set for their best week since February, following the ECB's decision to trim the size of its bond-buying program while also extending it for longer than many analysts had expected.

The ECB said it would reduce its monthly asset buys to 60 billion euros ($63.7 billion) as of April, from the current 80 billion euros, and extend purchases to December from March - three months longer than some analysts had forecast.

That dragged down two-year yields across Europe and sharply steepened the yield curve, a gift for banks that typically borrow short maturities and lend long.

European bank stocks pulled back on Friday, dropping 0.5 percent, but were still up nearly 10 percent for the week, with the sector set for its biggest weekly rise since December 2011.

One month on from November's U.S. presidential election, world stocks have gained nearly 4 percent, with Wall Street spurred to all time highs on hopes of higher growth and inflation as a result of President-elect Donald Trump's planned fiscal stimulus.

Analysts said that signs the ECB would continue to provide monetary support for as long as needed complemented the promise of fiscal stimulus, in a welcome cocktail for investors.

"Markets already excited by the prospect of a fiscal stimulus wave via a Trump election look in line to get more of both fiscal and monetary stimulus from next year," said Mike van Dulken, head of research at Accendo Markets.

"(That's) the best of both worlds for investors."

In all, Europe's STOXX 600 was up 0.6 percent.

The euro dipped for a second day, after Thursday's ECB announcement drove its biggest daily loss against the dollar since Britain's vote to leave the European Union in June.

It was trading around $1.0576, down nearly 0.4 percent against the dollar, having spiked as high as $1.0875 on Thursday in initial reaction to the ECB move.

The dovish tone of the ECB also saw a fall in euro zone borrowing costs, led by Southern Europe, though some said 2016 was the high water mark for monetary easing.

"You have to say central bank stimulus has peaked in 2016," said Charles Mackenzie, chief investment officer, fixed income, at Fidelity International. "The ECB are committed to keep quantitative easing continuing, and Bank of Japan has some way to run, so there’s still a lot of QE going into 2017, but you have to say it has peaked."

The ECB's bond purchase changes came less than a week before the Federal Reserve's policy meeting next Tuesday and Wednesday.

Interest rate futures implied traders saw a 98 percent chance the U.S. central bank would raise interest rates by a quarter point next week, and about a 50 percent chance it would raise rates by at least another quarter point by June 2017, according to CME Group's FedWatch program.

The dollar index, which tracks the greenback against a basket of six major rival currencies, was up 0.2 percent on the day at 101.32, up 0.6 percent for the week.

The dollar was up 0.6 percent at 114.72 yen, moving back toward last week's 10-month high of 114.83 yen.

Asian shares edged down on Friday but were on track for weekly gains. MSCI's broadest index of Asia-Pacific shares outside Japan dipped 0.2 percent, posting a weekly gain of 2 percent.

Japan's Nikkei stock index ended 1.2 percent up at its highest closing level since December 2015. The Nikkei earlier topped the 19,000-level for the first time in a year, as investors saw both the weak yen and prospects of Trump adopting reflationary policies benefiting Japan's major exporters.

Oil built on its gains after rebounding overnight on growing optimism that non-OPEC producers might follow the cartel's lead by agreeing to cut output.

U.S. crude added 0.9 percent to $51.32 a barrel. Brent crude rose 0.7 percent to $54.23.

Spot gold was down 0.4 percent to 1,166.1 an ounce and was set for a weekly decline of 0.9 percent, pressured by the stronger U.S. dollar and expectations that the Fed will raise interest rates next week.

1. High structural unemployment in the developed world (too many people are chronically unemployed and we risk seeing a lost generation if trend continues)
2. Rising and unsustainable inequality (negatively impacts aggregate demand)
3. Aging demographics, especially in Europe and Japan (older people get, the less they spend, especially if they succumb to pension poverty)
4. The global pension crisis (shift from DB to DC pensions leads to more pension poverty and exacerbates rising inequality which is deflationary)
5. High and unsustainable debt (governments with high debt are constrained by how much they can borrow and spend)
6. Massive technological disruptions (Amazon, Priceline, and robots taking over everything!)

The 2016 surge in stocks and bond yields is a rare positive for U.S. company and public pensions. But it doesn’t solve their problems.

In November large corporate retirement plans gained back $116 billion needed to pay out future benefits largely because of dramatic market movements following Donald Trump’s Nov. 8 election win, according to consulting firm Mercer Investment Consulting LLC.

The S&P 500 soared and long-term interest rates rose, boosting asset values and lowering liabilities for pensions at 1,500 of the largest U.S. companies. The present-day value of future obligations owed by companies falls when interest rates rise.

Even with November’s gains, corporate pensions were left with a $414 billion funding deficit, $10 billion larger than it was at the end of last year, according to Mercer. Funding deficits occur when the value of assets in pension plans don’t equal the projected future payments to retirees.

“It’s been good, but not great,” said Michael Moran, pension strategist at Goldman Sachs Asset Management. “Things are better than where we were a month ago, but it’s still too early to declare victory.”

That tempered reaction indicates the magnitude of the funding gap faced by managers of retirement assets across the U.S. Pensions still haven’t recovered from the chronic deficits created by the financial crisis and perpetuated by low interest rates.

The largest corporate-pension funds lost more than $300 billion during the 2008 downturn, according to consulting firm Milliman Inc., and that loss wiped out the previous five years of gains.

Pension deficits are a big deal for companies, because firms must close funding gaps with cash they could use for other purposes. Companies such as General Motors Co., International Paper Co., and CSX Corp. have all borrowed money this year to pump funds into their pension plans.

Companies in the S&P 1500 have contributed $550 billion into their pension plans between 2008 and Nov. 30 of this year, according to Mercer. Even with those contributions, their funded status was 81.3% as of Nov. 30.

Although pension-funding levels fluctuate during the year, most companies lock in their pension obligations at the end of the year for accounting purposes. November’s run-up, if it continues into December, could help lessen the burden of what had earlier been shaping up to be a big drag on 2016 financial results.

Funding holes are a trickier problem for funds that manage the pension assets of public workers because market rallies don’t automatically help close the gap.

Public-pension liabilities have grown significantly over the past decade, with the 30 largest plans tracked by the Public Plans Database showing a net pension debt of $585 billion in 2014, compared with $186 billion in 2005.

Almost all public retirement systems engage in an accounting practice known as “smoothing” returns, meaning it takes time to fully recognize investment earnings that exceed expectations. That approach limits how much the funding status will improve this year even if strong stock markets help the plans earn a return above their targets.

“All we know is that interest rates have popped up a little bit and equity prices have run up over the last three weeks,” said Alan Perry, an actuary with Milliman. “How that’s going to filter into the ingredients that go into forecasting long-term returns, it’s too early to tell.”

The largest public pension in the U.S., California Public Employees’ Retirement System, is debating whether to lower its expected rate of return—currently 7.5%.

The fund, known by its acronym Calpers, absorbed substantial losses during the last recession and currently has just 68% of assets needed to pay for future obligations. It earned 0.6% on its investments in the fiscal year ended June 30, well short of its annual goal.

“It’s too early to tell whether this [recent improvement] is something that’s going to be sustained,” said California State Controller Betty T. Yee, who serves on Calpers’s board.

"My recollection is that the Tories were lobbied hard for this after New Brunswick succeeded in its reform and reluctantly introduced the TB concept. I say reluctantly because they were more interested in promoting their group DC plan - forget the name (it was PRPPs).

So drafting was in works by civil servants before Liberals won. The Canada Post labour strife put back on front burner as TB is most helpful answer there but unions are fighting tooth and nail. Liberals likely thought there would be no outcry as there was none when Tories announced originally.

Still amazed that GM/Unifor went straight to DC instead of adopting TB."

"I would reserve the term Target Benefit for plans in which all accrued benefits (i.e. accrued benefits of active members, retirees and deferred vested benefits) are subject to adjustment based on the financial status of the plan. Aside from the New Brunswick's shared risk plans, the best examples of this type of plan are the union initiated multi-employer plans. I would describe OTPP and HOOPP as plans that are largely but not purely DB. They are not purely DB because they have shifted some financial risk from the contribution rate to the benefits.

The fact that you asked the question is important to me. It speaks to the reality that pension design is more like a spectrum of choice rather than a binary choice between DB and DC or even a three way choice among DB, DC and TB. There are any number of ways that financial risk can be allocated. Unfortunately, when the reality that confronts us is a spectrum, the language we will choose to describe it will almost always be more categorical than the reality itself. That’s why in my earlier email urged paying more attention to how risk is allocated and less to the labels we use."

Top officers of the largest U.S. pension fund want to lower their investment targets, a move that would trigger more pain for cash-strapped cities across California and set an increasingly cautious tone for those who manage retirement assets around the country.

Chief Investment Officer Ted Eliopoulos and two other executives with the California Public Employees’ Retirement System plan to propose next Tuesday that their board abandon a long-held goal of 7.5% annually, according to system spokesman Brad Pacheco. Reductions to 7.25% and 7% have been studied, according to new documents posted Tuesday.

The last time the California system lowered its investment expectation was in 2012, when the rate was dropped to 7.5% from 7.75%.

The new recommendation comes just 13 months after the fund known by its acronym Calpers agreed to a plan that would slowly scale back its target by as much as a quarter percentage point annually—and only in years of positive investment performance. Now Mr. Eliopoulos and other officials are concerned that plan may not be fast enough because of a mounting cash crunch and declining estimates of future earnings.

“There’s no doubt Calpers needs to start aligning its rate of return expectations with reality,” California Gov. Jerry Brown said in a statement provided to the Journal.

The accounting maneuver would have real-life consequences for taxpayers and cities. It would likely trigger a painful increase in yearly pension bills for the towns, counties and school districts that participate in California’s state pension plan. Any loss in expected investment earnings must be made up with significantly higher annual contributions from public employers as well as the state.

“Lowering the rate of return sooner is undoubtedly going to make it more difficult for cities that are teetering on the edge financially,” said Bruce Channing, chair of the city managers’ pensions committee for the California League of Cities.

Nearly three quarters of school districts said in a survey conducted by Calpers that the impact of dropping the rate would be “high” or “extremely high.”

A drop in Calpers’s rate of return assumptions could also put pressure on other funds to be more aggressive about their reductions and concede that investment gains alone won’t be enough to fund hundreds of billions in liabilities. Because of its size, Calpers typically acts as a bellwether for the rest of the pension world. It manages nearly $300 billion in assets for 1.8 million members.

Pensions have long been criticized for using unrealistic investment assumptions, which proved costly during the last financial crisis. More than two-thirds of state retirement systems have trimmed their assumptions since 2008, according to an analysis of plans by the National Association of State Retirement Administrators.

The Illinois Teachers Retirement System in August dropped its target rate to 7% from 7.5% in August, the third drop in four years, and the fund’s executive director has said the rate will likely be reduced further next year. The $184 billion New York State and Local Retirement System lowered its assumed rate from 7.5% to 7% in 2015.

The investment team at Calpers has been signaling that the current assumption of 7.5% long-term investment returns may be too high, and it would probably peg it around 6% instead.

The 7.5% rate is hardly unusual among government pension funds. But as the $300 billion gorilla in the pension world, any change — likely to be discussed at its Dec. 19 board meeting — will be watched by other pension plans that could then have a harder time justifying their own targeted returns.

This chart of expected-return assumptions of some of the larger pension plans shows that while about 40% of the largest corporate plans assume returns 7% and below, only 9% of public pensions assume returns 7% and below (click on image).

There is an element of subjectivity in estimating future returns, and the decision comes loaded with behavioral and political implications. The number determines how well-funded a pension plan is, which in turn determines the amount a state or municipality needs to pay into their pension system. A higher number can make the pension plan appear healthier, requiring lower contributions today.

If the funded status appears artificially high, one risk is that officials can promise a level of benefits that they may be unable to maintain. In the future that can lead to higher taxes, fewer services and even a cut in actual pension benefits.

The flip side is that reducing the expected return to 6% may double the immediate contributions of some municipalities, according to Pension & Investments, adding to local budget stresses.

Look at what has been happening in Dallas over the past month. The troubled $2.1 billion Dallas Police and Fire System suspended lump-sum withdrawals and has asked the city for a one-time infusion of $1.1 billion, an amount roughly equal to Dallas’ entire general fund (but nowhere close to what the pension fund needs to be fully funded).

This case highlights two negative behavioral implications of using artificially high future investment assumptions to value pension benefits. First, the impression of being well funded can lead to making promises you cannot keep. In 1993 Dallas provided generous benefits without appropriately accounting for how it might be able to meet them. Second, expecting higher returns can drive money into riskier investments with the promise of higher returns. In the case of Dallas, the pension system invested in real-estate deals that didn’t deliver as expected.

My friend and author Ben Carlson has collated a few more examples of troubled pension plans here.

Widening out across the nation, the extent of underfunding is likely not $1 trillion across states — but $6 trillion.

Why is this?

The financially accurate approach to valuing future liabilities is using a discount rate that you are relatively certain of earning, such as a Treasury or high quality bond rate. Private pensions are required to account for their liabilities using high-quality bond rates. As the chart below shows, the rates that public pensions are required to use to account for their liabilities are significantly higher than the rates used by corporate pensions. This results in understating public pension liabilities, and creates an incentive to make expected returns as high as possible (click on image).

The investment consultant Callan Associates created this series of pie charts to highlight the increased complexity that pension plans need to take on in order to meet a 7.5% return assumption today. In January 1995, the 10-year Treasury yield was around 7.75%, allowing you to earn 7.5% returns over 10 years with relative certainty; currently it is just under 2.5%, thereby pushing investors into assets such as equities and alternatives that might provide higher returns, but come with greater risk. The S&P 500 for example, returned an annualized return of 10% since 1995, but came with higher volatility, including a 50% decline in value during the financial crisis (click on image).

Calpers has a relatively well-balanced asset allocation, as this table shows, and shooting for higher returns would mean increasing the risk profile of the fund, which may not be prudent (click on image).

Critics of moving to a more financially accurate method of pension accounting rightly point to the immediate pain that would cause. If municipalities in California have to double their contributions by reducing discount rates from 7.5% to 6%, then it would be a disaster for them if they used a discount rate similar to that of corporate pensions.

However, there is something flawed in this logic. Instead of acknowledging the problem and then finding a solution, the critics would rather pretend the problem doesn’t exist. It’s the difference between “you owe $6 trillion, let’s work out a way for you to pay it off over time” and “you only owe $1 trillion, no big deal”.

Unless the true extent of underfunding is brought to light, we may be providing beneficiaries with a false hope that their promised benefits are secure. If taxpayers reach the limit of what they are willing to contribute, and state and federal governments are unable or unwilling to step in, then a cut in benefits may end up on the cards.

Even if over the next few years we see stellar investment returns (and I hope we do!), this conversation needs to happen. Instead of increasing benefits or reducing contributions, excess investment returns should be used to fill the widening hole. And the first step toward that is recognizing the size of that hole.

What Calpers decides to do with its expected-return assumption is likely to be a political decision, driven by compromise. The hope is that it can open up a much-needed debate that leads taxpayers, beneficiaries, pension committees and governments down the path of better understanding who is going to bear the risk of things not going as planned.

But if we hide the numbers, it’s hard to make the right decisions.

Amit Sinha has worked in the investment industry for over 16 years and in his spare time writes about bringing financial concepts, technology, design and behavior together. You can follow him on his blog The Thought Factory.

The main reason why US public pensions don't like lowering their return assumptions is because it effectively means public sector workers and state and local governments will need to contribute more to shore up these pensions. And this isn't always feasible, which means property taxes might need to rise too to shore up these public pensions.

This is why I keep stating the pension crisis is deflationary. The shift from defined-benefit to defined-contribution plans shifts the retirement risk entirely on to employees which will eventually succumb to pension poverty once they outlive their meager savings (forcing higher social welfare costs for governments) and public sector pension deficits will only be met by lowering return assumptions, hiking the contributions, cutting benefits or raising property taxes, all of which take money out of the system and impact aggregate demand in a negative way.

This is why it's a huge deal if CalPERS goes ahead and lowers its investment return assumptions. The ripple effects will be felt throughout the economy especially if other US public pensions follow suit.

Unfortunately, CalPERS doesn't have much of choice because if it doesn't lower its return target and its pension deficit grows, it will be forced to take more drastic actions down the road. And it's not about being conservative, it's about being realistic and getting real on future returns, especially now that California's pensions are underfunded to the tune of one trillion dollars or $93K per household.

A dollar surge that began after the U.S. election has accelerated with this week’s Federal Reserve interest-rate increase, pointing to a possible reckoning in coming months for economies around the globe.

The WSJ Dollar Index of the dollar’s value against 16 major trading partners hit a 14-year high Thursday, reflecting expectations that the Fed will pick up the pace of rate increases next year as the U.S. economy gains momentum.

A sharp increase in the dollar stands to have long-lived economic consequences, potentially hampering a U.S. earnings recovery and making the trillions in dollar-denominated debt around the world more expensive to pay back.

But the dollar’s renaissance this year already is rippling through global financial markets, sending currencies from Japan and India to Turkey and Brazil tumbling and presenting companies, consumers and governments in those nations with a list of increasingly difficult choices.

In China, fears that a rising dollar will destabilize trading in the yuan has swept financial markets, sending the Chinese currency to its lowest against the dollar in over eight years and raising concerns that outflows could increase. Such an outcome could signal further economic weakness ahead at a time when Chinese growth is slowing and could ripple through currency markets to push other emerging foreign-exchange rates down.

“China is going to become a big concern,” said Paresh Upadhyaya, a portfolio manager at Pioneer Investments. “They’re already trying to manage capital outflows, and this is going to put more pressure on the country.”

Japan’s yen fell to 118.18 against the dollar, its seventh decline in 10 days. That represents about an 11% retreat since Donald Trump was elected president Nov. 8.

The weaker yen will make Japan’s exports more competitive and could boost growth, and Tokyo’s Nikkei 225 stock index has risen for eight consecutive days. But a falling currency will test policy makers at the Bank of Japan who in recent months have sought to anchor the yield of the 10-year Japanese government bond at zero.

Now, though, prices on those bonds have been under pressure amid a global selloff on hopes of an improved economic outlook.

Japan’s central bank is considering raising its assessment of the nation’s economy for the first time since May 2015 as the weaker yen boosts its exports, The Wall Street Journal reported this week.

The euro also edged closer to parity against the dollar, at $1.0415, its lowest level against the dollar since 2003.

A few central banks have already acted to support their faltering currencies. Mexico on Thursday raised interest rates by a half-percentage point—twice what many analysts had expected—as it seeks to curb inflation driven by a weaker peso. Central banks in Indonesia and Malaysia have also moved to prop up their currencies since the U.S. election.

Some analysts said that the Chinese yuan’s decline could revive some fears about competitive devaluations among developing nations, especially if Mr. Trump’s protectionist trade proposals spark a trade war.

In the U.S., bond prices tumbled on Thursday, sending the yield on the 10-year U.S. Treasury note to 2.58%, its highest since September 2014. Prices drop when yields rise. The decline reflected in part a reaction to the Federal Reserve’s indication Wednesday that it expected interest rates to rise faster than previously projected.

The Dow Jones Industrial Average rose 59.71 points, or 0.3%, to 19852.24, coming within 50 points of its first intraday trade above 20000 before cooling off in afternoon trading. Financial shares led Thursday’s gains, extending a sharp rally that began in the hours after Mr. Trump’s election. Since then, the S&P Financials index of banks, insurers and others is up 18%.

A stronger dollar isn’t all bad. It increases the purchasing power of U.S. consumers by making foreign travel and imported products cheaper. And U.S. stock markets have been taking the dollar’s strength in stride with recent all-time highs, despite the threat that the strong dollar will curb a nascent recovery in corporate profits.

In Europe, where growth has also been sluggish, the weaker euro could help support exports and inflation. Morgan Stanley thinks the euro will fall to parity with the dollar around the middle of 2017.

But most vulnerable to the effect are emerging markets. More than $17 billion in foreign investment has departed emerging-market stocks and bonds since the U.S. election, according to the Institute of International Finance.

Investors worry that Mr. Trump’s proposed protectionist trade policies could hurt exports from developing economies. Emerging-market debt also looks less attractive when U.S. and other developed-market bond yields are rising.

Debt in these countries has risen in recent years, as many governments and companies took advantage of the global hunt for yield and issued more debt both at home and abroad. Developing countries have more than $200 billion in dollar-denominated bonds and loans due next year, IIF data show.

I view the world as a constant struggle between inflation and deflation. If policymakers fail to deliver the right amount of monetary and fiscal stimulus, then deflation will eventually take over and that will clobber risk assets (stocks, corporate bonds, commodities and commodity currencies) but benefit good old US nominal long bonds (TLT), the ultimate diversifier in a deflationary environment.

Where has deflation been most prevalent in the world? Japan, Euroland and China. Notice the article above states that the US dollar index (DXY) is rising and now stands at a five-year high relative to a basket of currencies (click on image):

As you can see, the US dollar has been on a tear since early August when I told my readers to ignore Morgan Stanley's call that the greenback is set to tumble (my best call of the year and their worst one ever). It is basically hitting a multi-year high.

So what does the US dollar rally mean and why should you care? Well, the US dollar has rallied mostly versus the euro (close to parity which is another call I made back in March) and the yen.

The decline in the yen and euro is actually good for Euroland and Japan because it means European and Japanese exporters will benefit from the devaluation in their respective currency. This is why Japanese and European stock markets have rallied sharply. It's also good news for fighting deflation in these regions because a decline in their currency increases import prices there, raising inflation expectations in these regions.

Unfortunately, raising inflation expectations via a declining currency is not the good type of inflation. It's a temporary reprieve to a long-term structural problem. The good type of inflation comes from rising wages when the labor force is expanding because that increases aggregate demand and shows a strong, vibrant economy.

Now, what does the rising US dollar mean for the United States? It's the opposite effect, meaning it will hurt US exporters and lower inflation expectations in the US. In effect, the US is taking on the rest of the world's deflation demons trying to stave off a global deflationary calamity.

Will it work? That is the multi-trillion dollar question which is why I began talking about global deflation and currencies because as Bridgewater's Bob Prince noted in his presentation in Montreal, with interest rates at historic lows and central banks pushing on a string, currency volatility will pick up. I would add this is where the epic battle versus global deflation will take place.

But again, currency devaluation is only a temporary reprieve to a long-term structural problem fueling global deflation. The six structural factors that I keep referring to are:

1. High structural unemployment in the developed world (too many people are chronically unemployed and we risk seeing a lost generation if trend continues)
2. Rising and unsustainable inequality (negatively impacts aggregate demand)
3. Aging demographics, especially in Europe and Japan (older people get, the less they spend, especially if they succumb to pension poverty)
4. The global pension crisis (shift from DB to DC pensions leads to more pension poverty and exacerbates rising inequality which is deflationary)
5. High and unsustainable debt (governments with high debt are constrained by how much they can borrow and spend)
6. Massive technological disruptions (Amazon, Priceline, and robots taking over everything!)

These six structural factors are why I'm convinced that global deflation is gaining steam and why we have yet to see the secular lows in global and US bond yields.

But now we have a newly elected US president who has promised a lot of things, including spending one trillion in infrastructure and cutting personal and corporate tax rates.

What will this fiscal thrust do? Hopefully it will help create more jobs and fight some of the chronic problems plaguing the US labor market. But if you really think about it, this too is a temporary boost to economic activity because once it's all said and done, those infrastructure jobs will disappear and US debt will explode up, which effectively means higher debt servicing costs (especially if interest rates keep rising), and less money to stimulate the economy via fiscal policy down the road.

This is why some people think Donald Trump's new Treasury secretary, Steven Mnuchin, is just kicking the can down the road if he goes ahead and issues Treasurys with longer maturities in an effort to cushion the US economy from rising interest rates.

The above is a condensed version of the major macro themes that are on my mind, but there is another one that bothers me a lot, what does a rising US dollar and Trump's presidency mean for emerging markets (EEM)? As the US dollar rises, it will hurt commodity exporting emerging markets and raise dollar-denominated debt but some think if handled correctly, emerging markets can thrive under President Trump.

That all remains to be seen and my biggest fear is that if a Trump administration follows through with protectionist policies which will antagonize others to retaliate with their own trade tariffs, it will cost American jobs and wreak havoc in emerging markets. And another crisis in Asia will basically cement global deflation for a very long time.

This is the global macro backdrop every investor needs to bear in mind. So far markets don't seem to care. Trump's victory has unleashed animal spirits in the stock market and boosted consumer confidence to a 12-year high.

It's all good, reflation is back, deflation is dead, Trump will make sure of it. Unfortunately, it's not that easy and as I keep warning you, President Trump could feel the wrath of the bond market (just like Bill Clinton and others have done in the past) and if his administration isn't careful, it will make a series of policy errors that will spell the decline of the American economy for a very long time.

• The surging US dollar continues to gain steam after the US elections, especially relative to the yen and euro. 
• The weakening yen and euro will temporarily boost exports which is one reason why their stock markets are going well. 
• The weakening yen and euro will also temporarily raise inflation expectations in these regions as import prices rise, leading to a temporary rise in inflation expectations. This is one factor driving the yields of their sovereign bonds higher and bond prices there lower.
• In effect, the surging greenback (US dollar) is relieving deflationary tension in these developed markets, allowing them to try to escape a long bout of deflation. The problem is that this is a temporary (cyclical) reprieve based on currency fluctuations, not a long-term structural one based on economic fundamentals which would raise wages and bolster aggregate demand for a long time.
• The surging greenback however means the US is importing deflation from the rest of the world and this will lower US inflation expectations going forward via lower import prices, which is bullish for US bonds.
• But the surging US dollar is causing all sorts of problems in China which has its currency pegged to the US dollar and a basket of other currencies. If things get really bad, competitive devaluation in Asia will cause another financial crisis there and create another deflationary tsunami which will spread around the world (this too is bullish for US bonds).

Import prices in the States slipped in November but the underlying trend was for a move away from deflation on the back of rising commodity prices and a waning dampening effect from strength in the US dollar, economists said.

The US import price index dipped by 0.3% month-on-month and 0.1% year-on-year, according to the Bureau of Labor Statistics.

Fuel import prices dropped at a 3.9% pace over the month and advanced by 2.7% on the year, while non-fuel import prices slipped 0.1% on the month and were down by 0.3% in comparison to the year ago month.

On the export side of the equation, prices of exports were off by 0.1% on the month and 0.3% over the past year.

Commenting on the data, Blerina Uruci at Barclays Research said: "Compared with a year ago, nonpetroleum import prices fell 0.2% y/y, a significant improvement from the strong deflationary trend in 2014 and 2015. The recent upward trend suggests that the impulse from the dollar appreciation has faded.

"We maintain our view that import prices will gradually move away from deflation territory in the coming months, following improving global commodity prices and the gradual waning of the effect of a stronger dollar."

Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been expanding at a moderate pace since mid-year. Job gains have been solid in recent months and the unemployment rate has declined. Household spending has been rising moderately but business fixed investment has remained soft. Inflation has increased since earlier this year but is still below the Committee's 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation have moved up considerably but still are low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months. 

Now that we’re a month past the election and most of the cabinet posts have been filled, it is increasingly obvious that we are about to experience a profound, president-led ideological shift that will have a big impact on both the US and the world. This will not just be a shift in government policy, but also a shift in how government policy is pursued. Trump is a deal maker who negotiates hard, and doesn’t mind getting banged around or banging others around. Similarly, the people he chose are bold and hell-bent on playing hardball to make big changes happen in economics and in foreign policy (as well as other areas such as education, environmental policies, etc.). They also have different temperaments and different views that will have to be resolved.

Regarding economics, if you haven’t read Ayn Rand lately, I suggest that you do as her books pretty well capture the mindset. This new administration hates weak, unproductive, socialist people and policies, and it admires strong, can-do, profit makers. It wants to, and probably will, shift the environment from one that makes profit makers villains with limited power to one that makes them heroes with significant power. The shift from the past administration to this administration will probably be even more significant than the 1979-82 shift from the socialists to the capitalists in the UK, US, and Germany when Margaret Thatcher, Ronald Reagan, and Helmut Kohl came to power. To understand that ideological shift you also might read Thatcher’s “The Downing Street Years.” Or, you might reflect on China’s political/economic shift as marked by moving from “protecting the iron rice bowl” to believing that “it’s glorious to be rich.”

This particular shift by the Trump administration could have a much bigger impact on the US economy than one would calculate on the basis of changes in tax and spending policies alone because it could ignite animal spirits and attract productive capital. Regarding igniting animal spirits, if this administration can spark a virtuous cycle in which people can make money, the move out of cash (that pays them virtually nothing) to risk-on investments could be huge. Regarding attracting capital, Trump’s policies can also have a big impact because businessmen and investors move very quickly away from inhospitable environments to hospitable environments. Remember how quickly money left and came back to places like Spain and Argentina? A pro-business US with its rule of law, political stability, property rights protections, and (soon to be) favorable corporate taxes offers a uniquely attractive environment for those who make money and/or have money. These policies will also have shocking negative impacts on certain sectors.

Regarding foreign policy, we should expect the Trump administration to be comparably aggressive. Notably, even before assuming the presidency, Trump is questioning the one-China policy which is a shocking move. Policies pertaining to Iran, Mexico, and most other countries will probably also be aggressive.

The question is whether this administration will be a) aggressive and thoughtful or b) aggressive and reckless. The interactions between Trump, his heavy-weight advisors, and them with each other will likely determine the answer to this question. For example, on the foreign policy front, what Trump, Flynn, Tillerson, and Mattis (and others) are individually and collectively like will probably determine how much the new administration’s policies will be a) aggressive and thoughtful versus b) aggressive and reckless. We are pretty sure that it won’t take long to find out.

In the next section we look at some of the new appointees via some statistics to characterize what they’re like. Most notably, many of the people entering the new administration have held serious responsibilities that required pragmatism and sound judgment, with a notable skew toward businessmen.

Perspective on the Ideology and Experience of the New Trump Administration

We can get a rough sense of the experience of the new Trump administration by adding up the years major appointees have spent in relevant leadership positions. The table below compares the executive/government experience of the Trump administration’s top eight officials* to previous administrations, counting elected positions, government roles with major administrative responsibilities, or time as C-suite corporate executives or equivalent at mid-size or large companies. Trump’s administration stands out for having by far the most business experience and a bit lower than average government experience (lower compared to recent presidents, and in line with Carter and Reagan). But the cumulative years of executive/government experience of his appointees are second-highest. Obviously, this is a very simple, imprecise measure, and there will be gray zones in exactly how you classify people, but it is indicative.

Below we show some rough quantitative measures of the ideological shift to the right we’re likely to see under Trump and the Republican Congress. First, we look at the economic ideology of the incoming US Congress. Trump’s views may differ in some important ways from the Congressional Republicans, but he’ll need Congressional support for many of his policies and he’s picking many of his nominees from the heart of the Republican Party. As the chart below shows, the Republican members of Congress have shifted significantly to the right on economic issues since Reagan; Democratic congressmen have shifted a bit to the left. The measure below is one-dimensional and not precise, but it captures the flavor of the shift. The measure was commissioned by a National Science Foundation grant and is meant to capture economic views with a focus on government intervention on the economy. They looked at each congressman’s voting record, compared it to a measure of what an archetypical liberal or conservative congressman would have done, and rated each member of Congress on a scale of -1 to 1 (with -1 corresponding to an archetypical liberal and +1 corresponding to an archetypical conservative).

When we look more specifically at the ideology of Trump’s cabinet nominees, we see the same shift to the right on economic issues. Below we compare the ideology of Trump’s cabinet nominees to those of prior administrations using the same methodology as described above for the cabinet members who have been in the legislature. By this measure, Trump’s administration is the most conservative in recent American history, but only slightly more conservative than the average Republican congressman. Keep in mind that we are only including members of the new administration who have voting records (which is a very small group of people so far).

While the Trump administration appears very right-leaning by the measures above, it’s worth keeping in mind that Trump’s stated ideology differs from traditional Republicans in a number of ways, most notably on issues related to free trade and protectionism. In addition, a number of key members of his team—such as Steven Mnuchin, Rex Tillerson, and Wilbur Ross—don’t have voting records and may not subscribe to the same brand of conservatism as many Republican congressmen. There’s a degree of difference in ideology and a level of uncertainty that these measures don’t convey.

Comparing the Trump and Reagan Administrations

The above was a very rough quantitative look at Trump’s administration. To draw out some more nuances, below we zoom in on Trump’s particular appointees and compare them to those of the Reagan administration. Trump is still filling in his appointments, so the picture is still emerging and our observations are based on his key appointments so far.

Looking closer, a few observations are worth noting. First, the overall quality of government experience in the Trump administration looks to be a bit less than Reagan’s, while the Trump team’s strong business experience stands out (in particular, the amount of business experience among top cabinet nominees). Even though Reagan’s administration had somewhat fewer years of government experience, the typical quality of that experience was somewhat higher, with more people who had served in senior government positions. Reagan himself had more political experience than Trump does, having served as the governor of California for eight years prior to taking office, and he also had people with significant past government experience in top posts (such as his VP, George HW Bush). By contrast, Trump’s appointees bring lots of high quality business leadership experience from roles that required pragmatism and judgment. Rex Tillerson’s time as head of a global oil company is a good example of high-level international business experience with clear relevance to his role as Secretary of State (to some extent reminiscent of Reagan’s second Secretary of State, George Shultz, who had a mix of past government experience and international business experience as the president of the construction firm Bechtel). Steven Mnuchin and Wilbur Ross have serious business credentials as well, not to mention Trump’s own experience. It’s also of note that Trump has leaned heavily on appointees with military experience to compensate for his lack of foreign policy experience (appointing three generals for Defense, National Security Advisor, and Homeland Security), while Reagan compensated for his weakness in that area with appointees from both military and civilian government backgrounds (Bush had been CIA head and UN ambassador, and Reagan’s first Secretary of State, Alexander Haig, was Supreme Allied Commander of NATO forces during the Cold War). Also, Trump has seemed less willing to make appointments from among his opponents than Reagan was (Reagan’s Chief of Staff had chaired opposing campaigns, and his Vice President had run against him).

By and large, deal-maker businessmen will be running the government. Their boldness will almost certainly make the next four years incredibly interesting and will keep us all on our toes.

Come on Ray, wait at least four years, then judge his and his administration's track record. By the way, inequality soared under Reagan, it will skyrocket under Trump. So, forget Ayn Rand, go back to the future and read John Kenneth Galbraith who once noted: '"If you feed enough oats to the horse, some will pass through to feed the sparrows"(referring to trickle down economics). Elites of the world unite and rejoice!

This is not a normal business cycle; monetary policy will be a lot less effective in the future; investment returns will be very low. These have come to be widely held views, but there is little understanding as to why they are true. I have a simple template for looking at how the economic machine works that helps shine some light. It has three parts.

First, there are three main forces that drive all economies: 1) productivity; 2) the short-term debt cycle, or business cycle, running every five to ten years; and 3) the long-term debt cycle, over 50 to 75 years. Most people don’t adequately understand the long-term debt cycle because it comes along so infrequently. But this is the most important force behind what is happening now.

Second, there are three equilibriums that markets gravitate towards: 1) debt growth has to be in line with the income growth that services those debts; 2) economic operating rates and inflation rates can’t be too high or too low for long; and 3) the projected returns of equities have to be above those of bonds, which in turn have to be above those of cash by appropriate risk premiums. Without such risk premiums the transmission mechanisms of capital won’t work and the economy will grind to a halt. In the years ahead, the capital markets’ transmission mechanism will work more poorly than in the past, as interest rates can’t be lowered and risk premiums of other investments are low. Most people have never experienced this before and don’t understand how this will cause low returns, more debt monetisation and a “pushing on a string” situation for monetary policy.

Third, there are two levers that policy-makers can use to bring about these equilibriums: 1) monetary policy, and 2) fiscal policy. With monetary policy becoming relatively impotent, it’s important for these two to be co-ordinated. Yet the current state of political fragmentation around the world makes effective co-ordination hard to imagine.

The long and the short of it

Although circumstances like these have not existed in our lifetimes, they have taken place numerous times in recorded history. During such periods, central banks need to monetise debt, as they have been doing, and conditions become increasingly risky.

What does this template tell us about the future? By and large, productivity growth is slow, business cycles are near their mid-points and long-term debt cycles are approaching the end of their pushing-on-a-string phases. There is only so much one can squeeze out of a long-term debt cycle before monetary policy becomes ineffective, and most countries are approaching that point. Japan is closest, Europe is a step behind it, the United States is a step or two behind Europe and China a few steps behind America.

For most economies, cyclical influences are close to being in equilibrium and debt growth rates are manageable. In contrast to 2007, when my template signalled that we were in a bubble and a debt crisis was ahead, I don’t now see such an abrupt crisis in the immediate future. Instead, I see the beginnings of a longer-term, gradually intensifying financial squeeze. This will be brought about by both income growth and investment returns being low and insufficient to fund large debt-service, pension and health-care liabilities. Monetary and fiscal policies won’t be of much help.

As time passes, how the money flows between asset classes will get more interesting. At current rates of central-bank debt buying, they will soon hit their own constraints, which they will probably have to abandon to continue monetising. That will mean buying riskier assets, which will push prices of these assets higher and future returns lower.

The bond market is risky now and will get more so. Rarely do investors encounter 
a market that is so clearly overvalued and also so close to its clearly defined limits, as there is a limit to how low negative bond yields can go. Bonds will become a very bad deal as ­central banks try to push more money into them, and savers will decide to keep that money elsewhere.

Right now, while a number of riskier assets look like good value compared with bonds and cash, they are not cheap given their risks. They all have low returns with typical volatility, and as people buy them, their reward-to-risk ratio will worsen. This will create a growing risk that savers will seek to escape financial assets and shift to gold and similar non-monetary preserves of wealth, especially as social and political ­tensions intensify.

For those interested in studying analogous periods, I recommend looking at 1935-45, after the 1929-32 stockmarket and economic crashes, and following the great quantitative easings that caused stock prices and economic activity to rebound and led to “pushing on a string” in 1935. That was the last time that the global configuration of fund­amentals was broadly similar to what it is today.